BOOK I: Of the division of labor
Adam Smith begins by stating that the greatest improvements in the productive power of labor lie in the division of labor. Even in the production of very simple products, division of labor always increases productivity exponentially. Smith offers three reasons for this increase in productivity. First, the division of labor creates specialized knowledge of a particular trade or task. This, in turn, makes the laborers engaged in this task more dexterous, and therefore more productive. Secondly, the division of labor saves the laborer time. In focusing on one task, rather than passing from one task to another, a process that requires him to use different tools and materials, he is able to maximize his time, thus increasing productivity. Finally, the amount of time spent by laborers on an isolated task leads to innovation in the methods and tools employed in the task, and therefore to technological innovation that ultimately makes that task easier. Therefore, increased division of the labor involved in the production of a particular product leads to increased productivity.
By increasing productivity, the division of labor also increases the opulence of a particular society, increasing the standard of living even of the most poor. Division of labor also means that many people are involved in the production of each and every manufactured product. This is a testament to the interconnectedness not only of the laborers employed in manufacturing, but of all the branches of commerce.
Of the principle which gives occasion to the division of labor
Chapter Two describes the manner in which material exchange spreads the benefits of the division of labor throughout society. At the beginnings of a particular society, it may have been talent that decided which member carried out which task. Division of labor by skill set would have allowed for modest efficiencies and surpluses. These surpluses would have allowed one member of society to trade the fruits of his labor for other objects that were needed. In this way, instead of each man struggling to produce some of the things he needed, each man would specialize, producing an excess of one thing, and exchange to gain all or most of required. This would increase the well-being of each member of society that was engaged in such production and trade.
The division of labor is not the result of oversight and regulation by an authority, but of human nature. Part of what makes us human, according to Smith, is our propensity to truck, barter, and exchange items. This propensity can be observed in any society, including the most primitive. It is, in turn, the assurance of being able to trade what one produces with others that encourages the division of labor. When two parties enter into a trade with one another, both come away with something they were previously lacking. The division of labor will continue to be a powerful force so long as this condition is fulfilled.
Adam Smith goes on to insist that it is not natural talent that determines the profession of most people, but habit, custom and education. In today's modern complex societies, people are most often employed in a certain way because they came to develop specialized knowledge of their role. This system of specialization and extensive education in particular subjects or trades would be impossible if human beings were not endowed with the propensity for trade. In the absence of this propensity, each person would be forced to acquire a wide variety of skills in order to sustain himself. Adam Smith uses this property to distinguish human beings from animals, who do not have the propensity for trade.
That the division of labor is limited by the extent of the market
It is the size of the market that regulates the extent of the division of labor that it can support. The larger the market, the greater the extent to which labor can be effectively divided. Because productivity increases with the division of labor, a large market is needed to consume the products that it gives rise to. In rural or sparsely populated areas, the market is too small to absorb the products arising from an extensive division of labor, and therefore the division of labor must be limited in such areas. Historically, improvements to art and industry are made only when there is an assurance of a large market that will be able to absorb the products of labor. This occurs either when the market grows, or when a certain settlement has easy transportation to other markets (such as river access).
Money also serves to extend the market because it facilitates trade to such a significant extent. If it were not for a standardized, universally accepted currency, people would always have to search out trading partners that had to offer exactly what they themselves needed, and vice versa. It would rarely be the case that these offerings and requirements coincided, and therefore people would have less faith in the ability to efficiently replace the surplus they produced with the objects they needed, and would be discouraged from producing such a surplus in the first place.
In the first three chapters of The Wealth of Nations, several of Smith's most important themes are already articulated. The first important theme is the benefit of the division of labor as a self-reinforcing phenomenon that spreads opulence to even the most poor. Because it enjoys such tremendous efficiencies, the division of labor produces a surplus that gives a greater amount of people access to products that would otherwise be unaffordable.
Another important concept that Smith begins to develop already is the idea that trade is natural, and part of human nature. He uses historical examples to show that trade was an important part of society even in primitive times. Making the point that trade is natural and integral to human nature allows Smith to make another important point—namely that, when two people decide to enter into a trade, they benefit mutually from its conclusion. Later in the work, this idea will be very important when Smith criticizes mercantilism.
