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v. ,CLASSICAL ECONOMIC THEORY: 
THE PROFITS OF STOCK 
The changes that the objects that fell within the analytical category of capital underwent during the first half of the nineteenth century were substantial. And the classical economists advanced 
many different theories to explain the behavior of capital. For "capital" exists only at a very high level of abstraction. At a lower level of abstraction, there is no capital. There are only inventories of finished goods, inventories of raw materials, cash 
on hand, work in progress, accounts receivable, implements used 
by workers, wages advanced to workers, plant, buildings, machines, animals, factories, knowledge. 
Yet the overall, analytical framework of classical political economy led all the classical economists to view capital as a single aggregate; all that was not human labor, was not "land" (natural resources), and was used in the process of production was termed "capital." Given this aggregate, each classical economist looked for the "representative" characteristics of capital in general-- 
and each set of representative characteristics of capital implied concomrnitant representative characteristics of the payments to capital, of what classical economists called "profit." 
As the nature of British capital changed, the "representative element" changed also. This shift in the representative element-along with the blithe assumption that valid analysis can be carried out in terms of such a representative element--made a major trans for- 


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mation in the classical economists' conceptions of capital essential to their being able to adequately analyze the industrial economy of the late nineteenth century. 
Ricardo staked out a theory in which capital was malleable, circulating, mobile, a stock of consumption goods to be consumed by workers while they worked and before they finished production; profit was accordingly seen as a physical surplus of workers' production over workers' sUbsistence. This conception of capital and profit was keyed to the mercantile, agrarian economy into which Ricardo was born. 
As the orthodoxy laid down by Ricardo dissolved, the successor economists of the second generation rejected pieces of Ricardo's theory of capital in favor of their own, more "industrial" pictures of capital and profit. They, however, reached no consensus on what were the "typical" characteristics of capital. And J. 
S. Mill and his fellow economists of the third generation established an orthodoxy in the theory of capital which accepted few of the diverse ideas of the economists of the second generation, which returned to a conception of capital and profit almost as mercantile and agrarian as Ricardo's conception. 
As was the case with their ideas of wages, the classical economists' ideas of capital and profit all started from the ground cleared in Books I and II of the Wealth of Nations.
When Smith speaks of capital, he speaks of undifferentiated 
"stock," by which he means "material possessions to be consumed": 
"When the stock which a man possesses is not more than sufficient 
to maintain him for a few days or weeks • 
Some few men have 


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more than this small amount of stock, and each of them, 
when he possesses stock sufficient to maintain him for months or years, he naturally endeavours to derive a revenue from it; reserving only so much for his immediate consumption as may maintain him until this revenue begins to come in. 
Thus, stock can be either for immediate consumption or for sav- 
ing. "The part which, he expects, is to afford him •.. revenue, 
is called his capital.,,2 The picture Smith paints is of general- 
ized resources, possessions, consumer goods in greater quantities 
than one can consume immediately. 
For Smith, the portion of stock that is capital "may be 
employed to yield a revenue or profit" in "two different ways": 
first, by using it to buy and sell, M-C-M', as a circulating capi- 
tal; second, by using it "in the improvement of land, in the pur- 
chase of useful machines and instruments of trade," as a fixed 
. I 3 caplta . 
Different industries require different ratios of fixed 
to circulating capital: a factory owner requires more fixed capi- 
tal than an artificer, who requires more fixed capital than a mer- 
chant. Circulating capital is, however, in all cases the most 
important of the two kinds: "no fixed capital can yield any revenue but by means of a circulating capital.,,4 Smith therefore takes 
the typical kind of capital to be circulating capital. Advances. 
"A stock of goods of different kinds • . . stored up somewhere 
sufficient to maintain" the worker. Of secondary importance is 
the role of capital in supplying the worker with "the materials 
and tools of his work.,,5 
In concluding that capital is primarily circulating, Smith 


