Adam Smith (1723-90)
and the 'invisible hand' of the market
Many economists would argue that modern economics dates from 1776. That was the year in which Adam Smith's An Inquiry into the Nature and Causes of the Wealth of Nations was published - one of the most important books on economics ever written.
Adam Smith was born in 1723 in Kirkcaldy in Scotland, a small coastal town north of Edinburgh. His father died when Adam was just a baby, and for most of his life he lived with his mother: he never married. After graduating from GlasgowUniversity at the age of 17, he first became a fellow of Balliol College Oxford, but then returned to Scotland and at the age of 29 became professor of moral philosophy at the University of Glasgow. At the age of 40 he resigned and spent three years touring the continent where he met many influential economists and philosophers. He then returned to Scotland, to his home town of Kirkcaldy, and set to work on The Wealth of Nations.
The work, in five books, is very wide ranging, but the central argument is that market economies generally serve the public interest well. Markets guide production and consumption like an invisible hand. Even though everyone is looking after their own private self-interest, their interaction in the market will lead to the social good.
In Book 1, Chapter II , he writes:
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 what 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.
Later, in Book 4, Chapter II , he continues:
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 the 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 the society. 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.
He argued, therefore, with one or two exceptions, that the state should not interfere with the functioning of the economy. It should adopt a laissez-faire or 'hands-off' policy. It should allow free enterprise for firms and free trade between countries.
This praise of the free market has led many on the political right to regard him as the father of the 'libertarian movement' - the movement that advocates the absolute minimum amount of state intervention in the economy (see Case Study 9.4). In fact one of the most famous of the libertarian societies is called ' The Adam Smith Institute'.
But Smith was not blind to the drawbacks of unregulated markets. In book I, chapter 7, he looks at the problem of monopoly:
A monopoly granted either to an individual or to a trading company has the same effect as a secret in trade or manufactures. The monopolists, by keeping the market constantly under-stocked, by never fully supplying the effectual demand, sell their commodities much above the natural price, and raise their emoluments, whether they consist in wages or profit, greatly above their natural rate.
Later on he looks at the dangers of firms getting together to pursue their mutual interest:
People of the same trade seldom meet together, even for merriment or diversion, but the conversation ends in a conspiracy against the public or in some contrivance to raise prices.