The logic of Smith's position here should be that if the value of a commodity falls, but the value of wages rise, then this can only be because the other costs of production, which make up the value of production – profits and rent – fall by more than the rise in wages. However, Smith does not argue that either profit or rent falls. Smith's explanation is,
““In consequence of better machinery, of greater dexterity, and of a more proper division and distribution of work, all of which are the natural effects of improvement, a much smaller quantity of labour becomes requisite for executing any particular piece of work; and though, in consequence of the flourishing circumstances of society, the real price of labour should rise very considerably, yet the great diminution of the quantity,” requisite for each particular article, “will generally much more than compensate the greatest rise which can happen in the price.” ([O.U.P., Vol. I, p. 280; Garnier,] Vol. II, p. 148.)” (p 370-1)
In other words, Smith abandons his cost of production theory of value here, and explains the fall in the value of commodities, concomitant with a rise in wages, by determining value once again on the basis of the labour-time required for production. This is also important for understanding the later discussion in relation to the difference between Marx's Law of the Tendency for the Rate of Profit to Fall, and a fall in the rate of profit due to a profits squeeze. Marx's Law arises in conditions where productivity is rising, which causes the value of labour-power to fall,, and the rate of surplus value to rise. The rate of profit then falls, because even if the unit value of materials falls (causing a fall in the value composition of capital) the mass of material processed (the technical composition of capital) by each unit of labour, rises by a greater proportion so that the organic composition of capital, c:v, rises.
But, the rate of profit also falls in the opposite conditions, i.e. where the profits get squeezed by rising costs, due to falling productivity, or rising wages, interest or rent. Smith, Ricardo, Malthus and others tried to explain The Law of Falling Profits on this latter basis. In Chapter 17, Marx explains why, although profits can indeed be squeezed in this way, and he also sets that out in Capital III, Chapters 6 and 15, this squeeze on profits is different to The Law of The Tendency For The Rate of Profit to Fall.
“Thus the value of the commodities falls, because a smaller quantity of labour is required to produce them; the value moreover falls although the real price of labour rises. If here the real price of labour means the value [of labour], then the profit must fall, if the price of the commodity falls as a result of the fall in its value. If, on the other hand, it means the quantity of the means of subsistence received by the worker, then the Smithian thesis is correct even where profit is rising.” (p 371)
As Marx points out, whenever Smith is analysing facts, he is led to drop his cost of production theory, and to revert to his labour theory of value. So, Smith writes, explaining why the price of woollen cloth was higher in the 16th century,
““It cost a greater quantity of labour to bring the goods to market. When they were brought thither, therefore, they must have purchased, or exchanged for the price of, a greater quantity” ([O.U.P., Vol. I, p. 284; Garnier,] Vol. II, p. 156).” (p 371)
The only mistake here, Marx says, is the use of the word “price”. Smith should have referred to value.
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