takes a position near one end of one particular line on which' 
capital can be placed. At one end, capital is wholly circulating. 
It is short-lived, used up by the worker and then purchased anew 
at the start of the next cycle of production. It can be thought 
of as "goods in transit" from one form or place to another, as the 
raw materials to which labor is applied. At the other end, capital 
is wholly fixed. It is long-lived, present before the cycle of 
production and, with only minor wear and tear, present after the 
cycle and ready to be used again. Fixed capital makes labor more 
productive. It can be thought of as "embodied technology," as hav- 
ing a productivity of.its own in addi.tion:to the productivity of 
labor. Smith views capital as lying near the first end of this 
line. 
If capital is typically circulating capital, it is not imme- 
diately obvious how it helps create either goods or value. For cir- 
culating capital helps one to buy and sell, and it is difficult to 
see how this is supposed to increase aggregate wealth. Smith has 
an answer: capital is productive because it is necessary for the 
division of labor. And the division of labor is the overwhelming 
source of increased productivity and wealth. 
The greatest improvement in the productive powers of labour, and the greater part of the skill, dexterity, and judgement with which it is any where directed, or applied, seem to have been the effects of the division of labour.6 
The division of labor increases productivity in three ways. First, 
it increases the dexterity of the inqividual workman; second, it 
reduces time lost "in passing from one sort of work to another"; 


takes a position near one end of one particular line on which 
capital can be placed. At one end, capital is wholly circulating. 
It is short-lived, used up by the worker and then purchased anew 
at the start of the next cycle of production. It can be thought 
of as "goods in transit" from one form or place to another, as the 
raw materials to which labor is applied. At the other end, capital 
is wholly fixed. It is long-lived, present before the cycle of 
production and, with only minor wear and tear, present after the 
cycle and ready to be used again. Fixed capital makes labor more 
productive. It can be thought of as "embodied technology," as hav- 
ing a productivity of.its own in addition:to the productivity of 
labor. Smith views capital as lying near the first end of this 
line. 
If capital is typically circulating capital, it is not imme- 
diately obvious how it helps create either goods or value. For cir- 
culating capital helps one to buy and sell, and it is difficult to 
see how this is supposed to increase aggregate wealth. Smith has 
an answer: capital is productive because it is necessary for the 
division of labor. And the division of labor is the overwhelming 
source of increased productivity and wealth. 
The greatest improvement in the productive powers of labour, and the greater part of the skill, dexterity, and judgement with which it is any where directed, or applied, seem to have been the effects of the division of labour.6 
The division of labor increases productivity in three ways. First, 
it increases the dexterity of the inqividual workman; second, it 
reduces time lost "in passing from one sort of work to another"; 


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third, "labour is facilitated and abridged by the application of 
the proper machinery," which is more likely to be invented and put into use the more subdivided is the labor. 7 Smith spends 
four chapters tracing the sources and effects of this mainspring of productivity and wealth, this division of labor.8 
Yet this division of labor requires capital: 
A weaver cannot apply himself entirely to his particular business, unless there is beforehand stored up somewhere ••• a; stock sufficient to maintain him, and to supply him with the materials and tools of his work, till he has not only completed but sold his web.9 
The degree of the division of labor ,depends explicitly upon the 
degree of the accumulation of capital: 
"labour can be more and 
more subdivided in proportion only as stock is previously more 
IO and more accumulated." 
Smith thus takes up a position on a second line along which 
the representative element of capital can be placed. At one end, 
capital is complementary to labor in the process of production. 
Each laborer requires a certain amount of capital. If each laborer 
has less, then fewer workers working with more capital per man could 
produce almost as much; if each laborer has more, than the extra 
capital does not increase his productivity. At the other' end, capi- 
tal is substitutible. A given amount can either be produced with 
much labor and little capital, or with little labor and much capital. 
Smith takes a position near the second end: a given product can be 
produced either by many unspecialized or by a few specialized wor- 
kers, and far more capital is required to support the second group 
than the first. 


