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The eighteenth-century Scottish economist Adam Smith is widely acknowledged as both the father of modern economics and the apostle of free trade. His cornerstone work, The Wealth of Nations (1776), was popular in Smith’s era (six editions were published before Smith’s death in 1790) and figures prominently in modern discussions of economic theory.

Life And Character

Adam Smith was born on June 5, 1723, in Kirkcaldy, Scotland, a posthumous child. His mother was in her early twenties, and she was widowed after less than three years of marriage. The bond between mother and son was very close, and as Smith never married, those who believe in psychoanalytic explanations have seen significance in this. Whenever it was feasible he lived with his mother, and a spinster cousin joined them in the 1760s.

Smith went to Glasgow University in 1737 at age fourteen. In 1740 he was sent to Balliol College, Oxford, where he stayed until 1746. Smith declined entering the church, a profession many thought advisable, and spent two unemployed years back at home in Scotland. Lord Kames and other friends then invited Smith to lecture on Rhetoric and Belles-Lettres in 1748, as a reigning Scottish fashion was to learn how to speak and write English like the English. Smith was considered a capital instructor for this purpose, and his lectures were well attended.

In 1751 Smith succeeded in being appointed to the professorship of moral philosophy at Glasgow. For the next twelve years his fame grew steadily, especially after the publication of his first book in 1759, The Theory of Moral Sentiments (TMS). TMS not only gave Smith a European reputation, it also appears to have gained him the position of tutor to the Duke of Bucceluch. This was a lucrative appointment, and it guaranteed Smith financial independence. Scottish University students paid their individual professors, and Smith behaved admirably in repaying his students their fees.

Smith had provided distinguished and valuable services to the university, not only as a teacher but also as an administrator. Since Smith’s absentmindedness and lack of address are undoubted, having been noted in a variety of historical sources, Smith’s success as an administrator shows that he had the ability to concentrate fully on a given task and to persuade his colleagues to do the same. He was college quaestor (treasurer) for six years, an unusually long term, and at the end of his time at Glasgow he was dean of faculty, vice-rector, and chairman of a special committee on internal university affairs. On accepting Smith’s resignation, the university minutes record sincere regret “at the Removal of Dr. Smith, whose distinguished Probity and amiable qualities procured him the esteem and affection of his Colleagues” (Campbell and Skinner 1982, p. 125).

The European tour with the Duke of Bucceluch took nearly three years, and from 1764 to 1767 Smith had the opportunity to meet most of the eminent European literati, including the school of French economists known as the physiocrats. The lectures Smith delivered at Glasgow had dealt, in part, with economic topics, but it was during his stay in France that Smith appears to have begun writing An Inquiry into the Nature and Causes of the Wealth of Nations in earnest. Perhaps from 1764 onward, and certainly from 1767 to 1776, with very few interruptions, Smith’s constant concern was the writing of his most prominent work.

Smith’s appointment as commissioner of customs in 1777 was due to the influence of the Duke of Bucceluch with the prime minister, Lord North. A humorous consequence of his new position was Smith’s realization that he had “scarce a stock, a cravat, a pair of ruffles, or a pocket handkerchief which was not prohibited to be worn or used in Great Britain.” In order to set an example he “burnt them all” (Smith 1987, p. 245). As Smith’s duties involved the control of smuggling, scholars have wondered how Smith could wish to punish the smuggler, who was not really blamable according to the dictates of natural liberty set out in The Wealth of Nations ? The issues raised by Smith’s acceptance of such a position have been most forcefully posed by the scholars Gary Anderson, William Shugart, and Robert Tollison: “The author of the Wealth and Commissioner Adam Smith were one and the same person … there is strong evidence that Smith sought the position and that it represented a reward not so much for intellectual accomplishment as for services he had rendered to the government” (1985, p. 742).

Consciously assertive of his originality, as early as 1755 Smith read a lecture strongly defending his priority for the idea of a system of natural liberty. Smith believed that several of his contemporaries, all major figures of the Scottish enlightenment, had plagiarized some of his thoughts. Adam Ferguson’s (1723-1816) work on the division of labor and William Robertson’s (1721-1793) economic interpretation of history provide two well-known examples of potentially plagiarized work while Hugh Blair (1718-1800) may have cooled relationships by his (acknowledged) use of Smith’s lecture notes on the subject of rhetoric in Blair’s Lectures on Rhetoric (1783). Smith had several eccentricities; among his personal habits, it was the absentminded consuming of sugar lumps, even in company; in conversation, he is said to have often taken opposite views of the same subject, according to his humor. Smith ended his days among admiring friends in Scotland, busy in his official duties and revising his publications, the last substantial revision being that of TMS. After ailing visibly for a while, Smith died on July 17, 1790.

