History of Economic Thought 101: Adam Smith

Foreword

This series of articles aims to provide a brief overview of the evolution of Economic thought through the lens of some of the key contributors to the discipline. Using Adam Smith’s Wealth of Nations as a jumping-off point, through John Maynard Keynes’ General Theory, Karl Marx’s Das Kapital, and the more recent contributions of Joseph Schumpeter and Milton Friedman. The series will conclude with an evaluation of modern-day Economic consensus.

The History of Economic Thought series consists of 6 main articles:

1. History of Economic Thought: Adam Smith

2. History of Economic Thought: John Maynard Keynes

3. History of Economic Thought: Karl Marx

4. History of Economic Thought: Joseph Schumpeter

5. History of Economic Thought: Milton Friedman

6. History of Economic Thought: Modern Day

History of Economic Thought: Adam Smith

Adam Smith, The Father of Modern Economics

Known as the “Father of Modern Economics”, Adam Smith was an 18th century Scottish Moral Philosopher and Political Economist. The work of his, titled: An Inquiry into the Nature and Causes of the Wealth of Nations is widely regarded as the foundational stone from which the entire field of contemporary Economics has developed.

Figure 1 Adam Smith, The Father of Economics.

Mercantilism and the Status Quo

To begin to understand Smith’s writings and overarching theory, it’s important to understand the context in which his work began. His defining work The Wealth of Nations was first published in 1776. The prevailing economic system in operation at this point was known as Mercantilism, which can be described as “economic nationalism for the purpose of building a wealthy and powerful state.” (LaHaye, 2008). Heavily set upon the premise of maintaining the existing feudal societal order, Mercantilism assumed that the level of wealth in existence is ultimately finite and purported that trade by default creates winners and losers rather than mutual gain. To be successful under a Mercantile system, a country must maintain a positive trade balance; that is; its exports must exceed its imports (Britannica, 2020). Mercantilism advocated for maintaining of the precious metals' stocks, such as gold and silver, and for the lobbying of tariffs and other anti-trade mechanisms on countries with whom a negative balance of trade existed (LaHaye, 2008).

The Rationale for Free Trade

Smith laid waste to the merits of this theory throughout his work The Wealth of Nations, determining that the policies in existence under the prevailing Mercantile system, which focused on limiting foreign trade, were foolhardy and needed an urgent overhaul. Rather than trade being a zero-sum game, it was according to Smith, in fact, a condition that could prove mutually beneficial to all parties involved.

Nothing, however, can be more absurd than this whole doctrine of the balance of trade, upon which, not only these restraints, but almost all the other regulations of commerce are founded. When two places trade with one another, this doctrine supposes that, if the balance be even, neither of them either loses or gains; but if it leans in any degree to one side, that one of them loses and the other gains in proportion to its declension from the exact equilibrium. Both suppositions are false. A trade which is forced by means of bounties and monopolies may be and commonly is disadvantageous to the country in whose favour it is meant to be established. (Smith, 1776, p. 376)

One of the hallmarks of contemporary Free Market Economics is the notion that Foreign trade should remain uninhibited. Though a strong, free trade advocate, “…trade which, without force or constraint, is naturally and regularly carried on between any two places is always advantageous, though not always equally so, to both” (Smith, 1776, p. 376), Smith acknowledged that trade does not by default benefit all parties equally. “If the balance be even, and if the trade between the two places consist altogether in the exchange of their native commodities, they will, upon most occasions, not only both gain, but they will gain equally, or very near equally” (Smith, 1776, p. 376)

While the vast majority of modern economists are heavily in favour of free trade and against the tenets of Protectionism – “policy of protecting domestic industries against foreign competition by means of tariffs, subsidies, import quotas, or other restrictions or handicaps placed on the imports of foreign competitors” (Britannica 2020). There is a lively debate as to whether unimpeded free trade is as mutually beneficial to all parties as we have necessarily been led to believe (Carrol and Hur 2019).

