Smith, Marx and the Factory

Part 7 traced economic systems up to about 1800: sharing bands, temple economies, feudalism, the Islamic world, Song China, India’s villages, mercantilism and colonial extraction. Markets, money and risk-sharing finance were all old. What was new around 1800 was a factory system that produced more, faster, than anything before it.

This part is about that system and the two people whose names still frame every argument about it. I’d heard “Smith versus Marx” all my life without knowing what either actually argued, or that they were mostly answering different questions.

As before, I’ve kept the questions I had along the way and what cleared them up.

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The Industrial Revolution

Starting in Britain around the 1760s, a cluster of inventions changed how things were made. Textile machines like the spinning jenny, the water frame and later the power loom let one worker produce many times more thread and cloth. James Watt’s improved steam engine, from the 1770s, could drive machines anywhere, not just beside rivers. Cheap coal fueled the engines, and better iron made the machines.

Work moved from homes and small workshops into factories, where hundreds of workers ran machines owned by someone else. For the first time, private ownership of the means of production, wage labor, market prices, profit and loss, free entry and capital markets all worked together at scale.

What it was like. Early on, it was often brutal: 12 to 14 hour days, dangerous machines, crowded and filthy cities, children working in mills and mines. Historians generally find that British workers’ real wages grew slowly or barely at all from about 1780 to the 1830s, even as output soared. Most of the early gains went to owners. After that, wages began rising steadily. The lag is sometimes called Engels’ pause, after Friedrich Engels, who described the misery of Manchester’s workers in 1845. A new technology can raise output for decades before most workers share in it.

It hurt other places too. Cheap machine-made British cloth, helped by colonial trade policy, wiped out much of India’s handloom textile industry. India went from a leading exporter of cloth to an exporter of raw cotton for British mills.

The classical economists. Thomas Malthus argued in 1798 that population grows faster than food, so wages would always be pushed back down to bare survival. For most of history before then, he was roughly right. He was wrong about what came next, because productivity outran population. David Ricardo showed in 1817 that even if England were worse than Portugal at making both wine and cloth, both would gain if each specialized in what it was relatively better at and traded: comparative advantage. He also argued that landowners collect rising rents just for owning land as a country grows. These ideas won a major political battle in 1846, when Britain repealed its Corn Laws, tariffs that kept grain prices high for landowners, and moved toward free trade.

The first critics. People pushed back long before Marx.

• The Luddites (1811 to 1816) were skilled hand-weavers and knitters in northern England who saw machines run by cheaper, less-skilled workers cut their pay and wipe out their jobs. They broke into workshops at night and smashed the machines, and the government sent soldiers and made machine-breaking punishable by death. “Luddite” now means someone who hates technology, but their complaint was narrower: the machines were being used to push down their wages and replace them, while the gains went entirely to owners.
• Robert Owen, a factory owner, ran his mills at New Lanark in Scotland with shorter hours, schooling for children and decent housing, and still made a good profit. His cooperative community, New Harmony in Indiana, founded in 1825, broke apart within a few years over disagreements and a shortage of people with practical skills.
• Charles Fourier imagined society reorganized into planned communities of about 1,600 people where work would match people’s interests. Henri de Saint-Simon imagined a society run by scientists and engineers. Marx later called these thinkers utopian socialists: good criticism of capitalism, no realistic theory of how society changes.
• Workers organized. Bans on unions in Britain were lifted in 1824, though unions stayed restricted for decades. The Chartists, from the late 1830s, demanded the vote for working men. The Factory Acts, starting in 1833, banned children under 9 from textile mills and limited hours for older children.

These are four responses to the same problem, bargaining power. The Luddites resisted the technology, Owen tried to be a better owner, the utopians imagined new systems, and the unions and Chartists tried to change the balance of power. That last approach mostly shaped what came next.

