Adam Smith

Review: Smith’s view of human nature: individual rationality (but we are sociable)

• Humans are social beings: They want to “truck, barter, and exchange.”

• But they are also greedy, always wanting MORE

• And they have little incentive to work: “A preson with no property can have no

• other interest but to eat as much and work as little as possible.”

• They are desperate for power and protection: • “The pride of man makes him love to domineer…he will prefer the service

of slaves to that of freemen. And the planting of sugar and tobacco can afford the expense of slave-cultivation.”

What is the ultimate purpose of Political Economy? To use “human nature” for

• National Wealth – Consumption

• More! • More! • More!

• The Social “Good”

– Perfect Liberty which is the free market which is an intrinsic good and a means to the social good.

– If we allow a free market system to operate, it will answer all the questions we have asked until now

Luckily, Individual Greed promotes social good and perfect liberty!

• “Every individual….intends only his own security; and …his own gain,

• and he is in this…led by an invisible hand to promote an end which was no part of his intention. . . .

• By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it.”

If Everyone is self-interested, how do we get what we want?

“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 self-interest. We address ourselves, not to their humanity, but to their self-love, and never talk to them of our necessities, but of their advantages.”

Social Good = Liberty + Wealth Now to the Production side…..

• Question: How do you increase Wealth? • Answer: Expand Production (assuming

demand) • Question: How do you expand production? • Answer: You need a division of labor • Question: What does that mean? • Answer: You can produce more if everyone

specializes in one task

Division of Labor = Specialization • Question: But didn’t Aristotle talk about this? • Answer: Yes, but his idea was not to increase wealth

but to bring self-actualization through doing what you are cut out to do…..like Steve Jobs said: “Have the courage to follow your heart and intuition. They already know what you truly want to become. Everything else is secondary." Steve Jobs thought like Aristotle.

• But in Smith’s division of labor you specialize in order to meet society’s needs (liberty and wealth)

• Question: Are the two reasons for specialization mutually exclusive?

• Answer: Yes and No.

We Specialize not because of our inherent skills but because of society’s needs

• In fact, we are not inherently all so different…..

"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… 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…"

And we specialize because specialization contributes to our natural freedom or “perfect liberty”

• The division of labor leads to the expansion of the market for goods…. The free market itself is an expression of perfect liberty which is an intrinsic good and a means to the social good.

• How does all this happen? Specialized producers (below) are also consumers! They drive the market – Firms begin to reap economies of scale – New social groups are formed – Income increases – Consumption increases – Wealth increases

Specialization or Self-Actualization?

• If you obey market incentives to specialize, are you free?

• Is it better to specialize in what your heart and intuition tell you, or to specialize in work that meets society’s need for more consumption?

• Should you specialize at all? Wouldn’t it be better to develop many talents?

• Does it matter if we are less free, less ourselves in production? Isn’t consumption the most important?

Why is the free Market better than Mercantilism?

• Wealth of Nations was written as a treatise against Mercantilism.

• So what is mercantilism? – Regulation and govt. monopolies, a govt. industrial policy

to produce for export… – Govt. control of foreign trade—purpose of trade: to get

gold and silver • So what is so bad about it? • The three central tenants of mercantilism

– Hoarding resources – Exporting a lot and importing as little as possible – Self-sufficiency

Smith: Mercantilism will not create Wealth, and it squashes Freedom

• Mercantilist definition of wealth vs. “real wealth”—gold and silver vs. a growing economy

• Smith’s attack of mercantilist trade practices vs. virtues of “free trade”

• Smith’s attack on colonialism • For Smith, all of this was “hurtful to the general

interest of society. – “the mean rapacity, the monopolizing spirit” is part of

human nature but can be reigned in for the social good”

How can “mean rapacity” be repressed? Through The Market Mechanism!

• All of us exercising individual self interest • Will compete for scarce resources • Competition provides the goods that society

wants • In the Quantity that society desires • At the prices society wants to pay

Competition (production side)

• Each individual wants to take advantage of his neighbor’s greed: self-interest makes us ruthless…….

• But if self-interest runs away with us, competitors will beat us

• So we can’t charge too much or pay too little • We would like to collude with others to set the

price…..but an upstart will always slip in with a lower-priced product

Through competition society gets what it wants

• Producers must heed society’s demands

Role of State

• Smith’s Doctrine of “Laissez Faire” • But Smith was not opposed to some government

intervention in society – Protection against violence and invasion – Exact administration of justice – Creation of public institutions

• The Big Enemy is Monopoly! “People of the same trade seldom meet

together, but the conversation ends in a conspiracy against the public, or in some diversion to raise prices.”

Smith's Great Transformation:

Selfishness leads to social harmony • Interaction of selfish motives social

harmony • No Planning authority, no Leviathan, no

“Prince,” no “just price” • Prices are kept in line with production costs • Society tells producers what to do • High prices are a self-curing disease.

The Market is self-regulating

• The Market is it’s own “guardian”

• It is the paragon of “freedom” but the strictest taskmaster

• Is Economic freedom an illusion?