Adam Smith was a radical and a revolutionary in his time—just

as those of us who preach laissez faire are in our time.

—Milton Friedman (1978, 7)

The story of modern economics begins in 1776. Prior to this famous

date, 6,000 years of recorded history had passed without a seminal

work being published on the subject that dominated every waking

hour of practically every human being: making a living.

For millennia, from Roman times through the Dark Ages and the

Renaissance, humans struggled to survive by the sweat of their brow,

often only eking out a bare existence. They were constantly guarding

against premature death, disease, famine, war, and subsistence wages.

Only a fortunate few—primarily rulers and aristocrats—lived leisurely

lives, and even those were crude by modern standards. For the common

man, little changed over the centuries. Real per capita wages were

virtually the same, year after year, decade after decade. During this

age, when the average life span was a mere forty years, the English

writer Thomas Hobbes rightly called the life of man “solitary, poor,

nasty, brutish, and short” (1996 [1651], 84).

1776, a Prophetic Year

Then came 1776, when hope and rising expectations were extended

to the common workingman for the first time. It was a period known

as the Enlightenment, which the French called l’age des lumieres.

For the first time in history, workers looked forward to obtaining a

basic minimum of food, shelter, and clothing. Even tea, previously a

luxury, had become a common beverage.

The signing of America’s Declaration of Independence on July

4 was one of several significant events of 1776. Influenced by John

Locke, Thomas Jefferson proclaimed “life, liberty, and the pursuit of

happiness” to be inalienable rights, thus establishing the legal framework

for a struggling nation that would eventually become the greatest

economic powerhouse on earth, and providing the constitutional

foundation of liberty that was to be imitated around the world.

A Monumental Book Appears

Four months earlier, an equally monumental work had been published

across the Atlantic in England. On March 9, 1776, the London printers

William Strahan and Thomas Cadell released a 1,000–page, two-volume

work entitled An Inquiry into the Nature and Causes of the Wealth of Nations.

It was a fat book with a long title destined to have gargantuan global

impact. The author was Dr. Adam Smith, a quiet, absent-minded professor

who taught “moral philosophy” at the University of Glasgow.

The Wealth of Nations was the intellectual shot heard around the

world. Adam Smith, a leader in the Scottish Enlightenment, had put

on paper a universal formula for prosperity and financial independence

that would, over the course of the next century, revolutionize the way

citizens and leaders thought about and practiced economics and trade. Its

publication promised a new world—a world of abundant wealth, riches

beyond the mere accumulation of gold and silver. Smith promised that

new world to everyone—not just the rich and the rulers, but the common

man, too. The Wealth of Nations offered a formula for emancipating

the workingman from the drudgery of a Hobbesian world. In sum, The

Wealth of Nations was a declaration of economic independence.

Certain dates are turning points in the history of mankind. The year

1776 is one of them. In that prophetic year, two vital freedoms were

proclaimed—political liberty and free enterprise—and the two worked together

to set in motion the Industrial Revolution. It was no accident that the

modern economy began in earnest shortly after 1776 (see Figure 1.1).

The Enlightenment and the Rumblings of

Economic Progress

The year 1776 was significant for other reasons as well. For example,

it was the year the first volume of Edward Gibbon’s classic work,

History of the Decline and Fall of the Roman Empire (1776–88),

appeared. Gibbon was a principal advocate of eighteenth-century

Enlightenment, which embodied unbounded faith in science, reason,

and economic individualism in place of religious fanaticism, superstition,

and aristocratic power.

To Smith, 1776 was also an important year for personal reasons.

8,000

6,000

4,000

2,000

0

1100 1200 1300 1400 1500

GDP per Capita (1990 $)

Wealth of Nations

published (1776)

1600 1700 1800 1900 1995

10,000

12,000

14,000

16,000

18,000

Income of England (1100–1995)

Figure 1.1 The Rise in Real per Capita Income, United Kingdom,

1100–1995

His closest friend, David Hume, died. Hume, a writer and philosopher,

was a great influence on Adam Smith (see “Pre-Adamites”

in the appendix to this chapter). Like Smith, he was a leader of the

Scottish Enlightenment and an advocate of commercial civilization

and economic liberty.

For centuries, the average real wage and standard of living had

stagnated, while almost a billion people struggled against the harsh

realities of daily life. Suddenly, in the early 1800s, just a few years

after the American Revolution and the publication of The Wealth of

Nations, the Western world began to flourish as never before. The spinning

jenny, power looms, and the steam engine were the first of many

inventions that saved time and money for enterprising businessmen

and the average citizen. The Industrial Revolution was beginning to

unfold, real wages started climbing, and everyone’s standard of living,

rich and poor, began rising to unforeseen heights. It was indeed

the Enlightenment, the dawning of modern times, and people of all

walks of life took notice.

Advocate for the Common Man

Just as George Washington was the father of a new nation, so Adam

Smith was the father of a new science, the science of wealth. The great

British economist Alfred Marshall called economics the study of “the

ordinary business of life.” Appropriately, Adam Smith would have an

ordinary name. He was named after the first man in the Bible, Adam,

which means “out of many,” and his last name, Smith, signifies “one

who works.” Smith is the most common surname in Great Britain.

The man with the pedestrian name wrote a book for the welfare of

the average working man. In his magnum opus, he assured the reader

that his model for economic success would result in “universal opulence

which extends itself to the lowest ranks of the people” (1965

[1776], 11).1

It was not a book for aristocrats and kings. In fact, Adam Smith

had little regard for the men of vested interests and commercial

power. His sympathies lay with the average citizens who had been

abused and taken advantage of over the centuries. Now they would

be liberated from sixteen-hour-a-day jobs, subsistence wages, and a

forty-year life span.

Adam Smith Faces a Major Obstacle

After taking twelve long years to write his big book, Smith was

convinced he had discovered the right kind of economics to create

“universal opulence.” He called his model the “system of natural liberty.”

Today economists call it the “classical model.” Smith’s model

was inspired by Sir Isaac Newton, whose model of natural science

Smith greatly admired as universal and harmonious.

Smith’s biggest hurdle would be convincing others to accept his

system, especially legislators. His purpose in writing The Wealth of

Nations was not simply to educate, but to persuade. Very little progress

had been achieved over the centuries in England and Europe because of

the entrenched system known as mercantilism. One of Adam Smith’s

main objectives in writing The Wealth of Nations was to smash the

conventional view of the economy, which allowed the mercantilists to

control the commercial interests and political powers of the day, and

to replace it with his view of the real source of wealth and economic

growth, thus leading England and the rest of the world toward the

“greatest improvement” of the common man’s lot.

The Appeal of Mercantilism

Following a long-standing tradition in the West, the mercantilists (the

commercial politicos of the day) believed that the world’s economy

was stagnant and its wealth fixed, so that one nation grew only at the

expense of another. The economies of civilizations from ancient times

through the Middle Ages were based on either slavery or several forms

of serfdom. Under either system, wealth was largely acquired at the

expense of others, or by the exploitation of man by man. As Bertrand

de Jouvenel observes, “Wealth was therefore based on seizure and

exploitation” (Jouvenel 1999, 100).

Consequently, European nations established government-authorized

monopolies at home and supported colonialism abroad, sending

agents and troops into poorer countries to seize gold and other

precious commodities.

According to the established mercantilist system, wealth consisted

entirely of money per se, which at the time meant gold and silver. The

primary goal of every nation was always to aggressively accumulate

gold and silver, and to use whatever means necessary to do so. “The

great affair, we always find, is to get money,” Smith declared in The

Wealth of Nations (398).

How to get more money? The growth of nations was predatory.

Nations such as Spain and Portugal sent their emissaries to faraway

lands to discover gold mines and to pile up as much of the precious

metal as they could. No expedition or foreign war was too expensive

when it came to their thirst for bullion. Other European countries,

imitating the gold seekers, frequently imposed exchange controls,

forbidding, under the threat of heavy penalties, the export of gold

and silver.

Second, mercantilists sought a favorable balance of trade, which

meant that gold and silver would constantly fill their coffers. How?

“The encouragement of exportation, and the discouragement of

importation, are the two great engines by which the mercantilist

system proposes to enrich every country,” reported Smith (607).

Smith carefully delineated the host of high tariffs, duties, quotas,

and regulations that aimed at restraining trade. Ultimately, this

system also restrained production and a higher standard of living.

Such commercial interferences naturally led to conflict and war

between nations.

Smith Denounces Trade Barriers

In a direct assault on the mercantile system, the Scottish philosopher

denounced high tariffs and other restrictions on trade. Efforts to promote

a favorable balance of trade were “absurd,” he declared (456).

He talked of the “natural advantages” one country has over another in

producing goods. “By means of glasses, hotbeds, and hotwalls, very

good grapes can be raised in Scotland,” Smith said, but it would cost

thirty times more to produce Scottish wine than to import wine from

France. “Would it be a reasonable law to prohibit the importation

of all foreign wines, merely to encourage the making of claret and

burgundy in Scotland?” (425).

