Adam Smith and The Wealth of Nations: Economic Theory Explained

Introduction

Adam Smith was one of the most influential thinkers of the modern era. His work laid the foundation for our modern economic system of capitalism, and he is sometimes referred to as the "father of capitalism." This analysis covers his life in a brief biographical section, followed by an examination of his theoretical contributions to capitalism. Smith was far ahead of his time in matters of political economy and argued that markets were an ideal form of resource allocation. However, in Smith's day, markets actually resembled small, physical gatherings 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 An Inquiry into the Nature and Causes of the Wealth of Nations (1776), he also wrote extensively on moral philosophy. Furthermore, although one of the most famous phrases associated with Smith is the "invisible hand," the term actually appears only twice in his works. Smith uses it to describe the social benefits that follow from individuals pursuing their own self-interest rather than the interests of others, as illustrated in this well-known passage:

"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 Smith was still an infant. Much of his childhood remains unknown; however, it is commonly noted that Smith was close to his mother and that she likely encouraged his academic career. At age fourteen, as was the usual practice, he entered the university 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 returning home and delivering a series of well-received lectures, Smith was appointed first as chair of logic (1751) and then as chair of moral philosophy (1752). His career took a fortunate turn when he left his academic post in 1764 to tutor the young Duke of Buccleuch. This arrangement exposed him to many of the leading intellectual figures of his day. For more than two years, Smith and his student traveled throughout France and into Switzerland, bringing Smith into contact with contemporaries such as Voltaire, Jean-Jacques Rousseau, François Quesnay, and Anne-Robert-Jacques Turgot (The Concise Encyclopedia of Economics, n.d.). The position also granted 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.

The Wealth of Nations was published as a five-book series and focused on the underlying factors that contribute to a nation's prosperity. Smith published only two major works in his lifetime — The Theory of Moral Sentiments, written when he was thirty-six, and The Wealth of Nations, completed when he was fifty-three (Kaufman, 2001).

One of Smith's most fundamental beliefs was that individuals benefited through trade — and, interestingly, this conviction was not confined to 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). Because human beings are social creatures, trading goods and ideas with one another yields many benefits. Smith was among the first thinkers to take a systematic approach to understanding this phenomenon.

The Wealth of Nations

The Wealth of Nations was the product of many years of note-taking by Adam Smith. The book was not published until he was fifty-three, and it is estimated to represent a culmination of more than 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 developing alongside the specialization and separation of labor. He understood the power of the division of labor and its potential to significantly increase the productive powers of a workforce. The sections below highlight some of Smith's major contributions as organized across the different books of 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, 1776)."

The power of the specialization of labor and a general theory of supply and demand are outlined in the first book and are well-known to most readers. However, one of the more interesting points is how Smith accounts for the development of specialization. He attributes it to a natural phenomenon — the human propensity to barter — and describes this as a uniquely human activity. On the surface, it might be tempting to find examples of creatures in the natural world that coordinate activities for mutual benefit. However, Smith writes about primitive humans and how they exhibit similar behaviors. He also compares the advantages of specialization against the unspecialized country workman, who perpetually changes tasks, going from one job to another; this peasant exhausts himself by moving back and forth between his field and his loom (Peaucelle, 2012).

Yet, through bartering guided by the self-interest of the individual, there exists a natural force that increases productivity beyond more primitive forms of human organization. This force is later referred to as the invisible hand of the market (though, as noted, the phrase appears only twice in Smith's writing). It is worth noting that Smith's concept of the invisible hand rests on a natural phenomenon with an evolutionary quality: productivity evolves as the equilibrium between supply and demand continually shifts, and the system becomes more refined over time.

Smith describes this dynamic as most evident in manufacturing compared to agriculture. Although some agricultural systems are better than others, they are only marginally so; by contrast, some manufacturing operations outperform alternatives by a far wider margin. Manufacturing, in other words, holds the greatest potential to benefit from the specialization of labor.

It is also instructive to consider how Smith conceptualizes labor relative to other notable economic thinkers such as Marx. For Smith, labor was a real and concrete phenomenon. He conceptualizes it as a malleable, adaptable resource capable of undertaking whatever the evolving economy may require (Rahim, 2011). Moreover, he believes that specialization develops more out of personal choice than out of innate individual advantages:

"The difference of natural talents in different men is in reality much less than we are aware of; and the 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, 1776).

Other economists and philosophers tend to argue that real or innate differences in ability explain disparities in productivity. Smith, by contrast, contends that the advantages arising from specialization are largely the product of personal choice and circumstance rather than natural endowment.

References

Biographies. (n.d.). Adam Smith (1723–1790). Retrieved from http://www.blupete.com/Literature/Biographies/Philosophy/Smith.htm

Brown, M. (2012). A review: Adam Smith: An enlightened life. Review of Social Economy, 520–524.

Kaufman, H. (2001). What would Adam Smith say now?: He would like much of what he sees, but he would also be worried. Business Economics, 7–13.

Peaucelle, J. (2012). Rhetoric and logic in Smith's description of the division of labor. European Journal of the History of Economic Thought, 385–409.

Rahim, E. (2011). The concept of abstract labour in Adam Smith's system of thought. Review of Political Economy, 95–110.

Smith, A. (1776). An inquiry into the nature and causes of the wealth of nations. Retrieved from Library of Economics: http://www.econlib.org/library/Smith/smWN1.html

Smith, A. (n.d.). Best-known quotations and passages. Retrieved from Library of Economics:

The Concise Encyclopedia of Economics. (n.d.). Adam Smith (1723–1790). Retrieved from Library of Economics: http://www.econlib.org/library/Enc/bios/Smith.html