Early Writings

Smith’s first love was rhetoric and literature. Dugald Stewart, Smith’s successor to the Edinburgh chair, records that “the variety of poetical passages which he was not only accustomed to refer to occasionally, but which he was able to repeat with correctness, appeared surprising even to those whose attention had never been attracted to more important acquisitions” (Rae 1965, p. 34). One of Smith’s most pleasant and instructive writings is the Essay on the History of Astronomy, which was published by Smith’s executors some five years after Smith’s death. The most interesting feature of the essay is Smith’s discussion of the principles that guide good philosophy and that hence serve to persuade readers. Smith asserts that “philosophy is the science of the connecting principles of nature” (Smith 1982, p. 45) and so good philosophy provides individuals connections from the familiar to the unfamiliar in such a natural manner that they are convinced of its truth. The essay considers the subject of astronomy from this perspective and concludes by praising the English physicist and mathematician Sir Isaac Newton (1642-1727) for providing “the greatest and most admirable improvement that was ever made in philosophy” (Smith 1982, p. 98). Smith was coy about the reality of the Newtonian system; his own principles suggest that all such systems are imaginary but he also wrote that the weight of evidence is such that one is forced to admit that the principles seem so natural, the arguments so well connected, and the evidence so overwhelming that one is insensibly led to speak of Newtonianism as real.

The most careful and sustained expositions of TMS, by twenty-first-century analysis the standard view, have been articulated by Alec Macfie, Roy H. Campbell, and David D. Raphael; the most interesting contrasts in the last two decades are those of Laurence Dickey and John Dwyer. Dickey argued forcefully that Smith changed his mind on the virtue of selfishness in the last edition of TMS (1986), while Dwyer showed how the circles Smith moved in were emphatic in asserting that the sympathetic passions were the most beneficial for society (1998).

Smith viewed moral philosophy as facing two main questions: What is the content of ethics and how does one come to accept one’s ethical precepts? He was very perceptive on the second question but only marginally illuminated the first. In modern language, TMS is probably best appreciated as a book on the socialization of morality rather than on the nature of right and wrong, which also explains why sociologists have been more struck with TMS than philosophers of ethics. Even though Smith did not illuminate practical ethics, it is notable that he insisted upon virtue being instinctive and not based upon calculation, as well as upon the reality of benevolence.

In TMS, humankind’s acceptance of moral rules is grounded upon the need for social approval. Individuals internalize morality by looking for the admiration of those who see them. This explanation serves well for children, or when adults are in company. Smith extended the application to adults who debate moral problems when alone by introducing the concept of an “impartial spectator”— someone who examines one’s moral quandaries with detachment and whose approval serves to sustain us when we suffer reverses of fortune.

The standard view argues that the sympathetic imagination of TMS leads to humankind’s codes of ethics and of law, while self-interest is the basis of economic behavior; the conflict between TMS and The Wealth of Nations is only apparent because the two books deal with different levels of social reality. Posterity has accorded fame to The Wealth of Nations and only appreciation to TMS because the link between self-interest and economic phenomena can be satisfactorily indicated, while a link of similar clarity between sympathy and ethics still awaits us. A late twentieth-century trend to interpret Smith’s economics through the lens of TMS faces the difficulty that only in the preface to the last edition of TMS, shortly before his death, did Smith make any public attempt to mention the two books together. Five editions of The Wealth of Nations (and of TMS) came and went without Smith ever trying to soften The Wealth of Nations with TMS. Scholars argue that if Smith had wanted modern-day readers to qualify the selfishness of The Wealth of Nations with the stoicism of The Theory of Moral Sentiments he would have done so himself.

The Wealth Of Nations

The manner of writing of The Wealth of Nations is modern in its frequent separation of theory from policy. In Books I through IV, Smith explained that free trade is the ideal policy for all nations. In Book V he explained the obvious practical requirement that governments must raise taxes to meet essential expenses. So the combined effect of all five books is to advocate a policy that imposes taxes for revenue but not for protection. This is the same policy that was supported in the popular literature of the 1740s in the pamphlets of William Richardson and Sir Matthew Decker. However, the separation of pure theory, which supports free trade, from practical policy, which recognizes the need for taxes, makes the ideas of The Wealth of Nations more attractive.

