The Ideas of Adam Smith

Adam Smith (Biographies, N.d.)

Smith's Biography

The Wealth of Nations

Book I: Of the Causes of Improvement in the productive Powers of Labor

Book II: Of the Nature, Accumulation, and Employment of Stock

Book III -- IV

Adam Smith was one of the most influential thinkers of the modern era. Smith's work laid the foundation for our modern economic system of capitalism -- he is sometimes referred to as the "father of capitalism." This analysis will cover his life and a brief biographical section, followed by his theoretical contribution to capitalism. Smith was far ahead of his time relative to political economy and argued that markets were an ideal form of resources allocation. However, in Smith's day, markets actually looked like small markets composed of buyers and sellers. Today, the concept of markets has become far more abstract and markets seldom resemble the form that Smith himself was familiar with. Although Smith is best known for his work, An Inquiry into the Nature and Causes of the Wealth of Nations (1776), he also wrote many works on moral philosophy. Furthermore, although one of the most famous phrases associated with Smith is the "invisible hand," the term actually only appears twice in his works and the term is used to describe the social benefits that follow from individuals pursuing their own self-interest and not the interest of others.

"As every individual, therefore, endeavours as much as he can both to employ his capital in the support of domestic industry, and so to direct that industry that its produce may be of the greatest value; every individual necessarily labours to render the annual revenue of the society as great as he can. He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. By preferring the support of domestic to that of foreign industry, 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. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it (Smith, N.d.)."

Smith's Biography

Adam Smith was born in Kirkcaldy, Scotland, where his widowed mother raised him after his father died when he was just a small baby. Much of his childhood remains unknown however it is commonly noted that Smith was close to his mother and it was likely her that pushed him towards his academic career. At age fourteen, as was the usual practice, he entered the University of Glasgow on scholarship; he later attended Balliol College at Oxford, graduating with an extensive knowledge of European literature and an enduring contempt for English schools (The Concise Encyclopedia of Economics, N.d.). After Smith returned home, and after delivering a series of well-received lectures was made first chair of logic (1751), then chair of moral philosophy (1752), at Glasgow University.

Smith's career took a fortunate turn. He left the school in 1764 to tutor the young duke of Buccleuch which allowed him to be exposed to many interesting contemporary minds. For more than two years Smith and his student traveled throughout France and into Switzerland, an experience that brought Smith into contact with his contemporaries Voltaire, Jean-Jacques Rousseau, FranAois Quesnay, and Anne-Robert-Jacques Turgot (The Concise Encyclopedia of Economics, N.d.). Furthermore, this position also gave him a degree of financial freedom. With the life pension he had earned in the service of the duke, Smith retired to his birthplace of Kirkcaldy to write The Wealth of Nations which was published as a five-book series and focused on the underlying factors that contributed to a nation's prosperity. Adam Smith actually published only two works -- the first was The Theory of Moral Sentiment when he was thirty-six years old and then The Wealth of Nations when he was fifty-three (Kaufman, 2001).

It has been argued that one of Smith's most fundamental beliefs is that individuals benefited through trade; interestingly however, this was not confined to the realm of economics. Trading, it turns out, was not only a central human trait in The Wealth of Nations but also in The Theory of Moral Sentiments. Phillipson writes that for Smith, "morality is a matter of trading sentiments in the hope of being able to conclude a rewarding emotional deal" (Brown, 2012). Since human beings are social creatures, trading goods, and even thoughts, with one another has many benefits. Smith was one of the first to take a systematic approach to understanding this phenomenon.

The Wealth of Nations

The Wealth of Nations was the product of many years of notetaking by Adam Smith. The book was not published until he was fifty-three and it has been estimated that it was the result of a culmination of over a decade and a half of notes on economic theory. Smith collected these notes at the beginning of the Industrial Revolution and had a first-hand account of the benefits and challenges that were developing with the specialization and separation of labor. Smith understood the power of the division of labor and its potential to significantly increase the productive powers of labor. This section will point out some of Smith's major contributions on the basis of the different books contained in the Wealth of Nations.

Book I: Of the Causes of Improvement in the productive Powers of Labor

"Nobody purposely invented industrial specialization with all its advantages for wealth creation. Rather, specialization evolved gradually -- as a by-product of the natural human propensity to truck, barter and exchange one thing for another. The precise nature of that propensity and its connection to our faculties of reason and speech is beyond the scope of the present enquiry. Here, I simply note that the propensity is common to all human beings and that it is unique to humanity (Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, 1776)."

The power of the specialization of labor and a general theory of supply and demand was outlined in the first chapter and theory is well-known by most. However, one of the more interesting points in this book is how Smith accounts for the specialization of labor. He attributes the development of the forms of specialization to a natural phenomenon -- the propensity to barter and describes this as a uniquely human activity. On the surface it would be tempting to find examples of creatures in the natural world that coordinate their activities in order to gain some sort of mutual benefit. However, Smith writes about primitive humans and how they also have similar behaviors. Smith also compares the many of the advantages to the unspecialised country workman who perpetually changes work, going from one task to another; this peasant exhausts himself by going back and forth between his field and his loom (Peaucelle, 2012).