According to Smith, mercantilist policies merely imitate real prosperity,

benefiting only the producers and the monopolists. Because

it did not benefit the consumer, mercantilism was antigrowth and

shortsighted. “In the mercantile system, the interest of the consumer

is almost always constantly sacrificed to that of the producer,” he

wrote (625).

Smith argued that trade barriers crippled the ability of countries to

produce, and thus should be torn down. An expansion of trade between

Britain and France, for example, would enable both nations to gain.

“What is prudence in the conduct of every private family, can scarce

be folly in that of a great kingdom,” declared Smith. “If a foreign

country can supply us with a commodity cheaper than we ourselves

can make it, better buy it of them” (424).

Real Source of Wealth Revealed

The accumulation of gold and silver might have filled the pockets of

the rich and the powerful, but what would be the origin of wealth for

the whole nation and the average citizen? That was Adam Smith’s

paramount question. The Wealth of Nations was not just a tract on

free trade, but a world view of prosperity.

The Scottish professor forcefully argued that the keys to the “wealth

of nations” were production and exchange, not the artificial acquisition

of gold and silver at the expense of other nations. He stated,

“the wealth of a country consists, not of its gold and silver only, but

in its lands, houses, and consumable goods of all different kinds”

(418). Wealth should be measured according to how well people are

lodged, clothed, and fed, not according to the number of bags of gold

in the treasury. In 1763, he said, “the wealth of a state consists in the

cheapness of provisions and all other necessaries and conveniences

of life” (1982 [1763], 83).

Smith began his Wealth of Nations with a discussion of wealth.

He asked, what could bring about the “greatest improvement in the

productive powers of labour”? A favorable balance of trade? More

gold and silver?

No, it was a superior management technique, “the division of labor.”

In a well-known example, Smith described in detail the workings of

a pin factory, where workers were assigned eighteen distinct operations

in order to maximize the output of pins (1965 [1776], 3–5).

This stages-of-production approach, where management works with

labor to produce goods and fulfill consumer wants, forms the basis of

a harmonious and growing economy. A few pages later, Smith used

another example, the woolen coat: “the assistance and co-operation

of many thousands” of laborers and various machinery from around

the world were required to produce this basic product used by the

“day-laborer”2 (11–12). Furthermore, expanding the market through

worldwide trade would mean that specialization and division of labor

could also expand. Through increased productivity, thrift, and hard

work, the world’s output could increase. Hence, wealth was not a fixed

quantity after all, and countries could grow richer without harming

or exploiting others.

Smith Discovers the Key to Prosperity

How can production and exchange be maximized and thereby encourage

the “universal opulence” and the “improvement of the productive

power of labor”? Adam Smith had a clear answer: Give people

their economic freedom! Throughout The Wealth of Nations, Smith

advocated the principle of “natural liberty,” the freedom to do what

one wishes with little interference from the state. It encouraged the

free movement of labor, capital, money, and goods. Moreover, said

Smith, economic freedom not only leads to a better material life, but

is a fundamental human right. To quote Smith: “To prohibit a great

people . . . from making all that they can of every part of their own

produce, or from employing their stock and industry in the way that

they judge most advantageous to themselves, is a manifest violation

of the most sacred rights of mankind” (549).

Under Adam Smith’s model of natural liberty, wealth creation was

no longer a zero-sum game. No longer was there a conflict of interests,

but a harmony of interests. According to Jouvenel, this came as an

“enormous innovation” that greatly surprised European reformers.

“The great new idea is that it is possible to enrich all the members

of society, collectively and individually, by gradual progress in the

organization of labor” (Jouvenel 1999, 102). This development could

be rapid and unlimited.

Here was something that could capture the imagination and hope

not only of the English worker, but of the French peasant, the German

laborer, the Chinese day worker, and the American immigrant,

for Smith was advocating a worldwide principle of abundance. The

freedom to work could liberate everyone from the chains of daily

chores.

What constitutes this new economic freedom? Natural liberty includes,

according to Smith, the right to buy goods from any source,

including foreign products, without the restraints of tariffs or import

quotas. It includes the right to be employed in whatever occupation

a person wants and wherever desired. Smith trenchantly criticized

European policy in the eighteenth century wherein laborers had to

obtain government permission (via certificates) to move from one

town to another, even within a country (1965 [1776], 118–43).

Natural liberty also includes the right to charge whatever wage

the market might bear. Smith strongly opposed the state’s efforts to

regulate and artificially raise wages. He wrote, “Whenever the law has

attempted to regulate the wages of workmen, it has always been rather

to lower them than to raise them” (131). Like every worker, Smith

desired high wages, but he thought they should come about through

the natural workings of the labor market, not government edict.

Finally, natural liberty includes the right to save, invest, and accumulate

capital without government restraint—important keys to

economic growth.

Adam Smith endorsed the virtues of thrift, capital investment, and

labor-saving machinery as essential ingredients to promote rising

living standards (326). In his chapter on the accumulation of capital

(Chapter 3, Book II) in The Wealth of Nations, Smith emphasized

saving and frugality as keys to economic growth, in addition to stable

government policies, a competitive business environment, and sound

business management.

Smith’s Classic Work Receives Universal Acclaim

Adam Smith’s eloquent advocacy of natural liberty fueled the minds

of a rising generation. His words literally changed the course of

politics, dismantling the old mercantilist doctrines of protectionism

and enforced labor. Much of the worldwide movement toward free

trade can be attributed to Adam Smith’s work. The Wealth of Nations

was the ideal document to usher in the Industrial Revolution and the

political rights of man.

Smith’s magnum opus has received almost universal acclaim. H.L.

Mencken stated, “There is no more engrossing book in the English

language” (in Powell 2000, 251). Historian Arnold Toynbee asserted

that “The Wealth of Nations and the steam engine destroyed the old

world and built a new one” (in Rashid 1998, 212). The English historian

Henry Thomas Buckle stretched the hyperbole even further to

claim that, in terms of its ultimate influence, Smith’s tome “is probably

the most important book that has ever been written,” not excluding the

Bible (in Rogge 1976, 9); and Paul A. Samuelson placed Smith “on

a pinnacle” among economists (Samuelson 1962, 7).3 Even Marxists

sometimes extol the virtues of Adam Smith.

The Life of Adam Smith

Who was Adam Smith, and how did he come to write his revolutionary

work on modern economics?

Seaports and commerce were an integral part of Adam Smith’s life.

Born in Kirkcaldy, on the east coast of Scotland near Edinburgh, in

June 1723, he had the unfortunate distinction of coming into the world

in the same year that his father died. It appeared that the newborn

Adam Smith was destined to be a student of trade and a customs agent.

His father, also named Adam Smith, was a comptroller of customs at

Kirkcaldy. His guardian, named Adam Smith as well, was a customs

collector in the same town, and a cousin served as customs inspector

in Alloa. The cousin’s name was—you guessed it—Adam Smith.

The last occupation of our Adam Smith (the famous one) was, not

surprisingly, customs commissioner of Scotland. But we’re getting

ahead of our story. In his early days in Kirkcaldy, Adam was regarded

as a “delicate child.” At age four, he was kidnapped by gypsies but

was soon returned to his mother. “He would have made a poor gypsy,”

commented biographer John Rae (1895, 5). His focus of affection was

always his mother, whom he cherished.

Although Smith had many female acquaintances, he never married.

“He speaks harshly, with big teeth, and he’s ugly as the devil,” wrote

Madame Riccoboni, a French novelist, upon meeting Adam Smith

for the first time in Paris in May 1766. “He’s a most absent-minded

creature,” she later wrote, “but one of the most lovable” (in Muller

1993, 16). We know pitifully little about his love interests. His biographers

relate that as a young man Smith fell in love with a beautiful

and accomplished young lady, but unknown circumstances prevented

their marriage (Ross 1995, 402). Several French ladies pursued this

unhandsome savant, but nothing came of it.

Smith occupied his spare time attending numerous clubs, such as

the Poker Club, the Club of Edinburgh, the London “literati,” and

Johnson’s Club, although David Hume frequently scolded him for

being too reclusive. “His mother, his friends, his books—these were

Smith’s three great joys,” declared John Rae (1895, 327).

At the youthful age of fourteen, Smith attended Glasgow University,

then won a scholarship to Oxford, where he spent half a

dozen years studying Greek and Latin classics, French and English

literature, and science and philosophy. Referring to Oxford University,

he wrote in The Wealth of Nations that “the greater part of the

public professors have, for these many years, given up altogether

even the pretence of teaching” (Smith 1965 [1776], 718). A few

pages later, Smith made his famous denunciation of the “sham-lecture”

by college professors: “If the teacher happens to be a man of

sense, it must be an unpleasant thing to him to be conscious, while

he is lecturing his students, that he is either speaking or reading

nonsense, or what is very little better than nonsense. It must too be

unpleasant to him to observe that the greater part of his students

desert his lectures; or perhaps attend upon them with plain enough

marks of neglect, contempt, and derision. . . . The discipline of colleges

and universities is in general contrived, not for the benefit of

the students, but for the interest, or more properly speaking, for the

ease of the masters” (720).4

In terms of physical appearance, Smith was of average height and

slightly overweight. He never sat for a picture, but several sketches

show “rather handsome features, full forehead, prominent eyeballs,

well curved eyebrows, slightly aquiline nose, and firm mouth and chin”

(Rae 1895, 438). He himself exclaimed, “I am a beau in nothing but

my books” (Rae 1895, 329).