Also implied in the second chapter is the idea that people are motivated primarily by their own self-interest. Self-interest, for Smith, does not have many of the negative connotations that it does today. Instead, Smith means to make the point that it is entirely natural, appropriate, and indeed necessary for society that each person look after his own welfare, and not put the burden of his maintenance upon others. It is this propensity that allows human economies, left largely to themselves, to thrive as if it were in their very nature to do so.
Finally, the third chapter shows readers that Smith is writing for a new historical era. He is writing at the very dawn of the Industrial Age, which was characterized by a mass migration to urban centers and a general population boom. Smith's work both predicts and explains these dual phenomena. The population boom and the urban migration ultimately led to a more extensive complexity and development of markets, which, in turn, led to further expansion.
Of the origin and the use of money
Once the division of labor has been accomplished, one man's labor supplies only a fraction of his wants and needs, and it is only through exchange that he can hope to attain them. Adam Smith goes on to speculate how the exchange must have occurred in primitive society, and argues that early trade must have been very clumsy. If bartering is conducted with perishable, non-divisible goods, it is rendered difficult, and many exchanges are simply impractical. It was these concerns, Smith posits, that led to the desire for a common currency. Metal lent itself to the being used as a currency because it is non-perishable, easily divisible, and compact. The text goes on to describe the various metals that were used throughout history as currency. After metal became the principle currency, coinage developed, in order to better ensure accuracy and purity in exchange.
Of the real and nominal price of commodities, or of their price in labor, and that price in money
In this chapter, Adam Smith explains that the source of value of all commodities derives not from their money price, but from the amount of labor required to purchase them. He is led to his point by considerations of seemingly nonsensical pricing differences. A diamond, for instance, is extremely expensive, but unnecessary for life. Water, on the other hand, is very inexpensive or even free of cost, but is absolutely essential to to preservation of life. Smith explains the difference between these prices by looking at the differing amounts of labor that was required to bring those products to market. While the money price of a particular commodity may fluctuate for a variety of reasons, the amount of labor required to purchase it remains constant. The wealth of a particular individual is therefore determined by the quantity of labor that he can command. If labor is the ultimate determinant of value, then the question arises of how to ascertain a proportion between two different quantities of labor, especially if they are fundamentally different.
Smith resolves the problem of accounting for different kinds of labor by re-introducing the concept of money. Because of the difficulties of equating various kinds of labor, commodities are more often exchanged for other commodities than for labor. It is convenient to estimate the value of one commodity by its exchangeable value, and therefore by its money price. He explains that, though money in the form of precious metals is sufficiently well-suited to serve as the measure of the exchangeability of commodities, it is imperfect because of the fluctuations in the value of these metals. However, though the money price of a commodity may change over time as a metal becomes more or less scarce, the price of a particular commodity will rise or fall to reflect its real value, which remains unchanged so long as the factors directly concerned with its production remain unchanged.
Of the component part of the price of commodities
Smith argues that the price of any commodity is complex, reflecting three different components. These components consist in the rent of the landlord, the wages and maintenance of laborers or animals used to produce the profit, and the profit made by the farmer or entrepreneur. The fact that the price of all commodities contains these three components may be obscured by the fact that in many cases, the roles of laborer, farmer or entrepreneur, and landlord are united in one person.
Of the natural and market price of commodities
In every society, there is a naturally regulated average rate of both labor and profit for different sectors. If the price of a commodity is sufficient to cover the rent, wages, and profit of stock associated with its production, it is said to be sold for its “natural price.”
Additionally, there is the “market price” of a commodity, which reflects not the cost of the rent, wages, and labor associated with it, but the demand that exists for the commodity. If demand exceeds supply, the market price rises above the natural price. The upper limit of the market price is then determined by the greatness of the deficiency of the commodity in question, and the wealth of those who are competing to purchase it. If the quantity of a commodity exceeds demand, then the price of the commodity will fall. When a dearth or an excess of a commodity in relation to demand continues for an extended period of time, members of society are prompted to act in a way that brings the price into line with its natural price (either by devoting more resources to the production of a particular commodity and thereby increasing its quantity, or by diverting resources elsewhere).
