Adam Smith (1723-90), a quiet, nervous, scholarly Scottish bachelor, taught first at Oxford University and then at the University of Glasgow. He gained fame as a moral philosopher, and during his lifetime, his book The Theory of Moral Sentiments earned the critics' appraisal as his best work. Consequently, he was already well known before publishing his enduring masterpiece, An Inquiry into the Nature and Causes of the Wealth of Nations.
During a three-year tour of Europe as traveling tutor of the stepson of Charles Townshend, Smith met the leading thinkers of the Age of Enlightenment, including Benjamin Franklin and Dr. Samuel Johnson. He was particularly impressed with Francois Quesnay, principal spokesman for the French physiocrats, who believed that wealth arises from production. While traveling, Smith worked on his Wealth of Nations and completed the book in 1776, ten years after his return to Scotland.
The Wealth of Nations, which resembles an encyclopedia, is far more than a mere textbook on economics. One critic calls it "a history and criticism of all European civilization." Among a host of topics, it discusses the origin and use of money, apprenticeship, statistics, waste, the military, foreign trade, landlords, the clergy, royalty, farming, and "the late disturbances in the American colonies."
The book's 900 pages are demanding reading, for Smith often belabors a point without drawing a conclusion. It is not actually original in the sense that its basic ideas are unique to Smith. The author refers to more than 100 authors in developing his arguments, including Locke and Hume. He borrows heavily from the physiocrats, particularly Quesnay, from whom he takes the doctrine of laissez faire, or "leave it alone." However, the book is a masterpiece because it presents a comprehensive picture of economics—a revolutionary doctrine which views the economy as though it were a living organism.
Briefly, these are Adam Smith's economic laws:
1. How can society depend on capitalism, which is an unregulated market system? Smith replies with two laws of the market. The desire for wealth permeates all human activity. Therefore, self-interest, or profit, motivates people to perform necessary tasks for which society is willing to pay. As Smith writes, "It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from our regard to their self-interest." Thus, the first law of the market is self-interest, or the profit motive.
2. But how can the individual's selfish desires benefit society? What stops greed from overwhelming the public, resulting in ruthless exploitation by profiteers? Smith answers that the individual, in the process of providing for personal interests, unintentionally contributes to the economic wellbeing of society. Therefore, the second law of the market is competition. The individual who overcharges for products soon learns that competitors will take away business by offering more reasonable prices. If wages are too small, workers will hire out to another employer who will pay more for their services. Thus, selfish motives are tempered by interaction, resulting in social harmony.
According to Smith, under the market system each worker freely chooses a trade. Through such a multitude of choices, society reaps the benefit of having all its necessary tasks filled. The individual, motivated by self-interest, selects a particular task. Competition for these tasks prevents the individual from over-charging society. Thus, the two laws of the market—self-interest and competition—react upon each other and form a balance, guaranteeing the survival of society.
In addition, the laws of the market not only insure that prices are competitive, but they also determine the quantities of goods produced. As Smith explains, when the public demands more gloves than shoes, there will be a brisk business in gloves, but little demand for shoes. Consequently, the price of gloves will rise as demand exceeds supply and pushes prices up. The price of shoes will go down because the supply exceeds the demand.
At this point, self-interest becomes a factor. Since there are higher profits in the glove business and a greater need for gloves, new producers begin manufacturing gloves. Workers move from shoe factories to glove factories. The result is that glove production rises and shoe production falls. Before long, the market achieves a balance. As the supply of gloves grows to meet demand, glove prices decrease. As the supply of shoes falls below demand, shoe prices rise. This price increase stimulates shoe production. Therefore, the opposing forces of self-interest and competition balance the market.
Finally, the laws of the market also regulate incomes of producers. When profits in one type of business become unusually large, new producers are attracted to the business—until competition reduces the surplus of profit. In the same way, labor's wages are regulated—workers are attracted to higher paying industry until the labor supply lowers the pay scale to that of comparable jobs. By the same token, the reverse is true—when profits or wages are too low, producers or workers will leave that field for more lucrative areas.
But the key to the operation of the laws of the market is that the market is "its own guardian." It is self-regulating if left alone (laissez faire) so that competition can operate freely without government control and without monopolies.
Does capitalism, or the market system, actually operate in this way? It did during Smith's time, for the business world was a world of atomistic, or elemental, competition. Yet, there was evidence that a large number of people did not profit from the system. Still, even though more than an eighth of England's population in 1720 was poor, Smith insisted that society could not flourish if "the greater part of the numbers are poor and miserable." In his radical view, society was definitely improving. By comparison, the capitalistic world of today differs greatly with its giant corporations and massive labor unions. However, the twin laws of self-interest and competition still form the basis of the market system.
Adam Smith was optimistic in his vision of the future. To him, the society of the market system was dynamic and progressive. During his lifetime, division and specialization of labor greatly increased productivity. He expressed enthusiasm after his visit to a pin factory which employed only ten people.
Each worker specialized in a single operation; the total daily output was over 48,000 pins. If each worker were to handle all steps involved in the manufacture of pins, the total output per worker would fall to twenty pins per day for a total production of 200 pins. According to Smith, a simple factory worker, in comparison with an African king, lives a more luxurious life as a result of the work of specialized labor.
In his vision of society's economic progress, Smith saw two additional fundamental laws which propelled the market system in an ascending spiral of productivity and away from the "avarice of private greed." These laws he called the law of accumulation and the law of population.
3. The law of accumulation refers to the accumulation of profits, which are put back into production. By accumulating profits, capitalists can purchase additional machinery, which will stimulate further division and specialization of labor, thereby boosting productivity. However, additional machinery means more workers to work them. Eventually this increased demand for workers leads to higher and higher wages until profits vanish. At this point, further accumulations are impossible.
4. The solution to this obstacle is Smith's law of population. Labor, like any other commodity, is subject to demand. As the law of accumulation increases wages for workers, the numbers of the working class will increase. As the population of workers increases, its size becomes a counterforce, pushing wages down. As a result of lower wages, profits for the capitalist will rise again, and accumulation will continue.
Thus, these two evolutionary laws form an endless chain for society through which progress is inevitable. Even though the Law of Population depresses wages toward a subsistence level, it never arrives there. Conditions steadily improve, resulting in further accumulation for further investment. What is the end result? Not a utopia, but the economy, if left alone, will ultimately reach its "promised reward" —a world where poverty and wealth balance each other.