Much of the charm of Smith’s work arises from the casual fluidity of his language. He expressed commonplace ideas forcefully and provided homely illustrations; Smith’s arguments are axiomatic, but he interrupted his exposition with much ordinary illustration. These nuances in his writing have led modern-day scholars to frequent, and perhaps endless, discussion about whether he was really inductive or deductive. Perhaps the most effective use of everyday thought was the phrase “invisible hand” to describe the harmony of the market. Moral philosophers had consistently rejected the use of the market as socially beneficial because they could not fathom how the universal prevalence of selfishness—the motivation of the market—could lead to a harmonious society. It was one of several euphemisms used by contemporaries to refer to God as the beneficent controller of the universe. When Smith came to proving this difficult point, he found it convenient to finesse the argument by referring instead to the invisible hand as one that provides coherence through the market. Smith knew he could count on the subliminal persuasiveness of the “invisible hand” to quash any doubts readers might have about the goodness of the market. Ferguson and Robertson, while serving as army chaplains, had each used the phrase to exhort their soldiers in 1747. Whether Smith himself believed in a Christian God is beside the point; it is his rhetorical skill that needs to be appreciated.

The fairest treatment of Smith’s contributions to economic theory would portray Smith’s ideas along with those of his contemporaries. Space does not permit and readability perhaps does not require such discussion. With a brief glance at contemporary thought, the focus herein is on the internal logic of Smith’s arguments, with the topics being chosen by their importance for modern economics. In considering Smith’s contributions to economic theory it is useful to begin with microeconomics, then to macroeconomics, and finally to international trade.

Jacob Viner provided a penetrating assessment of Smith’s contributions to micreconomics when he wrote, “On every detail, taken by itself, Smith appears to have had predecessors in plenty. On a few details was Smith as penetrating as the best of his predecessors” (1928, p. 118). The theoretical constructs of demand and supply, used by modern economists, had been widely and effectively used by economists for more than a century when Adam Smith wrote. A brief overview of Smith’s microeconomic theory shows that Smith’s attempted innovations were severely limited.

Smith distinguished between “natural” and “market” price, regarding the former as clearly the more fundamental of the two. What then determines natural price? Smith began by explaining to readers that in every society, at any given time, there exists an ordinary or average rate of wages, profits, and rent; these average rates for each factor of production Smith called the natural rate. He then defined the natural price as the sum of the natural rates of wages, profits, and rents. This price is distinguished from the market price, which is merely another name for whatever price reigns in the market at any given time. The demand of those individuals who are willing to pay the natural price of a commodity constitutes what is called the “effectual demand,” and market price is said to arise out of the interplay of the actual supply and the desires of the effectual demanders. The explicit theoretical construct thus consists of an awkward juxtaposition of a point supply and a point demand. If, however, one glosses over the location of equilibrium, that is, the natural price, and asks instead how Smith described what happens when the world is not in equilibrium, the treatment is excellent.

Since natural price is defined as the sum of natural wages, profits, and rents, this requires an explanation of the natural rates of wages, profits, and rents. The natural rates are naturally regulated by the structure of the economy and its growth, “partly by the general circumstances of the society, their riches or poverty, their advancing, stationary, or declining condition; and partly by the particular nature of each employment” (1976, I, 72, 159). The subsequent chapters, however, fail to show readers how to use structure and growth to find natural wages or profits in any particular situation.

Smith had claimed that product prices are to be explained by factor prices; this dichotomy between the forces determining product and factor prices was an innovation. He subsequently claimed that factor prices, and hence product prices, are to be explained by structural and growth factors. Somehow, microeconomics has disappeared. The procedure has led some rigorous critics such as Mark Blaug, to exclaim, “To say that the normal price of an article is the price that just covers money costs is to explain prices by prices. In this sense, Adam Smith had no theory of value whatever” (1985, p. 39).

