 | Thomas Patrick Burke, Th.D.
Lecture 3: The Free Market: Adam Smith (1632 – 1704)
The publication in 1776 of Adam Smith's book An Inquiry into the Nature and Causes of the Wealth of Nations
brought about a revolution in the economic life of the human race which
is still continuing. From the beginnings of recorded history,
governments have used their power to influence commerce in ways they
thought desirable, often to give special benefits to particular groups
of people. The Romans organized their empire so that the people of the
city of Rome (who often had decisive influence in the selection of the
emperor) had free "bread and circuses" at the expense of those who
lived in more remote regions (such as the Egyptians, who were compelled
to provide the wheat for the bread at low Roman prices). During the
middle ages in much of Europe the "three-field" system was imposed on
farmers, whereby all the land of the village was divided up into long,
narrow strips distributed over fertile and arid land in the interests
of "fairness." The Elizabethans legislated a maximum wage, to protect
employers from excessive competition; and so on. In international trade
before Adam Smith the prevailing system was what is known as
"mercantilism," which we will need to explain at greater length.
This
system was based on the apparently common-sense assumption that wealth
consisted in money, and therefore that the wealth of any particular
nation consisted in the amount of money the nation as a whole
possessed, and especially its government. It followed from this that
the aim of trade was to maximize the nation's quantity of money. And
since money is obtained by selling rather than by buying, the aim of
trade was to sell as much as possible and buy as little as possible,
i.e. to export as much as possible and import as little as possible.
This principle led the nations of Europe, especially Britain and
France, which were the furthest developed as nation-states, to create
overseas empires whose peoples would be obliged to buy the goods
produced by the mother-country at maximum prices, and sell it their own
products at minimum prices. (Actually the British Empire grew initially
mostly by accident, without any grand plan of the British government,
as a result of the need to protect British traders from assault by
envious locals. But once an area was brought into the empire, the
mercantilist system was imposed through tariffs and other means.)
Inevitably this led to armed conflict between these empires, as in the
French and Indian War in north America, since a benefit to one was a
loss to the other.Adam Smith's thesis is that this immense system
stretching right around the globe was an immense mistake and a recipe
for poverty rather than for wealth. The wealth of a nation does not
consist in money, he argued, but in the goods and services available to
its citizens. These are two very different things. Money, i.e. gold and
silver, is a commodity and its price can change depending on its
availability. Spain received a great deal of gold from its conquests in
South America, but this did not help the living standards of the
Spanish people, who remained poor. The aim of trade, then, is to
maximize the availability of goods and services. This is accomplished,
not by selling, but rather by buying. That nation will be wealthiest
which buys as much as it can from the labor of others, while selling as
little as possible of its own labor to pay for it. (Smith adopts the
view suggested by John Locke, known as the labor theory of value, that
the value of any product is created chiefly by the labor that goes into
it. This was intended just as part of his theory of private property:
property is acquired in the first instance out of nature by the labor
of the person who makes it available for human consumption. Many
subsequent writers, such as Marx, misunderstood this to mean that there
is an objective value in every object of commerce, namely the number of
hours of labor invested in it, which ought to determine its price.
Smith does not go so far, though he does accept the idea of a "natural
value." Hobbes, by contrast, had stated what is now the universal view
of economists, that the market value of any product is given by the
demand for it. "The value of all things contracted for is measured by
the appetite of the contractors, and therefore the just value is that
which they be contented to give.") Since we must labor to produce
exports, but not imports, the purpose of exports is just to pay for
imports, and so the less we have to pay for any given quantity of
imports, the better. But in the long run the best way to achieve this
is not by the government giving special favors to imports, for that
will instigate similar measures by other governments in favor of their
own imports and against our exports, but by "the simple system of
natural liberty" which allows everyone to buy or sell what he
likes.Smith begins his work with a discussion of the central role of
labor.
"The
annual labour of every nation is the fund which originally supplies it
with all the necessaries and conveniences of life which it annually
consumes, and which consist always either in the immediate produce of
that labour, or in what is purchased with that produce from other
nations.
According
therefore as this produce, or what is purchased with it, bears a
greater or smaller proportion to the number of those who are to consume
it, the nation will be better or worse supplied with all the
necessaries and conveniences for which it has occasion. (Introduction)"
This
depends in the first instance on the "skill, dexterity and judgment"
with which its labor is generally supplied rather than on the number of
people employed.