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Adam Smith’s Argument

Smith wrote two major books. The Theory of Moral Sentiments (1759) came first, and it’s about ethics. Its central idea is sympathy: humans naturally care about others and want their approval. Smith didn’t think people are purely selfish, which matters for reading his second book, The Wealth of Nations (1776). Its argument, in steps:

1. A nation’s wealth is what it can produce, not its gold.
2. Productivity grows when people specialize. In his pin factory, one untrained worker alone might make one pin a day, and certainly not twenty. Ten workers splitting the job into about 18 steps made upward of 48,000 a day.
3. Specialization needs trade, and the size of the market limits it. If Leo only teaches, he has to trade his teaching for food and rent. A village can’t support a full-time pin maker; a city or a global market can.
4. People mostly act in their own interest in economic life. “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.”
5. Competition turns self-interest into serving others. To earn Sam’s fees, a family has to be satisfied. If Sam charges too much or teaches badly, families go to a rival.
6. Prices guide resources to where they’re most wanted. Every good has a natural price, what it costs to produce including normal wages, rent and profit. Shortages push the market price above it and surpluses below it, but competition keeps pulling it back. When tutoring is scarce, prices and profits rise, drawing in new centers until profits fall back to normal.

His conclusions: markets with competition create wealth without anyone directing them, the idea that became known as the invisible hand, though the phrase appears only once in the book; government should provide defense, justice, contracts, public works and education, but not grant monopolies or restrict trade; and as wealth grows, wages rise.

What Smith was not. He’s often treated as the patron saint of leaving everything to the market, but:

• He distrusted business owners. “People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.”
• He saw real roles for government, including roads and canals that private businesses wouldn’t build, and public schooling for ordinary workers.
• He worried about the division of labor itself. Doing one simple task all day, he warned, could leave a worker mentally stunted. That’s surprisingly close to what Marx later called alienation.

The critiques of Smith

Most of these don’t throw Smith out. They mark the conditions under which his argument holds: real competition, honest information, prices that include all the costs, a stable economy, and a fair starting point.

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The Labor Theory of Value

The idea: the value of a good depends on how much work it takes to make it.

Smith’s example: among hunters, if killing a beaver usually takes twice as long as killing a deer, one beaver should trade for two deer. If beaver traded for less, hunters would switch to deer until the ratio settled back at about two to one. Ricardo extended it to tools: if a fishing net took a week to make, part of that week’s labor is in every fish the net catches. Marx made it the center of his theory, using socially necessary labor time: the time an average worker, with normal tools, needs to make something society wants. A slow worker doesn’t make a shirt more valuable by taking longer.

It seemed right because over the long run, competition does push prices toward the cost of making things, and in the 1700s and 1800s most of that cost was labor.

In the 1870s, three economists, William Stanley Jevons, Carl Menger and Léon Walras, independently replaced it with a different idea: value comes from what the next unit is worth to people. Water is essential and takes effort to supply, yet it’s cheap because there’s plenty. Diamonds are useless and expensive because they’re rare. This is the marginal theory of value, and mainstream economics has used it since. Labor affects value mainly through supply: things that take more work to make are scarcer.

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Marx’s Theory of History

Karl Marx (1818 to 1883) believed the most important fact about any society is how it produces things. He split that into the forces of production, the tools, technology and skills a society has, and the relations of production, who owns those tools and who has to work for whom. Together they form a mode of production, and he argued that everything else, a society’s classes, laws, politics and even its ideas of what’s fair, grows out of it. This view is called historical materialism.

In each system, one class owns the means of production, another does the work, and the owners take part of what the workers produce:

What moves history from one system to the next: technology keeps improving, the old ownership setup eventually holds it back, and the class that benefits from the new technology overthrows the old ruling class. Under feudalism, merchants and early factory owners grew rich from trade and manufacturing, but lords controlled the land, serfs couldn’t leave to work in factories, and guilds restricted production. So this new class, the bourgeoisie, Marx’s word for the owners of capital, overthrew the old order, with the French Revolution as the classic case.