The way in which the productivity of capital enters Smith's 
framework--as enabling the division of labor, which increases pro- 
ductivity, rather than as directly aiding the workers productiv- 
ity--is a result of Smith's position with respect to a third line 
along which the typical characteristics of capital can be thought 
of. To place the distinction in Marx's terminology, capital can 
either be variable or constant. If it is variable, capital is a 
stock of wage goods that are advanced to the workers to support 
them while they produce. In this scheme, the capitalist's de- 
mand for labor is identically equal to his ~tock of ("variable") 
capital. If capital is constant, then it is a stock of raw mat- 
erials and manufactured implements. The capitalist hires workers 
to work with and on his capital to produce his product. There 
is no necessary connection between a capitalist's stock of ("con- 
stant") capital and his demand for labor. Smith's vision of 
capital as permitting the division of labor generates both his 
belief that capital is primarily "substitutible" for labor and 
his belief that capital is primarily "variable." 
Smith's conception of capital also generates his picture 
of profit. Productivity depends on the division of labor, and 
the division of labor depends on the accumulation of capital, 
therefore productivity depends on the accumulation of capital. 
The profit of the capitalist is whatever share of this increased 
product he can extract from the workers by virtue of his superior 
bargaining position. 
Many workmen could not subsist a week • without employment. In the long-run the workman may be as necessary to his master as his master is to him, but the necessity is not so immediate.ll 


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The total amount of profit which the capitalist could 
extract under the (to him) most favorable conditions depends 
on the scarcity of capital and thus on the degree to which ad- 
ditional capital can enhance the division of labor; on, so to 
speak, the marginal revenue product of circulating capital. 
In a country which had acquired its full complement of riches, where in every particular branch of business there ~as the greatest quantity of stock that could be employed in it ••. the ordinary rate of clear profit would be very small. 
This is not a hypothetical limit case: 
"The province of Holland 
seems to be approaching near to this state.,,12 
For Smith, as for all the classical economists, profits 
are the return to the factor capital. All agreed that the "wages 
of management" were not properly part of profit at all: 
"the pro- 
fits of stock • • • are . • . altogether different from the wages 
of .•• inspection and direction,,13; "if the capitalist embarks 
in business. 	• he must in addition 
. be remunerated for 
the devotion of his time and labour.,,14 Apparent profits differ 
from "true" economic profits also because apparent profits contain 
an amount to compensate for the risk of capital loss.15 
Most important, the classical economists did not think that 
profits included the "returns to entrepreneurship." Smith considers 
the circumstance that an industry is "new" to be just a cause that 
disturbs profits from their natural rate, a cause similar to sudden 
disturbances in the level of demand, a cause not theoretically in- 
	. 	16 	h' 	f 	hI' I 	. 
terestlng. Entrepreneurs lp was thus, or t e c aSSlca economlsts, 
a minor disturbance to equilibrium, not a major dynamic presence 


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within the economy. Only Say and Walker, of all those connected 
with classical political economy, stressed the role of the entre- 
preneur as an economic agent alongside the landlord, laborer, and 
	, I' 	17 
caplta lst. 
This failure to make an analytical distinction is revealing: 
it is a sign that the classical economists implicitly believed that 
they lived in a world substantially in static equilibrium. And 
thus they were not likely to have been looking for the massive 
structural changes, transitions, and adjustments that were the 
industrial revolution.18 Furthermore, they were not likely to grasp 
hold of the dynamic nature of an industrial capitalist economy. 
For example, the classical economists' lack of concern for 
disequilibrium caused them to, for the most part, miss completely 
another important issue in the theory of capital: its mobility. 
Some capital can be quickly shifted from industry to industry in 
response to the opportunities given by the market. Other capital 
is immobile, is trapped in one particular line of business for a 
substantial time after its creation. If capital is of this second 
kind, a decision to invest in a given industry is a large gamble 
and depends upon the "state of expectations." Moreover, the abil- 
ity of the economy to adjust to changes in demand depends on how 
much of the capital concerned is immobile. Smith, and most of the 
classical economists after him, never explicitly faced this issue. 
Thus many of the characteristics of an industrial capitalist economy 
remained outside their comprehension. 
After the complex view of capital and profit held by Smith, 
the views of capital and profit held by the first generation of clas- 