"Among
the savage nations of hunters and fishers, every individual who is able
to work, is more or less employed in useful labour, and endeavours to
provide, as well as he can, the necessaries and conveniences of life,
for himself, or such of his family or tribe as are either too old, or
too young, or too infirm to go a hunting and fishing. Such nations,
however, are so miserably poor that, from mere want, they are
frequently reduced, or, at least, think themselves reduced, to the
necessity sometimes of directly destroying, and sometimes of abandoning
their infants, their old people, and those afflicted with lingering
diseases, to perish with hunger, or to be devoured by wild beasts.
Among civilised and thriving nations, on the contrary, though a great
number of people do not labour at all, many of whom consume the produce
of ten times, frequently of a hundred times more labour than the
greater part of those who work; yet the produce of the whole labour of
the society is so great that all are often abundantly supplied, and a
workman, even of the lowest and poorest order, if he is frugal and
industrious, may enjoy a greater share of the necessaries and
conveniences of life than it is possible for any savage to acquire.
(Introduction)."
This
naturally gives rise to the question, what causes some labor to be more
productive than other labor? Smith answers that it is the division of labor.
It would be difficult to exaggerate the importance of this concept,
which has application in many different fields. It is the idea that
instead of a single individual making an entire complex product, the
process of production is divided up between a number of people who each
make a particular portion of it. Smith argues that this specialization
is the main factor in productivity. He gives a striking example he has
personally witnessed.
"To
take an example, therefore, from a very trifling manufacture; but one
in which the division of labour has been very often taken notice of,
the trade of the pin-maker; a workman not educated to this business
(which the division of labour has rendered a distinct trade), nor
acquainted with the use of the machinery employed in it (to the
invention of which the same division of labour has probably given
occasion), could scarce, perhaps, with his utmost industry, make one pin in a day, and certainly could not make twenty.
But in the way in which this business is now carried on, not only the
whole work is a peculiar trade, but it is divided into a number of
branches, of which the greater part are likewise peculiar trades. One
man draws out the wire, another straights it, a third cuts it, a fourth
points it, a fifth grinds it at the top for receiving the head; to make
the head requires two or three distinct operations; to put it on is a
peculiar business, to whiten the pins is another; it is even a trade by
itself to put them into the paper; and the important business of making
a pin is, in this manner, divided into about eighteen distinct
operations, which, in some manufactories, are all performed by distinct
hands, though in others the same man will sometimes perform two or
three of them. I have seen a small manufactory of this kind where ten
men only were employed, and where some of them consequently performed
two or three distinct operations. But though they were very poor, and
therefore but indifferently accommodated with the necessary machinery,
they could, when they exerted themselves, make among them about twelve
pounds of pins in a day. There are in a pound upwards of four thousand
pins of a middling size. Those ten persons, therefore, could make among
them upwards of forty-eight thousand pins in a day. Each person,
therefore, making a tenth part of forty-eight thousand pins, might be
considered as making four thousand eight hundred pins in a day.
But if they had all wrought separately and independently, and without
any of them having been educated to this peculiar business, they
certainly could not each of them have made twenty, perhaps not one pin
in a day; that is, certainly, not the two hundred and fortieth, perhaps
not the four thousand eight hundredth part of what they are at present
capable of performing, in consequence of a proper division and
combination of their different operations."
(In
the following century Darwin will make brilliant use of this concept to
explain evolution, especially the evolution of the sexes.) This higher
productivity results from a number of factors: specialization improves
the dexterity of the worker, saves time, and, perhaps especially, leads
the specialized workmen to invent labor-saving machines and methods.
When the division of labor is employed widely, it produces a vastly
higher standard of living throughout the whole society.
"It
is the great multiplication of the productions of all the different
arts, in consequence of the division of labour, which occasions, in a
well-governed society, that universal opulence which extends itself to
the lowest ranks of the people."
If we examine even the simplest product, we will find that an astonishing number of people have contributed to its making.
"Observe
the accommodation of the most common artificer or day-labourer in a
civilised and thriving country, and you will perceive that the number
of people of whose industry a part, though but a small part, has been
employed in procuring him this accommodation, exceeds all computation.