How did Smith convince so many ordinary readers of the merits of the market? He does provide readers many convincing illustrations of opportunity cost and of the equalization of returns in different uses. Chapter X of Book I deals with the inequalities of wages and profits across different occupations. It is a beautiful exercise in tracing how differences in prestige or risk can account for such inequalities in money wages. While such explanations can be couched in the modern language of demand and supply, since Smith did not apply the modern apparatus, one has to ask if there are other, perhaps simpler, ways of getting to such results.

Suppose Smith began by assuming that any violation of natural liberty was both morally wrong and economically harmful; such a position could itself provide the grounds to condemn several institutions of Smith’s day. Such “politically based” arguments are convenient in that they need to consider the absence of competition on only one side of the market. For example, in the case of the Law of Settlements, which hindered the mobility of workers, it was enough to condemn the Laws that the rights of workers were being violated. Second, if one assumes that a market reaches a stable equilibrium, then the belief in one-sided competition alone suffices to provide several analytical results. For example, in the usual version of Ricardian rent theory, the same final outcome is reached whether only farmers compete (for land) or only landlords compete (for farmers). This one-sided analytical procedure works best when there are constant returns to scale and the assumption of fixed proportions, used on several occasions by Smith, is perhaps a consequence of his analytical method.

Smith’s contribution to microeconomics requires some care to elucidate: He did not advance scholars’ understanding of the equilibrium theory, involving demand and supply; he even confused matters by dichotomizing product and factor prices. But, from his very earliest lectures, Smith thoroughly appreciated the fundamental fact that liberty and competition lead to zero-profits. This observation was repeatedly and successfully applied to such fields as the choice of occupations, the preference for pasturage over tillage, and the determination of joint prices. It even sufficed to move analysts toward the “natural price,” wherever that might be. It is a form of argument that is attractive, easy to learn, and independent of the more intricate demand-supply apparatus, and accounts for Smith’s hold on the general public.

There is no direct concern for macroeconomic problems in The Wealth of Nations. By omitting any systematic discussion of unemployment in The Wealth of Nations, Smith made macroeconomic concerns seem chimerical and succeeded in focusing attention on capital accumulation and upon long-run issues. So perhaps the most notable victory of The Wealth of Nations was a silent one. When Smith did touch upon unemployment, the primary concern for his contemporaries, he used three separate arguments to de-emphasize that concern. Smith provided readers with a model of the economy as a giant corn farm, which employs workers by keeping aside a portion of last year’s harvest in order to feed the workers until the next harvest. Smith called this the “wages fund,” and since it is predetermined by last year’s decision, one cannot increase the numbers to be employed since the model provides the food for only so many. A second argument claimed that the soldiers disbanded after the Seven Years’ War found new jobs within a short space of time, and Smith used this as proof that persistent unemployment is not a real possibility. Finally, Smith made the “global” assertion that “what is annually saved is as regularly consumed as what is annually spent, and nearly in the same time too; but it is consumed by a different set of people” (1976, I, 337338). The implication that aggregate demand always equals aggregate supply, regardless of how much or little is saved, probably had great impact upon Smith’s contemporaries. The cumulative impact of the several arguments was to suggest to readers that the market economy is globally stable, and if only it were left free, it would also be efficient.

An important idea, never quite explicitly stated yet pervading the entire topic, is the superiority of commercial society over feudalism. This led Smith to the concepts of productive labor, which roughly correspond to economic activity that produces a measurable output, and to contrast it with unproductive labor or services. Without such a framework, one would be hard pressed to explain why a fully employed commercial society, making cloth and machines, is superior to a fully employed feudal one, making swords and monasteries. Much of the framework of modern national income accounting is set up at different points of The Wealth of Nations. To grasp the concept of national income one has to have all of a nation’s economic activity in one’s mind. A very important by-product, appropriate to someone who believed in unintended consequences, was the image of the economy as a whole. This constantly recurring background to all parts of The Wealth of Nations, the image of the economy as a complex machine always working away, has led scholars, such as Samuel Hollander, to argue that Smith was an early general equilibrium theorist (1976).

The effort to conceive of the economy as a whole and represent it by some number had a second potent conclusion. Since bundles of apples and oranges cannot be compared physically but only as economic values, the numerical concept led to a focus upon monetary values. In turn, this enabled Smith to conclude that growth is not based upon acquiring a surplus of some physical balance, as with mercantilism and bullion or with physiocracy and agriculture, but rather a value surplus—that of income over expenditure. In this sense, it has been well said that Smith’s novelty lay in the cumulative “shifts of focus” in The Wealth of Nations (Winch 1996, p. 22).