Smith goes on to detail that there are certain methods whereby the manufacturers of a particular commodity seek to raise the market price. These methods may include procuring trade secrets that lower the cost of production, or controlling the supply of a particular commodity by creating a monopoly.
In these chapters, Adam Smith gives an account of how metal money came to be, and how value can be deconstructed. Again, the description he provides of how metal coins come to stand in as exchange mechanisms reinforces the over-arching idea that trade is natural, occurs without much regulation or interference from governments, and becomes more sophisticated over time. In preceding chapters, Smith explained how the development of money served to extend the market. In chapter four, in which Smith gives a detailed history of the development of metal coins, he shows how the minting process did in fact have important effects upon the economy. The system of coinage and money is something that becomes increasingly adept as a tool over time.
In a struggle to account for extreme differences in the money price of products that have similar or disproportionate use values, Smith wants to give an account of value that will explain these dramatic differences. He is therefore led to account for value in terms of labor. This account of value might lead a modern reader to associate Smith's thinking with a “labor theory” of value, in Marx's sense. It is Smith's theorizing of the “labor theory” of value that would later allow thinkers like Marx to develop conceptions about how labor might be alienated, appropriated, monopolized, etc. However, it would be unfair and inaccurate to attribute this line of thinking to Smith. Smith actually seems to be accounting for what is referred to today as the total costs of production.
It is clear that Smith is interested in developing something more complex or simply other that a labor theory of value by chapter seven, when he complicates his account of how the price of a particular economy is determined. In this chapter, he introduces land and capital, which are also important components of price, because they are necessary costs involved in the production of commodities that have to be carried over into pricing.
In this section, Smith also gives a brief account of how supply and demand affect price. He is careful to distinguish between the natural price of a commodity, which is determined by the total costs of production, and the market price, which is determined by supply and demand. This is an extremely important theme throughout the book. The dual forces of supply and demand are at the heart not only of commodity pricing, but of a number of aspects of the market. They represent dual and opposed forces that, because of their very opposition, are always engaged in attaining or maintaining the equilibrium that makes the market such an effective distributor of goods and services.
The seventh chapter builds an interesting bridge between his account of the rise of money and the how he accounts for the rest of the fabric of the economic system over the course of the entire work. The ways in which supply and demand affect price seem abundantly clear. However, Smith's application of this principle to the regulation of wages is more complicated and less self-evident. It takes Smith several chapters to fully develop his idea, and describe the extent of its application. It is important, however, because it allows him to begin to show that the market has internal forces that allow it to regulate itself, and check excesses and inequalities.
Of the wages of labor
The wages of labor, in an unsophisticated system, consist of what the labor produces. In such a system, no landlord or master (employer) shares the price of what the self-employed laborer produces. It is the tension between masters and laborers that creates the market price of labor. In general, the interests of laborers and those of masters are starkly opposed to one another. Smith explains that while labor unions are perceived as ubiquitous, and are intimidating to masters, the union that exists among masters is at least as well developed as the one existing among laborers. Because the masters are a small and powerful group, this union is “tacit, but constant and uniform.” Masters, in combination, are more formidable than laborers because their greater wealth lets them subsist for a longer time without income, whereas laborers, who live with meager wealth, depend heavily on their wages for their daily subsistence, and cannot afford to do without them for long.
When laborers are abundant and employment is scarce, laborers bid against one another for employment, bringing down the price of labor. When masters compete for labor, the wages of labor increase. A situation in which the market price of labor is either significantly above or significantly below its natural price will be checked by actions of the laborers, who either devote themselves to a particular employment due to the high wages, or who turn their attention to other employments because wages are too low. In order for a consistent rise in wages over time, the revenue in a particular society must increase at a steady rate. Smith uses the colonial United States as an example, comparing it to England. In the colonies, he writes, revenue is greater than in England, but the wages are lower, because there is constant competition among workers. However, in the colonies, where there is an influx of capital that is equal to or greater than the rate at which the amount of labor increases, laborers are not involved in competition. Therefore, wages are relatively high. Growth keeps wages high. In a stagnant economy, even a wealthy one, the lowest classes will be desperately poor.
