Adam Smith (1723-1790) is pioneered the founding father of neo-classical economics. Free markets, free trade, laissez faire, justified division of labor, income distribution of supply and demand, and abolition of economic restraints and monopolies were the ideas Adam Smith advocated which was later known as classical economics. Although Critics note that Smith didn’t invent many of the ideas that he wrote about, he was the first person to compile and publish them in a format designed to explain them to the average reader of the day. Thus, he is responsible for popularizing many of the ideas and analyzing them in his very popular writing An Inquiry into the Nature and Causes of the Wealth of Nations published in 1776.
Adam Smith was born in the small town of Kirkaldy, from Edinburgh, Scotland. His father died six months before his birth and he was raised by his mother Margaret alone. Smith graduated from Glaslow University with an MA. In 1763, during a three year tour of Europe as a travelling tutor he worked on what was to become his massively influential masterpiece An Inquiry into the Nature and Causes of the Wealth of Nations. In 1776, he published this book and it became quickly widely known in Europe, France, Germany, etc. (Adam Smith Life Who Is Adam Smith and Adam Smith 1723-1790 An Outline Biography). His views and theories in this work were the diametrical opposite of the ongoing theories and practices of mercantilism. (Adam Smith The Wealth Of Nations Summary). Before we go deep into the theories of this book, let’s first discuss what mercantilism is and how the economy of Britain was like before Adam Smith.
Mercantilism was a belief and practice in the 15th, 16th and 17th century that the wealth of a country depended upon the accumulation of gold and that accumulation came from the exporting of goods/products. Opposed to free markets, there was also a rule of tradition and command on which the society worked. Tradition was the passage of unchangeable tasks from generation to generation. Command was dictatorship or tyranny of one ruler; in other words no democracy (Heilbroner).
Adam Smith came with a vengeance toward mercantilism and opened the society’s eyes toward a much broader and liberal view of economics. Adam Smith believed the wealth of a nation depended on the income and savings of people and not on the accumulation of gold. He believed in Say’s law i.e. the more people save, the more they can invest. In other words, savings are directly proportional to investment. He said in the Wealth of Nations that “Wealth does not consist in money, or in gold and silver, but in what money purchases, and is valuable only for purchasing” (Heilbroner). This is true till today because today the wealth of nations is measured per capita income. Smith had said in the Wealth of Nations that consumption is “the sole end and purpose of all production,” while mercantilists on the other hand emphasize only on production and not consumption for the prosperity of the economy (Adam Smith The Wealth Of Nations Summary).
Adam Smith said that society thrives on the law of accumulation and the law of population and these two laws are interdependent on each other. By the law of accumulation, he meant accumulation of profits. He did not only emphasize that the regular consumer should save for the cause of the wealth of nations but he also emphasized that capitalists should accumulate profits too. He said that by accumulating profits, capitalists can buy machinery and assimilate technology to increase production. But he pointed out that there is a complication too in buying machinery. More machinery would mean more workers to operate those machines.
More workers would mean higher and higher wages until the profits would become nil. To counter balance this complication, Smith said the law of population would work. Just as when supply exceeds demand for any product, its price goes down, labor is subject to the law of supply and demand too. Smith said that eventually the supply of workers would exceed their demand and wages would go down inevitably. Thus the profits will start rising again for the capitalist and the accumulation would continue. Smith said that this invisible balancing force that drives up profits is known as “the invisible hand” (Heilbroner).
In The Worldly Philosophers, Heilbroner explains the two main components of the Invisible Hand that Adam Smith invented and wrote in The Wealth of Nations. The first component he says is self-interest or the profit motive. Self-interest motivates people to perform society’s necessary tasks for which society is willing to pay. And in this matter the society benefits as a whole. In other words, “the free market guides its participants to pursue the good of the consumers by following their own self-interest” (Adam Smith Laissez Faire – Invisible Hand).
Cleverly, Smith puts forward a question which must have been bubbled up in the reader’s mind that how can greed and selfishness not come in the way of the invisible hand? What stops greed from overpowering the society? And Smith answers his own question – competition. Competition is the second component of the invisible hand that does not let businesses get out of moral lines in terms of prices and wages both.
For example, if a business overcharges for a product, competitors immediately offer more reasonable prices resulting in the downfall of the business that overcharged. Similarly, if an organization pays small wages to workers, there will always be other organizations waiting to pay more to those workers for their services. Thus the Invisible hand is essentially a natural phenomenon that guides free markets and capitalism through competition. Smith said that a free market not only determines price, but also the quantity of goods produced. (Heilbroner).
However, Smith also said that in order for the free market to work, the concept of “laissez faire” should be adopted by the market and the government. By laissez faire he meant no or limited government intervention in the affairs of the market. Smith said that the market is “its own guardian” and therefore it can self-regulate itself without the intervention of government, unnecessary regulations and also without the advent of monopolies. He believed that the role of the government should only be restricted in matters of national defense and security, administering justice and providing some amount of infrastructure. (Adam Smith Contributions to Economics).
To understand an overall concept of how Adam Smith brought revolution in the economic world, let’s discuss the three stages of capitalism. The earliest capitalism before Adam Smith’s writing of The Wealth of Nations was known as mercantilism and later it was given the title Commercial Capitalism. It lasted one hundred and fifty years from 1613 – 1767. The main motive of this
kind of capitalism was trade and government regulation of prices and interest rates. The source of profit and wealth was in the buying and selling of products and in the accumulation of gold; not in production (Rise of Mercantilism Commercial Capitalism). The second stage of capitalism was the Industrial Capitalism which began developing during the time of Adam Smith. Adam Smith made people realize that the value of a commodity is in the means of production and manufacture and not in the accumulation of gold. It lasted for the first three quarters of the nineteenth century. The last and the final and current stage of capitalism is Financial Capitalism. It began from the last quarter of the nineteenth century and is still ongoing until today. Financial capitalism emerged as a result of high requirement of corporate finance needed to power the expansion of businesses that had developed during the industrial revolution. In order to cover the cost and funding of creating huge corporate financing operations for building factories, importing of new technology and the merging of industries, the development of stock markets, banks and other financial institutions came into place and is still flourishing today. Private ownership has also become at its highest growing rate. (Financial Capitalism Opens Doors To Personal Fortune).
In a nutshell, Smith’s idea of a free market, his theory of the causes of the wealth of nations, his invisible hand theory and his emphasis on the importance of laissez faire is flourishing in most of the developed and underdeveloped countries of the world today.
“Adam Smith 1723-1790 An Outline Biography”
Heilbroner R., The Worldly Philosopher: The Lives Times and Ideas of the Great Economic Thinkers, 7th Edition, (1999) Touchstone.
“Adam Smith Life Who Is Adam Smith”
“Adam Smith The Wealth Of Nations Summary”
“Adam Smith Laissez Faire – Invisible Hand”
“Adam Smith Contributions to Economics”
“Rise of Mercantilism Commercial Capitalism”
“Financial Capitalism Opens Doors To Personal Fortune.” 30 September 2009.