Alan Greenspan, the American Republican economist and former Chairman of the US Federal Reserve, said that the life of government-controlled economies “ended with the fall of the Berlin Wall in 1989 and the collapse of the Soviet Union” and that the free market was “the sole remaining effective paradigm for economic organisation”. If this is true, it places philosopher and political economist, Adam Smith, as the father of all modern economic thought and practice. But what did Smith propose, and do the words of a man writing hundreds of years ago in the Age of Enlightenment really still resonate with today’s global economy?
With any great philosophical text, time inevitably draws out myriad readings and interpretations. Adam Smith (1723-1790) was a Scottish philosopher and economist working in the Age of Enlightenment. One of his key works, the 1776 publication ‘Inquiry into the Nature and Causes of the Wealth of Nations’, was the first in-depth study of how industry and commerce in Europe worked, and as such is taken by many as the basis for all modern readings of free market economics. By all, it is meant that there has been much disagreement as to what Smith meant and that this has been the bedrock of furious debate for a long time: whilst some view it as a genuinely libertarian statement, others have used it as a platform to create their own charter of greed and exploitation.
Smith’s analysis of existing commercial practices – in which trading was a very insular and highly controlled affair – put the case for the adoption of a free (as opposed to highly regulated) market and the removal of restrictive tariffs. He proposed ground-breaking practical ideas on the division of labour within the production process (long before Henry Ford) and also explored the profound psychological notion (in that it was contrary to contemporary thought) that human self-interest can (if moderated by the natural inclination to altruism) lead to wider and deeper social benefits through the development of industry and commerce.
The chain of events that followed the publication of the ‘Wealth of Nations’ were critical in enabling the Industrial Revolution to take a firmer grip of Britain (setting it up as the world’s largest ever empire) and eventually most of the rest of the world, cultivating dramatic changes in agriculture, manufacturing, mining, transportation and technology. The effect of this period (between 1750 and 1850) of intense development and rapid progress had an inestimable effect on the social, economic and cultural life of millions.
As well as being the inspiration for Treasury Today’s own annual Adam Smith Awards for treasury best practice and innovation, Smith’s contribution to economics has seen him commemorated in bronze and stone in various locations around the world. There are various international economic think-tanks established in his name; and he became the first Scot ever to grace an English banknote (he is on the current £20 note, having replaced composer Sir Edward Elgar). He also features on the £50 note issued by the Bank of Scotland, making him the only individual to appear on two British notes concurrently.
Smith was born in Kirkcaldy, Scotland in 1723. He studied at Oxford and Glasgow Universities, and was appointed at the latter as professor of logic in 1751 and then as professor of moral philosophy. Here, in 1759, Smith published his ‘Theory of Moral Sentiments’ to great acclaim.
In 1764, Smith gave up his position in Glasgow to travel the Continent as a tutor to Henry Scott, a future Duke of Buccleuch, and his brother, spending three years in France. Whilst travelling, he associated with of a number of leading European intellectuals including Voltaire, Rousseau, Quesnay and Turgot.
When Smith returned to Kirkcaldy, he began work on his ‘Inquiry into the Nature and Causes of the Wealth of Nations’. This was published in 1776, the same year that he departed for London where he moved in an intellectual circle populated by the likes of Samuel Johnson (with whom he had a tempestuous association), David Garrick and Joshua Reynolds.
In 1778, Smith moved back to Scotland and was duly appointed commissioner of customs in Edinburgh (his father, who died before he was born, was a customs officer in Kirkcaldy). In 1783, he became a founding member of the Royal Society of Edinburgh, Scotland’s National Academy of Science and Letters. Smith died in Edinburgh on 17th July 1790.
Commerce before Smith
Before Smith, national wealth was seen purely in physical terms, represented by the amassing of gold and silver. Exporting goods added to the stockpile of precious metals and was encouraged through the use of subsidies.
However, importing goods would deplete the stock of precious metals and was therefore discouraged, principally by imposing stringent taxes on incoming goods. These conditions led to the establishment of fiercely guarded trade routes and frequent trade wars, both of which came at a high cost.
The protectionist mindset pervaded the domestic trade scene as well. Tradespeople were prevented from moving between towns and cities to ply their business because local manufacturers and merchants could petition the king for protective monopolies (again, at a cost).
