Adam Smith
An Inquiry Into the Nature and Causes of the Wealth of Nations
Introduction
• Recall: Ethics, economics as part of a broader system of social science– Theory of Moral Sentiments: An exercise in
moral, social philosophy– Wealth of Nations: Extends this to provide a
working model for social interaction: the “System of Natural Liberty” as a vehicle for directing our self-regarding propensities
– A response to to the challenge directed toward Smith’s moral theory: Will the Impartial Spectator be sufficient to control “the passions”?
• Is the available information sufficient?
• Is that information really always interpreted impartially?
• Our claim: society needs institutional structure
• But TMS does not tell us where this comes from
Links to Kuhn: Smith’s Disciplinary Matrix
• A systematic– Exploration of the natural order underlying the
social world– Application of that understanding to social and
economic issues
• A unified system of explanation
• A definitive technique of analysis
• Provided economics (political economy) with its first generally accepted system of theories, concepts, analytic techniques: its first disciplinary matrix
• Part of his general theory of society
• That is: he gave it– An organized structure of assumptions– A problem orientation– A value system– An analytic framework– (later) a self-conscious intellectual community
• Much popular appeal of this paradigm– Relevance to immediate policy problems
• Population explosion; concern for Poor Relief; economic growth issue
• Corn Laws; and commercial policy
– Belief that political economy could provide• A simple, effective method of analyzing these
complex problems
• A reasoned approach to useful policy recommendations
– Ricardo, Malthus, others, as puzzle-solving: doing normal science
Fundamental Issue
• Under what conditions will society operate so as to maximize human happiness?
• TMS: Human happiness promoted by obeying the moral virtues under the observation of the Impartial Spectator; grounded in need for social approval
• WN: – More explicit recognition of the problem of
opportunistic behavior– Implications for the kinds of reforms necessary
to bring society closer to the system of natural order that would maximize happiness
– Note Smith’s location in time and space
• The machine metaphor: under what conditions does it operate best?
• The importance of policy
• WN as probably the first unified socio-economic model
The Major Themes
• Economic growth, development: society’s laws of motion
• Social coordination: How does a society in which each individual follows own self-interest keep from falling apart?
Economic Growth
• What’s the “wealth” of nations?– Mercantilist presumption– Smith: “Wealth”, from “weal”, well-being– What’s necessary for the “good life”?– For whom?
• Growth measured in terms of output per person
• Sources of productivity: where does growth come from?– Now: Focus on
• Technology
• Capital per worker
• Institutions
• Incentives
• Smith: Source of productivity growth in specialization, division of labor– The pin factory– Why does this happen?
• Improved dexterity: learning-by-doing
• Time saved moving from operation to operation
• Inventing labor-saving machines
• Who benefits?
• Origin of division of labor? “Propensity to truck, barter, and exchange . . .”
• We need the cooperation of many others to survive; do we get that cooperation by appealing to their benevolence?
• The social division of labor as important
• What affects the degree of specialization? The importance of the extent of the market
• Examples
The Importance of Money
• Specialization as implying exchange
• Barter, and the problem of transactions costs
• Commodity vs. fiat money
• The diamond/water paradox: a scientific puzzle
The Policy of Europe
• A first look at Smith’s argument for the “system of natural liberty”
• A way for Smith to talk about the consequences of interference with free exchange
• Examples: exclusive privileges; restrictions on labor mobility; the threat of monopoly
The Importance of Capital Accumulation
• Smith’s problem: How do we support ourselves until we produce and sell our own output?
• In our language: – Capital stock as necessary for more division of
labor– Capital, thus, as a major source of productivity
growth
• Productive vs. unproductive labor: What’s going on here?
• Distinction between output produced for
– Current consumption (consumer goods)– Future consumption (capital goods)
• How does society increase productive labor (capital accumulation)?– Parsimony: saving– Link to TMS, and saving as a dimension of
prudence/self-love
• The importance of good public policy– Smith’s warnings against a large public sector:
why?
