This fact of the recognition of the creation of this surplus physical product, was, as Marx sets out in Theories of Surplus Value, both the great advance made by the Physiocrats, and the source of their error. It was the basis of their great advance, as against the mercantilists, because it correctly located the basis of surplus value/profit in the realm of production, not distribution and exchange. It was the source of their error, because, focusing only on the physical agricultural/primary production, they equated this surplus product with surplus value, and saw only this production as value creating. Moreover, to explain the surplus production – more easy to see when you can compare the products consumed against the products produced – they wrongly attributed its source as being the land itself, which, thereby, gives the landowner the right to the surplus product.
Adam Smith corrected this error, whilst retaining the insight and advance made by the Physiocrats, as against the mercantilists. The surplus, Smith realised, following the Physiocrats, is created in production and not in exchange. Exchange simply realises the surplus created in production. However, Smith, also, recognised that the essence of value is labour, and not use-value, as the Physiocrats believed. The source of the surplus-value, therefore, was not some mystical power of the land, but that the labour undertaken, and embodied in the value of output is greater than the labour required to produce the commodities, including labour-power, consumed in production. In short, value is labour, and surplus value is surplus labour.
On this basis, Smith was able to go beyond the limitations of the Physiocrats and realise that it was not only agricultural labour that was value creating, but all labour, and not only labour that produces physical commodities that is productive-labour, i.e. productive of surplus value, but all labour that exchanges with capital. As Marx notes in Theories of Surplus Value, unfortunately, Smith, at times, also lapses into physiocracy, and, although he had set out everything required to properly identify the nature of surplus value, he failed to do so, because he failed to make the distinction between labour and labour-power.
As Engels notes, in Capital III, he was rather like Priestley who identified the existence of oxygen, but failed to fully draw the conclusions from his work, leaving it to Lavoisier to do so. As Marx notes, had Smith and Ricardo just recognised from their own analysis the distinction between labour and labour-power, the conundrum they faced would have simply disappeared. It was left to Marx to complete that task.
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