Adam Smith Invented Modern Free-Market Economics (2024)

Adam Smith's "Wealth of Nations" was published in 1776.

Good timing.

Coming out the same year as the Declaration of Independence, the book sparked its own revolution.

It showed that the best way to expand an economy was for government to get out of the way of entrepreneurs.

"He got most of it right, and for the past two centuries economists have been filling in the details," Tim Taylor, author of Teaching Co.'s audio course "Legacies of the Great Economists," told IBD. "If you disagree with him, you probably need to re-examine your ideas."

Smith (1723-90) was born in Scotland to a civil servant who died two months later. His mother encouraged his interest in learning and enrolled him in one of the best secondary schools, giving him a solid foundation in the Latin classics, history, writing and spelling.

At 14, he entered the University of Glasgow and studied moral philosophy, developing a passion for reason, free speech and liberty.

Three years later he received a scholarship to Oxford University, but found the professors uninterested in teaching or new ideas, so he spent his time outside class reading widely in the library.

Unhappy, he left in 1746 before his scholarship was up.

Soon he was hired to give lectures at the University of Edinburgh. Many of the themes involved his thoughts on the relationship of morality, freedom and prosperity.

In 1751 he earned a professorship at Glasgow University teaching logic and stayed in that post 12 years.

Production

All the while, he put down his thoughts — and in 1759 he came out with his first book, "The Theory of Moral Sentiments." In it, he showed how morality depended on sympathy between individuals.

"He explored the processes by which we acquire the senses of propriety, justice, political obligation and beauty on which our skills in the arts of social intercourse and our character depend," Nicholas Phillipson wrote in his new biography, "Adam Smith: An Enlightened Life." "In doing so, he introduced into his analysis a simple observation about the principles of human nature that had been ignored by modern philosophy, that man's natural indigence had somehow gone hand in hand with a love of improvement which he would exercise whenever he felt secure enough to do so."

The book attracted students from all over Europe. Smith inspired them by extending his thinking about the human tendency toward betterment — even economically.

In the prevailing European mercantilist system, the government granted royal charters for monopolies, imposed protective tariffs on certain goods, and regarded trade as a zero sum game among countries for an economic pie that could not be expanded.

Mercantilists also asserted that the poor needed to be kept poor or they wouldn't work.

"The belief that a nation's wealth and power depended on its foreign and not its domestic trade was built on the idea that 'wealth consists in money or in gold and silver' and not in labor," wrote Phillipson. "This had been manipulated by merchants and had become the intellectual engine of European politics that were threatening the peace and prosperity of the world, a belief as dangerous to the progress of civilization as the religious superstitions that had fueled the wars of religion."

Smith could see that mercantilism didn't work very well, but it would take him a long time to work out the arguments for a better economic system.

As Smith developed his theories, he was exposed to a variety of fresh ideas through his friendships with some of the towering minds of his time: David Hume, the foremost Scottish philosopher of the Enlightenment; Edmund Burke, the leading theorist of English political freedom; and Samuel Johnson, the brilliant literary critic.

In 1863, in the middle of the Glasgow University term, Smith accepted a lucrative job to tutor the young Duke of Buccleuch. The professor tried to return half the money his students had paid for his courses, but they refused to accept it, telling him that they had learned more from him than all their other teachers put together.

Smith and the duke spent most of the next couple of years in France, where they saw the ruinous effects of its wars, the feudal system of agriculture, and the excessive consumption of luxury goods by the church and unproductive royalty.

They discussed the issues of the day with leading figures such as Benjamin Franklin — and shared their new theory of a freer market.

In 1766 the duke's younger brother died and the tutoring ended.

Smith returned home to begin working on his magnum opus. Over the next decade he painstakingly collected anecdotes to illustrate his points.

Figuring It Out

"It wasn't that he was so much an original thinker, but he brilliantly blended and developed others' insights into a complete system," said Taylor. Among them:

• Competition will ensure a steady fall in prices and rise in the quality of goods.

• Price mechanisms will help supply meet demand.

• The division of work tasks enables manufacturers to be more productive.

• Government tends to favor big business, tariffs on selected imports, and licensed craftsmen who want to limit competition, none of which is necessarily in the interest of consumers.

"The book was a huge and immediate success," said Taylor.

Smith kept making revisions to "Wealth" for later editions. Two centuries later, British Prime Minister Margaret Thatcher was said to always carry a copy of "The Wealth of Nations" in her handbag.

Smith's lesson is that if you want to make breakthroughs, develop your ideas by drawing on a wide range of cutting-edge sources.

Those who think Smith's famous reference to "an invisible hand" was promoting laissez-faire economics (virtually no government control) haven't read the single reference in the context of its 700 pages, said John Paul Rollert, a professor at the University of Chicago:

"He is arguing that lifting trade restrictions would result in every merchant pursuing the most profitable trade available to him, making the most efficient use of his time and money. In so doing, he would be 'led by an invisible hand to promote an end which was not part of his intention,' namely, to benefit society and the broader welfare of its citizens. He believed government had a proper role in supporting education, building infrastructure and public institutions, and providing security, initiatives that should be paid for, in part, by a progressive tax code and duties on luxury goods."

Message For England

Smith was too and practical to be doctrinaire, says Taylor.

His lesson is that innovative thinking requires one to get rid of assumptions and dogma.

His warning at the end of "Wealth" about the American Revolution went unheeded. Explaining that raising taxes would not be feasible to finance a war, he argued that Britain should set up a free trade union similar to what it had with Scotland and Ireland, which would bring the Colonies economic and political benefits.

Smith became increasingly critical of the efforts to expand the British Empire, as well as of slavery.

After publication of "Wealth," which he wrote in Kirkcaldy, where he was born, Smith moved to London. In 1778 it was back to Scotland as commissioner of customs.

Smith was working on a systematic treatment of jurisprudence when he died at age 67. His will instructed that all 16 volumes of the unfinished book be burned, so no one knows what he wrote.

"This archival bonfire might be blamed on Smith's fastidious distaste for unhoned arguments which would inevitably be misunderstood, would retard 'the progress of truth' and would tarnish his posthumous reputation," wrote Phillipson.