After graduation, he held the position of Professor of Moral Philosophy

at the University of Glasgow between 1751 and 1763. His

first major work, Theory of Moral Sentiments, was published in 1759

and established Adam Smith as an influential Scottish thinker.

The Absent-Minded Professor

As to his personality quirks, the famous professor had a harsh, thick

voice and often stuttered. He was the quintessential absent-minded

professor. His life was one of ubiquitous disorganization and ambiguity.

Books and papers were stacked everywhere in his study. From

his childhood, he had the habit of talking to himself, “smiling in rapt

conversation with invisible companions” (Rae 1895, 329). Stories of

his bumbling nature abound: once he fell into a leather-tanning pit

while conversing with a friend; one morning he put bread and butter

into a teapot, and after tasting the tea, declared it to be the worst cup of

tea he had ever had; another time he went out walking and daydreaming

in his old nightgown and ended up several miles outside town.

 “He was the most absent man I ever knew,” declared a contemporary

(in West 1976, 176).

How He Wrote His Magnum Opus

In 1764, Charles Townsend, a leading British member of Parliament,

offered Smith a handsome fee and lifetime pension to tutor his stepson,

Henry Scott, the Duke of Buccleuch. They traveled to France, where

Smith met with Voltaire, Turgot, Quesnay, and other great French

thinkers. “This Smith is an excellent man!” exclaimed Voltaire. “We

have nothing to compare with him” (in Muller 1993, 15).

It was in France that Smith indicated he had lost interest in his

tutoring duties and began researching and writing The Wealth of

Nations. It took him ten years to write it. When finally published

by the premier English publisher, it became an instant bestseller,

and the first edition of a thousand copies sold out in six months.

David Hume and Thomas Jefferson, among others, praised the book,

which went through several editions and foreign translations during

Smith’s lifetime.5 A first printing of The Wealth of Nations then cost

thirty-six shillings. Today a collector might well pay over $150,000

for a first edition.

The Wealth of Nations remains a classic, and various editions can

be found in any major bookstore. Which edition should you read?

Since the copyright expired, many publishers have put out their own

editions, including the University of Glasgow, University of Chicago,

Everyman’s Library, and Liberty Press; there’s even a Bantam paperback,

unabridged! My preference is the 1937 (latest reprint, 1994)

Modern Library edition, edited by Edwin Cannan.

The significance of The Wealth of Nations has reached such biblical

proportions that a complete concordance was prepared by Fred

R. Glahe (1993), economics professor at the University of Colorado.

Oh, the wonders of computers! Did you know that the word

“a” appears 6,691 times in The Wealth of Nations? A concordance

is undoubtedly valuable, especially for scholars. For example, “de-

mand” appears 269 times while “supply” appears only 144 times.

Keynes would be pleased.

Smith Is Appointed Customs Official and Burns

His Clothes

Following the publication of his classic book, Smith was appointed

customs commissioner in Edinburgh, as noted earlier. He also spent

time revising his published books, lived a modest life despite his pension,

and over the years gave away most of his income in private acts

of charity, which he took care to conceal (Rae 1895, 437). He lived

in Edinburgh for the remainder of his life.

His position as a customs agent is full of irony. In The Wealth of

Nations, Smith argued in favor of free trade. He endorsed the elimination

of most tariffs and even wrote in sympathy of smuggling. Two

years later, in 1778, Smith actively sought a high-level government

appointment, possibly to enhance his financial condition. Smith succeeded

in his quest and was named Commissioner of Customs in

Scotland, despite his previous writings on free trade and the words of

his friend Dr. Samuel Johnson, who said that “one of the lowest of all

human beings is a Commissioner of Excise” (in Viner 1965, 64). The

job was a prestigious position that paid a handsome £600 a year. In a

strange paradox, the champion of free trade and laissez-faire spent the

last twelve years of his life enforcing Scotland’s mercantilist import

laws and cracking down on smugglers.

Once in office, Smith acquainted himself with all the rules and

regulations of customs law and suddenly discovered that for some time

he had personally violated it: Most of the clothes he was wearing had

been illegally smuggled into the country. Writing to Lord Auckland,

he exclaimed, “I found, to my great astonishment, that I had scarce a

stock [neck cloth], a cravat, a pair of ruffles, or a pocket handkerchief

which was not prohibited to be worn or used in Great Britain. I wished

to set an example and burnt them all.”6 He urged Lord Auckland and

his wife to examine their clothing and do the same.

Smith intended to write a third philosophical work on politics and

jurisprudence, a sequel to his Theory of Moral Sentiments and The

Wealth of Nations.7 Yet he apparently spent a dozen years enforcing

arcane customs laws instead. Such is the lure of government office

and job security.

Another Burning Affair in His Final Years

A second burning incident occurred at the end of Smith’s life in 1790.

He dined every Sunday with his two closest friends, Joseph Black

the chemist and James Hutton the geologist, at a tavern in Edinburgh.

Several months before his demise, he begged his friends to destroy

all his unpublished papers except for a few he deemed nearly ready

for publication. (Why he didn’t burn the papers himself is a mystery.)

This was not a new request. Seventeen years earlier, when he traveled

to London with the manuscript of The Wealth of Nations, he instructed

David Hume, his executor, to destroy all his loose papers and eighteen

thin paper folio books “without any examination,” and to spare nothing

but his fragment on the history of astronomy.

Smith had apparently read about a contemporary figure whose

private papers had been exposed to the public in a “tell-all” biography

and he feared the same might happen to him. He may have also been

concerned about letters or essays written in defense of his friend Hume,

who was a religious heretic during a period of intolerance. But Hume

died before Smith did, and a new executor of the estate was needed.

Approaching the end of his life, Smith became extremely anxious

about his personal papers and repeatedly demanded that his friends

Black and Hutton destroy them. Black and Hutton always put off

complying with his request, hoping that Smith would come to his

senses and change his mind. But a week before he died, he expressly

sent for his friends and insisted that they burn all his manuscripts,

without knowing or asking what they contained, except for a few items

ready for publication. Finally, the two acquiesced and burned virtually

everything—sixteen volumes of manuscript, including Smith’s

manuscript on law.

After the conflagration, the old professor seemed greatly relieved.

When his visitors called upon him the following Sunday evening for

their regular supper, he declined to join them. “I love your company,

gentlemen, but I believe I must leave you to go to another world.” It

was his last sentence to them. He died the following Saturday, July

17, 1790.

Adam Smith’s Crown Jewel

Let us examine in depth Adam Smith’s magnum opus and his revolutionary

economic philosophy. An economic system that would allow

men and women to pursue their own self-interest under conditions

of “natural liberty” and competition would, according to Smith, lead

to a self-regulating and highly prosperous economy. Eliminating

restrictions on imports, labor, and prices would mean that universal

prosperity could be maximized through lower prices, higher wages,

and better products. It would provide stability and growth.

Smith Identifies Three Ingredients

Smith began his book with a discussion of how wealth and prosperity

are created through democratic free-market order. He highlighted three

characteristics of this self-regulating system or classical model:

1. Freedom: individuals have the right to produce and exchange

products, labor, and capital as they see fit.

2. Competition: individuals have the right to compete in the

production and exchange of goods and services.

3. Justice: the actions of individuals must be just and honest,

according to the rules of society.

Note that the following statement by Adam Smith incorporates

these three principles: “Every man, as long as he does not violate

the laws of justice, is left perfectly free to pursue his own interest his

own way, and to bring both his industry and capital into competition

with those of any other man, or order of men” (1965 [1776], 651,

emphasis added).

ADAM SMITH DECLARES A REVOLUTION 19

The Benefits of the Invisible Hand

Smith argued that these three ingredients would lead to a “natural

harmony” of interests between workers, landlords, and capitalists.

Recall the pin factory, where management and labor had to work

together to achieve their ends, and the woolen coat that required the

“joint labor” of workmen, merchants, and carriers from around the

world. On a general scale, the voluntary self-interest of millions of

individuals would create a stable, prosperous society without the

need for central direction by the state. His doctrine of enlightened

self-interest is often called “the invisible hand,” based on a famous

passage (paraphrased) from The Wealth of Nations: “By pursuing

his own self interest, every individual is led by an invisible hand to

promote the public interest” (423).

