Adam Smith Capitalism Analysis
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POLITICAL THEORY - Adam Smith
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Similarly, wage rates would also be higher for those who engaged in dirty or unsafe occupations see Job Safety , such as coal mining and butchering; and for those, like the hangman, who performed odious jobs. In short, differences in work were compensated by differences in pay. Smith used numerate economics not just to explain production of pins or differences in pay between butchers and hangmen, but to address some of the most pressing political issues of the day. In the fourth book of The Wealth of Nations —published, remember, in —Smith told Great Britain that its American colonies were not worth the cost of keeping. His reasoning about the excessively high cost of British imperialism is worth repeating, both to show Smith at his numerate best and to show that simple, clear economics can lead to radical conclusions:.
A great empire has been established for the sole purpose of raising up a nation of customers who should be obliged to buy from the shops of our different producers all the goods with which these could supply them. For the sake of that little enhancement of price which this monopoly might afford our producers, the home-consumers have been burdened with the whole expense of maintaining and defending that empire.
For this purpose, and for this purpose only, in the two last wars, more than a hundred and seventy millions [in pounds] has been contracted over and above all that had been expended for the same purpose in former wars. The interest of this debt alone is not only greater than the whole extraordinary profit, which, it ever could be pretended, was made by the monopoly of the colony trade, but than the whole value of that trade, or than the whole value of the goods, which at an average have been annually exported to the colonies. Smith vehemently opposed mercantilism —the practice of artificially maintaining a trade surplus on the erroneous belief that doing so increased wealth. The primary advantage of trade, he argued, was that it opened up new markets for surplus goods and also provided some commodities from abroad at a lower cost than at home.
Adam Smith has sometimes been caricatured as someone who saw no role for government in economic life. In fact, he believed that government had an important role to play. Like most modern believers in free markets, Smith believed that the government should enforce contracts and grant patents and copyrights to encourage inventions and new ideas. He also thought that the government should provide public works, such as roads and bridges, that, he assumed, would not be worthwhile for individuals to provide. Interestingly, though, he wanted the users of such public works to pay in proportion to their use. Many people believe that Smith favored retaliatory tariffs. A retaliatory tariff is one levied by, say, the government of country A against imports from country B to retaliate for tariffs levied by the government of country B against imports from country A.
It is true that Smith thought they might be justified, but he was fairly skeptical. He wrote:. There may be good policy in retaliations of this kind, when there is a probability that they will procure the repeal of the high duties or prohibitions complained of. The recovery of a great foreign market will generally more than compensate the transitory inconveniency of paying dearer during a short time for some sorts of goods. To judge whether such retaliations are likely to produce such an effect does not, perhaps, belong so much to the science of a legislator, whose deliberations ought to be governed by general principles which are always the same, as to the skill of that insidious and crafty animal, vulgarly called a statesman or politician, whose councils are directed by the momentary fluctuations of affairs.
When there is no probability that any such repeal can be procured, it seems a bad method of compensating the injury done to certain classes of our people to do another injury ourselves, not only to those classes, but to almost all the other classes of them. When our neighbours prohibit some manufacture of ours, we generally prohibit, not only the same, for that alone would seldom affect them considerably, but some other manufacture of theirs. This may no doubt give encouragement to some particular class of workmen among ourselves, and by excluding some of their rivals, may enable them to raise their price in the home-market. Those workmen, however, who suffered by our neighbors prohibition will not be benefited by ours.
On the contrary, they and almost all the other classes of our citizens will thereby be obliged to pay dearer than before for certain goods. Every such law, therefore, imposes a real tax upon the whole country, not in favour of that particular class of workmen who were injured by our neighbours prohibition, but of some other class. Today, vouchers and school choice programs are touted as the latest reform in public education.
But Adam Smith addressed the issue more than two hundred years ago:. Were the students upon such charitable foundations left free to choose what college they liked best, such liberty might contribute to excite some emulation among different colleges. A regulation , on the contrary, which prohibited even the independent members of every particular college from leaving it, and going to any other, without leave first asked and obtained of that which they meant to abandon, would tend very much to extinguish that emulation.
And because more of his ideas have lasted than those of any other economist, some regard Adam Smith as the alpha and the omega of economic science. Smith , part I, section I, chap. I, para. Smith , book I, chap. VIII, para. Adam Smith This free-market force became known as the invisible hand , but it needed support to bring about its magic. In particular it was the market that emerged from an increasing division of labor, both within production processes and throughout society that created a series of mutual interdepencies, promoting social welfare through individual profit motives.
In other words, once you specialize as a baker and produce only bread, you now must rely on somebody else for your clothes, somebody else for your meat, and yet somebody else for your beer. Meanwhile the people that specialize in clothes now must rely on you for their bread, and so on. The automatic pricing and distribution mechanisms in the economy—which Adam Smith called an "invisible hand"—interact directly and indirectly with centralized, top-down planning authorities.