Of the profits of stock
The profits of stock are determined by the competition among merchants, masters, or those who invest their money in a particular trade. When a large amount of stock is turned toward a particular trade, the competition increases among those who direct their stock there, and profits fall. The profits of stock have an inversely proportional relationship to wages, which rise as the profits of stock fall.
Smith explains that it is difficult to measure or judge the profits of stock over time. He considers interest rates to be a good measure, since interest is paid with the profits of stock. In general, high interest rates correspond to high profits of stock. However, Smith gives several examples of situations in which this general theme is complicated by a high proportion of capitalists in a particular society. This phenomenon may lead to the coexistence of high profits of stock and high wages.
Of wages and profit in the different employments of labor and stock
Smith begins here by arguing that the advantages and disadvantages of various employments of labor and stock are, within a certain geographical area, either equal or tending toward equality. This is because people change how they employ their labor or their stock as advantages arise, thereby producing an overall equality.
There are certain inequalities that arise from the nature of an employment itself, namely the agreeableness or disagreeableness of the work; the level of expense and difficulty involved in learning the role; the constancy or inconstancy of employment in the role; the amount of trust placed in those who perform the role; and the probability or improbability of success in the role. The monetary rewards associated with various forms of employment seek to even out these discrepancies—difficult, highly skilled, disagreeable employments are better rewarded than easy, agreeable, low-skilled employments, etc. Because these considerations have little effect on the profits of stock, it follows that, for a given geographical area, the rates of profit for different employments of stock should be more on a level than those of labor.
However, the equality of advantages and disadvantages of the employments of labor or stock in a particular neighborhood are based upon three factors, namely that the employments must be well-known and long-established in a particular neighborhood; they must be in their normal state (not effected by temporary highs or lows that are due to outside circumstances such as war, harvest-time, etc.); and they must be the principal or sole employments of those who occupy them.
Smith explains that there are circumstances in which this equality may be upset by “factions” or special interest groups such as trade unions, international bankers, or corporate unions, or by the imposition of government subsidies. These circumstances raise profits of some to unnaturally high levels, upsetting the natural wages associated with labor, and causing overall harmful disturbances in the economy.
Of the rent of land
Just as the tension between laborers and masters regulates wages and the profits of stock, so the tension between the tenant and the landowner determines the rent of the land. The landowner endeavors to leave the tenant with a sum of money that will only allow him to subsist, to keep up his tools and whatever else may be necessary for his work, and enough stock to bring his products to market. Any money that is over and above what is necessary for these basic needs is generally claimed by the landowner as rent. In some cases, ignorance of either the landowner or the tenant may push the rent either up or down—down when it is the landowner that is ignorant, and up when it is the tenant. Because the tenant has a better understanding of how productive the land is and what kinds of prices its produce might fetch, it is generally the landowner who will be in a state of ignorance.
Smith goes on to explain that often, the rent of land is based upon the potential productivity of the land, the burden of improving the land falling upon the tenant. He gives an example of land that is located near water that is unusually abundant in fish. Farmers renting this land are charged not according to what they can make from the land, but what they can make from the land and the water combined. In this way, the rent of the land is always a monopoly, based not on what the landowner might have spent upon improving the land, neither what he can afford, but rather what the tenant can afford to pay.
In this section, Smith explains how the concept of supply and demand, explained in relations to commodity pricing in the last section, effectively extends to all of the factors of production. The factors of production, according to Smith, consist in labor, stock (or capital) and the space on which to work, or land. These three factors are inter-related and interdependent, and fluctuations in one realm cause repercussions in another. This is precisely Smith's innovation. Previously, it had been believed that the phenomena of production, valuation, and distribution all occurred relatively independently, and were determined more or less arbitrarily. Smith debunked this idea, asserting instead that the factors were inter-related. The latter portion of Book One endeavors to describe these complex relationships.