The issue that bridges macroeconomics and trade is monetary policy. Smith broke cleanly with the past and argued that the market was sufficient to provide whatever amount of circulating medium was necessary. Mercantilist arguments in favor of an influx of metals as a wartime buffer or for providing ample liquidity to the markets were all specious. Just as one does not try to regulate trade in pots and pans but trusts the market to provide them as needed, so too could the market suffice for money.

To attempt to increase the wealth of any country [by interfering with the trade in gold and silver] … is as absurd as it would be to increase the good cheer of private families, by obliging them to keep an unnecessary number of kitchen utensils (Smith 1976, IV, pp. 439-440).

From the time of publication of The Wealth of Nations until the middle of the twentieth century, Smith was viewed primarily as the source of laissez-faire ideas. According to Wesley Mitchell in his Types of Economic Theory (1967), the benefits of economic freedom can be argued on the basis of three axioms:

1. Individuals desire to maximize their wealth.

2. Individuals know better than governments how to maximize their own wealth.

3. National wealth is the sum of individual wealth (1967, pp. 61-64).

Axioms 1 and 2, in conjunction, prove that individual wealth is maximized when government leaves individuals alone. Axiom 3 then says that maximizing individual wealth suffices to maximize national wealth. If one describes the axioms loosely as greed, knowledge, and additivity, then greedy and knowledgeable individuals surely do not need government in order to maximize their wealth, and additivity suffices to assure one that, since the aggregate is the simple sum of the individuals, the aggregate also does not need government to maximize economic growth. Modern readers, familiar with externalities in the form of, say, pollution, will probably be most curious about the validity of axiom 3, but in most developing economies axioms 1 and 2 are also worth questioning.

The two most important policy measures of Smith’s time were bounties for infant industries in foreign trade and preventing speculation in food markets in domestic trade. Smith firmly rejected both bounties for infant industries and interference in food markets. He argued the case against bounties as follows: He noted that no one argues against natural advantages, and he went on to illustrate this with his famous example of growing grapes in hothouses in Scotland. Then he transferred the argument without any further reasoning to cases where there is no suggestion of natural advantage. “Whether the advantages which one country has over another, be natural or acquired, is in this respect of no consequence” (1976, IV, p. 458). One could ask how others acquired such an advantage and why anyone might not acquire it as well? This is just what all economists who urged “catch-up” to their countries did argue. Smith could have said that choosing which infant industries have promise requires too much knowledge and discrimination or that such infants have a persistent tendency not to want to grow up. He did neither. So strong was his feeling on the matter that he simply bypassed the argument.

If one wonders about the incongruity of the putative father of economics providing so many examples of indifferent economic analysis, one should remember that a critic found many proofs in Euclid’s Elements to be “more complicated than older versions … essential axioms of order and separation are entirely overlooked, the postulates inadequate to prove even the first theorem” (Goodstein 1951, p. 3). Modern-day scholars seem to remember historical figures as much for their intentions as for their achievements. Smith wrote at a time when his liberal cosmopolitanism won him many converts, especially outside Britain; the support of elite politicians probably mattered, especially when Smith could be used in support of conservative economic policies during scarcities; and the benefits to Britain of appealing to free trade when Britain was the leader in manufacturing meant that economic truth was supported by self-interest. How far Smith’s superior fame was due to these noneconomic factors is a question that only bias can solve.

It is appropriate to close by continuing with the words of Jacob Viner who wrote of Smith that he was only applying to society forms of reasoning that had long been utilized by theologians and philosophers to general phenomena and that only on a few details was Smith’s analysis superior: “But Smith made an original forward step when he seriously applied himself to the task of analyzing the whole range of economic process with the purpose of discovering the nature of the order which underlay its surface chaos” (1928, p. 118). It was not so much any refinement in analysis but Smith’s ambitious undertaking and his faith in the overall harmony of free trade that constitute his principal legacy.

Bibliography:

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Eden, F. M. 1928. The State of the Poor, ed. A. G. L. Rogers. London: Routledge.
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Rae, John.1965. Life of Adam Smith. New York: Augustus M. Kelley. (Orig. pub. 1895).
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Winch, Donald. 1996. Riches and Poverty. Cambridge, U.K.: Cambridge University Press.