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Adam
Smith and the Wealth of Nations
Adam
Smith (1723-1790) Adam Smith is frequently called the father of modern economics.
His best known work is An Inquiry into the Nature and Causes of the
Wealth of Nations, which has been shortened by most people to Wealth of
Nations, first published in 1776 (an easy date to remember).
It is frequently cited as one of the three most quoted and least read books in modern times. (The other two are Alexis
Tocqueville’s Democracy in America and the Bible.)
As part of your assignment this week I’ve asked you to read some Smith
so that you can appreciate him as an author (Warning! Reading this can induce
drowsiness. Don’t do this while operating heavy equipment).
His work is amazing because of its breadth.
He seems to have considered almost all the aspects of the market system
and how it works. To help you put his work in some context you should know a few
things. It was written in England
(he was a Scotsman) at the end of the period in European history known as
Mercantilism (1500 to 1750 or so). At this time, there was robust growth in what
we now call the middle class. Previously
there were three classes in medieval society the nobility, the clergy and the
peasantry. With the rise of the
middle class we have a fairly wealthy group of people that was technically part
of the peasantry but clearly much wealthier than most peasants and many of the
nobility. (This is the period Jane
Austin wrote about.) This new class
of people wanted to brake away from the restraints of the old social and
political system. The market system
was coming maturing and the new middle class benefited the most from it.
There were many who advocated letting markets work free of government
regulation the most famous being the Physiocrats of France who invented the
phrase laissez-faire, or let it be. This
phrase has become almost synonymous with Smith’s position on government
intervention. He thought that
government should play a very limited role in regulating markets.
H Without government guiding them would markets meet the essential
needs of society? Smith’s answer is very clear, and basically it goes like this:
1.
People are self-interested.
2.
People naturally trade as a means of getting what they want.
3.
In a “free” markets people will not exchange unless both
gain. 4.
Self interest will cause individuals to buy what they want and produce
goods that others want. 5.
Prices tell buyers and sellers the wants and needs of society. 6.
People will unintentionally meet society’s needs as they pursue their
self interest without government intervention. You need to keep in mind that Smith was part of the
philosophical movement called Enlightenment.
A basic tenant of Enlightenment philosophers was that there were laws
that God had set in place when the universe was created (natural laws).
They maintained that these laws are knowable by humans and we should
strive to understand them. Smith set about trying to understand the natural laws that
make economic societies successful. Smith (who was a Christian) was troubled by the fact that people
appear to be selfish, a very un-Christian characteristic.
Why would God create selfish people?
Smith deduced that this characteristic must somehow serve the society as
a whole. We now refer to this as a harmony
of interests: when people
follow their self interest they inadvertently fill society’s interest. The way
that Smith put it is that people, in the act of following their self-interest,
end up serving the social interest, as though they were being guided by an invisible
hand. This is a very important idea.
Most of us like to think someone should be in charge in order to make
sure that society’s needs are being served.
The mercantilist approach was based just on that kind of argument.
Businesses needed to be regulated and monopolies had to be granted, to
make sure that nations became prosperous. To
just let everyone do his or her own thing seemed to be inviting chaos, mired in
greed and selfishness. But Smith
argued that the market was self-regulating, led as if by an invisible hand to
meet society’s needs. For example, let’s say that the members of society would like
more wine and less mutton. As
people bought more wine and less mutton the price of wine would increase and the
price of mutton would decrease. Self-interested
wine makers would plant more grapes and hire more workers while self-interested
sheep ranchers would breed fewer sheep and put their land into more profitable
areas of production. So by allowing
individuals to follow their self-interest society ends up with what it wants.
There ends up being a Harmony of
Interest between individuals and society. According to Smith, this harmony doesn’t come about because
businesses are concerned about meeting society’s needs.
Indeed, Smith was no great believer in the nobility of business owners.
In fact, he was rather disdainful of their character, referring to them
as “mean and rapacious.” He
wrote that when they gathered together the results were always bad for the
consumer and thus for society as a whole. The
key for him was competition. What
would keep the baker from charging too much for that essential loaf of bread?
Other bakers. Competition keeps the avarice nature of individuals from
exploiting society. Specialization A second important fact that Smith stressed (in fact he starts
his book with this observation) was that specialization is the key to the wealth
of nations. When we specialize,
Smith argued, we divide up a task into smaller components. As individuals perform these sub-tasks it results in three
benefits. First, we don’t waste
time moving from task to task. Second,
repeating one task over and over allows one to gain a great deal of skill in one
small area. Finally, as these tasks
get smaller (narrower), it is easier to develop a machine that can help do the
task faster. Here he cited a now
famous observation of how a pin factory works and how it is so much more
effective than an individual pin maker. What should one specialize in?
According to Smith we are endowed with small difference that gives us an absolute
advantage. In other words we
are the lowest cost producer. Late
another classical economist (David Ricardo) will expand on this idea, calling it
comparative advantage.
Most economists still accept the idea of comparative advantage which
states that we are all endowed with differences and that if resources specialize
in their comparative advantage we will have lower opportunity
costs. This is what you
discovered in the three person economy. Whether
we specialize in our absolute or comparative advantage we increase our total
ability to produce. The drawback of this is that as individuals become more
specialized, the more they need to trade with other people to meet their daily
needs. Or they become more interdependent.
Go back to the island, in order to fish one needs a net.
Not all fishermen are good at making nets.
Thus, the task of fishing can be divided into fishing and making nets. If someone specializes in making nets they will become very
good at it, in fact better than anyone else.
If you allow this to happen, your society will catch a lot more fish
(wealth). But, while the best net
maker is doing his thing and the best fishermen go fishing at the end of the
day, that net maker must be able to get some food.
Markets really help that net maker do this. In fact, they reward the net maker by giving him more fish
than if he fished himself. All of
society is better off. We’ve got
more and better nets, leading to more fish. All of this is done based on the self interest of the
individual. But they need to be
free to pursue their interest. Indeed,
Smith pointed out that this specialization and capital accumulation (remember a
net is capital) would cause the nation to become wealthy. This all can be done without government intervention.
Wow, looks like the invisible hand strikes again! Conclusion Much of what Smith wrote about is still the core of what
economists study. Here, we have
only been able to skim over the surface of what he wrote. Those who tend to agree with his conclusions are now known as
neoclassical economists.
They have some important differences with Smith’s analysis, but not
with his basic conclusion: markets work best when they are unencumbered with
governmental regulation. I think
you should be able to see which political party is more likely to agree with his
conclusions. Whether you agree with
his conclusions or not, you should appreciate the impact of his work. His ideas changed the way that many people view how the world
works. |