In general, Smith argues, the market is self-regulating. Without interference, the market is always tending toward equilibrium. This idea is extremely important when he describes the forces that move the factors of production. However, this is the the first time in the work where Smith provides concrete details about how government regulation interferes with and disrupts this balance. Wages, Smith points out, are best regulated by supply and demand, but are often influenced by politics. Smith observes that people of the same trade, acting on self-interest, are motivated to erect barriers to entry, in order to drive up wages. This, in turn, hinders supply and demand by keeping people out of a particular trade when their service is in demand. This tendency, on the part of employees that are seeking to keep their wages unnaturally high, is natural enough. However, when the government steps in and aids the process, as it does when it establishes a public register of people involved in a particular trade, for example, these harmful tendencies receive the infrastructure needed to become a force that negatively impacts the economy.
Smith also expresses criticism of several social actors with specific roles in the economic system. He especially criticizes employers, because of what he sees as an unfair advantage that they have over employees. Their superior economic position puts them in a more comfortable starting position when opportunities arise for negotiation with employees. Employers can use their comfortable position to coerce. He seems to criticize the overwhelming negativity toward labor unions, pointing out that the cooperation of employers, by contrast, is implicit. He considers the situation imbalanced, to say the least.
Smith also expresses criticism of landowners, pointing out that their starting position allows them to monopolize the income of their tenants, demanding as much as they can. This seems unfair to Smith because the landowners have invested no special effort to earn this “monopoly price." They simply happen to own the land. Smith's criticism of landowners in particular can be seen as part of a wider criticism of the system of primogeniture, which runs throughout the work. Landowners, in Smith's era, were primarily inheritors. Smith goes on to point out that wealthy merchants, encouraged by the existence of a landed noble class, desired to purchase land in order to demonstrate their wealth, which further drove up land prices. Smith seems opposed to the idea that a system of income-generation that was based neither on industriousness nor merit, but chance, could be upheld and even celebrated through emulation. Smith will go on to criticize the system of primogeniture more concretely later in the work.
Smith also criticizes the vested interests and distortions that affect the stock. Stock, or what one would today call capital, can be both fixed and circulating. He explains how government regulation of interest rates is either completely ineffectual and redundant, or stifles the ability and the desire of those endowed with stock to lend it to those who seek to employ it in new endeavors. Because the relationship of interest rates to the employment of stock is so complicated, the market should be left to itself.
The most important theme in this section, and one that will remain important throughout the work, is the idea that the market, when left to itself and not meddled in by government regulations, possesses the forces that help it to self-regulate. Not only are all of the parts of the market interrelated, their interactions are automatic. Good are produced and exchanged, and resources are distributed with the best possible efficiency, in a process that occurs naturally and on its own.
CONSTITUTIONAL RIGHTS FOUNDATION
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Spring 2007 (Volume 23, No. 1)
Free Markets and Antitrust Law
Adam Smith and The Wealth of Nations | Progressives and the Era of Trustbusting | The Development of Antitrust Enforcement | Media Mergers and the Public Interest
Adam Smith and The Wealth of Nations
As the American Revolution began, a Scottish philosopher started his own economic revolution. In 1776, Adam Smith published The Wealth of Nations, probably the most influential book on market economics ever written.
Born in 1723, Adam Smith was the son of a customs official in Kirkcaldy, Scotland. At 14, he entered the University of Glasgow. After graduating, he attended Oxford in England and studied philosophy.
Smith became a professor of philosophy at Glasgow in 1751. He actively took part in Glasgow debating societies and often argued for free trade.
In 1759, Smith published The Theory of Moral Sentiments. His book looked at human nature and ethics. At the beginning of the book, he stated that all people had the capacity to care about others. He pointed out that no matter how selfish a man might be,
. . . there are evidently some principles in his nature, which interest him in the fortune of others, and render their happiness necessary to him, though he derives nothing from it except the pleasure of seeing it.
But Smith also believed that people often acted in their self-interest, especially in economic matters. He contended, however, that this was not bad. He concluded that self-seeking individuals were "led by an invisible hand" that caused them to unintentionally act in ways that still benefited society.
