Adam Smith Writings 1. An Inquiry into the Nature and Causes of the Wealth of Nations (1776) 2. The Theory of Moral Sentiments (1759) 3. Lectures on Justice, Policy, Revenue, and Arms (1895) - notes taken in 1763. Biographical Information from Worldly Philosophers 1. 2. 3. 4. 5. 6. 7. Adam Smith was born in 1723 in the town Kirkcaldy, County Fife, Scotland. At the age of seventeen, he went to Oxford University on a scholarship. Smith had a passion for reading. He was almost expelled from the University of Glasgow once for reading a copy of A Treatise of Human Nature by David Hume. In 1751 he was offered the Chair of Logic at the University of Glasgow. He was 28 years old. In 1758 he became a Dean (or the Dean) at Glasgow. In 1759 Smith published “The Theory of Moral Sentiments”. In the 1760s, during a visit to France, Smith was introduced to Quesnay and the Physiocrats. Upon returning to England he began the writing of the Wealth of Nations, which was published in 1776. Personal http://www.econ.unt.edu/~dmolina/econ4510.htm Born in Kircaldy (Scotland) Father died before he was born and his mother lived to the age of 90 Kidnap by Gipsies when he was 4 and was left abandon Walked 15 miles in Nightgown until awoken by bells Professorial Syndrom http://www.econ.unt.edu/~dmolina/econ4510.htm Walk in a distracted fashion and fell in a Pit Would work through academic matters out loud Brewed himself a drink of bread and butter and pronounced it the worst tea he had ever dranked “I am a beau in nothing but my books” Tutoring http://www.econ.unt.edu/~dmolina/econ4510.htm His book on moral theology attracted the attention of Charles Townshend Notorious to Americans since, as Chancellor of the Exchequer, he Refused to let colonist elect their own judges Increase the duty (tariff) on American Tea Townshend married well to the widow of a duke Tutoring (continued) http://www.econ.unt.edu/~dmolina/econ4510.htm He chose Adam Smith to tutor the son of the widow The contract was for 500 pounds per year plus expenses and a pension of 500 pounds per year for life after done Smith had never collected more than 100 pounds per year from fees collected directly from students His students refused refund when he had to leave saying they had more than received their return Tutoring (continued) http://www.econ.unt.edu/~dmolina/econ4510.htm For 18 months Smith and his student went to France Met Voltaire in the south of France Met Francois Quesney in Paris He agreed with the Laissez Faire of the Physocrats but did not agree with Agriculture being the source of all productivity Believed labor was an important component of production Life http://www.econ.unt.edu/~dmolina/econ4510.htm Smith met with Benjamin Franklin He was impressed with Mr. Franklin and his descriptions of the Colonies Probably why he later wrote about the Colonies a nation “which, indeed, seemed very likely to become one of the greatest and most formidable that ever was in the world.” An admiration that is later also shared by Karl Marx Life http://www.econ.unt.edu/~dmolina/econ4510.htm Adam Smith lived with his mother until she reached the age of 90 2 years after he published the Wealth of Nations he was appointed Commissioner of Customs for Edinburgh which paid 600 pounds a year His death went relatively unnoticed Smith Summarized • Three Laws of the Market 1. Self Interest and Competition will lead the market price to equal the cost of production. 2. Self-Interest and Competition will lead producers to provide the goods consumers demand. 3. Self-Interest and Competition will erode above-normal profits so that in the long-run rates of return will equalize for capital and labor. • In Smith’s view, markets are self regulating. Government intervention is unnecessary because the power of the competitive market limits the power of any one individual. Human Interest http://www.econ.unt.edu/~dmolina/econ4510.htm • Every man…. Is first and principally recommended to his own care; and every man is certainly in every respect fitter and abler to take care of himself than of any other person (Theory of Moral Sentiments) • In other words… Human beings are rational, calculating and motivated by self interest Human Interest http://www.econ.unt.edu/~dmolina/econ4510.htm • …the desire of bettering our condition [is] a desire which, though generally calm and dispassionate, come with us from the womb, and never leaves us till we to to the grave. In the whole interval which separates those two moments, there is scarce perhaps a single instant in which any man is so perfectly and completely satisfied with his situation, as to be without wish of alteration or improvement of any kind (Wealth of Nations) The Working of Competitive Markets 1. Assumptions a) Large number of sellers b) A group of resources owners knowledgeable about profits, wages, and rents c) Freedom of movement for resources among industries 2. Given these assumptions, the long run rate of profit, wages,and rents will equalize among the various sectors in the economy. 