As the number of workmen that can be kept in employment by any particular person must bear a certain proportion to his capital, so the number of those that can be continually employed by all the members of a great society must bear a certain proportion to the whole capital of that society, and never can exceed that proportion.Smith didn't present his invisible hand metaphor until six paragraphs later. But the argument about individuals promoting the public good in spite of seeking only private advantage is in the paragraph immediately following the above passage. The subsequent reference to an invisible hand merely emphasized and amplified the argument. Smith's premise about the proportion between the number of workers and the amount of capital defined, with minor modification, what came to be known as the wages-fund doctrine of classical political economy. Instead of the whole capital restricting the number of workers that could be employed, however, the wages-fund argument specified that it was only that portion of capital that consisted of wage-goods that imposed the limitation.
Few authors have noted the connection between the classical wages-fund doctrine and Smith's version of it. One was Henry Hoyt, who was governor of Pennsylvania from 1879 to 1883. In Protection versus Free Trade (1886), Hoyt credited Smith with having "laid down, as quite fundamental, this proposition… [as] one of the pillars of his free-trade system." He then categorized Smith's statement as a version of the wages-fund doctrine:
We shall see later on the essential vice of this statement as a statement of fact. It is not true that industry is limited by capital, and, as a matter of fact, there has never been any limitation on the employment of labor by reason of lack of capital. It is one mode of formulating the wages-fund theory.Twenty years after Hoyt, Leopold Amery delivered a series of lectures in which he evaluated The Fallacies of Free Trade, paying particular attention to Smith's "terminological inexactitude." Smith's concept of capital viewed the capital of a nation as merely an aggregate of individual capitals. The difference, Amery explained, was that an individual's capital "is the result of saving, and grows by saving from profits or by credit based on profits" while the capital of a nation, "grows by the exercise of the qualities and energies of which it consists." In the jargon of systems dynamics, Smith mistook a stock for a flow.
Amery subsequently served as a conservative Member of Parliament from 1911 to 1945 and was best known for a Commons speech he gave in 1940, following the Allied retreat from Norway. In that speech he criticized the government's conduct of the campaign and concluded with a quotation from Oliver Cromwell, "You have sat too long for any good you have been doing lately. Depart, I say, and let us have done with you. In the name of God, go!" Three days later, after surviving a motion of no confidence with a greatly reduced majority, the Conservative government of Neville Chamberlain resigned.
As Hoyt had done, Amery identified Smith's error with the wages-fund doctrine but also with "its daughter fallacy," which he specified as "the restriction of output":
It is upon this confusion, upon this terminological inexactitude, that they have based their exposition of many a plausible and mischievous fallacy - the long since exploded "wages fund" theory for instance, with its enduring legacy of class hatred, and with its daughter fallacy, the restriction of output, a fallacy involving most harmful consequences to the prosperity of the working man…In contrast to the wages-fund doctrine, which was boldly proclaimed by the champions of free trade and laissez faire, this so-called "daughter fallacy" -- also known as the "theory of the lump of labour" -- had no suitors.
This peculiar lack of utterance was sometimes noted by its detractors. James McCleary, who served in the U.S. House of Representatives from 1893 to 1907, claimed there was an "oft-repeated error" behind statements from union leaders made to the congressional committee on labor on which he sat. "It was rarely if ever put into words," McClary wrote in 1912, "but it was the unspoken major premise of many an attempted syllogism, the unstated basis of many an appeal." Half a century later, steel industry executive William Caples observed that the alleged fallacy was "one of the most tenaciously held and generally least articulated of trade union beliefs..." Least articulated by the trade unionists themselves, that is. Opponents of trade unionism never tired of attributing the belief to those who "rarely if ever" professed it.
McCleary's and Caples's perception of an absence of overt statement is confirmed by full-text searching of thousands upon thousands of historical documents, newspapers, pamphlets, books and journal articles using synonyms and cognate phrases for the proverbial fixed amount of work to be done. Up until the 1860s declarative statements of those phrases occurred exclusively in texts authored by political economists, propounding some version of the orthodox wages-fund doctrine. When trade union leaders or advocates used the phrases, it was invariably either with conditional if-clauses or in refutations of the claims of orthodox political economy.