In 1763, Smith quit his professorship at Glasgow and tutored the stepson of Charles Townshend, who later became Britain’s treasury minister in the years leading up to the American Revolution. Smith traveled to Paris with his student and met Voltaire and other philosophers involved in the French Enlightenment.
Smith also met the leading French economist, Francois Quesnay. Quesnay had devised a system called "Physiocracy," which he believed explained the source of national wealth. Quesnay took issue with the popular belief, known as mercantilism, that a nation’s wealth was its hoard of gold or silver. He believed a nation’s wealth came from its farm produce, which circulated throughout the land, nourishing everyone. Quesnay’s innovative idea prompted Smith to begin to write his own book on economics.
In 1766, Smith moved to London. He worked as a researcher for Charles Townshend, who was then in charge of Britain’s finances. Townshend had to deal with the huge national debt that resulted from the Seven Years’ War. This war enabled Britain to seize all of French North America. Townshend wanted the American colonists to help pay down the war debt through such measures as a tax on tea.
Smith researched Britain’s credit and debt along with the history of colonization by ancient Rome. He also became acquainted with leading political figures such as Benjamin Franklin and Edmund Burke (an important British political writer and leader).
The following year, Smith returned home to Scotland to finish his book, a task that took him nine more years. During this period, he visited London several times and witnessed debates in Parliament on the growing American resistance to British rule.
Finally, in March 1776, Smith published An Inquiry Into the Nature and Causes of the Wealth of Nations. This massive work of almost 1,000 pages was based on his exhaustive research and personal observations. Smith attacked government intervention in the economy and provided a blueprint for free markets and free trade. These two principles eventually would become the hallmarks of modern capitalism.
"An Obvious and Simple System of Natural Liberty"
When Adam Smith published his Wealth of Nations in 1776, Britain was just beginning to enter the Industrial Revolution. The first cotton-spinning factory had opened only a few years earlier. Increasingly, workers labored for pennies a day in factories and mines. Most employers believed that to get the poor classes to work, their wages had to be low, just enough to keep them from starving.
Smith began his book with a radical definition of "national wealth." He rejected the old mercantilist definition of acquiring gold and silver. Nor did he fully accept the Physiocrat view that wealth consisted solely of the produce of a nation’s farms. Instead, Smith proposed that the wealth of a nation consisted of both farm output and manufactured goods along with the labor it took to produce them. To increase its wealth, Smith argued, a nation needed to expand its economic production. How could a nation do this? Smith thought the key was to encourage the division of labor.
Smith argued that workers could produce more if they specialized. He gave the example of a pin factory based on his real-life observations. One worker who did all the operations necessary to make a single pin, he said, could produce no more than 20 in one day. Ten workers could make 200 pins this way. If, however, the 10 workers each specialized in one or two of the pin-making operations—from drawing the wire to putting the finished pin on a paper card—they would work more efficiently. Smith estimated that these 10 workers could produce 4,800 pins per worker or 48,000 altogether in a day.
Smith argued that if all production could be specialized like the pin factory, workers could produce more of everything. Because humans naturally trade with one another, Smith reasoned, those involved in making one product will exchange it (or the wages they earn) for the goods produced by other workers. Thus, Smith concluded, "a great plenty diffuses itself through all the different ranks of the society."
Smith did not just present a theory about increasing production and the wealth of a nation. He worked out exactly how this would occur by describing what he called the "free market mechanism." (See box.)
Adam Smith described free markets as "an obvious and simple system of natural liberty." He did not favor the landowner, the factory owner, or the worker, but rather all of society. He saw, however, self-defeating forces at work, preventing the full operation of the free market and undermining the wealth of all nations.
Smith’s Attack on Mercantilism
In the 18th century, European nations practiced an economic system known as "mercantilism." Each nation’s goal was to increase exports to its colonies and other nations, limit imports from them, and end up with a "favorable balance of trade." A nation that exported more than it imported demanded the difference in gold and silver.
The mercantilist nations believed that the more gold and silver they acquired, the more wealth they possessed. Smith believed that this economic policy was foolish and actually limited the potential for "real wealth," which he defined as "the annual produce of the land and labor of the society."