Figure 2 Smith’s signature tome “An Inquiry Into the Nature and Causes of The Wealth of Nations”, the ideas detailed within still form the basis of Economic thinking to this day

Division and Specialisation of Labour

In The Wealth of Nations, Smith advocates strongly for the division and specialisation of labour, “In every improved society, the farmer is generally nothing but a farmer; the manufacturer, nothing but a manufacturer.” (Smith, 1776, p. 9). According to Smith, through increased specialisation, workers could increase their level of skill. Thus in turn their level of productivity would be: “the improvement of the dexterity of the workman necessarily increases the quantity of the work he can perform, and the division of labour, by reducing every man’s business to some one simple operation, and by making this operation the sole employment of his life, necessarily increased very much the dexterity of the workman.” (Smith, 1776, p. 11)

The Importance of Capital Accumulation and Investment

Smith believed that the accumulation of capital alongside the division and specialisation of labour were the true forces of advancement in an economy. “As the division of labour advances, therefore, in order to give constant employment to an equal number of workmen, an equal stock of provisions, and a greater stock of materials and tools than what would have been necessary in a ruder state of things, must be accumulated beforehand” (Smith, 1776, p. 212). His theory ran that if workers only possessed enough stock (or capital) to reach a level of bare sufficiency, they would produce and innovate sparingly. If they were to possess an excess of stock (here to mean capital), they would be able to produce more, allowing them to focus on the generation of revenue, which could be invested in the further accumulation of stock. Leading to a self-sustaining cycle of economic growth (Smith, 1776).

Smith was a champion of Productivity and responsible future-oriented capital resource allocation. He held contempt for those who would invest their funds in a fashion that was not geared toward increased future output.

When a man of fortune spends his revenue chiefly in hospitality, he shares the greater part of it with his friends and companions; but when he employs it in purchasing such durable commodities, he often spends the whole upon his own person, and gives nothing to anybody without an equivalent. The latter species of expense, therefore, especially when directed towards frivolous objects, the little ornaments of dress and furniture, jewels, trinkets, gewgaws, frequently indicates, not only a trifling, but a base and selfish disposition. (Smith, 1776, p. 272)

Anti-Government? More Pro-Competition

While often seen as anti-government in terms of free-market functioning, it may be more appropriate to say that Smith was anti-monopoly, and by extension pro-freedom of competition.

To widen the market may frequently be agreeable enough to the interest of the public; but to narrow the competition must always be against it, and can serve only to enable the dealers, by raising their profits above what they naturally would be, to levy, for their own benefit, an absurd tax upon the rest of their fellow-citizens. (Smith, 1776, p. 200)

He wasn’t so much anti-government as anti the use of Government powers to maintain monopolised market practices and the prioritisation of the status quo.

Figure 3: Adam Smith, regarded to this day as “The Father of Economics”

The Invisible Hand

No discussion of Smith would be replete without mentioning his most famous observation, the “Invisible Hand” that guides market-based outcomes. Though in his original commentary, Smith’s depiction of the Invisible Hand was in fact quite different than how it has been commonly portrayed in a wider societal context, it is taken in the modern-day as a metaphor for how free markets function. The idea is that “beneficial social and economic outcomes may arise from the accumulated self-interested actions of individuals, none of whom intends to bring about such outcomes” (Britannica). That everybody, by acting in their own self-interest, may in fact, bring about a socially optimal outcome. A supposition that prompts debate as much now as ever.

Smith as a Social Thinker

For a man known as “The Father of Free-Market Economics” it may surprise some to know that Smith was in fact, a far more nuanced and socially conscious thinker than the perceived conventions of such a title would cast him as. He retained a strong distaste for the prevailing owner class “All for ourselves and nothing for other people, seems, in every age of the world, to have been the vile maxim of the masters of mankind.” (Smith, 1776, p. 321). He abhorred poverty, and the extent to which it was allowed to prevail under the feudal-based system of his time, “But poverty, though it does not prevent the generation, is extremely unfavourable to the rearing of children. The tender plant is produced, but in so cold a soil and so severe a climate, soon withers and dies” (Smith, 1776, p. 66).

The desire of the ruling class to maintain the existing status quo was for him crystallised in what is commonly termed The Iron law of wages, “which stated that all attempts to improve the real income of workers were futile and that wages perforce would remain near the subsistence level” (Spengler, J. J. 2021). Or as Smith himself put it; “Masters are always and everywhere in a sort of tacit, but constant and uniform combination, not to raise the wages of labour above their actual rate” (Smith, 1776, p. 57),

One may be forgiven at times for conflating some of Smith’s concerns and observations with those later expressed by fellow Philosopher and Economist Karl Marx. Strong parallels between the respective positions of both great social thinkers can be seen in the following passage, which focuses on the plight of the common man vs. ruling class, or as Marx would memorably later put it, the Proletariat and the Bourgeoisie.

What are the common wages of labour, depends everywhere upon the contract usually made between those two parties, whose interests are by no means the same. The workmen desire to get as much, the masters to give as little as possible. The former are disposed to combine in order to raise, the latter in order to lower the wages of labour. (Smith, 1776, p. 56).