The woollen coat, for example, which covers the day-labourer, as coarse
and rough as it may appear, is the produce of the joint labour of a
great multitude of workmen. The shepherd, the sorter of the wool, the
wool-comber or carder, the dyer, the scribbler, the spinner, the
weaver, the fuller, the dresser, with many others, must all join their
different arts in order to complete even this homely production. How
many merchants and carriers, besides, must have been employed in
transporting the materials from some of those workmen to others who
often live in a very distant part of the country! How much commerce and
navigation in particular, how many ship-builders, sailors, sail-makers,
rope-makers, must have been employed in order to bring together the
different drugs made use of by the dyer, which often come from the
remotest corners of the world! What a variety of labour, too, is
necessary in order to produce the tools of the meanest of those
workmen! To say nothing of such complicated machines as the ship of the
sailor, the mill of the fuller, or even the loom of the weaver, let us
consider only what a variety of labour is requisite in order to form
that very simple machine, the shears with which the shepherd clips the
wool. The miner, the builder of the furnace for smelting the ore, the
seller of the timber, the burner of the charcoal to be made use of in
the smelting-house, the brickmaker, the brick-layer, the workmen who
attend the furnace, the mill-wright, the forger, the smith, must all of
them join their different arts in order to produce them. Were we to
examine, in the same manner, all the different parts of his dress and
household furniture, the coarse linen shirt which he wears next his
skin, the shoes which cover his feet, the bed which he lies on, and all
the different parts which compose it, the kitchen-grate at which he
prepares his victuals, the coals which he makes use of for that
purpose, dug from the bowels of the earth, and brought to him perhaps
by a long sea and a long land carriage, all the other utensils of his
kitchen, all the furniture of his table, the knives and forks, the
earthen or pewter plates upon which he serves up and divides his
victuals, the different hands employed in preparing his bread and his
beer, the glass window which lets in the heat and the light, and keeps
out the wind and the rain, with all the knowledge and art requisite for
preparing that beautiful and happy invention, without which these
northern parts of the world could scarce have afforded a very
comfortable habitation, together with the tools of all the different
workmen employed in producing those different conveniences; if we
examine, I say, all these things, and consider what a variety of labour
is employed about each of them, we shall be sensible that, without the
assistance and co-operation of many thousands, the very meanest person
in a civilised country could not be provided, even according to what we
very falsely imagine the easy and simple manner in which he is commonly
accommodated. Compared, indeed, with the more extravagant luxury of the
great, his accommodation must no doubt appear extremely simple and
easy; and yet it may be true, perhaps, that the accommodation of a
European prince does not always so much exceed that of an industrious
and frugal peasant as the accommodation of the latter exceeds that of
many an African king, the absolute master of the lives and liberties of
ten thousand naked savages."
If
this is so, then the next question must be, what gives rise to the
division of labor? Smith's answer to this is memorable. It is not out
of any large or coordinated design, and especially not because they
were commanded to by government, but simply out of their individual
desire to earn a living: out of their self-interest. (Smith's concept
of "self-interest" is far broader, however, than might be assumed by
someone who has not read him: it can include sympathy and concern for
the well-being of our neighbor, for example.)
"This
division of labour, from which so many advantages are derived, is not
originally the effect of any human wisdom, which foresees and intends
that general opulence to which it gives occasion. It is the necessary,
though very slow and gradual consequence of a certain propensity in
human nature which has in view no such extensive utility; the
propensity to truck, barter and exchange one thing for another."
This is something distinctive of human beings: no animal does it.
"It
is common to all men, and to be found in no other race of animals,
which seem to know neither this nor any other species of contracts.
...Nobody ever saw a dog make a fair and deliberate exchange of one
bone for another with another dog. Nobody ever saw one animal by its
gestures and natural cries signify to another, this is mine, that
yours; I am willing to give this for that. When an animal wants to
obtain something either of a man or of another animal, it has no other
means of persuasion but to gain the favour of those whose service it
requires. A puppy fawns upon its dam, and a spaniel endeavours by a
thousand attractions to engage the attention of its master who is at
dinner, when it wants to be fed by him. Man sometimes uses the same
arts with his brethren, and when he has no other means of engaging them
to act according to his inclinations, endeavours by every servile and
fawning attention to obtain their good will. He has not time, however,
to do this upon every occasion. In civilised society he stands at all
times in need of the cooperation and assistance of great multitudes,
while his whole life is scarce sufficient to gain the friendship of a
few persons. In almost every other race of animals each individual,
when it is grown up to maturity, is entirely independent, and in its
natural state has occasion for the assistance of no other living
creature."
The
secret of the success of the system of exchanges we call the market is
that it does not depend on people's generosity or kindness, but
requires nothing more than an appeal to their self-interest.