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Marx’s Argument About Capitalism

1. Under capitalism, workers own nothing but their ability to work. Leo has no classroom, so he must sell his time to someone who does.
2. Labor is the source of value.
3. Workers produce more value than they’re paid. The gap is surplus value, and it’s where profit comes from. Marx called this exploitation, in a technical sense rather than a claim that Sam is cruel: the owner keeps value the worker produced.

Per tutor, per month:

With two tutors, that’s Sam’s $600 monthly profit, and in Marx’s view, all of it is value the tutors created and didn’t keep.

4. Competition forces owners to keep reinvesting and mechanizing. If Sam doesn’t buy AI tutoring software and cut staff, a rival will, and undercut her.
5. That squeezes profit over time. If only labor creates surplus value, replacing workers with machines shrinks the source of profit. Marx predicted a tendency for the rate of profit to fall.
6. Wages stay low. Machines create a pool of unemployed people, his reserve army of labor, so workers can always be replaced and can’t bargain up.
7. Crises keep coming, and big firms swallow small ones.
8. Work becomes alienating. Workers have no say over what they make or how, and don’t own the result, so work stops being a way of expressing themselves.

His conclusion: capitalism creates the conditions for its own end.

The mainstream answer about Sam’s $600. Most economists today use a different account. Leo couldn’t produce $1,000 of tutoring without the classroom, the books, a business that attracts families, and someone organizing it all. Sam’s profit pays for what she contributes:

And competition pushes wages up: if Leo can earn more at a private school, Sam has to match it or lose him.

The critiques of Marx

What Marx got right, by the account of many economists who reject his theory: bargaining power decides how value gets split, not just fairness; capitalism constantly reinvents how things are made, and Marx described that power more vividly than almost anyone; booms and busts are built in rather than accidental; big firms do tend to get bigger in many industries; and who owns the machines matters, especially when machines replace workers.

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How Marx Thought Socialism Would Come About

1. Capitalism has to come first. Socialism needed what capitalism creates: factories, machines, railways, huge productive capacity and a large industrial working class. So Marx expected it in the most advanced countries, like Britain and Germany.
2. A contradiction builds up. Production becomes deeply social: thousands of workers depend on each other and on suppliers across the world. But ownership stays private. He argued the gap keeps widening until private ownership holds production back through crises, unsold goods and idle factories, as feudal rules once held back early capitalism.
3. Society splits into two big classes. Crises wipe out small firms and big ones absorb them, so fewer people own the means of production. Shopkeepers, craftsmen and small farmers get squeezed into wage work.
4. Workers become aware of their position. Marx distinguished between workers sharing a situation and workers acting as a class, organized and aware of shared interests. He thought they’d get there through strikes, unions and parties, with crises speeding it up.
5. Workers take political power. Often, he expected, by revolution, since owners would resist. But in an 1872 speech he said that in countries with democratic institutions, like England, the US and the Netherlands, workers might win power peacefully. It would be international: “Workers of the world, unite!”
6. A transitional workers’ state. Workers would run the state for a period, to defend the revolution and reorganize the economy: his “dictatorship of the proletariat,” the proletariat being his word for the industrial working class. He meant rule by that class as a whole, not by one dictator. His model was the Paris Commune of 1871, whose officials were elected, could be recalled at any time and were paid ordinary workers’ wages.

The Communist Manifesto (1848) listed first measures for advanced countries. Several are now normal in capitalist ones:

What actually happened. The revolution didn’t come where Marx expected. Workers in Britain and Germany won the vote, formed unions and saw wages rise. It came instead in Russia in 1917, a mostly peasant country, and his followers split:

• Lenin argued workers left alone would only fight for better wages, so they needed a vanguard party of professional revolutionaries to lead them, and that rich countries avoided revolution by exploiting colonies.
• Eduard Bernstein argued the opposite: capitalism wasn’t collapsing, so socialists should win power through elections and gradual reform, which became social democracy, the root of today’s welfare states.
• Rosa Luxemburg argued against Bernstein that reforms alone could never end capitalism, but also warned that Lenin’s vanguard party could become a dictatorship over workers rather than of them, a warning that proved accurate.
• Antonio Gramsci asked why workers in rich countries didn’t revolt at all, and answered that the ruling class shapes culture, schooling and common sense so thoroughly that its rule feels natural: hegemony.

