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Philosopher and Economist

Adam Smith has a prominent place in history as a philosopher and economist whose book the
Wealth of Nations had a profound effect on the economic thinking of his time and became one of
the most influential books ever written.

The early years

He was born in Kirkcaldy Scotland on the 16th June 1723, a few months after the death of his
father, also Adam Smith. The young Adam Smith was described as a delicate child in relation to
his health but this improved as he grew older. His early schooling was important to him and he
was fortunate that the secondary school he attended, the Burgh school of Kirkcaldy was one of
the best secondary schools in Scotland at that time. Smith went on to study at Glasgow
University and then Balliol College in Oxford England.

The Father of Economics

Adam Smith is seen as a pioneer in his thinking and writing. He challenged the accepted
economic principles of his day which were based on simple Mercantilism, and propounded his
theories based on free market capitalism. His work deeply influenced the political powers of the
day and provided the intellectual basis of the periods growth in trade and commercial expansion
throughout the world.

Adam Smith's Contributions to Economics

Before the industrial revolution, world market products were so wide-open for English
manufacturing goods that English merchants no longer needed domestic market demand to sell
their finished goods. Traditional markets all over the world were considered as non-capitalist
markets, and most profit seeking English merchants strived to eliminate these non-capitalist
markets' structures. Traditional markets in most countries could not compete with the English.
The English had huge manufacturing advantages in comparison to non-capitalist countries,
especially in the area of technological innovation. Most of England's superiorities were founded
in textile and iron industries. This growing industrial prowess and capture of new markets
quickly led to new sources of profits and increased potentials for capital accumulation. After the
invention of steam engines, whole English lands were dedicated to the production of
manufacturing products. Soon, factories were built closer to markets located in the cities rather
than near rivers that were easily accessible to transportation or near mines for easy access to raw
materials. Furthermore, upon discovering that specialization and division of labor stimulate
productivity, manufacturers increasingly encouraged mechanizations and assembly line
production in their factories. As a result, manufacturing productivity also continued to increase.
Highly impressed with these developments during his day, especially with the effects on
productivity by specialization and division of labor, Adam Smith based most of his theories of
and thoughts of economics on his understandings of this beginning of industrial revolution in
England. Adam Smith was a Scottish professor who, after spending a few years in France and
interacting with both Quesnay and Turgot, published the renowned book An Inquiry into the

Nature and Causes of the Wealth of Nations (1776). Within these writings, Smith was the
first to complete a relatively consistent and abstract model of the nature, structure, and workings
of the capitalist system.
Adam Smith wrote during a time of industrial revolution, increasing economies of scale
(especially with the textile industry), invention of the steam engine in 1769, massive city growth
and urban concentration, and the establishment of centers of production from which the capitalist
owned everything including hired labor.
Smith was very impressed by the increases of productivity that could be gained from division of
labor and was the first to formally distinguish between profits originating from merchant capital
(in exchange) versus industrial capital (from production). During his time, new technologies
were being applied to the manufacture of several industries including textiles, agriculture,
transportation, and steel. Smith illustrated the advantages of specialization and division of labor
by using a pin manufacturing example. For example, Smith observed that using the right tools,
one person living in the 1770s could make 20 pins per day. However, if that particular pin
making operation could be broken up into a number of individually small operations in which
workers specialize (i.e. one to cut the wire, a second to straighten it, a third to put a point on it, a
fourth to grind it, a fifth worker to put finishing touches on it, etc.), then ten people could
significantly increase their output by making up to 48,000 pins per day. Even better yet, if a large
specialized labor market was available, an entire factory could produce and sell millions of pins
per day.
Contrary to popular understanding Adam Smith was not necessarily a champion of capitalism. In
fact, he felt very bad for capitalism's adverse effects, especially the pervasive and systematic
social and individual degradation that was occurring during his time. Interestingly, Smith also
provided the ideological starting material for opposing views of both contemporary neoclassical
(mainstream capitalism) and Marxian or socialist economic thought. Based, on this perspective,
Smith has not only been considered by many of today's economic scholars as the father of
modern capitalism but also of the father of radical economics - including socialism and
communism.
Smith's general support and basic economic thought regarding open foreign trade laid the
foundation for trade theory. For Smith, balanced foreign trade was highly beneficial because it
overcame the narrowness of the home market and thus provided a vent for surplus. He believed
that a general policy of free trade was also good for long-run productive potentialities because
exposure to an increased market size could lead to opportunities for more specialization and
division of labor. Foreign trade was also good because it allowed a country to "increase their
enjoyments" as more variety and choices of products would become available and at prices that
were possibly lower than they were before.
From his writings, Smith also recommended' that a country manufacture and trade products from
which they have a natural or acquired absolute advantage. He further recognized the important
"educative effect" that an open economy could realize due to "mutual communications of
knowledge of all sorts of improvements."