Adam Smith’s invisible hand doctrine has become a popular metaphor

for unfettered market capitalism. Although Smith uses the term

only once in The Wealth of Nations, and sparingly elsewhere, the

phrase “invisible hand” has come to symbolize the workings of the

market economy as well as the workings of natural science (Ylikoski

1995). Defenders of market economics use it in a positive way, characterizing

the market hand as “gentle” (Harris 1998), “wise” and “far

reaching” (Joyce 2001), one that “improves the lives of people” (Bush

2002), while contrasting it with the “visible hand,” “the hidden hand,”

“the grabbing hand,” “the dead hand,” and the “iron fist” of government,

whose “invisible foot tramples on people’s hopes and destroys

their dreams” (Shleifer and Vishny 1998, 3–4; Lindsey 2002; Bush

2002). Critics use contrasting comparisons to express their hostility

toward capitalism. To them, the invisible hand of the market may be

a “backhand” (Brennan and Pettit 1993), “trembling” and “getting

stuck” and “amputated” (Hahn 1982), “palsied” (Stiglitz 2001, 473),

“bloody” (Rothschild 2001, 119), and an “iron fist of competition”

(Roemer 1988, 2–3).

The invisible hand concept has received surprising praise from

economists across the political spectrum. One would expect high

praise from free-market advocates, of course. Milton Friedman refers

to Adam Smith’s symbol as a “key insight” into the cooperative, selfregulating

“power of the market [to] produce our food, our clothing,

our housing” (Friedman and Friedman 1980, 1). “His vision of the

way in which the voluntary actions of millions of individuals can be

coordinated through a price system without central direction . . . is

a highly sophisticated and subtle insight” (Friedman 1978, 17; cf.

Friedman 1981).

Not to be outdone are Keynesian economists. Despite its imperfections,

“the invisible hand has an astonishing capacity to handle a

coordination problem of truly enormous proportions,” declare William

Baumol and Alan Blinder (2001, 214). Frank Hahn honors the

invisible hand theory as “astonishing” and an appropriate metaphor.

“Whatever criticisms I shall level at the theory later, I should like to

record that it is a major intellectual achievement. . . . The invisible

hand works in harmony [that] leads to the growth in the output of

goods which people desire” (Hahn 1982, 1, 4, 8).

The First Fundamental Theorem of Welfare Economics

The invisible hand theory of the marketplace has become known

as the “first fundamental theorem of welfare economics.”8 George

Stigler calls it the “crown jewel” of The Wealth of Nations and “the

most important substantive proposition in all of economics.” He adds,

“Smith had one overwhelmingly important triumph: he put into the

center of economics the systematic analysis of the behavior of individuals

pursuing their self-interests under conditions of competition”

(Stigler 1976, 1201).

Building on the general equilibrium (GE) modeling of Walras,

Pareto, Edgeworth, and many other pioneers, Kenneth J. Arrow and

Frank Hahn have written an entire book analyzing “an idealized,

decentralized economy,” and refer to Smith’s “poetic expression of

the most fundamental of economic balance relations, the equalization

of rates of return. . . .” Hahn expects anarchic chaos, but the market

creates a “different answer”—spontaneous order. In a broader perspective,

Arrow and Hahn declare that Smith’s vision “is surely the

most important intellectual contribution that economic thought has

made to the general understanding of social processes” (Arrow and

Hahn 1971, v, vii, 1). Not only does welfare economics (Walras’s law,

Pareto’s optimality, Edgeworth’s box) confirm mathematically and

graphically the validity of Adam Smith’s principal thesis, but it shows

how, in most cases, government-induced monopolies, subsidies, and

other forms of noncompetitive behavior lead inevitably to inefficiency

and waste (Ingrao and Israel 1990).

Smith’s References to the Invisible Hand

Surprisingly, Adam Smith uses the expression “invisible hand” only

three times in his writings. The references are so sparse that economists

and political commentators seldom mentioned the invisible

hand idea by name in the nineteenth century. No references were

made to it during the celebrations of the centenary of The Wealth of

Nations in 1876. In fact, in the famed edited volume by Edwin Cannan,

published in 1904, the index does not include a separate entry

for “invisible hand.” The term only became a popular symbol in the

twentieth century (Rothschild 2001, 117–18). But this historical fact

should not imply that Smith’s metaphor is marginal to his philosophy;

it is in reality the central element to his philosophy.

The first mention of the invisible hand is found in Smith’s “History

of Astronomy,” where he discusses superstitious peoples who ascribed

unusual events to the handiwork of unseen gods:

Among savages, as well as in the early ages of Heathen antiquity, it is the

irregular events of nature only that are ascribed to the agency and power

of their gods. Fire burns, and water refreshes; heavy bodies descend and

lighter substances fly upwards, by the necessity of their own nature; nor

was the invisible hand of Jupiter ever apprehended to be employed in

those matters. (Smith 1982, 49)

A full statement of the invisible hand’s economic power occurs

in The Theory of Moral Sentiments, when Smith describes some unpleasant

rich landlords who in “their natural selfishness and rapacity”

pursue “their own vain and insatiable desires.” And yet they employ

several thousand poor workers to produce luxury products:

The rest he [the proprietor] is obliged to distribute . . . among those

. . . which are employed in the economy of greatness; all of whom

thus derive from his luxury and caprice, that share of the necessaries

of life, which they would in vain have expected from his humanity

or his justice. . . . [T]hey divide with the poor the produce of all their

improvements. They are led by an invisible hand to, . . . without intending

it, without knowing it, advance the interests of the society. (Smith

1982 [1759], 183–85)

The third mention, already quoted above, occurs in a chapter on

international trade in The Wealth of Nations, where Smith argues

against restrictions on imports, and against the merchants and

manufacturers who support their mercantilist views. Here is the

complete quotation:

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 may be 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. . . . [A]nd 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. (Smith 1965 [1776], 423)

A Positive or Negative Interpretation?

Most observers believe that Adam Smith uses the invisible hand in a

positive way, but in her recent book, Economic Sentiments, Cambridge

professor Emma Rothschild dissents. Using “indirect” evidence, she

concludes, “What I will suggest is that Smith did not especially esteem

the invisible hand.” According to Rothschild, Smith views the invisible

hand imagery as a “mildly ironic joke.” She goes so far as to claim

that it is “un-Smithian, and unimportant to his theory” (Rothschild

2001, 116, 137). She even suggests that Smith may have borrowed

the expression from Shakespeare. Rothschild notes that Smith was

thoroughly familiar with Act III of Macbeth. In the scene immediately

before the banquet and Banquo’s murder, Macbeth asks his dark being

to cover up the crimes he is about to commit:

Come, seeing night,

Scarf up the tender eye of pitiful day,

And with thy bloody and invisible hand

Cancel and tear to pieces that great bond

Which keeps me pale.

Thus we see an invisible hand that is no longer a gentle hand, but

a bloody, forceful hand. But Rothschild protests too much. Although

Smith used the “invisible hand” phrase only a few times, the idea of

a beneficial invisible hand is ubiquitous in his works. Over and over

again, he reiterated his claim that individuals acting in their own selfinterest

unwittingly benefit the public weal. As Jacob Viner interprets

Smith’s doctrine, “Providence favors trade among peoples in order to

promote universal brotherhood” (Viner 1972, foreword). Smith repeatedly

advocated removal of trade barriers, state-granted privileges, and

employment regulations so that individuals can have the opportunity

to “better their own condition” and thus make everyone better off

(1965 [1776], 329). The idea of the invisible hand doctrine occurs

more often than Rothschild realizes. Very early in The Theory of Moral

Sentiments, Smith made his first statement of this doctrine:

The ancient stoics were of the opinion, that as the world was governed

by the all-ruling providence of a wise, powerful, and good God, every

single event ought to be regarded as making a necessary part of the

plan of the universe, and as tending to promote the general order and

happiness of the whole: that the vices and follies of mankind, therefore,

made as necessary part of this plan as their wisdom and their virtue;

and by that eternal art which educes good from ill, were made to tend

equally to the prosperity and perfection of the great system of nature.

(Smith 1982 [1759], 36).

Although Smith failed to mention the invisible hand by name in

this passage, the theme is vividly portrayed. The author cited God

throughout The Theory of Moral Sentiments, using such names as the

Author of Nature, Engineer, Great Architect, Creator, the great Judge

of hearts, Deity, and the all-seeing Judge of the world.

How Religious Was Adam Smith?

That God is not mentioned in The Wealth of Nations has caused some

observers to conclude that Adam Smith, like his closest friend of the

Scottish Enlightenment, David Hume, was a nonbeliever. Smith did in

fact share many values with Hume. Neither of them was a churchgoer

or traditional believer in the Christian faith. Both Scottish philosophers

opposed the Greco-Christian doctrine of antimaterialism and

anticommercialism, and the Christian philosophy that carnal desires

are inherently evil. Smith, like Hume, believed that a moral, prosperous

society was possible in this life, and not just in the life to come,

and that this civil society should be based on science and reason,

not religious superstition and authoritarianism. Both advocated free

trade, opposed the mercantilist system of government subsidies and

regulations, and warned of the dangers of big government (Fitzgibbons

1995, 14–18).

