In his seminal work ( An Inquiry into the Nature and Causes of the Wealth of Nations ), Smith systematically analyzed the factors that contribute to national prosperity. In his time, Adam Smith's ideas shone like a beacon illuminating the shortcomings of the prevailing economic and political landscape. His work was not only warmly received in Europe but was also carefully read by the founding fathers of the United States.
But Adam Smith's ideas extended beyond political economy ; he was also a philosopher of ethics. His first book, published in 1759 and subsequently revised for a sixth edition a few months before his death, was * The Theory of Moral Sentiments * . Therefore, to fully understand Adam Smith's overarching thought, one cannot ignore the ethical theory interwoven into his political economy.
Adam Smith identified the factors that lead to national prosperity.
Smith lived during the nascent stages of the First Industrial Revolution and the height of the European Enlightenment (which emphasized the building of knowledge based on experience and reason). His most important teacher (Francis Hutcheson) and closest intellectual friend (David Hume) were both influential Enlightenment philosophers. In this context, Smith's overall philosophy was built upon his empirical observations of the dynamics of interpersonal relationships (economic, political, and ethical) within society.
Smith desired a good society; and he sought to identify the factors that would lead to that goal. Smith wrote: "No society can prosper and be happy when the majority of its members are poor and miserable."[1] He was concerned with how to develop the economy to reduce poverty for the majority of the population; but he also argued that money cannot buy happiness, as people have spiritual needs when living in a society.[2]
Adam Smith's ideas have stood the test of time because he avoided extremism and rigidly confined his views to every situation. For him, economic, political, and social life were inseparable elements. Therefore, his theories on market economics, the role of the state, and social relations remain relevant to the world today.
Increased productivity is the foundation of national prosperity.
Writing during Britain's transformation in the Industrial Revolution, Smith had the opportunity to observe firsthand the fundamental factors leading to national prosperity. For Smith, national wealth was not about the increase in the riches of the ruling class, but about a better material life for the vast majority of the people. Therefore, economic growth (an increase in the production of goods and services) was the key factor in improving living standards.
Smith analyzed and pointed out that economic growth depends on the economy's ability to increase productivity. And productivity depends on the division of labor. The higher the division of labor, the greater the specialization, leading to increased innovation and new technologies, thus boosting productivity.
But the extent of the division of labor depends on the size of the market. Smith wrote: "It is by the power of exchange that the sharing of work is made possible, so the extent of this sharing is always limited by the extent of that power, or in other words, by the extent of the market. When the market is very small, no one has the incentive to devote all his time to one job, for the lack of the ability to exchange the surplus of his labor product, which is outside his consumption needs, for portions of the labor product of others that he needs."[3]
Thus, the key to market size is the "power of exchange," meaning that the more freedom people have to buy and sell, the larger the market becomes. Globally, the more free trade is, the larger the market becomes, which in turn promotes the division of labor, specialization, and increased productivity. In short, economic freedom is the foundation for improving material living standards. And reality has proven Smith's assertion. Today, the link between trade and productivity is clear. Increased trade is a key factor in improving productivity.[4] With the increase in globalization over the past decades, billions of people around the world have been lifted out of extreme poverty. The World Trade Organization (WTO) and the World Bank (WB) have pointed out that: "Trade has made a significant contribution to poverty reduction [once] and further integration of developing countries into international markets will be essential to end poverty and leave no one behind."[5]
Development model
Smith viewed economic freedom as a "natural liberal system" consistent with human nature, capable of unleashing the creative potential of individuals in a society regulated by a limited state to ensure a level playing field.
Smith argued that "it takes little to raise a nation from a state of lowliness and barbarity to the heights of wealth except peace, reasonable taxes, and an acceptable system of justice. Everything else will fall into place according to the natural order of things."
For Smith, natural law is formed from the interaction between individuals in a free market, leading to a generally positive outcome for society as a whole. State intervention in a free market would disrupt this law because state policies often make mistakes due to various subjective and objective reasons.
Smith wrote: "The system believer […] often appears very intelligent in his own eyes; and he is so captivated by the imagined beauty of the ideal plan of the state that he cannot accept any small deviation from any part of it… He seems to imagine that he can arrange the different members of a great society as he would arrange the pieces on a chessboard. He does not consider that… on the great chessboard of human society, each piece has its own distinct principle of movement, entirely different from that which the state may choose to impose upon it."[6] This observation did not come from someone without experience of the state. Interestingly, Smith himself was a member of the state system for more than a decade (a customs official of Scotland) until his death in 1790.[7]
More specifically, Smith's observation is based on three closely related points. First, the natural tendency of each individual is to always seek the best way to improve their life with their limited resources. Second, only each individual (not the state) knows themselves best (in terms of ability and resources) in order to make the best choices (decisions). Third, when individuals are free to pursue their interests in a society where justice is protected, it will lead to a good outcome for the whole society, because to succeed individuals must do their best and voluntarily cooperate with each other.[8] This is the operation of the "invisible hand" as Smith called it.