However, there are some meaningful conceptual fallacies in an argument that is framed as the invisible hand versus the government. The invisible hand is not actually a distinguishable entity. Instead, it is the sum of many phenomena that occur when consumers and producers engage in commerce. Smith's insight into the idea of the invisible hand was one of the most important in the history of economics. It remains one of the chief justifications for free-market ideologies.
The invisible hand theorem at least in its modern interpretations suggests that the means of production and distribution should be privately owned and that if trade occurs unfettered by regulation, in turn, society will flourish organically. These arguments are naturally competitive with the concept and function of government. The government is not serendipitous—it is prescriptive and intentional. Politicians, regulators, and those who exercise legal force such as the courts, police, and military pursue defined goals through coercion. However, in contrast, macroeconomic forces—supply and demand, buying and selling, profit and loss occur voluntarily until government policy inhibits or overrides them.
In this sense, it is more accurate to suggest that government affects the invisible hand, not the other way around. However, it is the absence of market mechanisms that frustrates government planning. Some economists refer to this as the economic calculation problem. When people and businesses individually make decisions based on their willingness to pay money for a good or service, that information is captured dynamically in the price mechanism. This, in turn, allocates resources automatically toward the most valued ends. When governments interfere with this process, unwanted shortages and surpluses tend to occur.
Consider the massive gas shortages in the United States during the s. The Nixon and Ford administrations responded by introducing price controls to limit the cost of gasoline to American consumers. The goal was to make cheap gas available to the public. Instead, gas stations had no incentive to stay open for more than a few hours. Oil companies had no incentive to increase production domestically. Consumers had every incentive to buy more gasoline than they needed. Large-scale shortages and gas lines resulted. Those gas lines disappeared almost immediately after controls were eliminated and prices were allowed to rise. While it is tempting to say the invisible hand limits government, that wouldn't necessarily be correct.
Rather, the forces that guide voluntary economic activity toward large societal benefit are the same forces that limit the effectiveness of government intervention. Boiling the principles Smith expressed regarding the invisible hand and other concepts down to essentials, Smith believed a nation needed the following three elements to bring about universal prosperity. Smith wanted people to practice thrift , hard work, and enlightened self-interest. He thought the practice of enlightened self-interest was natural for the majority of people.
In his famous example, a butcher does not supply meat based on good-hearted intentions, but because he profits by selling meat. If the meat he sells is poor, he will not have repeat customers and, thus, no profit. Therefore, it's in the butcher's interest to sell good meat at a price that customers are willing to pay, so that both parties benefit in every transaction. Smith believed the ability to think long-term would curb most businesses from abusing customers.
When that wasn't enough, he looked to the government to enforce laws. Extending upon self-interest in trade, Smith saw thrift and savings as important virtues, especially when savings were used to invest. Through investment, the industry would have the capital to buy more labor-saving machinery and encourage innovation. This technological leap forward would increase returns on invested capital and raise the overall standard of living. Smith saw the responsibilities of the government as being limited to the defense of the nation, universal education, public works infrastructure such as roads and bridges , the enforcement of legal rights property rights and contracts , and the punishment of crime.
The government would step in when people acted on their short-term interests and would make and enforce laws against robbery, fraud, and other similar crimes. He cautioned against larger, bureaucratic governments, writing, "there is no art which one government sooner learns of another, than that of draining money from the pockets of the people. His focus on universal education was to counteract the negative and dulling effects of the division of labor that was a necessary part of industrialization.
The third element Smith proposed was a solid currency twinned with free-market principles. By backing currency with hard metals, Smith hoped to curtail the government's ability to depreciate currency by circulating more of it to pay for wars or other wasteful expenditures. With hard currency acting as a check on spending, Smith wanted the government to follow free-market principles by keeping taxes low and allowing free trade across borders by eliminating tariffs.
He pointed out that tariffs and other taxes only succeeded in making life more expensive for the people while also stifling industry and trade abroad. To drive home the damaging nature of tariffs, Smith used the example of making wine in Scotland. He pointed out that good grapes could be grown in Scotland in hothouses, but the extra costs of heating would make Scottish wine 30 times more expensive than French wines. Far better, he reasoned, would be to trade something Scotland had an abundance of such as wool, in return for French wine.
In other words, because France has a competitive advantage in producing wine, tariffs aimed to create and protect a domestic wine industry would just waste resources and cost the public money. It lacks proper explanations for pricing or a theory of value and Smith failed to see the importance of the entrepreneur in breaking up inefficiencies and creating new markets. Both the opponents of and believers in Adam Smith's free-market capitalism have added to the framework set up in "The Wealth of Nations. Marginal utility , comparative advantage , entrepreneurship, the time-preference theory of interest, monetary theory , and many other pieces have been added to the whole since