Yet Smith explicitly opposed important aspects of Hume’s philosophy,

especially his hostility toward organized religion. Hume favored a

noncompetitive state religion because it would sap the zeal of religious

followers and maintain political order. Smith, on the other hand, opposed

a state religion, which he thought would encourage intolerance

and fanaticism. He thought religion was beneficial if religious beliefs

and organizations were free and open. “In little religious sects, the

morals of common people have been almost remarkably regular and

orderly: generally much more so than in the established church” (1965

[1776], 747–48). He favored “a great multitude of religious sects”

and a competitive atmosphere that would reduce zeal and fanaticism

and promote tolerance, moderation, and rational religion (744–45).9

Smith himself secretly made many charitable contributions in his

lifetime, and once helped a blind young man to prepare for an intellectual

career (Fitzgibbons 1995, 138).

Smith rejected Hume’s amoral philosophy and both his nihilistic

attitude toward informed judgment and his extreme skepticism toward

traditional virtue, as found in A Treatise on Human Nature. Unlike

Hume, Smith was a believer in a final reconciler. His faith was more

in keeping with the Deist belief in a Stoic God and Stoic nature than

in a personal Christian God of revelation, or rewards and punishments

in a future life. His Theory of Moral Sentiments endured six editions

during his lifetime, and the final one, written after The Wealth of Nations,

makes frequent references to God. As Robert Heilbroner states,

the theme of “the Invisible Hand . . . runs through all of the Moral

Sentiments. . . . The Invisible Hand refers to the means by which ‘the

Author of nature’ has assured that humankind will achieve His purposes

despite the frailty of its reasoning powers” (Heilbroner 1986, 60).

Smith followed Hume in rejecting creeds and institutionalized

churches, but there is little doubt that Adam Smith did believe in a

Creator. As A.L. Macfie concludes, “the whole tone of his work will convince

most that he was an essentially pious man” (Macfie 1967, 111).

Adam Smith’s overwhelming theme throughout his works was to

provide a liberal democratic society, a “system of natural liberty,”

where freedom is maximized economically, politically, and religiously,

within a workable moral foundation of laws, customs, and values.

Faith in an Invisible God

Historian Athol Fitzgibbons has aptly called this new economic blueprint

“Adam Smith’s System of Liberty, Wealth, and Virtue” (1995).

If this “new account of Smith” is true, the invisible hand metaphor is

an entirely appropriate way to describe his system of natural liberty,

since establishing a virtuous society requires a systematic understanding

of right and wrong.

As indicated earlier, the invisible hand is another name Smith used

to describe God. As Salim Rashid states, “perhaps the ‘Invisible Hand’

can be thought of as the directing hand of the Deity” (Rashid 1998,

219). Though not a traditional Christian, Smith was familiar with the

Bible and Christian beliefs. In the Bible, providence is sometimes

called the “Invisible God.” St. Paul wrote to Timothy, “Now unto

the King eternal, immortal, invisible, the only wise God, be honour

and glory for ever. Amen” (1 Timothy 1:17; see also Colossians

1:15–16).

It is curious how frequently modern-day economists have invoked

religious terminology in describing the invisible hand. In his famous

essay, “I, Pencil,” Leonard Read (a devotee of the Austrian school)

characterizes the invisible hand’s work in the creation of the pencil

as a “mystery” and a “miracle” (Read 1999 [1958], 10–11). Milton

Friedman uses similar language (Friedman and Friedman 1980, 3,

11–13). Frank Hahn notes that the invisible hand concept assumes

“a lively sense of original sin [inherent in] a society of greedy and

self-seeking people” (Hahn 1982, 1, 5). James Tobin talks of “true

believers in the invisible hand” (Tobin 1992, 119). And this religious

symbolism brings us to the four degrees of faith and how to apply it

to the warring schools of economics.

Varying Degrees of Faith in Capitalism

The Bible discusses a hierarchy of individual faith in God and his

works, differentiating among those who have no faith, little faith,

great faith, and complete faith in the existence of a higher being. God

is “invisible.” Consequently, people differ widely in their religious

beliefs. In today’s world, a few true believers have absolute faith in

God, that he lives and works miracles in their lives, and never doubt.

Others have great faith in miraculous powers, though they may occasionally

doubt. At the same time there are many who have little faith

in God; they occasionally see his “invisible” handiwork, but seldom

attend church. Finally, there are agnostics and atheists, who have no

faith in God, who reject the idea of revelation or the supernatural, and

who rely solely on the five senses, the natural world, and reason.

Just as people have varying levels of faith in an “invisible God,”

so people have differing degrees of belief in the beneficial “invisible

hand” of capitalism and freedom. By faith, I mean a certain degree of

confidence that, left to their own devices, individuals acting in their

own self-interest will generate a positive outcome. Faith represents

a level of predictability of the future: Will an unfettered economy

recover on its own from a recession? Will eliminating tariffs between

two countries increase trade and jobs between them? Will decontrolling

oil prices eliminate the energy crisis? Will technological unemployment

in one industry lead to new employment in another? Will a

competitive environment eventually break down monopolistic power

ADAM SMITH DECLARES A REVOLUTION 27

in a particular market? Individuals have differing levels of confidence

in the marketplace to respond positively to change or crisis. Some have

full faith that all will work out for the better. Others have great faith

that in most cases private actions will benefit society. Still others have

little faith in the free market and worry that, most of the time, private

enterprise does what is best for individual people but not for society.

Finally, there are a few who deny that any good thing can come from

the dog-eat-dog chaotic world of Mammon, that the multinational

corporate world is so corrupt and crisis-prone that nothing can improve

the matter save major institutional reform or outright revolution.

In chapter 9 of my book Vienna and Chicago, Friends or Foes?

I identify four schools of economics that fit these varying levels of

belief in capitalism and free markets: the hard-core Marxists have no

faith that the capitalist system can solve social problems; the Keynesians

have doubts about the invisible hand; the Chicago economists

have great faith that capitalism works; and the Austrians have perfect,

sometimes even blind, faith in capitalism (Skousen 2005, 261–67).

Does Adam Smith Condone Egotism and Greed?

Critics worry that the Scottish blueprint for freedom would also give

license to avarice and fraud, even “social strife, ecological damage,

and the abuse of power” (Lux 1990). Is not The Wealth of Nations

an unabashed endorsement of selfish greed and vanity? How could

Adam Smith ignore everyday cases of rapacious capitalists deceiving,

defrauding, and taking advantage of customers, thus pursuing their

own self-interest at the expense of the public?

Contrary to popular belief, Smith did not condone greed, egotism, and

Western-style decadence, nor did he want economic efficiency to replace

morality. Self-interest does not mean ignoring the needs of others; in fact,

it means just the opposite: his system assures that both buyer and seller

benefit from every voluntary transaction. Most readers have misjudged

Smith’s famous quote, “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.” Here is the context of this statement:

But 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 shew

them that it is for their own advantage to do for him what he requires of

them. . . . Give me that which I want, and you shall have this which you

want, is the meaning of every such offer. 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. (Smith 1965 [1776], 14)

What Adam Smith is saying is that you can only help yourself by

helping others—the Golden Rule. Businesses that focus on fulfilling

the needs and desires of their customers will be the most profitable.

Although capitalists are motivated by the desire for personal gain,

the way that they maximize their profits is by focusing their everyday

attention on meeting the needs of the public. Thus, the successful

capitalist inevitably orients his everyday conduct toward the task of

helping and serving others. Self-interest leads to empathy.

Smith favored self-restraint. Indeed, he firmly asserted that a free

commercial society functioning within the legal restraints he outlined

would moderate the passions and prevent a descent into a Hobbesian

jungle, a theme he inherits from Montesquieu (see pages 40–41) and

later Senior Nassau.10 He taught that commerce encourages people

to become educated, industrious, and self-disciplined, and to defer

gratification. It is the fear of losing customers “which restrains his [the

seller’s] frauds and corrects his negligence” (1965 [1776], 129).

All legitimate exchanges must benefit both the buyer and the seller,

not one at the expense of the other. Smith’s invisible hand only works if

businessmen have an enlightened long-term view of competition, where

they recognize the value of reputation and repeat business. In short,

self-interest promotes the interests of society only when the producer

responds to the needs of the customer. When the customer is defrauded

or deceived, an event that occurs all too frequently in the marketplace,

self-interest succeeds at the expense of society’s welfare.

Smith recognized that people are motivated by self-interest. It is

natural to look out for one’s self and one’s family above all interests,

and to reject this would be to deny human nature. Yet at the same

time, Smith did not condone greed or selfishness. For Adam Smith,

greed and selfishness are vices. He would be uncomfortable with Ayn

Rand’s calling selfishness a virtue, or Walter Williams’s labeling greed

a good thing (Rand 1964). However, Smith accepted these as human

frailties, and he contended that these base motives cannot be outlawed

or prohibited, only that they might be discouraged and moderated in

a commercial society with the right incentives. As Dinesh D’Souza

interprets Smith, “Capitalism civilizes greed in much the same way

that marriage civilizes lust. Greed, like lust, is part of our human

nature; it would be futile to try to root it out. What capitalism does

is to channel greed in such a way that it works to meet the wants and

needs of society” (D’Souza 2005).

In fact, Smith’s ideal society would be infused with virtue, mutual

benevolence, and civic laws prohibiting unjust and fraudulent business

practices. Smith’s “impartial spectator” reflects the moral standards

and judgment of the community (Smith 1982 [1759], 215 passim).

