Classical Economics

Adam Smith

Adam Smith was born on June 16, 1723, at his baptism in Scotland and a Scottish political economist. Smith attended the University of Glasgow at age 14, later transferring to Balliol College in Oxford, England. He spent years teaching and tutoring, publishing some of his lectures in "The Theory of Moral Sentiments" in 1759. Lecturer and essayist who is principally known for having authored. Smith is best known for two classic works: “The Theory of Moral Sentiments (1759)” and “An Inquiry into the Cause of the Wealth of Nations (1776). Adam Smith, generally known as the father of Economics defined Economics as ‘science of wealth’.

Smith is principally known for his contributions to political economy and moral philosophy. He was an extremely sensitive man who possessed a strong sense of right and wrong that guided the way in which he conducted his life. Wealth of Nations represents a highly critical commentary on mercantilism, the prevailing economic system of Smith's day. It should be noted that Smith developed an increasingly critical view of the Christianity of his time, partly because of his personal experiences with Christianity and surely also due to the critical view of Christianity that prevailed in the intellectual circles that shaped the Scottish Enlightenment.

Adam Smith Contribution of Economics

Mercantilism

In the 18th century, European nations practiced an economic system known as “mercantilism.” Each nation’s goal was to increase exports to its colonies and other nations, limit imports from them, and end up with a “favorable balance of trade.” A nation that exported more than it imported demanded the difference in gold and silver. The mercantilist nations believed that the more gold and silver they acquired, the more wealth they possessed. Smith believed that this economic policy was foolish and actually limited the potential for “real wealth,” which he defined as “the annual produce of the land and labor of the society.”

In a major section of The Wealth of Nations, Smith attacked mercantilist trade practices. He insisted that what enriched European nations was not importing gold and silver but opening up new free-trade markets in the world. This trade, he wrote, further stimulated the division of labor, expanded the production of trade goods, and increased “the real revenue and wealth” of all.

However, Smith’s writings span a broad spectrum of topics ranging from astronomy to the origin of language. Smith first achieved notoriety because of his Theory of Moral Sentiments (1759) where he emphasized the important role of sympathy in making moral decisions. In Moral Sentiments he described a moral compass within humankind that he referred to as the "impartial spectator." The "impartial spectator" led the individual to intuit right from wrong.76) and The Theory of Moral Sentiments (1759) where he emphasized the important role of sympathy in making moral decisions. In Moral Sentiments he described a moral compass within humankind that he referred to as the "impartial spectator." The "impartial spectator" led the individual to intuit right from wrong. Wealth of Nations represents a highly critical commentary on mercantilism, the prevailing economic system of Smith's day. Mercantilism emphasized the maximizing of exports and the minimizing of imports. In Wealth of Nations Smith argues that everyone benefits from the removal of tariffs and other barriers to trade. Because of supply and demand, production will increase as demand increases. This may lead to new employment opportunities for the workforce and to collateral industries emerging in response to new demands. Smith makes compelling arguments for the free market and his economic and moral writings remain relevant today. Wealth of Nations serves as one of the most elegant explanations for the rapid economic growth experienced by the United States and other industrial powers in the nineteenth and twentieth centuries.

In 1763, Smith quit his professorship at Glasgow and tutored the stepson of Charles Townshend, who later became Britain’s treasury minister in the years leading up to the American Revolution. Smith traveled to Paris with his student and met Voltaire and other philosophers involved in the French Enlightenment. Smith also met the leading French economist, Francois Quesnay. Quesnay had devised a system called “Physiocracy” that he believed explained the source of national wealth. He took issue with the popular belief, known as mercantilism that a nation’s wealth was its hoard of gold or silver. Quesnay believed a nation’s wealth came from its farm produce that circulated throughout the land, nourishing everyone. Quesnay’s innovative idea prompted Smith to begin to write his own book on economics.

Though Smith aimed much of his fire at the 'mercantile system', his argument fell short of the level of analytical sophistication reached earlier by his friend, David Hume. In the 1760s Hume had attacked mercantilism by invoking a theory linking the general level of prices to the quantity of money. The larger the supply of money, he had argued, the higher the price level was likely to rise; higher prices, in turn, would tend to make exports less competitive in foreign markets and imports more competitive in home markets. The mercantilist drive to enlarge the stock of money would thus be self-defeating; the accumulation of precious metals would produce effects that would later erode the favorable balance of trade. Hume, of course, needed another prop to this argument before it could stick; after all, a convinced mercantilist could reply that appropriate regulations could check a deterioration in the balance of trade. Hume supplied the needed reinforcement by insisting that restrictions on trade would be damaging to the national interest. A country invoking direct controls would be punishing itself by foregoing the benefits of an international specialization and division of labor. This line of critique carried more weight than did much of Smith's attack. His position, in fact, can largely be summarized in the proposition that government meant restrictions and that restrictions necessarily frustrated the natural division of labor, the operation of the invisible hand, and the progress of improvement. 

Invisible Hand Theory

"The Wealth of Nations," documented industrial development in Europe. While critics note that Smith didn't invent many of the ideas that he wrote about, he was the first person to compile and publish them in a format designed to explain them to the average reader of the day. As a result, he is responsible for popularizing many of the ideas that underpin the school of thought that became known as classical economics.

Laissez-faire philosophies, such as minimizing the role of government intervention and taxation in the free markets, and the idea that an "invisible hand" guides supply and demand are among the key ideas Smith's writing is responsible for promoting. These ideas reflect the concept that each person, by looking out for him or herself, inadvertently helps to create the best outcome for all. "It is not from the benevolence of the butcher, the brewer, or the baker, that we can expect our dinner, but from their regard to their own interest," Smith wrote.

Adam Smith’s “Free Market Mechanism”

The following is a simplified version of the economic system Adam Smith believed would emerge once governments ended their oppressive mercantilist policies.

1.      A man builds a cloth-making factory, hires workers, and divides their labor into many specialized operations. The factory owner is motivated by self-interest, profit, maybe even greed.

2.      Others, however, are also building factories to make and sell cloth. They all have to compete for the money of the buyers whose self- interest is to buy cloth at the best price.

3.      Buyers bid up the price of the cloth when the supply of cloth is low and their demand for it is high. But when there is an oversupply, the buyers can pick and choose and refuse to purchase high-priced cloth. The factory owners then have to reduce their prices to attract more buyers. Economists call this the “law of supply and demand.”

4.      Additional innovative divisions of labor, maybe brought on by new machinery, motivate others to invest in more factories. But they must compete to hire more workers. The “law of supply and demand” applies here, too, and wages go up.

5.      Higher wages lengthen the lives of workers and their children. The population grows, which increases the supply of workers. Wages then stop rising. But, soon another division of labor wave occurs, producing more economic growth and the need for even more workers. Wages go up again. The cycle repeats itself.

6.      Families now can afford to buy (demand) more cloth and lots of other products. The factory owners make more profits. Everybody wins and society as a whole improves.

7.      The cloth factory owner never intended to improve society; he just wanted to make money for himself. But his self-interest, as if “led by an invisible hand,” resulted in the betterment of all. As Adam Smith himself put it, “By pursuing his own interest he frequently promotes that of the society more effectively than when he really intends to promote it.”

Conclusion

The ideas that became associated with Smith not only became the foundation of the classical school of economics, but also gained him a place in history as the father of economics. His work served as the basis for other lines of inquiry into the economics field, including ideas that built on his work and those that differed. Smith died on July 19, 1790, but the ideas he promoted live on. In 2007, the Bank of England placed his image on the £20 note.