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sical economists appear simple. For they were all couched mainly 
in terms of Ricardo's "Corn Model." And in its essentials, that 
model is fairly simple. 
Population being given, the demand for food is also given. 
In any year that amount of land is cultivated which is necessary 
to feed the then existing population. Landlords receive, as rent, 
the differential excess product of their land over the product 
of the "worst quality" of land under cultivation. Thus, each 
worker splits with his capitalist an amount of the product equal 
to the production of a single worker on "marginal" land. The 
laborer's wage is fixed--at psychological subsistence, at what 
is customary. The capitalist receives the residual, the physical 
surplus of production less rent over what was required to initiate 
production and to support the laborers. Therefore the rate of 
profit in agriculture is given by the excess of the product of 
the worker on marginal land over the amount of his necessary sub- 
sistence. The total capital advanced is simply the laborer's sub- 
sistence for the year. The total profit is product, less rent, 
less wages. And the rate of profit is obtained by simple divi- 
	, 	19 
Slon. 
All agricultural capitalists receive this rate of profit: 
if they receive more--or less--competition of landlords or of 
capitalists drives profit back to its Ricardian level. Non-agri- 
cultural capitalists also receive this rate of profit; otherwise 
capital would move from one industry to another.20 Ricardo thus 
arrives at his general conclusion: 
"In all countries, and at all 
times, profits depend on the quantity of labour requisite to pro- 


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vide necessaries for the labourers, on that land or with that 
capital which yields no rent.,,21 
The capital in Ricardo's forrnulationis primarily circu- 
lating, primarily mobile, primarily "complementary," and primar- 
ily "variable." It is laborers' subsistence plus seed corn. In 
this, its most simple form, Ricardo presented his argument in his Essay on Profits.22 The rationale behind this simple formulation 
is "that in agriculture the same commodity, namely corn, forms 
both the capital (conceived as composed of the subsistence neces- 
23 sary for workers) and the product." 
Malthus opposed this doctrine: 
"In no case of production, 
is the produce exactly of the same nature as the capital advanced. 
Consequently we can never refer to a material rate of produce.,,24 
Yet Ricardo disagreed; it was precisely his desire to refer to a 
material rate of produce that led him to wrestle so closely with 
the problem of value in Chapter I of his principles.25 And, given 
the overwhelming importance of food in the consumption of the 
workers of Ricardo's time, and thus the near equivalence in form 
of input and output in agriculture, the bare Corn Model remained 
in Ricardo's eyes a very close approximation to the actual way in 
which the rate of profit was determined: 
the great questions of Rent, Wages, and Profits must be explained by the proportions in which 
the whole produce is divided between landlords, capitalists, and labourers, and which are not essentially connected with the theory of value.26 
Since Ricardo believed in the determination of the rate of 
profit by the productivity of labor in agriculture, the distinction 
between fixed and circulating capital was not at the center of his 


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concerns. The typical element of capital was circulating, but 
the competition of capitals ensured that all types would earn 
the same rate of profit. The existence of different durabilities 
of capital created some thorny problems in the theory of value, 
but--given the overwhelmingly circulating nature of the capital 
employed in agriculture--did not much affect the determination 
of profit. And so Ricardo avoided any detailed examination of 
fixed capital until the third edition of his Principles.
John Barton wrote a pamphlet of which Ricardo thought 
highly, and Barton raised questions Ricardo wished to treat. So 
he wrote a new chapter for the third edition, the chapter "On 
Machinery." In it, Ricardo stated his previous view on the na- 
ture of capital: 
If, by improved machinery, with the employment of the same quantity of labour, the quantity of stockings (producedJ could be quadrupled, and the demand for stockings were only doubled, some labourers would necessarily be discharged from the stocking trade; but as 
the capital which employed them was still 
in being, and as it was in the interests of those who had it to employ it productively, 
it appeared to me that it would be employed 
on the production of some other commodity, 
	useful to society 	27 
Before he read Barton, Ricardo had believed that all capital was 
mobile and "complementary," combined with labor in fixed factor 
proportions. 
And a moment's consideration reveals that here are two holes 
in Ricardo's previous argument. First, if any of the capital is 
immobile, is stuck in the stockipg industry, then the introduction 
of improved machinery means that the old, unimproved machinery is 


