It was that "Economics went astray from the very first sentence of Adam Smith’s Wealth of Nations in 1776". In this opening to the book, I will argue that economics should have been based on the work of the Physiocrats, especially Richard Cantillon and Francois Quesnay. Though Smith read their works, and met Quesnay, he abandoned their fundamental insight that all wealth came from land--which, when understood from today's knowledge of Thermodynamics, means Energy.
By claiming instead that labour, rather than land, was the source of wealth, Smith set off a two and a half century long wild goose chase over what was value, leading to economic theories from both Marxists at one extreme and Neoclassicals (and Austrians) at the other which violated the inviolable Laws of Thermodynamics.
Herewith the opening lines of my next book. I won't get a chance to work on it in earnest until I finish up at Kingston in the middle of 2018, but when I return to writing it, these are the lines with which it will commence.
The True Father of Economics
Labor without Energy is a Corpse;
Capital without Energy is a Statue
Economics went astray from the very first sentence of Adam Smith’s Wealth of Nations in 1776:
“The annual labour of every nation”, Smith asserted, “is the fund which originally supplies it with all the necessaries and conveniences of life which it annually consumes, and which consist always, either in the immediate produce of that labour, or in what is purchased with that produce from other nations.”
This paragraph mimicked the structure, and even the cadence (though not the brevity), of the opening sentence of Richard Cantillon’s 1730 treatise Essai sur la Nature du Commerce en Général (which Smith read). However, Smith made one crucial substitution: he asserted that “Labor … is the fund” from which our wealth springs, whereas Cantillon asserted that it was Land:
“Land”, Cantillon began, “is the source or matter from which all wealth is drawn; man’s labor provides the form for its production, and wealth in itself is nothing but the food, conveniences, and pleasures of life.” (21)
Both these assertions are strictly false. The true source of the wealth that humanity has generated from production is neither Labor nor Land, but the Energy that humanity’s production systems harness and turn into useful work (now known as “Exergy”). However, Smith’s assertion is irredeemably false, whereas Cantillon’s merely needs generalization to make it consistent with the fundamental laws of the universe known as the Laws of Thermodynamics.
These Laws are still poorly known by economists, which in part explains why economic theory has managed to be in conflict with them for so long. Illustrating why this is so, and why it is crucial, will take time, and effort on your part too to understand them (if you do not already). But the fact that no theory that contradicts them can be taken seriously, was stated eloquently by the physicist Arthur Eddington in his 1928 book for lay readers The Nature of the Physical World:
The law that entropy always increases—the second law of thermodynamics—holds, I think, the supreme position among the laws of Nature. If someone points out to you that your pet theory of the universe is in disagreement with Maxwell’s equations—then so much the worse for Maxwell’s equations. If it is found to be contradicted by observations—well, these experimentalists do bungle things sometimes. But if your theory is found to be against the second law of thermodynamics I can give you no hope; there is nothing for it but to collapse in deepest humiliation. (37)
On this undeniable basis, the only pre-2016 economic theory of production which does not have to “collapse in deepest humiliation” is that of Richard Cantillon and the School to which he belonged, the Physiocrats. Their assertion that Land was the source “from which all wealth is drawn” was derived from observing the physical surplus in agriculture, where the output was also the crucial input:
Land aided by human labor, naturally produces 4, 10, 20, 50, 100, 150 times the amount of wheat sown, depending on the fertility of the soil and the industry of the inhabitants… The farmer who runs the operation generally keeps two-thirds of the production, with one third paying his expenses and upkeep and the other being the profit for his enterprise. (150)
At the same time, Cantillon acknowledged that not all that was harvested could be consumed, so while outputs exceeded inputs, there was a necessary sense in which less than what was produced was available as the net product:
Today, land in Europe yields on the average six times what is sown, so that five times the seed remains for the consumption of the people. (Cantillon 1755, p. 87)
Had economics built on Cantillon’s proposition rather than Smith’s, it would have been able to easily make itself compatible with these Laws as physicists developed them during the late 19th century. Instead, it was cleft in the Value Wars between Marxists asserting that “Value” was objective and Labor was the source of surplus value (outputs exceeding inputs, measured in terms of labor-time) on the one hand, and Neoclassicals on the other asserting that Value was subjective, with both Labor and Capital jointly contributing to the physical output in which the increase in subjective utility was embodied. In neither School of Thought did Energy play any essential role.
There is no explicit role for Energy in Smith’s identification of Labor as “the fund”, and neither in Smith’s own writings, nor in the subsequent theories developed on or in reaction to his treatise, does Energy play an essential role. Marx’s “Labor Theory of Value” identified Labor as the sole “source of surplus value”. While he tangentially acknowledged a link with Energy given his familiarity with the work of the key 19th century physicists who developed the Laws of Thermodynamics, his assertion that machinery could not be a source of surplus value contradicts these Laws, as I will explain below.
Neoclassical theory attained dominance largely in reaction to Marx turning Smith and Ricardo’s classical method from a defence of capitalism to a critique of it. It treats output as the joint product of labor and machines (“Capital”), but the role of Energy—which cannot be reduced to Capital—was ignored.
The Neoclassical School of course became ascendant, both ideologically and in academic discourse, and in the late 19th century, JB Clark developed “Marginal Productivity Theory”, in which both production and distribution were determined by the marginal products of labor and capital. In 1928, this “theory” was codified into the constant-returns-to-scale “Cobb-Douglas Production Function”, in which output (Y) was portrayed as being generated by the product of the inputs of Labor (L) raised to one power and capital (K) to another, with the exponents summing to 1...