One for all and all for one … unintentionally
Having laid the groundwork for themes such as rational self-interest in his ‘Theory of Moral Sentiments’ (in which he also espoused the Enlightened view that humans have a natural sympathy for other humans), Smith expanded the notion and concluded that such a condition, if applied to competitive commerce, could lead to improved economic benefit for society in general. This was counter-intuitive for many (then and now) but he explains it thus: “It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages.” (The Wealth of Nations, Book I, Chapter II, pp. 26-7, paragraph 12). Because trade benefits both sides of the import and export space (few would trade without personal benefit), Smith argued that it must increase prosperity for all. It followed that protectionism was counter-productive and that only by opening up trade flow could the right conditions for general prosperity be achieved.
“It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest.”
The Wealth of Nations, book I, chapter II, pp. 26-7, paragraph 12
He was not advocating a conscious descent into chaos or unbridled greed (as in the 1987 film, Wall Street, where the central character, Gordon Gekko, famously states that “greed … is good”). Instead, Smith argued that a natural order would be imposed on trade, regulating the move towards society’s unspoken goal of progressive improvement and fulfilment for all. The manifestation of natural order and harmony, unimpeded in a “well-governed society” (but, notably, without government intervention), is an unintentional by-product of self-interest and Smith likened it to being guided by an “invisible hand”.
Every individual, he wrote, “neither intends to promote the public interest, nor knows how much he is promoting it, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention”. (The Wealth of Nations, Book IV, Chapter II, pp. 456, paragraph 9).
The ‘Wealth of Nations’ also proposes another radical departure from the norm, with Smith turning his attention to contemporary production techniques. The current British £20 note shows a picture of a pin-making factory. Smith had spent some time analysing the handcrafted workings of this manufacturing business. He concluded that far greater efficiencies could be achieved if each major production process (18 in total) was divided into a set of simple tasks which would be performed by specialised workers. His recommendation is reported to have increased production 240-fold.
The kind of savings that could be made in most operations would leave the factory owners with a surplus that they could exchange with others (and thus add to the general health of the economy) or plough back into the business in the form of more efficient machinery. From which could be derived even greater surplus (contrary to Smith’s expectations, this gave rise to the Luddite movement – 19th Century English textile artisans who violently protested against the use of machinery to replace them with less-skilled, low-wage labourers, leaving them without work).
The specialisation of labour would extend to all means of production of a society in that (in today’s market) we have engineers, artists, administrators and so on, each offering certain skills, using them to create personal wealth in exchange for the output of the skills (and/or the means of production) that they do not have (it also informed the Marxist concept of alienation as many, mostly unskilled workers, lost sight of the purpose of their engagement with their jobs).
As Smith saw it, in a commercial society, each person becomes a trader of their own labour. As with all goods and services, rarity drives up cost because people will pay more for it. As profit from supply increases, so producers will invest more capital into production. If there is a glut, prices and profits will fall and so producers will shift their capital elsewhere. It is the basis of supply and demand, guiding industry to deliver the goods and services that society deems the most important (at a price that those who desire them deem acceptable, ie what the market will bear).
The process of specialisation extends to nations too, said Smith. He offered as an example the folly of trying to make wine in Scotland, when it can be done so much easier and cheaper in France. His point was that countries should stick to what they do best; exporting to countries that need those goods or services and importing what they can’t do themselves. A well-worn quote from ‘Wealth of Nations’ sums it up perfectly: “It is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than to buy … What is prudence in the conduct of every private family, can scarce be folly in that of a great kingdom.” (The Wealth of Nations, Book IV Chapter II, pp. 456-7, paragraphs 11-12).
Automatic for the people
Whether at an individual or national level, Smith saw the process as self-regulating and automatic. But he insisted that it can only work where there is healthy free trade and competition, and where the rules of fair play are observed by each player. As soon as monopolies, tax preferences, tariffs and other such controls and privileges are introduced by the authorities, the whole system becomes distorted or collapses because price and demand fail to reach their natural levels and one party or another will be disadvantaged.
A hundred years earlier, in 1651, English philosopher Thomas Hobbes had written (in ‘Leviathan’) that “the condition of man is a condition of war of everyone against everyone”. Hobbes here refers to a life in the raw, a condition without government. Hobbes was responsible for developing some of the fundamentals of European liberal thought, and notably promoted the idea of social contract theory in which people submit to the rule of law in exchange for the protection of the rest of their rights.