So Marx’s path split into two roads: revolution led by a party, which produced the Soviet model, and reform through democracy, which produced the mixed economies.

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Socialism and Communism

Marx described two stages after capitalism, most clearly in an 1875 text, Critique of the Gotha Programme:

Under socialism, Sam’s center belongs to the workers or the town, Leo is paid by the hours he teaches, and no owner takes a profit, but harder or longer work still earns more. Under communism, tutoring is free to anyone who wants it, and Leo teaches because he enjoys it and takes whatever he needs from what society produces. The core difference is the payment rule: socialism still ties what you get to what you do, and communism cuts that link. Its slogan is “from each according to their ability, to each according to their needs.”

The words also get used two other ways, which is why they’re confusing. The Soviet Union, Mao’s China and others were run by Communist Parties, because communism was their final goal, but they described their economies as socialist, the first stage. The USSR was the Union of Soviet Socialist Republics. No country ever reached Marx’s final stage. And in everyday politics today, “socialism” often means a capitalist economy with a large welfare state, strong unions and public healthcare, like the Nordic countries. Strictly, that’s social democracy.

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Capitalism Changes

By the late 1800s, both economics and capitalism were changing.

• The marginal revolution (1870s) replaced the labor theory of value with value at the margin, and Alfred Marshall’s textbook in 1890 popularized the supply and demand diagrams still taught today.
• Henry George argued in Progress and Poverty (1879) that land values rise because of everyone’s progress, not the landowner’s effort, so land, and only land, should be taxed.
• Monopolies. In the US, giant companies like Standard Oil and the big railroads came to dominate their industries. The Sherman Antitrust Act of 1890 made monopolizing a market illegal.
• The first welfare state. In Germany in the 1880s, Chancellor Otto von Bismarck created the first national health insurance, accident insurance and old-age pensions. He wasn’t a socialist: he did it partly to win workers away from the socialists. It became a template for the world.
• Japan’s state-led industrialization. After the Meiji Restoration in 1868, Japan’s government built railways, factories and modern banking, then often sold them to private companies: capitalism with the state driving it.

By 1900, real wages in Britain and other industrial countries were clearly rising. Marx’s prediction that workers would get steadily poorer was already looking shaky, though the gains came only after decades of hardship, and only after workers organized and governments stepped in.

Capitalism didn’t survive the 1800s by staying pure. It survived by absorbing parts of its critics’ demands. The parallel to now is hard to miss: a powerful new technology, huge productivity gains, workers worried about being replaced, and an open question about how long it takes, and what policies it takes, for the gains to be widely shared.

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Where Each Still Holds Up

They’re often presented as opposites, but they mostly answer different questions. Smith asked how wealth gets created. Marx asked who gets it. That’s the difference between creating value and capturing it, and the AI question needs both: will AI make us far more productive, and if machines do the work, who owns them, and what happens to workers’ bargaining power?

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What’s Next

The factory system produced more than any system before it, and for decades most of the gains went to owners. Smith explained how competitive markets create wealth, and his critics mapped out the conditions his argument needs. Marx explained capitalism as a class system that hides how owners take a share, predicted crises, concentration and revolution, and imagined socialism and then communism beyond it. His predictions about wages failed, but his questions about bargaining power and ownership didn’t go away.

Part 9 covers 1900 to 1975: the Russian Revolution and the socialist calculation debate, the Great Depression and Keynes, fascism, the New Deal and Gandhi, and the postwar decades when almost every country turned the dials toward a mixed economy.