Adam Smiths Economics of Freedom

To start with one misconception, economics did not begin with the great 18th-century Scotsman, Adam Smith. Economic thought can be traced back through St. Thomas Aquinas all the way to Aristotle. Nor was Smith the first economist. In his time there was a group of theorists in France which anticipated some of his ideas. They are now known as the Physiocrats, except that they called themselves economistes. In England at the time many pamphlets, tracts and books on economic questions were being written by businessmen, bankers and scholars of various sorts. The dominant point of view then, Mercantilism, thought of economics as strategy in the competition among trading nations. This first epoch of the “science” of economics did not begin with Adam Smith; it culminated in him.

What Smith did in the watershed year of 1776 was to come out with a great tome of a thousand pages with the abridged title of The Wealth of Nations. In time it was to become a blockbuster in economics and it has been called one of the world’s truly great books. What Smith did in the book was to survey all the scattered ideas and writings about economics before him and then assemble them into a coherent whole which, for the first time, compelled the recognition that economics was and deserved to be a single, special field. In Adam Smith political economy, as it was known then, was the beginning of modern economic thought.

The complete title of his book was An Inquiry into the Nature and Causes of the Wealth of Nations, and that well describes his point of departure. Economic debate in the 18th century focused on the source of national wealth. Was it agriculture, labor or commerce? The answer suggested by the quickening of business activity in England at the time was commerce.

Not Just Precious Metals, But All Items of Commerce

The Mercantilists held that wealth was gold and silver, mostly acquired in foreign trade. But Smith saw it differently: Wealth was the nation’s production of the “necessaries, comforts and conveniences of life” or, as he also put it, the “annual produce of the land and the labor of the people.” This is what is now called GNP, gross national product. As for the source of this wealth, Smith started with what economists would call a “labor theory of value.” For Smith and his followers, and for all Marxists to this day, human labor was the ultimate source of wealth.

Smith pointed out the great increase in human productivity yielded by what he called the “division of labor,” that is, the growing practice of splitting up the job of making something into separate tasks assigned to different workers. In effect, he was describing an early stage in the development of mass production and, to illustrate it, he chose the pin factory of his time.

He asserted that “. . . a workman not educated to this business . . . nor acquainted with the machinery employed in it . . . could scarce, perhaps, with his utmost industry, make one pin in a day, and certainly could not make twenty. But in the way in which this business is now carried on . . . One man draws out the wire, another straights it, a third cuts it, a fourth points it, a fifth grinds it at the top for receiving the head; to make the head requires two or three distinct operations; to put it on, is a peculiar business, to whiten the pins is another; it is even a trade in itself to put them into the paper; and the important business of making a pin is, in this manner, divided into about eighteen distinct operations, which, in some manufactories, are all performed by distinct hands, though in others the same man will sometimes perform two or three of them. I have seen a small manufactory of this kind where ten men only were employed, and where some of them consequently performed two or three distinct operations. But though they were very poor, and therefore but indifferently accommodated with the necessary machinery, they could, when they exerted themselves, make among them about twelve pounds of pins in a day. There are in a pound upwards of four thousand pins of a middling size. These ten persons, therefore, could make among them upwards of forty-eight thousand pins in a day.”

Thus, Smith made his point about the productivity realized by means of the division of labor—and in a small shop employing ten men at the very beginning of the Industrial Revolution.

Smith went on to describe how the division of labor operated not just in a shop or factory but also in a whole national economy made up of diverse, -specializing firms and industries in the different localities and regions, taking advantage of local differences in climate, soil, location, natural resources, the characteristics of the local population: all of those things which can make possible more efficient and lower-cost production of particular goods than can be accomplished elsewhere. And, similarly, Smith described an international division of labor in the production of commodities for foreign trade among the diverse nations and regions of the world.

Economic Growth

From that starting point, Smith went on to describe the system of production of goods in a national economy and outlined what he conceived of as the forces which led to the “progress of opulence,” or what today would be called economic growth. He saw the production of material wealth, that is, of goods, as requiring three things: the division of labor, the widening and extension of markets for the goods produced, and increasing “stock,” his term for production equipment, machinery and working capital.

In Smith’s scheme, it was the accumulation of capital which led to the progress of opulence from an agricultural economy to manufacturing to commerce. The resulting increased output of food and other goods necessary to life permitted the survival of a larger population which, in turn, meant further extension of markets, a larger and more skilled labor force, and further accumulation of capital. In this way he saw the economy spiraling to higher and higher levels of development, raising the whole social order with it. It was an optimistic, almost buoyant view which was largely justified by the times he lived in but was not to survive its author by very long.