3. Hence, competitive markets lead to the optimal allocation of resources with consumers receiving goods at the lowest possible cost. 4. One must remember the assumptions if one is to accept the conclusions. (i.e. without competitive markets one does not achieve these results) 5. Government intervention is criticized. a) Government intervention restricts individual liberties. This is a criticism of the government assigning rights. b) Mercantilist writings that advocate government intervention in the interest of the public good are not objective. The Working of Competitive Markets (cont.) http://www.econ.unt.edu/~dmolina/econ4510.htm • In other words, given competitive market & absence of government intervention, resulting natural prices bring about optimum allocation of resources because consumers receive goods they want at lowest prices and maximum rate of growth occurs • THIS IS THE INVISIBLE HAND ANALOGY The Invisible Hand • • This is the only time Smith usees the words “Invisble Hand”. But the annual revenue of every society is always precisely equal to the exchangeable value of the whole annual produce of its industry, or rather is precisely the same thing with that exchangeable value. As every individual, therefore, endeavours as much as he can, both to employ his capital in the support of domestic industry, and so to direct that industry that its produce maybe of the greatest value; every individual necessarily labours to render the annual revenue of the society as great as he can. He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, 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 the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good. It is an affectation, indeed, not very common among merchants, and very few words need be employed in dissuading them from it. (p. 364) The Laws of Accumulations and Population 1. The Law of Accumulation is that savers will invest, investment will lead to further wealth and employment opportunity, and the increases in wealth will lead to further investment. This cycle can only be stopped by a lack of labor (i.e. diminishing returns), which will lead to increases in wages. 2. The Law of Population rescues the Law of Accumulation. Further increases in wages will lead to a higher standard of living, lower rates of infant mortality, and a higher population. The higher population will lead to lower wages, better investment opportunities, further accumulation, and the process continues.... What is the Wealth of Nations? 1. Mercantilist viewpoint: Accumulation of precious metals via trade. 2. Physiocrats viewpoint: Land or agriculture is the source of wealth. 3. Smith: a) Wealth is measured in terms of goods and services which are consumed. b) The primary source of wealth is stated to be labor, although ultimately it is capital. c) Wealth should also be measured in per-capita terms. Trade not a zero-sum game? • “Private people who want to make a fortune, never retire to the remote and poor provinces of the country, but resort to the capital, or to some of the great commercial towns. They know where little wealth circulates, there is little to be got, but that where a great deal is in motion, some share of it may fall to them. • The same maxims which would in this manner direct the common sense of [individuals]...should make a whole nation regard the riches of its neighbors as a probable cause and occasion for itself to acquire riches. A nation that would enrich itself by foreign trade, is certainly most likely to do so when its neighbors are all rich and industrious” Capital accumulation is one key to the wealth of a nation. 1. Productivity of workers depends upon capital accumulation. 2. The number of productive workers depends upon capital accumulation. 3. Capital accumulation depends upon a) a free market without government interference. b) private property. c) an unequal distribution of income . WHY? 4. Present wealth depends upon capital accumulation, since this is what determines the division of labor and the proportion of the population engaged in productive labor. 5. Capital accumulation is necessary for economic development, or future wealth. 6. Individual self interest and the accumulation of capital leads to an optimum allocation of capital among various industries. Who accumulates capital? • Wages are too low for labor to accumulate substantial savings. • Land owners have the ability to save, but do not because their purpose is to maintain a high standard of living. • Only capitalists have the willingness and means to accumulate the savings necessary to acquire future capital. Productivity of labor, or Another Key: The Division of Labor • Division of labor is the primary determinant of productivity • Extent of the market limits the division of labor • Accumulation of capital allows for the division of labor and the extent of the market. The Pin Factory Story from Adam Smith (1776, p.3) • • • To take an example, therefore, from a very trifling manufacture, but one in which the division of labour has been very often taken notice of, the trade of a pin-maker: a workman not educated to this business (which the division of labour has rendered a distinct trade, nor acquainted with the use of the machinery employed in it (to the invention of which the same division of labour has probably given occasion), could scarce, perhaps, with his utmost industry, make one pin in a day, and certainly could not make twenty. But in the way in which this business is now carried on, not only the whole work is a peculiar trade, but it is divided into a number of branches, of which the greater part are likewise peculiar trades. One man draws out the wire; another straights it; a third cuts it; a fourth points it; a fifth grinds it at the top for receiving the head; to make the head requires two or three distinct operations; to put it on is a peculiar business; to whiten the pins is another; it is even a trade by itself to put them into the paper; and the important business of making a pin is, in this manner, divided into about eighteen distinct operations, which, in some manufactories, are all performed by distinct hands, though in others the same man will sometimes perform two or three of them. The Pin Factory Story from Adam Smith (1776, p.3) • • I have seen a small manufactory of this kind, where ten men only were employed, and where some of them consequently performed two or three distinct operations. But though they were very poor, and therefore