The Wealth of Nations, by Scottish philosopher Adam Smith, is the most significant work in economic history, earning Smith the title “Father of Economics”. Even to this day, Smith’s ideas are widely accepted and respected among economists, so its natural to hear his wisdom on how a country becomes rich.
For Smith, the foundation of economic prosperity lies in a government that’s just and fair to all of its people, not one that acts to further enrich the elites. The people in this society, through the pursuit of their self-interest, will specialize, work hard, save, and trade to enrich themselves, and as a byproduct, their country. The famous “invisible hand” refers to this system of people all acting in their self-interest, resulting in markets that supply all of society’s needs – somewhat magically, without coercion or a planner.
The government’s job, aside from establishing laws that benefit all, is primarily to fill the gaps of the private market and set things up so that the invisible hand can do its work. Smith describes this as a government that provides fair courts, armed forces, essential infrastructure like roads, essential institutions like embassies, and the education of its citizens to a basic standard. Additionally, the government should ensure the currency is stable, avoid debt, work towards free trade, and prevent the formation of monopolies. These expenses should be funded with a simple and equitable tax system.
The Wealth of Nations is a fascinating and insightful read, at the same time it is lengthy and requires a large time commitment to read. This article draws on quotes directly from The Wealth of Nations to give you a deep understanding of what Adam Smith actually thought about how a nation grows wealthy.
Background of the Book
Despite being published in 1776, The Wealth of Nations and Adam Smith are still relevant today, with ideas like the “invisible hand” or the “division of labor” being referenced regularly in the business world, education systems, and political institutions around the world. And for good reason. Smith was one of the most influential thinkers of the enlightenment – an era in which people began relying on reasoning and evidence instead of religious dogma to study how the world worked. The economic system Smith set out to dismantle was called mercantilism, a view that the riches of a nation consisted in its stash of gold and silver, leading to policies that emphasized their collection, using tariffs, taxes, and any means necessary. Smith instead uses his powers of observation and available data to argue that the economy works much differently. A nation’s wealth is not in its stash of gold, but in the total value of its trade and commerce – the amount of labor it can command.
“They [money] contain the value of a certain quantity of labour which we exchange for what is supposed at the time to contain the value of an equal quantity. Labour was the first price, the original purchase-money that was paid for all things. It was not by gold or by silver, but by labour, that all the wealth of the world was originally purchased…”1
How Does A Nation Grow Rich Then?
#1 – Set Just Laws
As discussed in my previous article, modern economic research indicates that institutions are the ultimate reason why some nations are rich and others are poor today. Adam Smith anticipated this over 200 years ago:
“Commerce and manufactures can seldom flourish long in any state which does not enjoy a regular administration of justice, in which the people do not feel themselves secure in the possession of their property, in which the faith of contracts is not supported by law, and in which the authority of the state is not supposed to be regularly employed in enforcing the payment of debts… Commerce and manufactures, in short, can seldom flourish in any state in which there is not a certain degree of confidence in the justice of government.”2
Smith particularly hammers down on countries that are operating under the mercantilist philosophy, like Spain and Portugal, who famously turned their discovery of the new world into a treasure hunt for gold and silver. Smith disdains this, pointing out:
“In Spain and Portugal, the bad effects of the monopoly, aggravated by other causes…have, perhaps, nearly over-balanced the natural good effects of the colony trade. These causes seem to be, …monopolies…, degradation of the values of gold and silver [inflation of currency]…, exclusion from foreign markets by improper taxes upon exportation [trade tariffs], and… by still more improper taxes upon transportation of goods… but above of all, that irregular and partial administration of justice [emphasis mine], which protects the rich and powerful debtor from the pursuit of his injured creditor, and which makes the industrious part of the nation afraid to prepare goods for the consumption of those haughty and great men…”3
Why Are Just Laws The Foundation?