It was Adam Smith’s description of how a market economy worked which was the starting point of a complex theoretical system which would become the new “science of economics.” His theory of markets would be elaborated and refined by economists throughout the 19th century, and it has remained center stage in the 20th century, at least in the negative sense of growing dis agreement and retreat from it after the debacle of theory in the Great Depression. But the theory of markets is too central a part of economics to be quickly set aside, and much of modern economic debate has amounted to repeated attempts to dislodge it in favor of corrective or alternative formulations.

Market Pricing

In effect, Smith conceived of the economy of a nation as one vast whole with immense internal complexity but with interaction and interdependence of internal forces which were self-adjusting and self-regulating. In Smith’s scheme the market was not a place but the totality of exchanges—that is, of buying and selling—of the products of all the different occupations and industries in the national economy. At the center of this were prices, constantly changing in accordance with the laws of supply and demand and, in turn, balancing supply and demand not just for goods but for the resources, both human and material, needed to produce them.

As for those resources—land, labor and capital, needed in varying proportions to produce each good—their prices, mediated by supply and demand, directed them to those places and those employments where they would produce the most for the economy and the population as a whole. Of course, money spent by one person is money received by another. So, in Smith’s system, those prices were also income: rent for the landlords, wages for laborers, and profits for the capitalists and businessmen. These people, making up the three great classes of the popu lation of Great Britain in his time, divided up the total income generated by the national economy, which amounted to the prices paid for all of the goods and commodities produced—that is, for all the “necessaries, comforts and conveniences” of the people, the sovereign consumers for whom the system operated.

The Role of the Businessman

In Smith’s market theory people were not only the beneficiaries but the moving parts of the system: householders, workers, farmers, land owners, manufacturers, merchants and traders, all of them rational economic men (and they were almost solely male at that time) who were free to pursue their own gain, the best return for their own contributions to the economic life of their communities and the country. To Smith, the key to the success of the system was the capitalist businessmen, whom he referred to as “under takers,” in the sense that they were the ones who undertook business ventures. For it was the “undertakers” who coordinated the movements and combinations of all the other participants in the economy for their best possible employments under existing conditions.

Smith mistrusted businessmen. In one of the best known passages in his book, he wrote: “People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.” But he gave them credit for being the savers who accumulated capital for new business ventures, without which there would be no economic growth. He wrote that in contrast to the workers, who were forced to spend all they earned on the necessaries, and the idle rich, who squandered their incomes on the comforts and conveniences, the capitalist businessmen put off immediate spending for consumption to some extent and set aside part of their profits for investment in future undertakings, with no guarantee that the capita] they risked might not be lost in an unsuccessful venture.

Mobility and Competition

Smith set forth two linked and indispensable conditions to be met if the economic system he described were to work: There must be free movement for all in the system so that each man might seek the best opportunity for his labor or resources. And there must be free competition among all, for the buyer’s shilling, for markets, for labor and for jobs. There must be no monopolies or combinations in restraint of trade or limiting entry into new fields, and no government-granted privileges for a favored few. Smith railed at the dense thicket of government regulations and restrictions of his time, which he saw as preventing the fluid and free movement of men and capital throughout the economy that was necessary for prosperity and growth.

Smith sensed an order in the economic universe, not imposed from above but somehow the outcome of the almost infinite number of transactions in the exchange economy. It has been said that the nature of this order was the “mystery” he set out to solve in his book. Instead of government direction of the economy as the source of that order, Smith came up with his famous metaphor of the “invisible hand.” It was, he wrote, as though there were an invisible hand directing the efforts of everyone—even though each man was pursuing his own gain—in a way that promoted the interests of society as a whole.

As a man of his time, Smith was a deist, and it was the hand of Providence he meant. It was not that he thought the invisible hand was tugging on puppet strings to guide the economic behavior of each individual. To Smith, the invisible hand was a metaphor for the workings of the market economy in the setting of the institutions of political and economic freedom. It was Providence, he thought, that had en dowed mankind with the capacities and propensities which made possible such a society and such a system. Today, what Smith called the invisible hand might be thought of in cybernetic terms as “feedback loops”-for example, as market prices being regulated by negative feedback.

Smith knew, of course, that his ideal of the invisible hand operating in a completely free, purely competitive market economy was never a very realistic picture of an economy in the real world. But he contended that the more nearly the ideal was realized, the better the economy would work. And it was that ideal which was the unifying concept he applied to the wilderness of economic phenomena to reveal an underlying order.

A Self-Regulating Arrangement

By now the idea of the self-regulating economy is a familiar one, whether accepted or not. And many of the elements contained in the idea had been described before Smith put them all together. But how did he come up with the whole “vision” and where did he get it from? In effect, it was already at hand, in the climate of opinion and generally held ideas of that time—although in a different context.