His economic man is cooperative and fair without harming others.

A good moral climate and legal system would benefit economic

growth. Smith supported social institutions—the market, religious

communities, and the law—to foster self-control, self-discipline, and

benevolence (Muller 1993:2). After all, Adam Smith was not just an

economist, but a professor of moral philosophy.

Das Adam Smith Problem: Sympathy Versus Self-Interest

In his 1759 work, The Theory of Moral Sentiments, Adam Smith wrote

that “sympathy” was the driving force behind a benevolent, prosperous

society. In The Wealth of Nations, “self-interest” became the primary

motive. German philosophers called this apparent contradiction Das

Adam Smith Problem, but Smith himself saw no conflict between the

two. He took an historical perspective. In a precapitalist community

described in The Theory of Moral Sentiments, benevolence, or love,

was probably the most dominant factor within the family or in relations

with colleagues and friends in a village where everyone knew

each other. However, in the capitalist industrial world, cities such as

London and Paris attract thousands of strangers and the motivation

changes from sympathy to self-interest in economic activity, for “it is

in vain to expect it from their benevolence only” (1965 [1776], 14).

Smith combined both motives in The Wealth of Nations, where

sympathy and self-interest were the driving motivators in a modern

capitalist society. Smith believed that every man had a basic desire to

be accepted by others. To obtain this sympathy, people would act in

a manner that would gain respect and admiration. In economic life,

this meant enlightened self-interest, wherein both seller and buyer

mutually benefit in their transactions. Moreover, Smith contended

that economic progress and surplus wealth were a prerequisite for

sympathy and charity. In short, Smith desired to integrate economics

and moral behavior (Fitzgibbons 1995, 3–4; Tvede 1997, 29).

The Scottish philosopher believed man to be motivated by both

self-interest and benevolence, but in a complex market economy,

where individuals move away from their closest friends and family,

self-interest becomes a more powerful force. In Ronald Coase’s

interpretation, “The great advantage of the market is that it is able to

use the strength of self-interest to offset the weakness and partiality

of benevolence, so that those who are unknown, unattractive, and

unimportant will have their wants served” (Coase 1976, 544).

How Monopoly Hurts the Market System

Smith said that competition was absolutely essential to turning selfinterest

into benevolence in a self-regulating society. He preferred the

cheaper “natural price, or the price of free competition” to the high

price of monopoly power and “exclusive privileges” granted certain

corporations and trading companies (such as the East India Company).

Smith vehemently opposed the “mean rapacity” and “wretched spirit

of monopoly” (428) to which privileged businessmen were accustomed.

Competition means lower prices and more money to buy other

goods, which in turn means more jobs and a higher standard of living.

According to Smith, monopoly power creates a political society,

characterized by flattery, fawning, and deceit (Muller 1993, 135).

Monopoly fosters quick and easy profits and wasteful consumption

(Smith 1965 [1776], 578).

While believing in the marketplace, Smith was no apologist for

merchants and special interests. In one of his more famous passages,

he complained, “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”

(128). His goal was to convince legislators to resist supporting the

vested interests of merchants and instead to act in favor of the common

good.

Adam Smith Updated

Adam Smith’s model offers two hypotheses: first, that his system of

natural liberty would lead to a higher standard of living; and second,

that the effects of economic liberalism would benefit rich and poor

alike. Since Smith wrote his book, have economists confirmed or

denied these propositions? Let us examine each hypothesis.

Update 1: Free Economies Are Richer

First, has economic freedom led to higher living standards? If Adam

Smith were alive today, he would undoubtedly credit a free and

democratic capitalism with the widespread increase in the standard

of living. An exhaustive study by James Gwartney, Robert A. Lawson,

and Walter Block released in 1996 and updated subsequently

each year by Gwartney and Lawson (see 2004) appears to confirm

this Smithian view that economic freedom and prosperity are closely

related. The authors painstakingly constructed an index measuring

the level of economic freedom for more than 100 countries, based on

five criteria (size of government, property rights and legal structure,

sound money, trade, and regulations). Then they compared the each

country’s level of economic freedom with its growth rate, based on

per capita income in purchasing power terms. Their conclusion is

documented in the remarkable graph in Figure 1.2.

According to this study, the greater the degree of freedom, the

higher the standard of living, as measured by per capita real gross

domestic product (GDP) in purchasing power terms. Nations with the

highest level of freedom (e.g., the United States, New Zealand, Hong

Kong) grew faster than nations with moderate degrees of freedom

(e.g., the United Kingdom, Canada, Germany) and substantially more

rapidly than nations with little economic freedom (e.g., Venezuela,

Iran, Congo). The authors conclude, “Countries with more economic

freedom attract more investment and achieve greater productivity from

their resources. As a result, they grow more rapidly and achieve higher

income levels” (Gwartney and Lawson 2004, 38).

What about those countries that change policies? Gwartney and

Lawson state, “Countries stagnate when their institutions stifle

trade and erode the incentives to engage in productive activities. . . .

Countries with low initial levels of income, in particular, are able to

grow rapidly and move up the income ladder when their policies are

supportive of economic freedom” (2004, 38).

Update 2: The Poor Benefit from Capitalism

Second, Adam Smith argued that both rich and poor benefit from a

liberal economic system. He declared, “universal opulence . . . extends

itself to the lowest ranks of the people” (Smith 1965 [1776], 11). The

modern-day statistical work of Stanley Lebergott and Michael Cox

confirms this Smithian view and disputes the commonly held criticism

that under a free market the rich get richer and the poor get poorer.

The poor also get rich, according to recent studies by Lebergott (1976)

and Cox and Alm (1999).

Stanley Lebergott, professor emeritus at Wesleyan University,

has studied individual consumer markets in food, clothing, housing,

fuel, housework, transportation, health, recreation, and religion. For

example, he developed the statistics shown in Table 1.1 to show improvements

in living standards from 1900 to 1970.

As Lebergott’s table shows, the standard of living has risen substantially

for all classes, including the lowest, in the twentieth century. He

confirms the statement once made by Andrew Carnegie: “Capitalism

is about turning luxuries into necessities.” Through the competitive efforts

of entrepreneurs, workers, and capitalists, virtually all American

consumers have been able to change an uncertain and often cruel world

into a more pleasant and convenient place to live and work. A typical

homestead in 1900 had no central heating, electricity, refrigeration,

flush toilets, or even running water. Today even a large majority of

poor Americans benefit from these goods and services.

Another recent study by Michael Cox, an economist at the Federal

Reserve Bank of Dallas, and Richard Alm, a business writer for the

Dallas Morning News, concludes that the real prices of housing, food,

gasoline, electricity, telephone service, home appliances, clothing,

and other everyday necessities have fallen significantly during the

twentieth century. The researchers also demonstrate that the poor in

America have seen gradual improvements in their economic lives as

well. More poor people own homes, automobiles, and other consumer

products than ever before, and televisions are found in even the poorest

households (Cox and Alm 1999).

Finally, Gwartney and Lawson have done studies showing that the

poorest 10 percent of the world’s population earn more income when

the countries in which they live adopt institutions favoring economic

freedom (2004, 23). Economic freedom also reduces infant mortality,

the incidence of child labor, black markets, and corruption by public

officials, while increasing adult literacy, life expectancy, and civil

liberties (2004, 22–26).

Smith Favors a Strong But Limited Government

As a proponent of the Scottish Enlightenment and the virtues of natural

liberty, Adam Smith was a firm believer in a parsimonious but strong

government. He wrote of three purposes of government: “Little else

is required to carry a state to the highest degree of opulence from the

lowest barbarism, but peace, easy taxes, and a tolerable administration

of justice” (in Danhert 1974, 218). More specifically, Smith endorsed

(1) the need for a well-financed militia for national defense; (2) a

legal system to protect liberty and property rights, and to enforce

contracts and payment of debts; (3) public works—roads, canals,

bridges, harbors, and other infrastructure projects; and (4) universal

public education to counter the alienating and mentally degrading

effects of specialization (division of labor) under capitalism (Smith

1965 [1776], 734–35).

In general, the Scottish professor favored a maximum degree of

personal liberty in society, including a diversity of entertainment—as

long as it was “without scandal or indecency” (748). Smith was no

pure libertarian.

Smith Warns About the Dangers of Big Government

At the same time, he was a sharp critic of state power. Politicians are

usually spendthrift hypocrites, according to Smith. Some of the folADAM

lowing quotes from The Wealth of Nations could be used in political

debates today:

There is no art which one government sooner learns of another, than that

of draining money from the pockets of the people. (813)

It is the highest impertinence and presumption, therefore, in kings and

ministers, to pretend to watch over the economy of private people, and

to restrain their expense, either by sumptuary laws, or by prohibiting the

importation of foreign luxuries. They are themselves always, and without

exception, the greatest spendthrifts in the society. Let them look well after

their own expense, and they may safely trust private people with theirs.