In the 1860s and after a remarkable metamorphosis took place. Just as the wages-fund doctrine was being refuted, repudiated and recanted by economists, there emerged a chorus of remonstrance against what John Wilson in the Quarterly Review called a "Unionist reading of the Wage-fund theory." As usual, no evidence was given of unionists stating any such view, only indignant assertions.
Leo Amery's analysis of terminological inexactitude is useful here to help understand what is going on in the incongruous transformation from avowed principle to alleged error. The first step was to deploy, as Smith had done, an individualist concept of accumulated capital in place of a societal concept of exercised capacities – substituting the stock for the flow. The second step was to uphold this ideal of aggregate capital accumulation as the standard by which the workers' self-interest must be gauged. To attempt to restrict the accumulation of capital was thus denounced as delusional. This argument led to what Maurice Dobb later called "the apparent paradox that the more the workers allow themselves to be exploited, the more their aggregate earnings will increase (at least in the long run), even if the result is for the earnings of the propertied class to increase still faster." The illegitimate "daughter" was thus conceived entirely in the image of the banished father.
Let me try to explain that once more because the sleight of hand of the operation makes it difficult to follow what's going on. In order to allege the derivative restriction-of-output fallacy, the plaintiff needed both to commit AND to disavow the original wages-fund fallacy. This was accomplished by accepting both the “terminological inexactitude” and the conclusion of the original (social benefit from individuals pursuing self-interest) while failing to acknowledge the conclusion's disgraced premise (the number of workers proportionate to accumulated capital).
Even if we understand how the derivative fallacy claim works the question still remains, why is it widely persuasive? I would propose two parts of an answer to that question. First, regardless of the invalidity of its premises, there is a compelling kernel of truth in Smith's invisible hand metaphor. Actions that are wholly motivated by self-interest can, and often do, indeed have "unintended" social benefits. An avid gardener may care little about the pleasure the garden provides to neighbours and passers-by. Commerce certainly enables a wider and presumably preferable variety of commodities than would otherwise be available. On the other hand, the social costs of actions motivated wholly by self-interest may be diffuse and deferred and thus hard to trace.
The second reason is both an historical and a theological one. As such it can only be briefly alluded to here. Smith's fable is a theodicy of sorts. Instead of addressing the question of how there can be evil in the world if God is omniscient, omnipotent and good, it addressed the paradox of the persistence of poverty in the midst of plenty. The intellectual climate of the Enlightment was awash in rationalistic theodicies. The legacy of those intellectual pursuits during the emergence of supposedly secular political economy has been addressed elsewhere in depth, for example, by John Milbank in "Political Economy as Theodicy and Agonistics," by Michael Sonenscher in "Physiocracy as a Theodicy," and most recently by Joseph Vogl in The Spectre of Capital.
Vogl identified what he called the "oldest and most deep seated convictions" of liberal economics as arising from "the conviction that market activity is an exemplary locus of order, integration mechanisms, harmonization, appropriate allocation, and hence social rationality, and that it demands to be represented in a coherent, systematic way." At the core of such representations is the notion of individual actions motivated only by self-interest leading unintentionally to socially-beneficial outcomes.
A recurring feature of theodicy is the assumption of a closed system, "characterized by constancy of sum and the preservation of energy," as Vogl described Leibniz's metaphysics. In other words, the desire to be reassured about the ultimately benign nature of God, the universe or the economic system – especially when confronted with disconcerting evidence to the contrary – leads inexorably back to the notion of equilibrium, a self-correcting mechanism that presupposes a closed system. That is the narrative box we are in. It is how that story goes. No one is immune from the desire for reassurance.
The question that has to be asked, though, is whether the detachment and complacency enabled by such reassurance is not itself the greater evil. To paraphrase Leopold Amery, quoting Oliver Cromwell, "Depart, Invisible Hand, and let us have done with you. In the name of God, go!"