In Smith’s time the burgeoning commercial society of England was beginning to generate the Industrial Revolution, that great outburst of inventions which meant the end of the old system of hand-crafted production and ushered in the modern age of mass production in factories equipped with power-driven machinery. England was harnessing water power and steam. Soon to come were the giant textile mills in the north of England where uprooted country people, and their children, tended looms which disgorged immense quantities of cotton cloth for new world markets. In its “satanic mills,” capitalism was to produce enormous quantities of goods and amass hitherto unattainable wealth—as well as great fortunes for a few.

It was this great national wealth which, in effect, bought and paid for the British Empire, financing the Royal Navy, the troops and the colonial administrations which would rule one-third of the world. But there was a vital question posed by capitalism, although the word was not yet then in currency. How was this incredible machine to be controlled? It was showing signs of becoming a juggernaut.

Smith had been professor of “moral philosophy” at Glasgow University in Scotland. Economics or, rather, political economy as it was known at the time, was still a branch of moral philosophy, which corresponded to the social sciences of today. Besides moral philosophy there was natural philosophy, the physical sciences.

The “Age of Enlightenment”

Eighteenth-century philosophers, in the “Age of Enlightenment,” believed they were beginning to make sense of the world in the light of scientific thought, which had erupted in the century that preceded them. In the 17th century Isaac Newton’s theoretical physics with its concept of the physical universe as a mechanical system and its theory of the “natural laws” of the movements of the heavenly bodies had seemed to show a harmony in nature, a cosmos with all its parts reliably performing their appropriate functions in the over-all smooth working of the whole.

Inspired by that concept, the men of the Enlightenment believed there were also natural laws governing man’s behavior. The social and moral sciences of that time were finding in the world of man the possibility of a similar, harmonious human-social cosmos, a world of free individuals pursuing the satisfaction of their natural desires and in so doing acting in ways that would fit into an orderly system of natural social processes.

But, outside of the libraries and studies of the scholars of that time, there was change, ferment and disorder all around. The iron constraints of medieval society had long since given way, and the Protestant Reformation had rejected the absolute authority over the individual of God’s church. The people were beginning to ask questions about their lot; there was a growing clamor for personal liberties and a chance to get in on the new opportunities to make money. The social philosophers of the 17th century were forced to confront some less than theoretical questions: How does social order emerge from the potential chaos of an individualistic society? Is there a natural social order? What should be the role of government?

By Adam Smith’s time in the 18th century these questions had brought an answer: a theory of liberal democracy which was believed to rest on natural law like the laws of the physical world. The theory harked back to the philosopher John Locke in the previous century and, along with many others, was advanced in Smith’s time by his close friend and fellow Scottish philosopher, David Hume.

According to the theory, each individual was a part of nature and therefore was endowed with “natural” rights: to life, liberty and property. Further, he was endowed with God-given capacities, and propensities which would flower in a society that served the best interests of all. To realize that society, a political system of the rule of law rather than of a few powerful men was required. The laws would provide even-handed justice, personal freedoms, minimal government, private property, the sanctity of private contracts, economic freedoms, and free trade, both domestic and foreign. In the kind of society made possible by such laws, free men would both compete with and cooperate with each other, exercising their rights to pursue their own visions and, at the same time, respecting the rights of others.

Classical Liberalism

This doctrine of classical liberalism was patterned after Newton’s concept of the physical universe as a mechanical system embodying “natural laws”; the doctrine amounted to a similar vision, that of a human-social system also embodying natural laws. And, in much the same way, what Smith did in his theory of a liberal economy was to pattern it, too, after Newton’s system, using quasi-gravitational mechanics to explain the workings of a self-regulating market economy. What made it possible for Smith to do this was his encyclopedic knowledge of economic history and his authoritative mastery of the economic life of his own time, which he described in realistic and convincing detail.

Classical liberalism provided the vision for political and social reforms in England for two centuries.

By the 20th century that time had largely passed in England and in the rest of Europe where intellectuals and social reformers were convinced by Marx’s dissection of capitalism and excited by the utopian spell of socialism. But the Founding Fathers of this country were very much men of the Enlightenment and it was the ideas of classical liberalism as expressed in the Declaration of Independence and the Constitution that gave shape to the American republic and have been the foundation of our liberties ever since.

On publication, Adam Smith’s great tome was well received by his fellow scholars both in Britain and abroad. But government, understandably, was in no hurry to take its advice, with one notable exception: The younger Pitt, to become George the Third’s prime minister, was deeply influenced by the book as a student and would be the first English statesman to be converted to the doctrine of free trade.

Smith’s death in 1790 attracted little notice. But the influence of his book continued to grow. By the time another 20 years had passed, his readers had become his followers and successors, and had established him as the father of classical economics. His book routed the Mercantilist ideas that had prevailed in his lifetime and for a while virtually blotted out the memory of those who had come before him.