Adam Smith (1723-1790) was a Scottish economist that many believe is the founder of classical economics. Along with David Ricardo and Thomas Malthus he gave shape to what today is called the science of economics. Before his time folk studied economics, usually under philosophy; there was no separate discipline called economics. All these changed when Adam Smith published his “An Inquiry Into the Nature and Cause of the Wealth of Nations, in 1776 (the very year that the USA came into being and embraced his gospel of Laissez Faire Economics).
Adam Smith wrote his book in reaction to the prevailing economic theory, Mercantilism. In mercantilism foreign trade was looked at from the perspective of the state, what was thought is good for the state (that turned out, according to Smith, was not good for it). The state controlled what was imported into the country and exported to other countries, and to whom it was exported to. The idea was to limit what goes from one country to others and what comes in from one country to another. Trade was a means of economic and political warfare.
For example, the English government determined what was imported into its American Colonies and from where they were imported. Whereas left to free trade the colonists would search for cheaper goods and imported them and saved money, the English Crown determined where they imported goods from (perhaps from countries the Crown wanted to do favor for). In the meantime, the cost of the import is high, meaning that the consumer was obligated to pay a high price for the Crown’s politics of economics. The Crown made such minute decisions as to whose ships carried imports to the Colonies. This often meant that English ships would buy goods from the Caribbean, first take them to England and then re-export them to the Colonies. When the cost of this business is added up it often doubled or tripled the price English colonists were obligated to pay for goods that they could have bought cheaply if they were permitted to buy directly from the producer in the Caribbean.
Adam Smith set out to demonstrate the advantages of allowing goods and services to move freely from the producer to the consumer without the interference of the Crown. He pointed out that free trade would lead to more buying and selling and the result would be more revenue for the Crown, more wealth for the nation than were trade to be limited.
If you allowed whoever wanted to produce something to do so and sell it wherever he wanted to sell it, he would take it to wherever he believes that there are buyers of his goods, and try to sell it.
In selling more goods he would have more money to pay the Crown taxes (from his profits) and, more importantly, he would have made goods and services readily available to whoever wanted them.
Adam Smith went on to show, through empirical analysis that non-interference in the movement of goods and services leads to more production and more efficient allocation of resources.
In a free market, the seller or producer produces only those goods (and or services) that there is demand for; if he produces what there are no buyers for he does not sell and loses his investment.
The businessman is a rational person; as such, he calculates what economic behavior makes him profit, money; he produces only what he thinks (through market study, albeit a hunch) that there are buyers for. Thus, he produces and sells and that way is able to allocate resources to where they are demanded (perceived as useful).
Collectively, businesses behaviors lead to a more efficient allocation of resources in the economy.
Conversely, if some one sat down and planned how to allocate resources in the economy, the chances are that he would not employ demand and supply yardsticks and would use more subjective yardstick, such as the desire to do good, in his production of goods and or services. The result is that resources would not be allocated to where those who have the money to pay for them are. This leads to inefficiencies in the supply and distribution of goods and services in the economy.
Adam Smith goes on to show that planners, the state, make mistakes when they use the idea of goodness in determining where resources are allocated. He demonstrated that human beings are motivated by self interests. Each person knows what he thinks serves his best interests, what he wants and wants it as cheaply as is possible. He wants to buy what meets his needs and buy it at the lowest possible price.
The buyer, consumer, goes to the market and buys what he wants and buys it from the person selling it at the cheapest price.
The sellers selling the same good at a very high price find out that very few persons are willing to buy from them. Therefore, to sell their goods and or services, sellers figure out a way to produce them cheaply so as to sell cheaply.
The seller figures out a way to buy the raw materials he needs to produce his goods cheaply; he also figures out a way to obtain labor at a minimum cost. Having reduced his cost of production, he sells to consumers what they need at a low price.
Since consumers not only want to buy cheaply but also want to buy high quality goods, the producer tries to produce very high quality goods as cheaply as is possible.