• The direction of spending matters: Spending for luxury goods in a poor country as blocking economic development
The System of Natural Liberty
• Book IV, and further discussion of mercantilist legislation
• The trade balance: – Do we need to worry about trade deficits?– Are gains to one trading partner matched by
losses to the other?
– Why see restraints on trade?– Contemporary versions
• The basic idea: The competitive market as reconciling private, social interests; the social mechanism for regulating the economy
• Imposes orderly rules of behavior on economic agents
• Thus: The “Invisible Hand”– As working automatically to coordinate
people’s individual decisions– As working best with minimum interference
• Potential problems:– Desire to monopolize– Tendency for protectionism– Grounded in self-interest?
• Where’s government in all this? To provide– Legal system: Administer justice– Anti-monopoly protection– Military security– Provide certain public works
In the End: The Central Theme of the Invisible Hand
• Under certain social arrangements private and social interests can be harmonized
• Market forces assure a social result that is independent of individual intentions
• Self-interest works for general welfare only under appropriate set of rules
• Does a market economy guarantee the “best of all possible worlds”? Is Dr. Smith really Dr. Pangloss in disguise?
• Is government without fault? The incentives facing politicians, bureaucrats
The Evolution of Social Institutions
• Unresolved issue: Where do social institutions (including government) come from? Why are they necessary?– TMS, and their necessity; but not how they
come to be– WN, and a story about their origin (Books III
and V): a “philosophical history”
• How does human society begin? The propensity to “ . . . truck, barter, and exchange . . . “
• Necessity of defining, monitoring, enforcing property rights
• Security, order as necessary for society; and social order requires system of law
• So: how do institutions evolve?– Brief definition: Institutions as rules (explicit; or
implicit)– Origin with the evolution of property– Sources of authority:
• Age
• Fortune
• Birth
• Personal qualifications
– Stages of society• Subsistence (hunting, fishing)
• Pasturage
• Agriculture
• Commercial
– Evolution of differences in property ownership; and associated evolution of property rights
– Importance of preconditions for growth
• Why does Smith do this? To show how changes in the nature of the economy are reflected in institutional changes
– The basic argument:• Humans are self-regarding is all spheres of society
• Helps us understand the pursuit of wealth, security
• Economic development creates different stages of society, each with its own characteristic institutional structure
• Two case studies:– Western Europe after the fall of Rome
• The manor as the basic unit of society– Disorder; conflict
– Provided security
– Mutual claims, lords and serf
• Changes in system of property rights: entail; primogeniture
• Limited growth possibilities
• Emergence of a market economy– Links, town and country
– Political alliances, monarchs and towns
– Role of foreign trade
– Decline in lords’ feudal power• Conversion of feudal obligations into cash
• Dissipation of fortunes: buying goods and services
• So: Commerce brought about what feudal violence could not: a decreased power for nobles
In the End . . .
• “Whenever a person seeks to serve his own ends, he invariably serves the ends of society”
• Did Smith provide a solution to this problem? Did he suggest the conditions (social arrangements) under which this can happen?
• Self-interest makes the market system go
• But benevolence (a moral sentiment) makes the market system possible
• Social institutions important in harnessing, channeling, pecuniary motives
• A set of policy prescriptions grounded in– The existing institutional structure– His analysis
• Is the free-market economy the “best of all possible worlds”? Is Dr. Smith really Dr. Pangloss in disguise?
• Another issue: Is market society (capitalism) civilizing or self-destructive? What’s the effect of capitalism on the social and moral order?
– The “Doux-Commerce” hypothesis: Favorable effects of capitalism
• Limitations on the powers of monarchs
• A moralizing agent: people are useful to each other
• Smith, and frugality, integrity, industriousness
• The influence of continuing relationships
– The “Self-Destruction” hypothesis: Capitalism as undermining the moral foundations on which any society must rest
• Influence of the Industrial Revolution
• Emphasis on individual advantage: atomism as corrosive of social cohesion
• Rationalism undermines religious belief
• “Commercial spirit” replaces “higher values”
– Can both be held at the same time?– Is there an inevitable outcome for capitalism?