Smith argued that government interference in the free trade process was essential but that it must be limited to upholding the rules by which it could be sustained, in as much that property could be kept secure and contracts would be honoured (what he called “natural liberty”). For him, justice and the rule of law is a key part of the free trade process and so governments should stick to their core functions, which he lists as maintaining defence, keeping order, building infrastructure, promoting education, and of course, keeping the market economy open and free and resisting any action that could distort its natural progress.
“It is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than to buy … What is prudence in the conduct of every private family, can scarce be folly in that of a great kingdom.”
The Wealth of Nations, book IV, chapter II, pp. 456-7, paragraphs 11-12
On the matter of taxation, Smith argued strongly that where it has to be raised for the purposes of upholding government function, the rate paid should be in strict proportion to the ability of the individual to pay, with transparent rates for all. He also urged governments not to tax capital, which he saw as a key part of national productivity, and to avoid building up large debts which, he noted, draws capital away from future production.
Smith in the modern world
One of the most prominent modern-day followers of Adam Smith’s economic theory is Alan Greenspan, the American Republican economist. Greenspan served as Chairman of the US Federal Reserve from 1987 to 2006 and was similarly convinced that the economy works best with less government regulation. He cited the ‘Wealth of Nations’ as “one of the great achievements in human intellectual history”.
Greenspan commented that although Smith did not introduce the term laissez-faire economics (eg. don’t let government interfere), he did “identify the more general set of principles that brought conceptual clarity to the seeming chaos of market transactions”.
Greenspan was devoted to the life and works of Russian American philosopher and novelist, Ayn Rand. Rand created a philosophical system, which she called Objectivism, that basically stated reality exists separately from consciousness, and that direct connection to reality comes via sensory perception. Mankind, she wrote, “must live by the independent judgement of his own mind; that his highest moral purpose is the achievement of his own happiness … that each man must live as an end in himself and follow his own rational self-interest”.
Rand believed that the only social system that afforded respect for individual rights was that embodied in laissez-faire capitalism and that the proper functionaries of a government (police, army etc) existed solely to ensure the system and its players could carry on unhindered. Although some of these ideas resonate with Smith’s, a key difference is Rand’s insistence that altruism undermines the individual. As Maria Bustillos, writing for ‘The Awl’, commented: “The possibility that the unfettered egoism of guys like Stalin was the main problem with the Russian government, rather than too much altruism, escaped Rand entirely.”
Another torch bearer for Smith was former British Prime Minister, Margaret Thatcher. Apparently, she carried a copy of the ‘Wealth of Nations’ in her handbag (at 600 or so pages long, presumably there was little room for much else). In 1979, her Conservative government rose to power on a promise of lower taxes, smaller government and freer markets. In 1986, Thatcher’s close ally, US Republican President, Ronald Reagan (another Smithian devotee), said: “Our trade policy rests firmly on the foundation of free and open markets”. He added that “the freer the flow of world trade, the stronger the tides of human progress and peace among nations.” He did, somewhat hypocritically, adopt a harsh protectionist view when it came to imports from Japan and his Treasury Secretary, James Baker, claimed that Reagan had granted “more import relief to US industry than any of his predecessors in more than half a century”.
One outspoken critic of right wing readers (and practitioners) of the ‘Wealth of Nations’ is American academic, Noam Chomsky who commented in his 1995 book, ‘Class Warfare’, that “what we would call capitalism, he despised”.
His only research on the subject, he stated, was actually reading the whole book. Chomsky believes that most people just read the first paragraph where Smith discusses the benefits of the division of labour, “but not many people get to the point hundreds of pages later, where he says that division of labour will destroy human beings and turn people into creatures as stupid and ignorant as it is possible for a human being to be”.
With this in mind, Chomsky detects Smith’s opposition to wage labour and corporations and his cutting remarks about how the principal architects of policy are (in Smith’s words) the “merchants and manufacturers” who make certain that their own interests are “most peculiarly attended to”, no matter what the effect on others. This, says Chomsky, is a truism of class analysis, adding that “you don’t have to go to Marx to find it. It’s very explicit in Adam Smith.”
“Not many people get to the point hundreds of pages later, where he says that division of labour will destroy human beings and turn people into creatures as stupid and ignorant as it is possible for a human being to be”.
Smith was speaking from the perspective of the Enlightenment. “His driving motives were the assumption that people were guided by sympathy and feelings of solidarity and the need for control of their own work, much like other Enlightenment and early Romantic thinkers,” said Chomsky. “The version of him that’s given today is just ridiculous.”