In his life's work ( An Inquiry into the Nature and Causes of the Wealth of Nations ), Smith systematically analyzed the factors that lead to national prosperity. In his time, Adam Smith's thoughts were like a bright torch that illuminated the shortcomings of the economic and political foundations at that time. His work was not only warmly received in Europe but also carefully read by the founding fathers of the United States.
But Adam Smith's thought was not only in the realm of political economy, he was also a moral philosopher. The first book he published in 1759 and continued to edit for the sixth edition a few months before his death was The Theory of Moral Sentiments . Therefore, to understand Adam Smith's overall thought, it is impossible to ignore the theory of morality integrated into his theory of political economy .
Adam Smith pointed out the factors that lead to national prosperity.
Smith lived in the context of the First Industrial Revolution that was beginning to take place and the European Enlightenment (which emphasized the construction of knowledge based on experience and reason) was at its height. Smith's most important teacher (Francis Hutcheson) and closest intellectual friend (David Hume) were both influential Enlightenment philosophers. In such a context, Smith's overall thought was built on his empirical observations of what happened in the relationships (economic/political/moral) between people in society.
Smith wanted a good society; and he sought to identify the factors that would lead to that goal. Smith wrote: "No society can be prosperous and happy, where the majority of its members are poor and miserable."[1] He was interested in how the economy could develop to reduce poverty for the majority of the population; but he also believed that money could not buy happiness, because people also had spiritual needs when living in a society.[2]
Adam Smith’s ideas have endured because he did not fall into extremes and frame them in all situations. For him, economic, political, and social life were inseparable elements. Therefore, his theories on the market economy, the role of the state, and social relations are still valuable for today’s world.
Productivity growth is the foundation of national prosperity.
Writing as Britain was undergoing the Industrial Revolution, Smith had the opportunity to make empirical observations that would help him identify the fundamental factors that led to national prosperity. For Smith, national wealth was not the increase in wealth of the ruling elite but the improvement in the material life of the majority of the people. In this sense, economic growth (the increase in the production of goods and services) was the key to improving life.
Smith analyzed and pointed out that economic growth depends on the ability of the economy to increase productivity. And productivity depends on the division of labor. The higher the division of labor, the higher the specialization, leading to increased innovation and new technology, promoting increased productivity.
But the extent of the division of labor depends on the size of the market. Smith writes: "Since the power of exchange leads to the division of labor, the extent of this division 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 any incentive to devote his whole time to one occupation, for want of the possibility of exchanging the surplus of his labor, which is beyond his own consumption, for the portion of the labor of others which he needs."[3]
Thus, the key to market size is the “power of exchange,” meaning that the more people are free to buy and sell, the larger the market. On a global scale, the freer trade leads to larger markets, which promote division of labor, specialization, and increased productivity. In short, economic freedom is the foundation for improving material life. And Smith’s observation has been proven. Today, the link between trade and productivity is clear. Increased trade is an important factor in improving productivity.[4] With the rise of globalization in recent 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 an important contribution to poverty reduction [in the past], and further integration of developing countries into international markets will be essential to ending poverty and leaving no one behind."[5]
Development model
Smith viewed economic freedom as a "system of natural liberty" 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 "little is needed to raise a nation from its low and primitive state to the height of its wealth but peace, easy taxes, and a tolerable administration of justice. Everything else follows according to the natural course of things."
For Smith, natural law is formed from the interaction between individuals in a free market, leading to a common good result for the whole society. State intervention in the free market will upset this law because state policy often makes mistakes due to various subjective and objective reasons.
Smith wrote: "The believer in the system […] is often so clever in his own eyes; and he is often so absorbed in the imaginary beauty of the ideal plan of the state that he cannot admit of the slightest deviation from any part of it... He seems to imagine that he can arrange the various members of a great society as the hand arranges the pieces on a chessboard. He does not consider that... on the great chessboard of human society, each piece has a distinct principle of motion, quite different from that which the state may choose to impose upon it."[6] This remark does not come from someone who had no experience of the state. Interestingly, Smith himself was a man of statecraft for over a decade (as a Scottish customs officer) until his death in 1790.[7]
In more detail, Smith's above comment is based on three closely related points. First, the natural tendency of each individual is to always seek the best way to improve his life with his limited resources. Second, only each individual (not the state) knows himself best (in terms of abilities and resources) so that he can make the best choices (decisions). Third, when individuals are free to pursue their own interests in a society where justice is protected, it will lead to good results for the whole society, because to succeed, individuals must try their best and voluntarily cooperate with each other.[8] This is the operation of the "invisible hand" as Smith calls it.
But Smith was also careful to point out the role of the state in supporting the market and building a good society. Maintaining peace and security is the function of the state. Providing public services to support economic development (such as transport 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 heads" of the people. Smith advocated a simple, transparent, and income-proportionate tax system.
And a free market that works effectively and produces 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) people's lives, (2) property, and (3) contracts. Smith was careful to limit the definition of justice so that the state would not intervene excessively in the market and society in general in the name of justice.[9]
Smith pointed out that there is always the possibility that powerful businesses collude with government officials (crony capitalism) to extract benefits through policies that grant (subsidies) or help limit competition. He advised that any proposals from these groups should be carefully examined and their intentions questioned. Policy rent-seeking is not only unfair (because it benefits a small group at the expense of the public) but it also hinders economic growth (because it distorts the allocation of resources).[10]
In the "system of natural liberty", individuals are not only regulated by competition and the enforcement of justice, but also moral behavior is indispensable in a prosperous and happy society. Smith wrote: "Happiness consists in tranquility and pleasure. Without tranquility there can be no pleasure; and where there is perfect tranquility there is scarcely anything that cannot make one happy." Smith pointed out that to have tranquility, it is necessary to live with three fundamental moral values: justice, prudence, and knowing how to benevolent to others. Only then will each individual be truly happy and society truly good.[11]
When the above three values are spread in society, they also contribute to building trust, promoting cooperation to lead to a better society. Trust here means believing in individuals and state organizations that they will behave reliably, in accordance with common expectations. On a personal level, economic transactions will be convenient and increase when individuals trust each other. And when the state enforces laws in a transparent and effective manner to protect justice, it will increase people's confidence in the positive role of the state, creating conditions for the success of policies.
Scholar Fransis Fukuyama, through his empirical research, has shown that "a nation's prosperity, as well as its competitiveness, depends on a single, pervasive cultural characteristic: the level of trust that exists in society." In societies with high levels of trust, "transaction costs" are reduced, facilitating increased economic activity to promote growth.[12]
Throughout Adam Smith's "system of natural liberty" are human motives. Pursuing self-interest to make a living is one motive, acting morally to gain trust is another motive. When individuals are free to interact in a free market with fair "rules of the game," individual motives will be consistent with social interests.
Economic freedom has improved the lives of billions of people around the world. But economic freedom does not come naturally; it is a deliberate choice of a society (nation). In societies that respect freedom, Adam Smith's "system of natural liberty" will have the opportunity to show all its positive features originating from the individual human being. As social animals, in order to survive and develop, free people will find ways to cooperate no matter how society changes. A free society is flexible, creative, and always developing to suit 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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