European mercantilism depended on a web of laws, subsidies, special economic privileges, and government-licensed monopolies designed to benefit specific manufacturers and merchants. This system, however, inflated prices, hindered economic growth, limited trade, and kept the masses of people impoverished. Smith argued that the free-market system along with free trade would produce true national wealth, benefiting all social classes, not just the privileged few.
In a major section of The Wealth of Nations, Smith attacked mercantilist trade practices. He insisted that what enriched European nations was not importing gold and silver, but opening up new free-trade markets in the world. This trade, he wrote, further stimulated the division of labor, expanded the production of trade goods, and increased "the real revenue and wealth" of all.
Smith criticized how the British Parliament had passed laws that crippled free trade and hindered the expansion of national wealth. These laws imposed high import duties, gave subsidies to favored companies, and granted monopolies to powerful special interests like the East India Company.
These laws harmed society by limiting competition and keeping prices high. Such measures, Smith wrote, were "extorted from our legislature" and "written in blood" since they served the interest of only a small class of privileged manufacturers and merchants.
Smith reserved his greatest criticism for the British colonial empire. He concluded it was "hurtful to the general interest of society." He focused especially on trade restrictions placed on the colonies in America.
Smith opposed mercantilist policies that required Americans to export certain products like fur pelts only to England. The Americans also had to ship their exports on British ships. Regulations prohibited transporting woolen products from one colony to another. Laws made it illegal for Americans to operate steel-making furnaces. Government-licensed monopolies like the East India Company held the exclusive right to sell goods like tea to the Americans.
According to Smith, these and hundreds of other restrictions benefited British special interests. But they slowed production and international trade, the sources of a nation’s "real wealth." To Smith, the mercantilist system was self-defeating and resulted from "the monopolizing spirit of merchants and manufacturers." Their greed flowed from "an interest to deceive and even oppress the public."
Smith concluded that to achieve economic growth and social betterment, Britain should sweep away its network of government economic privileges and restrictions. Let the "free market mechanism" operate on its own without government intervention, Smith advised.
Adam Smith and the Role of Government
Adam Smith advocated a limited role for government. But he recognized significant areas where only it could act effectively.
Smith saw the first duty of government was to protect the nation from invasion. He argued that a permanent military force, rather than citizen militias, was necessary to defend any advanced society. Next, he supported an independent court system and administration of justice to control crime and protect property.
Smith favored "public works" to create and maintain an infrastructure to promote the free flow of commerce. These works included such things as roads, bridges, canals, harbors, and a postal system that profit-seeking individuals may not be able to efficiently build and operate.
Adam Smith’s "Free Market Mechanism"
The following is a simplified version of the economic system Adam Smith believed would emerge once governments ended their oppressive mercantilist policies.
1. A man builds a cloth-making factory, hires workers, and divides their labor into many specialized operations. The factory owner is motivated by self-interest, profit, maybe even greed.
2. Others, however, are also building factories to make and sell cloth. They all have to compete for the money of the buyers whose self- interest is to buy cloth at the best price.
3. Buyers bid up the price of the cloth when the supply of cloth is low and their demand for it is high. But when there is an oversupply, the buyers can pick and choose and refuse to purchase high-priced cloth. The factory owners then have to reduce their prices to attract more buyers. Economists call this the "law of supply and demand."
4. Additional innovative divisions of labor, maybe brought on by new machinery, motivate others to invest in more factories. But they must compete to hire more workers. The "law of supply and demand" applies here, too, and wages go up.
5. Higher wages lengthen the lives of workers and their children. The population grows, which increases the supply of workers. Wages then stop rising. But, soon another division of labor wave occurs, producing more economic growth and the need for even more workers. Wages go up again. The cycle repeats itself.
6. Families now can afford to buy (demand) more cloth and lots of other products. The factory owners make more profits. Everybody wins and society as a whole improves.
7. The cloth factory owner never intended to improve society; he just wanted to make money for himself. But his self-interest, as if "led by an invisible hand," resulted in the betterment of all. As Adam Smith himself put it, "By pursuing his own interest he frequently promotes that of the society more effectively than when he really intends to promote it."