"...
man has almost constant occasion for the help of his brethren, and it
is in vain for him to expect it from their benevolence only. He will be
more likely to prevail if he can interest their self-love in his
favour, and show them that it is for their own advantage to do for him
what he requires of them. Whoever offers to another a bargain of any
kind, proposes to do this. Give me that which I want, and you shall
have this which you want, is the meaning of every such offer; and it is
in this manner that we obtain from one another the far greater part of
those good offices which we stand in need of. It is not from the
benevolence of the butcher, the brewer, or the baker that we expect our
dinner, but from their regard to their own interest. We address
ourselves, not to their humanity but to their self-love, and never talk
to them of our own necessities but of their advantages. Nobody but a
beggar chooses to depend chiefly upon the benevolence of his
fellow-citizens. Even a beggar does not depend upon it entirely.
The charity of well-disposed people, indeed, supplies him with the
whole fund of his subsistence. But though this principle ultimately
provides him with all the necessaries of life which he has occasion
for, it neither does nor can provide him with them as he has occasion
for them. The greater part of his occasional wants are supplied in the
same manner as those of other people, by treaty, by barter, and by
purchase. With the money which one man gives him he purchases food. The
old clothes which another bestows upon him he exchanges for other old
clothes which suit him better, or for lodging, or for food, or for
money, with which he can buy either food, clothes, or lodging, as he
has occasion."
Of course, this does not mean that the market positively excludes kindness and generosity. They always remain welcome possibilities. Only it does not demand them as a prerequisite for success.
"As
it is by treaty, by barter, and by purchase that we obtain from one
another the greater part of those mutual good offices which we stand in
need of, so it is this same trucking disposition which originally gives
occasion to the division of labour. In a tribe of hunters or shepherds
a particular person makes bows and arrows, for example, with more
readiness and dexterity than any other. He frequently exchanges them
for cattle or for venison with his companions; and he finds at last
that he can in this manner get more cattle and venison than if he
himself went to the field to catch them. From a regard to his own
interest, therefore, the making of bows and arrows grows to be his
chief business, and he becomes a sort of armourer. Another excels in
making the frames and covers of their little huts or movable houses. He
is accustomed to be of use in this way to his neighbours, who reward
him in the same manner with cattle and with venison, till at last he
finds it his interest to dedicate himself entirely to this employment,
and to become a sort of house-carpenter. In the same manner a third
becomes a smith or a brazier, a fourth a tanner or dresser of hides or
skins, the principal part of the nothing of savages. And thus the
certainty of being able to exchange all that surplus part of the
produce of his own labour, which is over and above his own consumption,
for such parts of the produce of other men's labour as he may have
occasion for, encourages every man to apply himself to a particular
occupation, and to cultivate and bring to perfection whatever talent or
genius he may possess for that particular species of business."
The Wealth of Nations is filled with perceptive comments on human nature. Here is one of them:
"The
difference of natural talents in different men is, in reality, much
less than we are aware of; and the very different genius which appears
to distinguish men of different professions, when grown up to maturity,
is not upon many occasions so much the cause as the effect of the
division of labour. The difference between the most dissimilar
characters, between a philosopher and a common street porter, for
example, seems to arise not so much from nature as from habit, custom,
and education. When they came into the world, and for the first six or
eight years of their existence, they were perhaps very much alike, and
neither their parents nor playfellows could perceive any remarkable
difference. About that age, or soon after, they come to be employed in
very different occupations. The difference of talents comes then to be
taken notice of, and widens by degrees, till at last the vanity of the
philosopher is willing to acknowledge scarce any resemblance. But
without the disposition to truck, barter, and exchange, every man must
have procured to himself every necessary and conveniency of life which
he wanted. All must have had the same duties to perform, and the same
work to do, and there could have been no such difference of employment
as could alone give occasion to any great difference of talents.
As
it is this disposition which forms that difference of talents, so
remarkable among men of different professions, so it is this same
disposition which renders that difference useful. Many tribes of
animals acknowledged to be all of the same species derive from nature a
much more remarkable distinction of genius, than what, antecedent to
custom and education, appears to take place among men. By nature a
philosopher is not in genius and disposition half so different from a
street porter, as a mastiff is from a greyhound, or a greyhound from a
spaniel, or this last from a shepherd's dog. Those different tribes of
animals, however, though all of the same species, are of scarce any use
to one another. The strength of the mastiff is not, in the least,
supported either by the swiftness of the greyhound, or by the sagacity
of the spaniel, or by the docility of the shepherd's dog. The effects
of those different geniuses and talents, for want of the power or
disposition to barter and exchange, cannot be brought into a common
stock, and do not in the least contribute to the better accommodation
ind conveniency of the species. Each animal is still obliged to support
and defend itself, separately and independently, and derives no sort of
advantage from that variety of talents with which nature has
distinguished its fellows. Among men, on the contrary, the most
dissimilar geniuses are of use to one another; the different produces
of their respective talents, by the general disposition to truck,
barter, and exchange, being brought, as it were, into a common stock,
where every man may purchase whatever part of the produce of other
men's talents he has occasion for."