If their own extravagance does not ruin the state, that of their subjects

never will. (329)

Great nations are never impoverished by private, though they sometimes

are by public prodigality and misconduct. The whole, or almost the whole

public revenue, is in most countries employed in maintaining unproductive

hands. Such are the people who compose a numerous and splendid court,

a great ecclesiastical establishment, great fleets and armies, who in time

of peace produce nothing, and in time of war acquire nothing which can

compensate the expense of maintaining them, even while the war lasts.

Such people, as they themselves produce nothing, are all maintained by

the produce of other men’s labour. (325)

Smith pleaded for balanced budgets and opposed a large public

debt. He advocated privatization, the sale of crown lands as a

way to raise revenues and cultivate property. He favored minimal

government interference in citizens’ personal lives and economic

activity. Smith argued that war is unnecessary and ill advised in

most cases, and that ending a war will not result in massive unemployment

(436–37).

He sounded as if he had just been audited by revenue agents when

he expressed sympathy for taxpayers “continually exposed to the

mortifying and vexatious visits of the tax-collectors” (880). After

lambasting the complexity and inequality of the tax system, he prescribed

tax cuts across the board, although he favored rigid usury laws

and progressive taxation.

Perhaps the following statement by Smith, taken from The

Theory of Moral Sentiments, most eloquently expresses the universal

principles of individualism and liberty, and the dangers of

government:

The man of system . . . seems to imagine that he can arrange the different

members of a great society with as much ease as the hand arranges

the different pieces upon a chess-board. He does not consider

that the pieces upon the chess-board have no other principle of motion

besides that which the hand impresses upon them; but that, in the great

chess-board of human society, every single piece has a principle of

motion of its own, altogether different from that which the legislature

might choose to impress upon it. If those two principles coincide and

act in the same direction, the game of human society will go on easily

and harmoniously, and is very likely to be happy and successful. If

they are opposite or different, the game will go on miserably, and the

society must be at all times in the highest degree of disorder. (Smith

1982 [1759], 233–34)

Smith Endorses Sound Money and the Gold Standard

Smith also worried about governments’ manipulation of the monetary

system. While rejecting the idea that gold and silver alone constitute

a country’s wealth, he favored a stable monetary system based on

precious metals, and supported the doctrine of free banking. He also

rejected the prevalent “quantity theory of money,” which holds that

the price level rises or falls in proportion to changes in the money

supply. In his “Digression on Silver,” Smith showed that prices have

varied considerably when the supply of silver (money) increased

(1965 [1776], 240).

The Essence of the Classical Model of Economics

In sum, the classical model developed by Adam Smith and endorsed

by his disciples in generations to come consisted of four general

principles:

1. Thrift, hard work, enlightened self-interest, and benevolence

toward fellow citizens are virtues and should be

encouraged.

2. Government should limit its activities to administer justice,

enforce private property rights, engage in certain public works,

and defend the nation against aggression.

3. The state should adopt a general policy of laissez-faire noninterventionism

in economic affairs (free trade, low taxes,

minimal bureaucracy, etc.).

4. The classical gold/silver standard restrains the state from

depreciating the currency and provides a stable monetary

environment in which the economy may flourish.

As we shall see, the classical model of Adam Smith would repeatedly

come under attack over the centuries by friends and foes alike.

Adam Smith and the Age of Economists

Adam Smith was not perfect by any means. He led disciples David

Ricardo and Thomas Malthus down the wrong road with his crude

labor theory of value, his critique of landlords, his strange distinction

between “productive” and “unproductive” labor, and his failure

to recognize the fundamental principle of subjective marginal utility

in price theory. But these are parenthetical deviations that were

unfortunately magnified by the classical economists and distort his

overwhelming positive contribution to economic science.

Adam Smith is to be congratulated for his fierce defense of free

trade and free markets, his central theme of “natural liberty,” and a

self-regulating system of competitive free enterprise and limited government.

His eloquent expression of economic liberty helped free the

world from provincial mercantilism and heavy-handed intervention

by the state. Without his leadership, the Industrial Revolution might

have stalled for another century or more.

The Great Optimist

Adam Smith, a child of the Scottish Enlightenment, was above

all an optimist about the future of the world. His principal focus

throughout his economic magnum opus was the “improvement”

of the individual through “frugality and good conduct,” saving

and investing, exchange and the division of labor, education and

capital formation, and new technology. He was more interested in

increasing wealth than dividing it (in sharp contrast to his disciple

David Ricardo). According to Adam Smith, even a powerful, sinister

government cannot stop progress:

“The uniform, constant, and uninterrupted effort of every man to

better his condition . . . is frequently powerful enough to maintain the

natural progress of things toward improvement, in spite both of the

extravagance of government, and of the greatest errors of administration”

(1965 [1776], 326; cf. 508).

Adam Smith Makes a Famous Remark

During the American Revolution, Adam Smith was approached by a

citizen who was alarmed by the defeat of the British at Saratoga in

1777. “The nation must be ruined,” the man exclaimed with panic

in his voice. Smith, then in his fifties, replied calmly, “Be assured,

my young friend, that there is a great deal of ruin in a nation”

(Rae 1895, 343; Ross 1995, 327). Smith’s dictum is frequently

cited by Milton Friedman, Gary Becker, and other economists in

response to economic doomsayers. It suggests that a nation has

built up such tremendous wealth, institutions, and goodwill over

the centuries that it would take more than a major war or natural

disaster to destroy it.

His life complete, Adam Smith may well have entertained the words

of the psalmist, “Return unto thy rest, O my soul: for the Lord hath

dealt bountifully with thee” (Psalm 116:7).

Appendix: The Pre-Adamites

Adam Smith did not create modern economics out of a vacuum,

the way Athena sprang full grown and fully armed from the brow

of Zeus. Instead, Smith was influenced by a wide number of

economic thinkers, going all the way back to the ancient Greek

philosophers.

Plato and Aristotle

A child of the Scottish Enlightenment, Smith would find little

appeal in reading Plato’s Republic, which advocated an ideal

city-state ruled by collectivist philosopher-kings. He considered

Aristotle better, because of his defense of private property and

his critique of Plato’s communism. Private property, according to

Aristotle, would give people the opportunity to practice the virtues

of benevolence and philanthropy, all part of the Aristotelian

“golden mean” and “good life.” But Adam Smith would have no

part of Aristotle’s scorn of moneymaking and his denunciation of

monetary trade and retail commerce as immoral and “unnatural,”

a philosophy that was later sanctioned by many Christian writers

in the Middle Ages.

Protestants, Catholics, and the Spanish Scholastics

Adam Smith was greatly influenced by Calvinist doctrines favoring

thrift and hard work while condemning excessive luxury, usury, and

“unproductive” service labor. Catholics and Protestants alike debated

what constituted “just price” in a market economy. The Spanish

scholastics in the sixteenth century determined that the “just price”

was nothing more than the common market price, and they generally

supported a laissez-faire philosophy (Rothbard 1995a, 97–133). As

Montesquieu later wrote, “It is competition that puts a just price on

goods and establishes the true relations between them” (Montesquieu

1989 [1748], 344).

In many ways, Adam Smith aimed to replace the antimaterialist

Greco-Christian doctrines of Western Europe, which were a hindrance

to liberty and economic growth, with a system that combined moral

living and the reasonable pursuit of material desires (Fitzgibbons

1995, v, 16).

Bernard Mandeville and The Fable of the Bees

Some economists contend that Adam Smith developed his “invisible

hand” concept from the scandalous work The Fable of the

Bees (1997 [1714]), by Bernard Mandeville (1670–1733), a Dutch

psychiatrist and pamphleteer. In the first version, Mandeville

told the story of a thriving “grumbling hive” of bees that turned

“honest” and was swiftly reduced to poverty and destruction after

converting to a moral community. In the second popular edition,

Mandeville described a prosperous community in which all the

citizens decided to abandon their luxurious spending habits and

military armaments. The result was a depression and collapse in

trade and housing. His conclusion: private vices of greed, avarice,

and luxury lead to public benefits of abundant wealth, and “the

Moment Evil ceases, the Society must be spoiled, if not totally

dissolved.” Clearly, under Mandeville’s infamous paradox, selfinterest

results in social benefit.

Both Friedrich Hayek and John Maynard Keynes have written approvingly

of Mandeville’s fable. According to Hayek, Adam Smith

gained insights into the division of labor, self-interest, economic

liberty, and the idea of unintended consequences from Mandeville

(Hayek 1984, 184–85). Keynes approved of Mandeville’s antisaving

sentiments and statist pressures to assure full employment in society

(Keynes 1973a [1936], 358–61).

However, it is clear in The Theory of Moral Sentiments that Smith

did not approve of Mandeville. Calling his book “wholly pernicious”

and his thesis “erroneous,” Smith disagreed that economic progress is

achieved through greed, vanity, and unrestrained self-love, complaining

that Mandeville seems to make no distinction between vice and

virtue (Smith 1982 [1759], 308–10).