Thus, remarkably for the time, Smith advocated the education of all youth. He believed there was little difference in intelligence between the poor and the rich. Only the social conditions of the poor held them in ignorance, he concluded. He called for a "little school" in every district, supported by public taxes and small parent fees. "An instructed and intelligent people," Smith wrote, "are always more decent and orderly than an ignorant and stupid one."
Smith wrote that paying taxes was "a badge, not of slavery, but of liberty." By this, he meant that a taxpayer was an owner of property rather than the property of a master. Furthermore, Smith was an advocate of setting tax rates according to one’s ability to pay. Taxpayers, he argued, should pay "in proportion to the revenue which they respectively enjoy under the protection of the state."
Smith believed in taxing property, profits, business transactions, and wages. But these taxes should be as low as possible to meet the public needs of the country. He also thought they should not be arbitrary, uncertain, or unclear in the law. Nor should they require home inspections that intruded into the private lives of individuals.
Smith criticized a large public debt, which, he observed, resulted mainly from wars. He believed that the mercantilists encouraged wars so that they could lend money at high interest to the government and exploit conquered lands. Smith viewed wars as "waste and extravagance," producing a "perpetual" public debt that diverted money away from investment in new enterprises and economic growth. Public debt, Smith concluded, "has gradually enfeebled every state which has adopted it."
Applying The Wealth of Nations to the World
Recognizing that the American colonists were victims of Britain’s mercantile policies, Smith advised Parliament to let the American colonies peacefully go their own way. For the sake of maintaining a monopoly of trade, he argued, the colonies had cost the British people much more than they had gained. In the case of the Americans, Smith declared that denying "a great people" the freedom to pursue their own economic destiny was "a manifest violation of the most sacred rights of mankind." He urged Britain’s rulers to awaken from their imaginary and wasteful "golden dream" of empire.
We know Adam Smith today as the father of laissez faire ("to leave alone") economics. This is the idea that government should leave the economy alone and not interfere with the "natural course" of free markets and free trade. But he was mainly thinking about the government granting special economic privileges to powerful manufacturers and merchants. To Smith, these mercantile monopolists and their allies in Parliament were the great enemies of his "free market mechanism."
In The Wealth of Nations, Smith only glimpsed the impact of the Industrial Revolution in Britain and later the United States. He did not foresee the development of huge corporate monopolies that suppressed competition without the need for government licenses. He did not imagine the brutal working and living conditions suffered by masses of men, women, and children. Thus, he never fully addressed the issue of whether government should intervene in the economy to prohibit such things as corporate monopolies and child labor.
Adam Smith did not write any other books. He died in 1790, well regarded by all who knew him. By this time, the British prime minister, William Pitt "The Younger," was adopting Smith’s economic principles as government policy. Thus began the revolution of modern free market capitalism that dominates world economics today.
For Discussion and Writing
1. Explain Adam Smith’s ideas about human self-interest and the "invisible hand." Do you agree with him? Explain.
2. What did Adam Smith mean by the phrase "wealth of nations"?
3. Compare Adam Smith’s "free market mechanism" with mercantilism.
4. What economic problems was Smith addressing in his day? What economic problems face modern society?
For Further Reading
Heilbroner, Robert L. The Worldly Philosophers, The Lives, Times, and Ideas of the Great Economic Thinkers. rev. 7th ed. New York: Simon & Schuster, 1999.
Smith, Adam. An Inquiry Into the Nature and Causes of the Wealth of Nations. Great Books of the Western World, vol. 39. Chicago, Ill.: Encyclopaedia Britannica, Inc., 1952.
A C T I V I T Y
Adam Smith and Government Interventions in the Economy
1. Do you think Adam Smith would agree or disagree with the following government interventions in the economy today?
• anti-monopoly laws
• child-labor laws
• minimum-wage laws
• inheritance taxes
• Social Security
• North Atlantic Free Trade Association (NAFTA)
2. Form six small groups to each investigate one of the above interventions.
3. Use your textbook and school library resources to find out about the intervention you are investigating. Use quotes and other evidence from the article to decide what position Adam Smith would likely take on the intervention.
4. Each group should then report to the class its conclusion along with supporting evidence.