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no longer worth what it was. Therefore not all the capital which had employed the workers was still in being. Second, the introduction of new, advanced technology may well change the capitallabor ratio; capital may substitute for labor. The same amount of capital may no longer employ as many workers. Thus, two corrections needed to be made in Ricardo's previous position. Yet in "On Machinery" he makes only the second. He recognizes that the capital-labor ratio may change; he does not recognize that some capital may be immobile. 
The fact that the first correction did not occur to Ricardo28 even in his third edition implies that his thought moved within a range in which the idea that fixed capital might be immobile, might be specific to a given industry, was not raised 
to theoretical consciousness. And Ricardo does not think his readers will believe in the second correction until they have worked through a long example--that example is, in fact, the center of "On Machinery.,,29 
Ricardo considers a single firm. Each year, the owner uses his i,ooo pounds of constant capital ("buildings, implements, &c.") and his 13,000 pounds of variable capital ("circulating capital 
in the support of labour") to produce, after allowing for depreciation, 15,000 pounds' worth in value to replace the consumed 13,000 pounds of variable capital and allow for 2,000 pounds of profit, which then disappears from the system. In Ricardo's terminology, there is a "gross produce" worth 15,OOO and a "net pro- 
30 duce" worth 2,000 pounds. 
Now Ricardo postulates a transitional year, during which 


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the capitalist employs half his workers in constructing "a ma- 
chine." During this year the capitalist must still make the cus- 
tomary rate of profit, which Ricardo has assumed is ten percent-- 
otherwise the capitalist would not make the machine. Furthermore, 
he can make a profit of no more than ten percent--the rate of 
profit in all industries is still ruled by the rate of profit 
in agriculture. Therefore at the end of the transitional year 
the capitalist has his old constant capital, worth 7,000 pounds, 
his new constant capital--the machine--which as the produce of 
half his workers must be worth 7,500 pounds, and the produce of 
the half of his workers not engaged in making the machine, which 
is also worth 7,500 pounds. The capitalist consumes his 2,000 
pounds of profit, and is left with constant capital of the value 
of 14,500 pounds and variable capital of 5,500 pounds. In suc- 
ceeding years, the capitalist will use this capital to produce 
(after depreciation) a gross produce of 7,500 pounds and a net 
31 produce of 2,000 pounds. 
The entire point of this long example has been to show that 
technical change can lead to the substitution of capital for labor 
and thus to a decrease in employment. Ricardo, however, takes 
pains to point out that this is only a short-run effect: 
I have before observed, too, that the increase of net incomes, estimated in commodities, which is always the consequence of of improved machinery, will lead to new savings and accumulations. These savings, it must be remembered, are annual, and 
must soon create a fund, much greater than the gross revenue, originally lost by the discovery of the machine.32 


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Ricardo only admits that it is theoretically possible, 
not that it is likely, for capital to substitute for labor in 
such a degree for the phenomenon to be important in practice. 
He does raise the ideas of the importance of fixed capital and 
of the "substitutibility" of capital for labor to the forefront 
of his theoretical consciousness. But, at least implicitly, 
capital remains fully mobile and, by virtue of the regulation 
of the rate of profit by the physical productivity of agriculture, 
capital remains "variable," capital as "advances to workers" re- 
mains the characteristic form of capital. 
In the case of capital and profit James Mill, as he had 
done in the case of wages, confined himself to attempting to lay 
out clearly the doctrines of his master, Ricardo. Following him 
on rent, the elder Mill stated that "rent is something altogether 
extraneous to what may be considered as the return to the produc- 
tive operations of capital and labour." With rent removed from 
the picture "we might . • • with equal propriety . . . affirm that 
wages determine profits, or that profits determine wages." But 
since "population, as compared with capital, has a tendency to 
superabound, the active principle of change is on the side of pop- 
ulation, and constitutes a reason for considering • 
. wages as 
33 the regulator." 
The elder Mill had no idea that there was any meaningful 
difference between fixed and circulating capital. 
"There is a 
mode of viewing the gross return to the capitalist," he said 
which has a tendency to simplify our language, and, so far, has a great advantage to recommend it. The case of fixed and circulating capital may be treated as the same, by merely 