Montesquieu and Doux Commerce

Smith’s attitude toward self-interest was more positively affected by the

great French jurist and philosopher Charles de Secondat Montesquieu

(1689–1755). His book The Spirit of the Laws, first published in 1748,

encouraged James Madison and Alexander Hamilton to push for constitutional

separation of powers, a concept endorsed by Smith. Montesquieu,

who wrote before the Industrial Revolution, saw many virtues in doux

commerce (gentle commerce). He expressed the novel view that the pursuit

of profit making and commercial interests serve as a countervailing

bridle against the violent passions of war and abusive political power.

“Commerce cures destructive prejudices,” Montesquieu declared, “it

polishes and softens barbarous mores. . . . The natural effect of commerce

is to lead to peace” (1989, 338). According to Montesquieu, Sir James

Steuart, and other philosophes of the era, the image of the merchant and

moneymaker as a peaceful, dispassionate, innocent fellow was in sharp

contrast with “the looting armies and murderous pirates of the time”

 (Hirschman 1997, 63). Commerce improves the political order: “The

spirit of commerce brings with it the spirit of frugality, of economy, of

moderation, of work, of wisdom, of tranquility, of order, and of regularity”

(Hirschman 1997, 71).11 As pointed out in this chapter, Smith endorsed

this progressive view of commercial society.

In the French edition of The General Theory, John Maynard Keynes

rated Montesquieu as France’s greatest economist, primarily due to

his embryonic liquidity-preference theory of interest, his opposition

to hoarding, and his advocacy of a high level of money expenditure

to maintain and promote economic welfare. Yet, unlike Keynes, Montesquieu

was a passionate supporter of the doctrine of laissez-faire.

He detested authoritarian regimes and rejected all forms of central

planning, which, he said, robbed society of its natural dynamics. He

defended free trade as a civilizing, educating, and cooperative force

between nations. Like Adam Smith, he recognized that goods and

services rather than precious metals represented the real wealth of

a nation. He opposed excessive monetary inflation as ruinous, using

Spain as an example. Before the Physiocrats popularized the erroneous

doctrine that agriculture was the sole source of wealth, Montesquieu

taught that industry and commerce were equally significant as

fountains of prosperity. Entrepreneurship and frugality were essential

ingredients to economic growth. And, unlike Malthus, Montesquieu

regarded a large, growing population as desirable.

Dr. François Quesnay and His Tableau Économique

The most prominent Physiocrat encountered by Adam Smith in France

was the eminent surgeon and doctor François Quesnay (1694–1774),

who at one time was the personal physician of King Louis XV’s favorite

mistress. His famous diagram, the tableau économique, was

considered by contemporaries as one of the three greatest economics

inventions of mankind, after writing and money (Smith 1965 [1776],

643).

Quesnay’s zigzag diagram, first published in 1758, has created

considerable interest and controversy over the years. It has been

hailed as a forerunner of many developments in modern economics:

econometrics, Keynes’s multiplier, input–output analysis, the

circular flow diagram, and a Walrasian general equilibrium model.

It is certainly a “macro” view of the economy, without any reference

to prices, but no one is sure of its real meaning. As the principal

spokesman for the Physiocrats, Quesnay endorsed the false belief

in agriculture as the only “productive” expenditure and industry as

“sterile.”

As to Quesnay’s influence, The Wealth of Nations proclaimed Dr.

Quesnay a “very ingenious and profound author” who promoted the

popular slogan “Laissez faire, laissez passer,” a phrase Smith would

endorse wholeheartedly, although he himself never referred to his

system as laissez-faire economics. (He preferred “natural liberty” or

“perfect liberty.”) As a leading Physiocrat, Quesnay opposed French

mercantilism, protectionism, and state interventionist policies. However,

The Wealth of Nations denied the basic physiocratic premise that

agriculture, not manufacturing and commerce, was the source of all

wealth (1965 [1776], 637–52).

Richard Cantillon

The other prominent influences on the Scottish economist were Richard

Cantillon, Jacques Turgot, and Etienne Bonnot de Condillac. Richard

Cantillon (1680–1734) is regarded by Murray Rothbard and other

economic historians as the true “father of modern economics.”

An Irish merchant banker and adventurer who emigrated to Paris,

Cantillon became involved in John Law’s infamous Mississippi bubble

in 1717–20, but shrewdly sold all of his shares before the financial

storm hit. His independent status allowed him to write a short book on

economics, Essay on the Nature of Commerce in General (published

posthumously in 1755). He died mysteriously in London in 1734,

apparently murdered by an irate servant who subsequently burned

down his house to cover up the crime.

ADAM SMITH DECLARES A REVOLUTION 43

Cantillon’s Essay is really quite impressive and undoubtedly influenced

Adam Smith. It focuses on the automatic market mechanism of

supply and demand, the vital role of entrepreneurship (downplayed in

The Wealth of Nations), and a sophisticated “pre-Austrian” analysis of

monetary inflation—how inflation not only raises prices, but changes

the pattern of spending.

Jacques Turgot

Jacques Turgot (1727–81) was a leading French Physiocrat whose

profound work, Reflections on the Formation and Distribution of

Wealth (1766), also inspired Adam Smith. As a devoted free trader

and advocate of laissez-faire, Turgot was an able minister of finance

under Louis XVI; he dissolved all the medieval guilds, abolished all

restrictions on the grain trade, and maintained a balanced budget.

Turgot was so effective that he provoked the ire of the King, who

dismissed him in 1776.

As a Physiocrat, Turgot defended agriculture as the most productive

sector of the economy, but beyond that, his Reflections exhibited

a profound understanding of economics, even surpassing Smith in

many areas. His lucid work offers a brilliant understanding of time

preference, capital and interest rates, and the role of the capitalistentrepreneur

in a competitive economy. He even described the law of

diminishing returns, later popularized by Malthus and Ricardo.

Condillac

Another influential French economist and philosopher was Etienne

Bonnot de Condillac (1714–80). He lived the life of a Paris intellectual

in the mid-1770s and came to the defense of Turgot in the

difficulties he faced in 1775 as finance minister over the grain riots.

Like Turgot and Montesquieu, Condillac supported free trade. His

important work Commerce and Government was published in 1776,

only one month before The Wealth of Nations. Condillac’s economics

was amazingly advanced. He recognized that manufacturing was

productive, that exchange represented unequal values, that both sides

gain from commerce, and that prices are determined by utility value,

not labor value (Macleod 1896).

David Hume

The great philosopher David Hume (1711–76) was a close friend of Adam

Smith and was highly influential in his limited writings on trade and

money. Smith identified his Scottish friend as “by far the most illustrious

philosopher and historian” of his age (Fitzgibbons 1995, 9) and “nearly

to the idea of a perfectly wise and virtuous man, as perhaps the nature

of human frailty will permit” (Smith 1947, 248). Hume opposed ascetic

self-denial and endorsed luxury and the materialistic good life.

Like Smith, Hume condemned the mercantilist restraints on international

trade. Using his famous “specie-flow” mechanism, Hume

proved that attempts to restrict imports and increase specie (precious

metals) inflow would backfire. Import restrictions would raise domestic

prices, which in turn would reduce exports, increase imports, and

generate a return outflow of specie.

Hume also debunked mercantilist claims that acquiring more specie

would lower interest rates and promote prosperity. Hume made the

classical argument that real interest rates are determined by the supply

of saving and capital, not by the money supply. An adherent to

the quantity theory of money, Hume felt that an artificial expansion

of the money supply would simply raise prices.

Smith’s close friendship with Hume caused many observers to

conclude that he endorsed Hume’s antireligious rebellion and his

purely secular commercial society. They point to the fact that God is

not mentioned in The Wealth of Nations. However, as noted earlier,

Smith did not abandon his religious beliefs. His Theory of Moral

Sentiments, which he edited again after the publication of The Wealth

of Nations, makes numerous references to God and religion.

Smith was admittedly no longer a practicing Presbyterian, rebelling

against austere Calvinist behavior, but he was a believer, a Deist

who adopted the Stoic belief that God works through nature. As an

optimist, Smith believed in the goodness of the world and envisioned

a heaven on earth.

Benjamin Franklin

Biographers John Rae and Ian Simpson Ross give credence to the

story that the American founding father, Benjamin Franklin (1706–90),

developed a friendship with Adam Smith and had some influence on

his writing The Wealth of Nations. John Rae recounted how Franklin

visited with Smith in Scotland and London and, according to a friend

of Franklin, “Adam Smith when writing his Wealth of Nations was

in the habit of bringing chapter after chapter as he composed it to

himself [Franklin], Dr. Price, and others of the literati; then patiently

hear their observations and profit by their discussions and criticisms,

sometimes submitting to write whole chapters anew, and even to

reverse some of his propositions” (Rae 1895, 264–65; see also Ross

1995, 255–56).

In his economic writings, Franklin wrote about the advantages of

thrift, free trade, and a growing population, themes readily apparent

in The Wealth of Nations. (However, I’m not sure Smith would agree

with Franklin’s case, published in 1728, for advocating a large increase

of paper currency to stimulate trade in Pennsylvania.) Smith’s favorable

remarks toward American independence may have been due to

Franklin (Smith 1965 [1776], 557–606).