But Smith was also careful to highlight the state's role in supporting the market and building a good society. Maintaining peace and security is a function of the state. Providing public services to support economic development (such as transportation infrastructure) is also an important role of the state. When the state performs its duties effectively, tax money is used properly and will not fall on the people's shoulders. Smith advocated a simple, transparent tax system that is proportionate to each person's income.
And an efficient free market that brings about good results for society as a whole must be based on a foundation of justice protected by the state. For Smith, justice is protected when the state has clear laws to protect (1) life, (2) property, and (3) contracts of citizens. Smith carefully limits the definition of justice so that the state does not, in the name of justice, interfere excessively in the market and society in general.[9]
Smith pointed out that there is always the possibility of powerful business groups colluding with government officials (crony capitalism) to profit through policies that grant (subsidies) or help restrict competition. He advised that any proposals from these groups should be carefully considered and their motives questioned. Policy profiteering is not only unjust (because it benefits a small group while the public pays the price) but it also hinders economic growth (because it distorts the allocation of resources).[10]
In a "system of natural freedom," individuals are regulated not only by competition and the enforcement of justice, but also by moral conduct, which is indispensable in a prosperous and happy society. Smith wrote: "Happiness lies in peace and pleasure. Without peace there can be no pleasure; and where there is perfect peace there is rarely anything that cannot make people happy." Smith pointed out that to have peace one must live by three fundamental moral values: justice, prudence, and doing good to others. Only then can each individual be truly happy and society truly be good.[11]
When these three values are disseminated throughout society, they contribute to building trust and fostering cooperation, leading to a better society. Trust here means believing in individuals and state organizations that they will act reliably and in accordance with shared expectations. On a personal level, economic transactions become more convenient and efficient when individuals trust each other. And when the state enforces laws transparently and effectively to protect justice, it increases public trust in the positive role of the state, facilitating the success of policies.
Scholar Fransis Fukuyama, through his empirical research, has shown that "the prosperity of a nation, as well as its competitiveness, depends on a single, profound cultural characteristic: the level of trust that exists in society." In societies with high levels of trust, "transaction costs" decrease, creating conditions for increased economic activity to drive growth.[12]
Throughout Adam Smith's "system of natural freedom" runs the human motive. The pursuit of personal gain to sustain life is one motive, and ethical actions to gain trust are also a motive. When individuals are free to interact in a free market with fair "rules of the game," individual motives align with societal interests.
Economic freedom has improved the lives of billions of people around the world. But economic freedom doesn't come naturally; it's a deliberate choice made by a society (nation). In societies that respect freedom, Adam Smith's "system of natural freedom" will have the opportunity to fully display its positive aspects, stemming from individual human beings. As social animals, to survive and thrive, free individuals will seek to cooperate regardless of societal changes. A free society is dynamic, creative, and constantly evolving to meet the needs of the times.
[1] Adam Smith, An Inquiry into the Nature and Causes of The Wealth of Nations (Chicago: The University of Chicago Press, 1976).
[2] Dennis Rasmussen, "The Problem with Inequality According to Adam Smith," The Atlantic, June 9, 2016.
[3] Smith, The Wealth of Nations .
[4] Gary Hufbauer and Zhizao Lu, "Increased Trade: A Key to Improving Productivity," Peterson Institute for International Economics, October 2016.
[5] "Trade and Poverty Reduction: New Evidence of Impacts in Developing Countries," The World Bank Group and The World Trade Organization, December 11, 2018.
[6] Adam Smith, The Theory of Moral Sentiments (Overland Park: Digireads.com Publishing, 2018).
[7] Gary Anderson, William Shughart and Robert Tollison, "Adam Smith in the Customhouse," Journal of Political Economy 93, no. 4 (1985): pp. 740-759.
[8] James Otterson, The Essential Adam Smith (Fraser Institute, 2018).
[9] James Otterson, The Essential Adam Smith (Fraser Institute, 2018).
[10] Lauren Brubaker, "Is the System Rigged? Adam Smith on Crony Capitalism, Its Causes - and Cures," The Heritage Foundation, March 31, 2018.
[11] Michael Busch, "Adam Smith and Consumerism's Role in Happiness: Modern Society Re-
examined,” Major Themes in Economics , 10 (2008): 65-77.
Major Themes in Economics, 10, 65-77.
[12] Francis Fukuyama, Trust: The Social Virtues and the Creation of Prosperity (New York: Free Press Paperbacks, 1996).
(Tran Le Anh - Joan Weiler Arnow 49' Professor of Economics and Management Lasell University)
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