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considering the fixed capital as a product, which is regularly consumed and replaced, by every course of productive operations. The capital, not consumed, may be always taken as an additional commodit¥r. the result of the productive process. 4 
Of course, joint production raises theoretical problems of its 
own. The elder Mill did not recognize them. 
Although Robert Torrens had strong theoretical disagree- 
ments with Ricardo on the subject of value, these disagreements 
did not extend to the questions of the nature of capital and the 
source of profit. For Torrens also, "capital" is the sameithing 
as "stock": "Capital, indeed, is but a particular species of 
wealth; and the only peculiar and distinguishing circumstance 
belonging to it is that of being destined, not to the immediate 
supplying of our wants, but to the obtaining of other articles of 
utility." And Torrens refers to Ricardo's "very original and val- 
uable doctrine respecting the profits of stock.,,35 
Once again only Malthus among the Principles writers of 
the first generation did not accept the Ricardian theory--because 
only Malthus did not believe in the practical short-run applica- 
bility of the Malthusian population principle. 
Malthus begins his argument with a definition: 
"The profits 
of capi.tal consist of the difference between the value of the advan- 
ces necessary to produce a commodity, and the value of the commod- 
ity when produced." Since the costs of supporting labor during the 
process of production "are generally the greatest and most impor- 
tant" of all the expenditures of the capitalist,36 profits will 
be largely determined by 


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lst. The difficulty or facility of production on the land, by which a greater or less proportion of the value of the whole produce is capable of supporting the labourers employed. 
And 2dly, the varying relation of the quantity of capital to the quantity of labour employed by it, by which more or less of 
the necessaries of life may go to each individual labourer.37 
The first of these two factors is the one exclusive deter- 
minant in Ricardo's theory. The second is, despite what may 
first appear, not a statement that the physical capital-labor 
ratio may vary but a claim that the rate of profit depends on 
the real wage--which is, for Malthus, determined by supply and 
demand in the labour market. Both of these causes are active in 
determining the rate of profit in Malthus's scheme, and this re- 
suIts in "those varied phenomena which it is not always easy to explain, ,,38 the complexities of the economy. Malthus cannot agree 
with Ricardo's theory of profit because he cannot agree with Ri- 
carda's theory of wages. 
Malthus agrees that Ricardo's theory of profits is true in 
the long run. It is "a truth • • • indeed necessarily involved 
both in . . . the Principle of Population and in the theory of rent which I published separately in 1815.,,39 But the run in which 
Ricardo's theory is true is long indeed:' 
Powerful and certain as this cause is, in its final operation, so much so as to overwhelm every other, yet in the actual state 
of the worlg,its natural progress is not only extremely slow, but is so frequently counteracted.and overcome by other causes, as to leave very great play to the principle of 
the competition of capital; so that at any one period of some length in the last of following hundred years, it might more safely 


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be asserted that profits had depended or would depend very much more upon the causes which had occasioned a comparatively scanty or abundant supply of capital, than upon the natural fertility of the land last taken into cultivation.40 
Malthus's quarrel is only with his contemporaries' deter- 
mination to use the population principle to determine the short- 
run rate of profit. He had no quarrel with the treatment of 
capital as "stock." For Malthus, as for the other economists 
of the first generation, capital was mobile, primarily "complementary," primarily circulating, and overwhelmingly "variable.,,41 His 
conception of capital was well adapted to the analysis of the ac- 
tual reproducible capital stock of Britain at the beginning of the 
nineteenth century.