Essay: Free Adam Smith Essay

What do you consider to be Adam Smith’s legacy to the economics discipline?

Introduction

Adam Smith more popularly knows as the father of Economics wrote The Wealth of Nations, which is believed to have laid the foundation of economic thought and led to emergence of various schools of economic thought. Smith was a lecturer at the University of Glasgow where his concern was morality and ethics. Smith’s writings were considered revolutionary in those times. It would be fair to say that his views not only had an impact on the Europeans but also on those who mapped out the structure of the US government. According to John Farmer,

“Adam Smith stimulates insights about the relationship between economic and political concerns. Adam Smith and his legacy provide the conceptual space within which governmental and societal organization and management are now viewed and understood.”[1]

The above clearly proves that Smith left a legacy and had an impact on the discipline of economics even though his intentions were not to create a ripple effect. It has been argued that Smith did not aim to write just on economics, in fact, his writings focused around morality and economics. Amongst many things, Smith advocated that free exchange and competitive markets would harness self-interest as a creative force. Directed by the ‘invisible hand’ of market prices, individuals pursuing their own interests would be encouraged to produce the goods and supply of the resources that others value cost highly relative to cost. Smith’s concept of invisible hand led to emergence of new classical economists who supported the classical view and opposed Keynesian view on the subject that market forces do not automatically adjust and the economy does not automatically come back to full equilibrium levels. He argued that the wealth of a nation did not lie in gold and silver, but rather in the goods and services produced and consumed by people. According to Smith, co-ordination, order and efficiency would result in the planning and direction of central authority.[2]

This paper will provide a critical analysis of Smith’s explanation of various economic concepts. It will also provide the arguments put forward by other economists who believe that Adam Smith has left a legacy for economics discipline. A few key concepts will be discussed in the following paragraphs to highlight Smithian view and how his views have evolved in the present day economic sense.

Smith on Division of Labour

Smith noted that specialisation and division of labour permitted far more output. To explain his point further, Smith took the example of a factory producing pins. Smith believed that when each worker specialised in productive function, ten workers were able to produce 48,000 pins per day, or 4,800 pins per worker. Without specialisation and division of labour, Smith doubted that an individual worker could produce even 20 pins per day. In the present day scenario it can be seen that division of labour and specialisation has had a positive impact enabling productivity to increase. As it is already known, that there are several reasons why division of labour leads to enormous gains in output per worker. Firstly, specialisation permits individuals to take advantage of their existing abilities and skills. Division of labour lets organisations adopt complex, large-scale production techniques unthinkable for an individual household. The consequence of the above would be that the society would benefit from higher productivity and better organisational performance leading to making a higher level of profit.

Invisible Hand

Many economists believe that Adam Smith’s main contribution has been the principle of invisible hand. Adam Smith emphasised that personal self-interest when directed by market prices is a powerful force promoting economic progress. Using terminology employed by Smith, economists refer to the tendency of competitive markets to direct the actions of self-interested individuals and bring them into harmony with the general welfare as the invisible hand principle. Smith’s major point was that market prices are able to harness self-interest and put it to work for the benefit of the society. This view was further supported by the Classics however opposed by Keynes, which seemed to explain recession and the economy during Great Depression, therefore adding credibility to his views.

James Tobin (1990) argued that the principle of invisible hand is the most important legacy of Adam Smith to macroeconomics. He believes that it is particularly important, as it has served as the ultimate inspiration for New Classical Macroeconomics and for Real Business Cycle theory.

According to Tobin, Smith’s Wealth of Nations did not contain a huge chunk of macroeconomics; in particular, he argues that very little was discussed about short-run fluctuations in economic activity. It is argued that that while Smith emphasised stock as circulating capital, he assumed a one period-lag between inputs of labour and materials and outputs of saleable goods. This assumption enabled Smith to speak of profits on stock interchangeably as mark ups and as rates of return over time.

According to Tobin, Adam Smith’s specific macroeconomic ideas are not an important part of his legacy to modern ‘new classical’. The Invisible hand is their true inspiration. They reject the Keynesian dichotomy and expect competitive markets to transmute self-interest into public interest in macroeconomic as well as microeconomic outcomes.

Adam Smith on Competition

According to Smith, with the existence of competition in the economy, even self-interested individuals would tend to promote the general welfare. Conversely, when competition is weakened, business firms have more leeway to raise prices and pursue their own objectives and less incentive to innovate and develop better ways of doing things. Gwartney (2000) in support of the above argument stated that competition is a disciplinary force for both buyers and sellers. In a competitive environment, producers must provide goods at a low cost and serve the interests of consumers since they will have to woo them away from other suppliers. He further argued that this process leads to improvement in both products and production methods, while directing resources towards projects where they are able to produce more value. The above also leads to the conclusion that monopoly was not seen as a necessarily positive force.

In Smith’s own words,

“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 of wages and profit, greatly above the natural rate”[3]

Thus, the above re-establishes the fact that Smith’s considered monopoly as a necessary evil. Looking at the economies and world around us, it can be seen that countries promote competition for the reasons that resources are limited and it would eventually in the best interest of the society to maximise utilisation of resources. European Union and forming alliances between member countries, goes to prove that countries have realised the benefits of working together to move towards economic development and growth, which can be made possible by encouraging competition.