but indifferently accommodated with the necessary machinery, they could, when they exerted themselves, make among them about twelve pounds of pins in a day. There are in a pound upwards of four thousand pins of a middling size. Those ten persons, therefore, could make among them upwards of forty-eight thousand pins in a day. Each person, therefore, making a tenth part of forty-eight thousand pins, might be considered as making four thousand eight hundred pins in a day. But if they had all wrought separately and independently, and without any of them having been educated to this peculiar business, they certainly could not each of them have made twenty, perhaps not one pin in a day; that is, certainly, not the two hundred and fortieth, perhaps not the four thousand eight hundredth, part of what they are at present capable of performing, in consequence of a proper division and combination of their different operations. More on the Division of Labor 1. Division of labor is discussed from two perspectives 1. Specialization of tasks within a firm. 2. The social division of labor (i.e. the economic system is in essence a vast network of interrelations among specialized producers. 2. The division of labor “encourages every man to apply himself to a particular occupation, and to cultivate and to bring to perfection whatever talent or genius he may possess for that particular species of business”. 3. The division of labor is constricted by the extent of the market. Such an observation leads one to a discussion of returns to scale. Exceptions to Laissez-Faire • Regulation of Banking • Regulation of Competition • Public education • Infant industry argument • National defense considerations Adam Smith and Bank Regulation • Such regulations may, no doubt, be considered as in some respect a violation of natural liberty. But those exertions of the natural liberty of a few individuals, which might endanger the security of the whole society, are, and ought to be, restrained by the laws of all governments; of the most free, as well as or the most despotical. The obligation of building party walls, in order to prevent the communication of fire, is a violation of natural liberty, exactly of the same kind with the regulations of the banking trade which are here proposed. Business should be regulated http://www.econ.unt.edu/~dmolina/econ4510.htm • People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices. It is impossible indeed to prevent such meetings, by any law which either could be executed, or would be consistent with liberty and justice. But though the law cannot hinder people of the same trade from sometimes assembling together, it ought to do nothing to facilitate such assemblies, much less to render them necessary. Wealth of Nations, Book 1, Chapter 10. The Downside to the Division of Labor • • • In the progress of the division of labour, the employment of the far greater part of those who live by labour, that is, of the great body of the people, comes to be confined to a few very simple operations; frequently to one or two. But the understandings of the greater part of men are necessarily formed by their ordinary employments. The man whose whole life is spent in performing a few simple operations, of which the effects, too, are perhaps always the same, or very nearly the same, has no occasion to exert his understanding, or to exercise his invention, in finding out expedients for removing difficulties which never occur. He naturally loses, therefore, the habit of such exertion, and generally becomes as stupid and ignorant as it is possible for a human creature to become. The torpor of his mind renders him not only incapable of relishing or bearing a part in any rational conversation, but of conceiving any generous, noble, or tender sentiment, and consequently of forming any just judgment concerning many even of the ordinary duties of private life. Of the great and extensive interests of his country he is altogether incapable of judging; and unless very particular pains have been taken to render him otherwise, he is equally incapable of defending his country in war. The uniformity of his stationary life naturally corrupts the courage of his mind, and makes him regard, with abhorrence, the irregular, uncertain, and adventurous life of a soldier. It corrupts even the activity of his body, and renders him incapable of exerting his strength with vigour and perseverance in any other employment, than that to which he has been bred. His dexterity at his own particular trade seems, in this manner, to be acquired at the expense of his intellectual, social, and martial virtues. But in every improved and civilized society, this is the state into which the labouring poor, that is, the great body of the people, must necessarily fall, unless government takes some pains to prevent it. Smith against and for • from Heilbroner (1999) • What Smith is against is the meddling of the government with the market mechanism. He is against restraints on imports and bounties on exports, against government laws that shelter industry from competition, and against government spending for unproductive ends. Notice that these activities of the government all bear against the proper working of the market system. • One should note that Smith was in favor of public education and his last job was working for the government (he was commissioner of customs in Scotland). • He was also in favor of progressive taxation (i.e. the more income you have, the higher the precentage of income you should be in taxation). • Smith also wrote before the Industrial Revolution. So he didn’t understand the role technology played in continual economic growth. In fact, he didn’t think the British economy would continue to grow forever.