Good and fair laws are so important to Smith because without them, the people of the nation will have no reason to work hard and produce as much food, services, and manufactured goods. Once the laws are in place, people will naturally use their self-interest to enrich themselves. Farmers will strive to improve their land, manufacturers will do their best to increase efficiency and output, and the common man or woman will: save, invest, and work to increase their wealth. The unintentional but resulting byproduct of all this, is that the nation will likewise grow wealthy:
“Every individual is continually exerting himself to find out the most advantageous employment for whatever capital he can command. It is his own advantage indeed, and not that of society, which he has in view. But the study of his own advantage naturally, or rather necessarily leads him to prefer that employment which is most advantageous to society.”4
Just Laws Must Be Maintained
Smith was aware however, that as the wealth and power of a certain group of society grows, they will attempt to change the laws to benefit themselves, at the expense of the rest of society. Smith saw the interests of the common man, and the landholder as generally aligned with what’s best for society; he was skeptical of laws originating from businessmen:
“The interest of the dealers [merchants and large manufacturers], however, in any particular branch of trade or manufactures, is always in some respects different from, and even opposite to the public. To widen the market and to narrow competition, is always the interest of the dealers. … The proposal of any new law or regulation of commerce which comes from this order, ought always to be listened to with great precaution, and ought never to be adopted till after having been long and carefully examined… with the most suspicious attention. It comes from an order of men, whose interest is never exactly the same with that of the public, who have generally an interest to deceive and even to oppress the public, and who accordingly have, upon many occasions, both deceived and oppressed it.”5 [emphasis mine]
Far from being naïve, Smith was a very nuanced thinker who anticipated how his proposed system could fail. He was not Laissez-Faire in the sense of letting happen what will happen in the markets, monopolies and powerful companies would be viewed with great suspicion by him, and we can be confident that he would support government intervention in weakening their hold over the market.
Why Does He Make Such a Big Deal About Free Trade?
Smith is famous for supporting free trade, primarily because it results in a bigger market, (the nation sells its goods to more people) allowing for even more specialization of labor and the productivity gains that come with it. For this reason, Smith sees free trade as simply being the extension of a just and fair government. Why would a government support tariffs and subsidies when most of them are designed to enrich the merchants and manufacturers at the expense of the rest of the nation? Exactly – society wouldn’t do such a thing if it were just. Since trade restrictions raise the prices of goods:
“The proposition [that people want to buy goods at the cheapest prices] is so very manifest, that it seems ridiculous to take any pains to prove it; nor could it ever have been called in question, had not the interested sophistry of merchants and manufacturers confounded the common sense of the mankind. Their interest is, in this respect, directly opposite to that of the great body of the people. As it is the interest of the freemen of a corporation to hinder the rest of the inhabitants from employing any workmen but themselves, so it is the interest of the merchants and manufacturers of every country to secure to themselves the monopoly of the home market. Hence in Great Britain, and in most other European countries, the extraordinary duties upon almost all goods imported by alien merchants. Hence the high duties and prohibitions upon all those foreign manufactures which can come into competition with our own…”6
Smith Does Favor Trade Restrictions – If They’re Good For the Nation
Smith does support certain trade restrictions if the reasons for having them benefit society as a whole. For example, having a powerful navy, was an important part of Great Britain’s national defense, thus even drastic measures by the government to grant the monopoly of shipping to domestic companies was an act of “most deliberate wisdom.”7
“As defence, however is of much more importance than opulence, the act of navigation [an act that gave a monopoly Great Britain’s shipping trade to Britain’s sailors and companies] is, perhaps, the wisest of all the commercial regulations of England.”8
He also looked favorably upon tariffs on imported goods if there was already a tax on that same good when it was produced domestically; competition should be a fair fight. In The Wealth of Nations, Smith shows himself to be a nuanced and conscientious thinker, quite the opposite of the simplistic way politicians portray him, in the pursuit of their agendas.
