Summary and Analysis Chapter 3



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.


To comprehend fully why Smith's Wealth of Nations was a revolutionary book, one must know something of the economy and living conditions in England in 1776. The nation was entering the second of three stages of capitalism.

  1. The first stage, known as commercial capitalism, occurred between 1450 and 1750. It was brought about by the five factors which produced the Economic Revolution and was affected by geographic discoveries, colonization, and increase in overseas trade. The early capitalists were protected by government control, subsidies, and monopolies and made their profits from transporting goods.
  2. The second stage began about 1750 and was made possible by new sources of energy, primarily the steam engine. This invention enabled the factory system to develop through the use of machines for manufacturing and resulted in the rapid growth of wealth. This stage, known as industrial capitalism, which reached its height during the 1850s, resulted as capitalists profited from manufacturing.
  3. The third stage of capitalism began in the last quarter of the nineteenth century. Because of the control and direction of industry by financiers, this stage is known as financial capitalism, with profits coming from investing.

Wealth of Nations appeared in England just as the Industrial Revolution was beginning, a fact unknown to Adam Smith and the capitalistic class of his day. In England, the government controlled practically every sector of the economy, including prices, wages, hours of work, production, and foreign trade. The House of Lords represented the noble families, or landed aristocracy, which controlled the vote as well as public office. Only 3 percent of the population affected the election of members to the less static House of Commons.

For the poor, conditions were abominable. Men, women, and children, stripped to the waist and stooped over in semi-darkness, worked in dank mineshafts. The masses struggled brutally for a meager existence. When wool became a profitable commodity, land owners enclosed new pastures to raise sheep. The process of enclosure, which began in the sixteenth century, reached its height in the nineteenth century, with thousands of tenant farmers thrown off the land in order to make room for the more profitable sheep. Over 1.5 million of England's twelve to thirteen million population suffered poverty. Yet the grasping aristocracy, who considered the poor a necessary segment of a stable society, opposed any suggestion of a more equitable distribution of wealth.

Mercantilism, the dominant economic concept of the day, upheld the view of government and business that real wealth consisted of gold and silver. Since the reign of Henry VIII, mercantilists sought a strong, self-sufficient economy, protected by a strong central government. Their program called for the following:

  1. accumulation of gold and silver
  2. a favorable balance of trade through an excess of exports
  3. the self-sufficiency of the nation through the utilization of raw materials from either England or her colonies
  4. colonies to provide raw materials, as well as a market for England's manufactured goods
  5. low wages and long hours for workers
  6. high tariffs to protect home industry and to discourage imports
  7. a strong merchant marine

Adam Smith's Wealth of Nations launched a specific attack on the doctrine of mercantilism. In his celebrated Book IV, he called for free trade and the abolition of economic restraints and monopolies. Forget "balance of trade," he argued. "Wealth does not consist in money, or in gold and silver, but in what money purchases, and is valuable only for purchasing." As opposed to the emphasis on agriculture by the physiocrats, Smith emphasized manufacture. For Smith, the real wealth of nations consists of the goods which they can produce and trade. This condition can be accomplished only by allowing production and commerce to develop freely, without controls.

The replacement of mercantilism with the doctrine of laissez faire did not come immediately with the publication of Smith's views. It was not until the nineteenth century that the Wealth of Nations made its full impact. Then Great Britain discarded mercantilism completely to become the world's wealthiest nation. Unfortunately, the rising industrial capitalists managed to disregard certain stinging accusations in Smith's philosophy, such as "People of the same trade seldom meet together but the conversation ends in a conspiracy against the public, or in some diversion to raise prices . . ."

Adam Smith, in fact, was neither pro-capital nor pro-labor. At the University of Glasgow, he was influenced by the concept of "the greatest happiness of the greatest number." Consequently, he avoided taking sides with any class, concerning himself with the promotion of wealth for all of England's classes.

A principle which his contemporary capitalists chose to ignore was Smith's concept of labor value. His observation that labor is the only real standard of value has been contradicted by most economists, but widely adopted by socialist writers. Some ninety years later, Karl Marx seized and expanded upon this idea, building it into his exaggerated theory of "surplus value."

What British capitalists stressed was Smith's gospel of laissez faire. Ignoring the philosopher's warnings about the dangers of monopoly, they justified resistance to government attempts at social legislation. During this era, child labor was common in poorly ventilated and unsanitary factories; manufacturers shackled children to machines. To quell child labor laws, factory owners quoted Wealth of Nations in defense of deregulation.

Accordingly, Adam Smith's proposals for protective measures for workers, farmers, consumers, and society as a whole; the abolition of slavery; and the control of monopolies were ignored. Capitalists championed the Wealth of Nations as a vindication of corrupt business practices. In this way, Adam Smith, the soft-spoken scholar, became the patron saint of free enterprise in the capitalistic world. In later times, Adam Smith, by thoroughly describing and explaining the market system, became the father of modern economics.

He founded the school of Classical Economists, whose chief spokesmen were David Ricardo and Thomas Malthus.


Age of Enlightenment A period (roughly 1700-89) when political, economic, and social thought was dominated by an optimistic faith in reason and in the progress of the human race.

Mercantilism The doctrine which dominated European economic policies from 1500 until the advent of laissez faire through a program which stressed that the real wealth of a nation resulted from its stores of gold and silver, which could be acquired by an excess of exports to imports, self-sufficiency of the nation, and exploitation of colonies.

Physiocrats A group of thinkers during the Age of Enlightenment who opposed mercantilism, believing instead that the true source of wealth derives from land and agriculture; they advocated the doctrine of laissez faire.

Francois Quesnay (1694-1774) French economist who founded the school of Physiocrats and greatly influenced Adam Smith.

Laissez Faire Literally, "let [it] function" — the economic doctrine founded by Quesnay and the Physiocrats and expounded by Adam Smith, stressing no governmental interference in the operations of the market economy.

Industrial Revolution The transition from the stable agricultural and commercial society of the Western world to the modern industrialized society; the second stage of capitalism.

Enclosure Movement The practice of fencing off lands formerly subject to common rights in order to provide pasture land for sheep. This movement caused a shift of the poor in England from farms to cities.

Patron Saint of Free Enterprise Adam Smith.

Father of Modern Economics Adam Smith.

Classical Economists The economists who preached the doctrine of laissez faire and stressed that the production, consumption, and distribution of goods and wealth are determined exclusively by economics laws and principles.