The producer who brings to the market goods and services that are of the highest quality and sells them at the lowest price sells more of them than those who sell shoddy goods and at higher prices.
Adam Smith shows that the consumer pursuing what are in his self interest buys certain goods and that such behavior compels the producer to produce high quality goods and services and sell them cheaply. This way wealth is created in the economy.
People pursuing their selfish interests come to the market and force each other to produce and sell high quality goods and services at low prices.
The mutual selfish behavior of the producer and buyer leads to the production of high quality goods and services. Left to his devices the producer is not likely going to produce high quality goods and sell them cheaply just because he likes the buyers. It is because he knows that the rational buyer would only buy high quality goods at low price that he resolves to produce high quality good as cheaply as is possible and sell them as cheaply as he could do and still cover his cost of production (and hopefully make some profit).
Without the state, the Crown, interfering in the market, the forces of selfishness leads the economy to produce goods efficiently and allocate them to where they are demanded most.
The invincible hand of the market makes suppliers and buyers to serve each others needs. The market performs the job of distributing resources to where they do the most good.
Adam Smith was able to demonstrate that the impersonal, blind forces of the market, if unfettered by the state, lead to the production of more goods and services, and the selling of more such goods. The cumulative effect of this free enterprise is the growth of the Wealth of Nations.
Nations do not grow by interfering in the market but by leaving market forces to distribute goods and services where they may.
The Crown benefits if it did not interfere in international trade and the location of factories.
If the international economy is allowed to distribute goods uninterferred with what happens is that businessmen take their factories to where raw materials and labor is cheap, produce cheaply and sell cheap in the market. If American business men build factories in Asia, where the cost of labor is cheap, they reduce their manufacturing costs and are able to sell their products cheaply.
Americans would have paid exorbitant prices for the goods they bought were they to be manufactured in the USA where labor cost is high.
This may seem a disadvantage to American workers but Adam Smith expects American workers to go train in those professions that pay good wages, high tech professions, for example, and in this way the American economy would produce high tech labor that low tech countries may not have, and are willing to pay for them.
Altogether, Adam Smith shows that laissez faire economy is more advantageous than an economy that the state over regulates. Free markets lead to the growth of wealth in nations.
Smith would prefer government’s hands off of the economy, including international trade. He did not want high tariffs, for those led to inefficiencies in the movement of goods and services (if you over taxed goods coming from China then their cost would be the same as if they were produced in the USA and in doing so you are not doing the American consumer any good).
Adam Smith was not opposed to taxation; he recognized that governments need money to operate. He wants governments to tax individual income and corporate income but at rates that do not destroy the incentive to work and make money.
In his other writings, especially in his Theory of Moral Sentiments, Adam Smith suggests governmental actions that today we would call welfare policy. He advocates sympathy for the poor and doing something to help them.
This would seem a contradiction to his teaching of government’s handoff the economy. This seeming contradiction is not really so. If the business man is allowed to make profit and encouraged to be philanthropic and gives his money to the needy that is fine with Adam Smith.
If governments engage in policies that lead to the creation of wealth and as a result have good revenue from taxes and choose to use that money to help the poor that is fine with Adam Smith.
Adam Smith was not a hard hearted Scrooge; he was simply interested in economic policies that lead to overall wealth in nations.
The newly born American Polity took Adam Smith’s economic theory to heart and attempted to practice it, free enterprise, that is. America succeeded beyond its wildish dreams.
Having prospered through Smith’s free enterprise economy, America became an apostle of this economy and teaches it all over the world. Adam Smith’s economic system thrives.
Alternatives to the free enterprise economy, such as socialism and communism (planned economy) are like flash in the pan: they come and go.
Does that mean that the free enterprise system does not have problems? It has lots of problems; it has periods of boom and burst. Inflation, depression, recession etc are built into the Capitalist economy.
Other economists have sought solutions to the problems of the capitalist economy. We shall see what John Maynard Keynes had to say about these problems and the institutions created to deal with them.
Adam Smith. Wealth of Nations. 1776. (Many editions.)