Adam Smith on Capital and Income

Abstract

In this paper I critically analyze Smith's thesis in book I, chapter 6 of the "Wealth of Nations" that the replacement of the capital goods consumed in production becomes fully income. I argue that Smith’s argument is defective and does not imply this, and that, once it is properly corrected, it implies that the full value of commodities does not become income; in other words: that GNP is not equal to aggregate income. On this basis, I proceed to analyze Smith's definitions of gross and net income in book II, chapter 2. I hold that they contradict Smith's previous and fallacious argument of book I, chapter 6, and imply, rightly, that the value of aggregate output is not equal to aggregate income. There is a fourth part in the price of commodities which is not income at all, but capital. In book II, ch. 2 Smith makes contradictory statements about wages and does not reach a definition of gross and net income. The cause of these contradictions is the extension of the error about capital consumption to wages. If Smith had kept to the Physiocratic brut-net distinction, he would have seen that the capital of the economy is made up not only by the investments on productive means other than labor, but also by the investments on labor (wages), which do not belong in income even though they represent a part of the value of the output of consumption goods. Finally, I clear up a mistake in Marx’ comments upon Smith on the subject of capital and income.