Adam
Smith's greatest single discovery is what I have termed "the principle
of mutual benefit." This is the fact that exchanges take place for one
reason only: both parties consider that they benefit. It can
never happen that, in the absence of force and fraud, only one party to
an exchange can expect to benefit. If that were the case the exchange
would not take place. It is true that the benefit may not be equal, but
a lesser benefit is still a benefit, not a loss. He deals with this
mainly in his discussion of the "balance of trade," which occupies the
whole of Book 4.
"Nothing,
however, can be more absurd than this whole doctrine of the balance of
trade, upon which, not only these restraints, but almost all the other
regulations of commerce are founded. When two places trade with one
another, this doctrine supposes that, if the balance be even, neither
of them either loses or gains; but if it leans in any degree to one
side, that one of them loses and the other gains in proportion to its
declension from the exact equilibrium. Both suppositions are false. A
trade which is forced by means of bounties and monopolies may be and
commonly is disadvantageous to the country in whose favour it is meant
to be established, as I shall endeavour to show hereafter. But that
trade which, without force or constraint, is naturally and regularly
carried on between any two places is always advantageous, though not
always equally so, to both."
Since
every exchange benefits both parties, even if not equally, those
benefits become available for further exchanges. The result is that,
without anyone intending to benefit society, nonetheless in a system of
free exchanges the entire society benefits, as "by an invisible hand."
"As
every individual, therefore, endeavours as much as he can both to
employ his capital in the support of domestic industry, and so to
direct that industry that its produce may be of the greatest value;
every individual necessarily labours to render the annual value of
society as great as he can. He generally, indeed, neither intends to
promote the public interest, nor knows how much he is promoting it. By
preferring the support of domestic to that of foreign industry, he
intends only his own security; and by directing that industry in such a
manner as its produce may be of the greatest value, he intends only his
own gain, and he is in this, as in many other cases, led by an
invisible hand to promote an end which was no part of his intention.
Nor is it always the worse for the society that it was no part of it.
By pursuing his own interest he frequently promotes that of society
more effectually than when he really intends to promote it. I have
never known much good done by those who affected to trade for the
public good. It is an affectation, indeed, not very common among
merchants, and very few words need be employed in dissuading them from
it."
He concludes that all systems of government intervention in the market are self-defeating.
"It
is thus that every system which endeavours, either by extraordinary
encouragements to draw towards a particular species of industry a
greater share of the capital of the society than what would naturally
go to it, or, by extraordinary restraints, force from a particular
species of industry some share of the capital which would otherwise be
employed in it, is in reality subversive of the great purpose which it
means to promote. It retards, instead of accelerating, the progress of
the society towards real wealth and greatness; and diminishes, instead
of increasing, the real value of the annual produce of its land and
labour."
At the end of Book 4 he gives what has become the classic statement of the role of government in a free society:
"All
systems either of preference or of restraint, therefore, being thus
completely taken away, the obvious and simple system of natural liberty
establishes itself of its own accord. Every man, as long as he does not
violate the laws of justice, is left perfectly free to pursue his own
interest his own way, and to bring both his industry and capital into
competition with those of any other man, or order of men. The sovereign
is completely discharged from a duty, in the attempting to perform
which he must always be exposed to innumerable delusions, and for the
proper performance of which no human wisdom or knowledge could ever be
sufficient; the duty of superintending the industry of private people,
and of directing it towards the employments most suitable to the
interest of the society. According to the system of natural liberty,
the sovereign has only three duties to attend to; three duties of great
importance, indeed, but plain and intelligible to common
understandings: first, the duty of protecting the society from violence
and invasion of other independent societies; secondly, the duty of
protecting, as far as possible, every member of the society from the
injustice or oppression of every other member of it, or the duty of
establishing an exact administration of justice; and, thirdly, the duty
of erecting and maintaining certain public works and certain public
institutions which it can never be for the interest of any individual,
or small number of individuals, to erect and maintain; because the
profit could never repay the expense to any individual or small number
of individuals, though it may frequently do much more than repay it to
a great society."
Read Lecture 4: Free Speech: John Stuart Mill (1806 - 1873)
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