VS: Young students in economics and the humanities desiring to better understand the world in which we live and how it came about need to study the two great works of Adam Smith. In 1759 Smith published his first book, The Theory of Moral Sentiments (Hereafter TMS). He considered it his most important work, although posterity would not judge it so. You would be wrong to assume that the best wisdom of the past is always integrated into modern sources of learning.
His second book was published in an eventful year for America, 1776. This was An Enquiry into the Nature and Causes of the Wealth of Nations. (Hereafter WN) It was a spectacular success largely because it caught the attention of British and American intellectuals and politicians, particularly after the American Revolutionary war ended. The book importantly influenced William Pitt, Prime minister of Britain for 17 years. Countering the popular views of the time, Smith opposed slavery, empire, colonialism, mercantilism, and taxation without representation. The book argued for free trade in direct opposition to the mercantilist policies of taxing the goods that Britain allowed to be imported into the American colonies. His position was based on his penetrating mastery of the causes of national wealth creation, not on the political controversies of his time. Mercantilism represented the heavy hand of undue influence by special interests—we call it “rent seeking” today. For Smith this sort of crony influence was not merely unfair, it was an impediment to wealth creation. Smith was remarkably forward in interpreting current conditions, and speaking frankly—calling the shots as he saw them. The book’s centrality to the issues of the day is indicated by the fact that the American colonies erupted on July 4th of the same year, a few months after the publication of WN, in protest at the tea tax—the last of a series of abusive policies as seen by the Americans. Smith understood and sympathised with that cause, but did so as a loyal British citizen. The British were badly and unexpectedly beaten, and this together with the wise economic analysis of Smith enabled the start of an agonising re-evaluation in his country and in the colonial world.
EA: Adam Smith wrote about how the pursuit of self-interest promoted general economic welfare. Was he suggesting that people ought always to behave selfishly?
VS: Smith was the intellectual architect of the system of natural liberty which called for the removal of all imposed privileges of preference or of restraint: “Every man, as long as he does not violate the laws of justice is left perfectly free to pursue his own interest in his own way…” (WN, Vol 2, p 184). But to understand what he meant by “the laws of justice” and “own interest in his own way” it is essential to read TMS. Because of the enormous success of WN, people to this day do not read TMS. Consequently his essential message is easily distorted as people fail to grasp the pre-conditions that gave it context in Europe.
In TMS (pp 78-91; 109-120) we learn that, although every mature person is strictly self-interested, and fitter than others to take care of himself, none can look mankind in the face and suggest that this principle governs all his actions. Rather, in the process of growing up in society, he learns to “humble the arrogance” of his self-interest in the light of what “others will go along with”. Only in this way do we each become socialised and learn self-control in following the cultural rules of propriety. This is because of our unique human capacity for “mutual fellow-feeling”. We naturally desire to reward others in response to their properly motivated actions of a beneficent tendency toward us.
EA: According to Smith, what was the origin of property rights, and why was this important?
VS: Just as we may empathise with those who behave well towards us, sometimes, we naturally feel resentment and a strong urge to punish those who intentionally choose actions that are hurtful to us. For Smith, this is a more powerful sentiment than those arising from our feelings of beneficence. Feelings easily escalate becoming more than an eye-for-an-eye, and society cannot subsist. This is why, after long practice, viable communities come to have “property rights”, once called “propriety rights”, which allow for the proportionate punishment of specific hurtful acts of injustice. This is also why in the civil order of law the greatest punishment is reserved for murder, the most hurtful of all acts. Next, and calling for less punishment, are theft and robbery which, because they take from us what we possess, are greater crimes than violations of promises—breach of contract—which only disappoint us of what we expected.
Where a person has learned to be social and follow rules that discourage hurtful actions, she still follows her self-interest, but does so in the service of harmony with you. You follow the same rules and you both co-operate to your mutual benefit. Those societies that achieve a high level of harmony, where most people are law abiding, and people generally engage in mutually beneficial rule-following behavior, also tend to be the wealthiest.
EA: What was Adam Smith’s most important observation about the ‘nature and causes of the wealth of nations’, and how can the pursuit of self-interest promote the general welfare?
VS: Now that we have seen what Smith meant by natural liberty we can appreciate the causes of wealth creation.
Smith used the operations of a pin factory to dramatise the great wealth gains from the co-operative “division of labour” among tasks: or specialisation as we call it today. Specialisation in the economy, however, occurs not by top-down orders, but is discovered naturally in people-to-people interactions, because of the human propensity “to truck, barter and exchange one thing for another”. With this key axiom, Smith shows that this propensity leads to prices; and prices facilitate comparison calculations. The farmer can discover that he can benefit (profit) by producing more pigs and less maize, buying his maize and selling his pigs in market exchange with others. Through markets people form a vast co-operative network with each specialising in those activities for which they learn to be most productive, and each thereby profiting. As a result of each being more productive, the wealth of all is increased relative to a world with no trade.
The basic theorem in Smith is that specialisation is limited by the extent of the market: the bigger the market the greater the possibilities for specialisation and beneficial trade. Property rights, wherein each person has a natural right to the income produced by his own labour, and to the investment return on saving out of income, are a pre-condition for this wealth creation process to occur:
Smith’s account, together with the innovation it encourages, defines a forward looking system based on merit, not a backward looking system of privilege. This attitude change explains the enormous growth in per capita economic betterment beginning in Northern Europe in the 1700s, spreading westward to North America, to the rest of Europe, to Australia, New Zealand, Hong Kong, Singapore, and most recently to China, India and Asia generally. That growth, however, is hampered to the extent that people are not free in their economic and political choices.
The overarching themes in Adam Smith are firstly the sources of human social betterment in The Theory of Moral Sentiments, and secondly, the origins of human economic benefit in the Wealth of Nations.
Prof Vernon L. Smith is a Nobel Laureate in Economics.