Smith indeed retained awareness and pronounced sympathy for the plight of the common man. Here elaborating on the magnitude of the difficulty faced by the working class in attempting to improve their station.

The masters, being fewer in number, can combine much more easily; and the law, besides, authorizes, or at least does not prohibit their combinations, while it prohibits those of the workmen. We have no acts of parliament against combining to lower the price of work, but many against combining to raise it. In all such disputes, the masters can hold out much longer. (Smith, 1776, p. 56).

Smith also took a rather glib view of the existing ruling or upper class, particularly those whom he would dub idle, “That portion of his revenue which a rich man annually spends is in most cases consumed by idle guests and menial servants, who leave nothing behind them in return for their consumption.” (Smith, 1776, p. 264)

Legacy and Conclusion

Adam Smith’s legacy as “The Father of Modern Economics” is firmly entrenched in the fields of social, political and economic study. While he is regarded as the forebearer of modern free-market economics, he was a much more broad and socially aware thinker than many might think on the basis of this caricature. From the plight of the common man, to the accumulation of capital stock, the merits of free-trade and the efficiency of markets guided by “an Invisible Hand”. Smith’s ideas continue to provoke admiration and debate right up to the present day. They are in many ways as vital now as when they were first introduced well over 200 years ago.

References:

La Haye L. (2008) Mercantilism. In: Palgrave Macmillan (eds) The New Palgrave Dictionary of Economics. Palgrave Macmillan, London. Retrieved from https://doi.org/10.1057/978-1-349-95121-5_838-2

https://link.springer.com/referenceworkentry/10.1057/978-1-349-95121-5_838-2

Smith, A., (1776) An Inquiry into the Nature and Causes of the Wealth of Nations — Books I, II, III, IV and V, Edited by Soares S. M., MetaLibri, 2007, v.1.0p. Retrieved from

https://www.ibiblio.org/ml/libri/s/SmithA_WealthNations_p.pdf#

Blinder, A. S. Free Trade, (2002) (Econlib.org)

https://www.econlib.org/library/Enc1/FreeTrade.html

Britannica, T. Editors of Encyclopaedia (2020, May 13). Mercantilism. Encyclopedia Britannica. Retrieved from

https://www.britannica.com/topic/mercantilism

Smith, A. (1790) The Theory of Moral Sentiments, Sixth Edition, originally published 1759, Edited by Soares. S. M. MetaLibri, 2005, v1.0p. Retrieved from

http://www.ibiblio.org/ml/libri/s/SmithA_MoralSentiments_p.pdf

Heilbroner, R. L., Britannica, (2021, Dec). Economic Growth. Encyclopedia Britannica. Retrieved from

https://www.britannica.com/biography/Adam-Smith/Economic-growth

Britannica, T. Editors of Encyclopaedia (2020, May 15). Protectionism. Encyclopedia Britannica. Retrieved from

https://www.britannica.com/topic/protectionism

Carroll, D., Hur, S., (2019), The Winners and Losers from Trade. Economic Commentary, Number 2019-15 September30, 2019, Federal Reserve Bank of Cleveland. Retrieved from

https://www.clevelandfed.org/en/newsroom-and-events/publications/economic-commentary/2019-economic-commentaries/ec-201915-winners-and-losers-from-trade.aspx

Spengler, J. J. (2021, December 22). Iron Law of Wages. David Ricardo. Encyclopedia Britannica. Retrieved from

https://www.britannica.com/biography/David-Ricardo

Image Sources:

Figure 1: Etching created by Cadell and Davies (1811), John Horsburgh (1828) or R.C. Bell (1872), retrieved from https://www.library.hbs.edu/hc/collections/kress/kress_img/adam_smith2.htm

Figure 2: Author Adam Smith, Editor Tony Darnell (2018), The Wealth of Nations Hardcover, retrieved from Amazon.com https://www.amazon.com/Wealth-Nations-Adam-Smith/dp/1680920960

Figure 3. Unknown author - Created circa 1800. Portrait of the political economist and philosopher Adam Smith (1723-1790) by an unknown artist, which is known as the ‘Muir portrait’ after the family who once owned it. The portrait was probably painted posthumously, based on a medallion by James Tassie.

retrieved from

https://www.nationalgalleries.org/art-and-artists/3787/adam-smith-1723-1790-political-economist via https://en.wikipedia.org/wiki/Adam_Smith#/media/File:Adam_Smith_The_Muir_portrait.jpg