Adam Smith on Gains from Specialisation and Trade

“If a foreign country can supply us with a commodity cheaper than we ourselves can make it, [we had] better buy it of them with some part of our own industry, employed in a way in which we have some advantage”[4]

The above relates to what the law of comparative advantage, which explains why a group of individuals, regions, or nations can gain specialisation and exchange. As it has been seen that specialisation in the area of one’s comparative advantage minimises the cost of production and leads to maximum joint output. Evidence suggests that international trade leads to mutual gains because it allows the residents of each country to specialise more fully in production of those things that they do best and import goods when foreigners are willing to supply them at lower cost than domestic producers.

In his writings Smith also highlighted the paradox that water, which is necessary for life, sells so cheaply while diamonds have a far greater price. This was explained y the theory of marginal analysis; according to which the total value of the good includes consumer surplus; thus total value could be quite large even though the price is low, which reflects marginal value is low. This provided a vital explanation for why market prices have little to do with the total contribution that a good makes to the welfare of the users. In other words it can be said that it is possible for something to have a large total value but a very small marginal value and vice versa.

Smith regarded saving as a constraint on growth. In agreement with Smith’s belief, [5]Tobin comments,

“He [Smith] correctly saw holdings of gold and silver as diversions of stock from productive employment, and therefore he welcomed prudent substitution of paper money for these precious metals”

Smith’s further contribution to the field of economics was his belief in the purchasing power parity for tradable goods, even in the short run. After two decades this led to the emergence of theory relating to balance of payments, which has contributed in understanding globalisation and international trade in a present day context

Amongst many opinions expressed on Smith’ contribution to economics, David Farmer argues that Smith’s writings have not only focused on the principles of invisible hand, but it has also examined the fundamental forces that underlie economic development. Thus, Smith’s contribution also lies in laying the foundation to understand economic growth and development.

Farmer believed that Smith was more of a philosopher than an economist. Being classed as the founder of political economy he saw politics and economics as dimensions of a larger philosophy. For Smith, a value-free economics was only part of the story, he wanted to write on three main aspects namely, ethics, economics and government. According to Farmer, Smith wanted a government that was capable of coping with the capitalists’ ability to challenge government to private interests, however.  He recognised the importance of the government. He also favoured the governmental provision of public goods, like bridges and canals. Farmer further stated that that Smith was in favour of governmental action not only in situations of market failure but also for specific policy purposes. Thus, according to Farmer, Smith supported government intervention.

Thus it can be said Smith’s work has proved to be a legacy not only for the economics discipline, but it has also permeated disciplines like public administration theory and practice and it can be recognised by considering the central role accorded to efficiency, a central concept in economic theory.

Conclusion

From the preceding paragraphs it can be said that Smith’s contribution to the economics discipline is invaluable. While it can be argued that Smith might not have had a deep insight into the various aspects of economics, however, the points he raised in Wealth of Nations led to various schools of thought to come with arguments and counter arguments. Thus it can be said that Smith cannot be considered to have all the answers for all the economic problems, but Smith has contributed by making economic writers think and re-think and in many cases modify theories and explanations ad helped economics discipline to explore various facets. Smith’s contribution can never be quantified; it would be suffice to say that he laid down the foundation of economics. Various concepts and ideas that he had discussed in Wealth of Nations like competition, specialisation and division of labour, automatic adjustment of market forces have been key in understanding the principles of macroeconomics. In summary it can be said that Smith has left behind a legacy laying down foundations for further research in economics.

BIBLIOGRAPHY

1. Baiman, R.P., Boushey, H. and Saunders, D., Political Economy and Contemporary Capitalism: Radical Perspectives on Economic Theory and Policy, (2001), M.E.Sharpe

1. Dow, S.C., The Legacy of Adam Smith: Foundations in Economic Thought for Policy Making in Scotland, (2003), Scotecon

1. Fry.M., Adam Smith’s Legacy: His Place in the Development of Modern Economics, (1992), Routledge, an imprint of Taylor & Francis Books Ltd

1. Gwartney, James D., Stroup, Richard L., and Sobel, Russell S., Economics Private and Public Choice, (2000), Ninth Edition, The Dryden Press.

1. Werhane, P., Adam Smith’s legacy for ethics and economics (Research papers in management studies), (1993), Judge Institute of Management Studies.

Journals and Articles

1. Farmer, D.J., Contemporary Conceptual Space: Reading Adam Smith, 1997 Journal of Management History 3 (3), pp246-255

1. James Tobin, The Invisible and in Modern Macroeconomics, For Adam Smith Bicentenary, 1990. Cowles Foundation Discussion paper 966.

1. West, Edwin G., Economic Progress, Morality and Civic Virtue: The Legacy of Adam Smith, 1994

Footnotes

[1] Farmer, D.J., Contemporary Conceptual Space: Reading Adam Smith, Journal of Management History 3 (3), pp 246-255

[2] Gwartney, James D., Economics Public and Private Choice, 9^th edition (2000), The Dryden Press, p-11

[3] Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (1776; Cannan’s ed. Chicago: University of Chicago Press, 1976), p.69

[4] Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (1776; Cannan’s ed., Chicago: University of Chicago Press, 1976), pp 478-479

[5] James Tobin, The Invisible and in Modern Macroeconomics, For Adam Smith Bicentenary, 1990. Cowles Foundation Discussion paper 966.