Adam Smith and Capitalism

Adam Smith and Modern Capitalism

Adam Smith's ideas are often considered the foundation of modern capitalism. He argued for a minimalist government that made only limited intervention in the economy, a challenge to the prevailing models of mercantilism that had been practiced by most of Europe's imperial powers.

Adam Smith's Theory of Competitive Capitalism and Growth

Underpinning Adam's Smiths thoughts on capitalism and economic development was the high value he placed on competition and what he considered to be the efficient working of markets.

Adam Smith's theory of competitive capitalism and growth held that in a wealthy society, each individual would choose to engage in the economic activity in which they had a comparative advantage and that would best benefit them. By extension, this would lead to the best overall outcome.

To help imagine Adam Smith's theory of competitive capitalism and growth, think of 2 individuals, one who is very good at making shoes and one who is very good at making jackets. If each focused on their skills and make the best shoes and jackets, respectively, that they could, they would both be able to make the most money for themselves.

By competing with other shoemakers and jacket makers, they would be driven to be more efficient and provide people with higher quality products at better prices, leading to more wealth for everyone. Applying this to a larger scale, Smith argued for increased labor, production, and trade among nations to produce more wealth for all.

Adam Smith and His Invisible Hand of Capitalism

Smith coined the concept of the "invisible hand" of the market, an idea that remains highly influential in modern capitalism today.

To understand Adam Smith and his invisible hand of capitalism, it's important to keep in mind the idea of a free market for labor and trade, as well as the motivation for people to work and conduct trade between them. In this theory, as each person pursues their own individual interests of economic gain, they will also improve society as a whole by producing more and better goods as better prices.

This unspoken motivation is Adam Smith's idea of the invisible hand as something that guided the work of individuals. In his view, this motivation and self-interest should be celebrated and encouraged as a way to produce the best outcome.

Adam Smith and Free Trade

As part of this idea of the invisible hand, Adam Smith also argued for the importance of trade with no or minimal restrictions. This was a direct challenge to the mercantilist policies practiced by most European nations at the time.

Under mercantilism, a nation's society was seen as tied to the total amount of gold, silver, or goods it possessed, and trade between nations was often suppressed as it shared that wealth with other nations.

Smith instead argued that overall labor and production was more important as a measure of a nation's wealth.

Trade and selling goods abroad, therefore, provided more opportunities for labor, creating more production and more possibilities to earn more wealth. One way to think about this is to consider mercantilism as promoting the idea of keeping the largest slice of a pie possible, while Smith argued it was better to try to grow the entire pie.

This idea of measuring wealth by production contributed to the invention of the metric of Gross Domestic Product (GDP) as an important measure of wealth and the economic health of a nation today. While Smith didn't invent this measure, his ideas provided the theoretical foundation of it.

Fig 2 - Merchant ships.

Adam Smith and the Division of Labor

An important part of Smith's idea of the invisible hand and increased production was the division of labor and specialization. This called for workers to focus on and get very good at completing one specific task. By dividing the different aspects of producing a good, it could allow for greater efficiency and more production.

Take our example of a jacket maker above. In this theory, it was best not for one worker to produce an entire jacket by themselves but to divide the work between multiple workers. For example, one person could cut the cloth, one could dye the cloth, and one could sew on the buttons. By dividing the steps this way, they could collectively produce more jackets in a day than if one person did every step.

This idea of the division of labor would be very influential to the development of industrial capitalism and lead to the assembly line.

Adam Smith and laissez-faire

Smith argued for an extremely limited view of government intervention in the economy. For this reason, he is often linked to the ideology of laissez-faire, or a hands-off approach to the economy by government.

Smith saw government's primary responsibilities as providing for the defense of the nation through armed forces, giving a framework for justice by enforcing the law, and promoting education. He was suspicious of government that sought to promote virtue or transformative change in society, preferring to let the invisible hand guide society to the greatest outcome for all.

He believed, generally, business should be left to businessmen who were better fit for producing the greatest economic gains than politicians.

Fig 3 - Title page of Adam Smith's The Wealth of Nations.

Adam Smith and the Bad Qualities of Capitalism

However, Adam Smith also believed businessmen should stay out of government.

When thinking about Adam Smith and the bad qualities of capitalism, he understood that while self-interest would guide businessmen in producing the best outcomes for the economy, this same self-interest meant their involvement in politics would not always serve the interests of the citenzry as a whole, but their own.

Contrary to many more contemporary proponents of laissez-faire, Smith was concerned with the poorest in society. In fact, he saw one of the goals of his proposed economic model to be the uplifting of the poor to be more productive and wealthier with access to all their necessities. In his view, the improvement to labor and production would achieve this goal.

Smith is often cited by those that favor pro-business political policies. While Smith was very skeptical of government attempts to control or guide the economy, he was not entirely opposed to some forms of regulation and government action.

For example, in addition to defense, justice, and education, he also called on government to support and build infrastructure and believed that more wealthy individuals should pay more in taxes. He believed government had an important role to play in providing for the greater good in ways that business would not do on its own, but he did believe the invisible hand would produce the best economic results if left to function on its own without government intervention.

Adam Smith and Consumer Capitalism

The opinions of Adam Smith and consumer capitalism are complex and debatable.

On the one hand, Smith's ideas seemed to predict consumer capitalism. His views on the division of labor recognized that behind any one good or product, there were many people that benefited.

He famously used the example of a woolen coat. The purchase of this common coat benefitted the shepherd, the person who sorted the wool, the person who dyed it, the person who weaved it, and the merchant who fitted and sold it. Behind each of those, there were even more people who benefited indirectly, such as those employed on ships that transported the different materials.

On the other hand, he was critical of unnecessary luxury and extravagance. In fact, in his discussion of the woolen coat, he deliberately chose a simple piece of clothing used by the common worker and argued its production provided as much value in terms of providing work for people, if not more, than elaborate clothing produced for a rich man. However, it's clear he saw that behind any purchase of a consumer good, there were important benefits for many others involved in its production.

Sketch of a portrait of Adam Smith. Source: Public Domain, Wikimedia Commons.

Legacy of Adam Smith and Capitalism

Adam Smith's ideas were highly influential in promoting free trade and market economies. The system of mercantilism gave way to one based on his ideas as the Industrial Revolution progressed, paving the way for much of our present-day ideas of capitalism.

He influenced economists of all different political ideologies, from Karl Marx to Milton Friedman, and his ideas remain highly influential today.