Yet, through bartering, which is guided by the self-interest of the individual, there exists a natural force that increases the productivity of the bartering human over more primitive versions of human arrangements. This is the force that increases productivity and is later referred to as the invisible hand of the market (although this description only appears twice). However, it is interesting to note that Smith's concept of the invisible hand is based upon a natural phenomenon that has an evolutionary quality -- that productivity evolves as the equilibrium between supply and demand continually shifts and improves the productivity rates as this system continually becomes more refined. Smith describes this as being most evident in manufacturing as compared to agriculture. Although some agricultural systems are better than others, they are only marginally better while some manufacturing facilities are significantly better than can be found elsewhere. That is, manufacturing has the greatest potential to benefit from the specialization of labor.

It is also interesting to consider how Smith considers labor compared to other notable economic thinkers such as Marx. To Adam Smith, labor was a real and concrete phenomenon. Smith conceptualizes labor as a malleable, adaptable resource, capable of undertaking whatever may be required of it as the economy evolves over time (Rahim, 2011). Further he believes that specialization develops more out of personal choice than it does based on individual advantages that one individual may have over another.

"The difference of natural talents in different men is in reality much less than we are aware of; and very different genius which appears to distinguish men of different professions, when grown up to maturity, is not upon many occasions so much the cause, as the effect of the division of labour. The difference between the most dissimilar characters, between a philosopher and a common street porter, for example, seems to arise not so much from nature, as from habit, custom and education..." (Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, 1776).

Other economists or philosophers tend to argue that there are real or innate differences in ability that one individual may possess over another. Whereas Smith seems to believe that the advantages in specialization arise more out of personal choice.

Book II: Of the Nature, Accumulation, and Employment of Stock

Book II is also an interesting philosophical work in which Smith tackles the accumulation of capital. He basically breaks down the players in the economy into two different types of people. First, there is the labors who do not possess enough capital to use for the purpose of investment. Rather, this group uses capital to buy goods that represent the necessities of life and in today's lexicon, would be the equivalent to someone that is living paycheck to paycheck. The second group represents those who have acquired enough capital to be able to use it for investment purposes. Basically, such an individual would like to put their accumulated capital to work to gain interest or seek profitability through some endeavor in the market.

"When the stock which a man possesses is no more than sufficient to maintain him for a few days or a few weeks, he seldom thinks of deriving any revenue from it. He consumes it as sparingly as he can, and endeavours by his labour to acquire something which may supply its place before it be consumed altogether. His revenue is, in this case, derived from his labour only. This is the state of the greater part of the labouring poor in all countries ...But when he possesses stock sufficient to maintain him for months or years, he naturally endeavours to derive a revenue from the greater part of it; reserving only so much for his immediate consumption as may maintain him till this revenue begins to come in. His whole stock, therefore, is distinguished into two parts. That part which, he expects, is to afford him this revenue, is called his capital (Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, 1776)."

However, Smith also points out some interesting points about those who do not chose to put whatever capital they have to work. In Smith's time, there were many individuals who had inherited money from family fortunes. However, not all of these individuals who possessed capital chose to put this capital to work. He compares these individuals (the rich and unproductive) to the most menial servants in the society (the poor and unproductive). Neither of these individuals, from Smith's perspective, contribute anything of value to the society. It is understandable why the poor individual who does not have the capital to invest in any form of value creation is perceived as unproductive. However, those with capital who are still unproductive and add nothing of real value to the society should be held in higher contempt. Furthermore, Smith associates the proportion between capital and revenue as a factor that is related to the proportion between industry and idleness. "Capitals are increased by parsimony, and diminished by prodigality and misconduct (Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, 1776)."

Book III -- IV

In books III through IV, Smith puts his basic assumptions of economic theory to the task of explaining why some nations fair better economically than others. In Book III, Smith considers such things as the investment proportions that exist between the allocations of capital to the countryside's and the cities. The rural agricultural areas provide the food and basic needs of society to the cities and these needs must be met. Once these basic needs are met, the cities can act to amplify the investments of capital through production using specialization.

However, he also outlines these investments in terms of risks and states that the safer investment is in agricultural because it "is much less liable to accident, than that of the trader, who is obliged frequently to commit it, not only to the winds and the waves, but to the more uncertain elements of human folly and injustice (Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, 1776)." Although Smith doesn't actually use the word risk, it is clear that he is refereeing to a similar concept. The more risk you accept the greater the returns that are required. In this sense, the society transitions through three types of investments: from agriculture, to manufacturing, and then to foreign commerce. The society that progress through these phases is likely to have the greatest chance of receiving "opulence." "

In Book IV Smith challenges some of the contemporary thoughts that existed towards economic ideas that existed at the time -- notably mercantilism. Smith argued against protectionist policies that limited free trade. He argues that both parties of trade can benefit from specialization in the use of capital and that protectionism is detrimental to efficiency in the market. Furthermore, he also argues against the idea that nations need to attempt to accumulate precious metals as a form of economic investment. Based on the theories he outlines in Book II, precious metal represent a form of capital that is being stored and not productively adding any value to the society.

The final book in The Wealth of Nations, Smith argues for and against various taxation schemes. Many of the arguments are still valid today as modern economists argue for or against taxation policies such as redistribution. The tax system was not well-developed in Smith's day and much of this work can be interpreted subjectively. However, he did believe that the state had many legitimate reasons to collect resources from its citizens for the purpose of collective benefits. For example, Smith believed that the state had the responsibility to protect citizens, contracts, and property. However, he outlined many activities by states that could hinder economic growth and therefore the economy as a whole.