#2 – Government Has a Few Basic Jobs
Smith is Skeptical of Too Much Government
Smith was certainly skeptical of most government action taken to “help” society prosper. Smith lambasts governments of all countries for their short-sighted policies throughout the book – describing economic growth as something that happens in spite of their intervention, not because of it.
“But though the profusion of government must, undoubtedly, have retarded the natural progress of England towards wealth and improvement, it has not been able to stop it… In the midst of all the exactions of government, this capital has been silently and gradually accumulated by the private frugality and good conduct of individuals, by their universal, continual, and uninterrupted effort to better their own condition. It is this effort, protected by law and allowed by liberty to exert itself in this manner that is most advantageous, which has maintained the progress of England, towards opulence and improvement…”9
What Should The Government Be Doing?
That summarizes Smith’s position clearly enough. So, does Smith see the government’s role as setting good laws and getting out of the way? Not exactly, Smith recognizes that things like education of the poor or roads will not be provided well or at all by the private market – filling this gap is the job of the government.
The government should provide a fair court system, where grievances and disputes can be settled without corruption. It also should pay for the defense of the nation, maintaining a standing army in case of war. The various infrastructure that is essential to commerce should also be provided, like roads, canals, bridges, ports, a national treasury, a post office, and so on. Similarly, institutions that grease the gears of commerce can best be provided by the government; these would include ambassadors posted in foreign countries and embassies built to facilitate communication with foreign governments. Smith also considered basic education, although very beneficial to the industry and wealth of a nation, as something that would never be provided to the common class on its own. Thus, it was necessary that the government provide this to a basic level.
On Taxation
Apart from this, Smith’s discussion of the government’s role consists primarily of how it should fund these essential expenses. To Smith, a simple and fair system of taxation was essential to the prosperity of a nation. He believed that in levying taxes, four principles must be maintained:
- Equality – People should contribute to the government in proportion to their income, with those who make more and benefit more from the government contributing more.
- Certainty – The timing, quantity, and manner of payment should be certain, not arbitrary. The tax system should be simple and clear to all.
- Convenience of Payment – The due date of the taxes shouldn’t impose an unreasonable burden. Thus, the government should tax most goods at the point of their consumption – when they are purchased for use – and taxes on the farmer should be due after he receives his harvest.
- Economy in Collection – Collecting taxes should be as cheap and simple as possible – minimize the number of tax officers and bureaucracy required by having a simple system. The more bureaucrats and waste, the more taxes that must be collected, and the more the economy’s growth is stunted.
Also important to Smith is that the government should discourage the formation of monopolies, stay away from incurring debt, and maintain a stable currency.
Conclusion
From the quotations of Adam Smith that are heard all too often in the media, it’s easy to assume that Smith was a dogmatic advocate of principles like free trade and free markets at all costs. Hopefully, this article has shown that this is not the case. Far from being concerned with economic growth at all costs, Smith was concerned with the overall wellbeing of the nation, not just a particular class of people or a GDP number. His economic policies revolved around enabling the entire nation to thrive, by harnessing the most powerful force each nation has: the striving of each citizen to better themselves and their families, with the government providing the level playing field to make this pursuit possible.
Have you read The Wealth of Nations and have some thoughts you want to share on this article? Do you have any thoughts on how Smith’s prescription applies to the economies of today? If so, I’d love to hear your thoughts, leave a comment below.
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All quotations from: Smith, Adam, and Edwin Cannan. The Wealth of Nations. New York, N.Y: Bantam Classic, 2003. Print.
- Book I, Chapter V, page 44
- Book V, Chapter III, pages 1157-1158
- Book IV, Chapter VII, pages 774-775
- Book IV, Chapter II, pages 569-570
- Book I, Chapter XI, pages 338-339
- Book IV, Chapter III, page 622
- Book IV, Chapter II, page 582
- Book IV, Chapter II, page 583
- Book II, Chapter III, page 441
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