Smith identified four stages of economic and social development that were applicable, at least
until his time period: hunting, pasturage, agriculture, and commerce.
Interestingly, Smith mentioned that it was the growth of the cities that transformed rural
agriculture to one of a capitalist-mass producing type agriculture operation. The commercial
stage of capitalism created markets where landlords could sell their goods and in return could
buy manufactured goods produced in cities. The desire for manufactured goods also had the
effect to encourage the enclosure movement (as discussed in the first chapter) because inefficient
medieval agricultural methods and unnecessary costs, such as payments to tenants and serfs, did
not create enough agricultural products to purchase the desired manufactured 'goods. Therefore,
selfish motives encouraged landlords to abolish serfdom and enjoy the new found freedoms and
rewards associated with of capitalism type-wealth producing property ownership. In this manner,
efficient and mass manufactured production in cities helped establish an improved economic
base in rural areas. As rural areas adopted more capitalist and efficient methods in production,
the expansion of the cities inevitably became just a matter of time.
From Wealth of Nations we find that Smith specifically felt that each individual or player in a
competitive market was "led by an invisible hand to promote an end which was no part of his
intention." Interestingly enough, even though Smith's ideas of this "invisible hand" concept are
so widely renowned and highly regarded today, they are only discussed in seven pages out of his
greater than 1000 page book.
In the study of economic thought, there has always been a dispute regarding the source of
"value" particularly whether value is created, on the one hand, in the realm of exchange as
determined by individual utility or satisfaction, or on the other hand, in the sphere of production
based on labor time. Smiths' theory of value formed the first frameworks of this theory. His
theory was based on recognition that the process of production can be reduced to a series of
human exertions. In other words, that all items going into a commodity, including capital (raw
materials and tools) are products of labor either directly, indirectly, or from past labor. This view
suggests that the amounts of both direct labor (labor that uses the means of production) and
indirect labor (labor embodied in the means of production) along with past labor embodied in
raw material, tools, and equipment determines the exchange value of the commodity. Overall,
Smith's principal concern was to ascertain what social and economic forces were most conducive
to increasing human welfare. He said welfare depended on the annual "production of labor" and
the "the number of those who are to consume it." In other words, greater supply should meet
greater demand or vice versa.
According to Smith's analysis, economic development was expected first in agriculture, then in
manufacturing, and third in foreign trade. Again, a commercial society was both a requirement
and necessity to develop urban-rural specialization. After the development of the agricultural
sector in laissez-faire (i.e. a condition of perfect competitiveness) capitalism, capital would then
flow into the manufacturing sector and enable it to develop as well.
Although Smith contributed many founding principles for Marxism and socialist thought, he felt
that capitalism would reach its greatest height when government would adopt a "laissez-faire"
policy, or as Smith called it, "the obvious and simple system of natural liberty" . Laissez-faire

policy encourages free interplay of supply and demand to regulate economies and allows all
economic behavior to be characterized by selfish and acquisitive motives.
While his thoughts on how to fund government are relegated to just one book of his five-part
tome, from the Wealth of Nations, many of his ideas have found their way deep into the genome
of modern public finance theory. In particular, the maxims of taxation laid out by Adam Smith
are the precursors to the same principles argued by todays tax experts across the political
spectrum.
The first of the four maxims, which deals with the distribution of tax burdens, is given the most
space for its particular relevance in the current public debate on tax policy. Smith argues that
taxes should be levied in proportion to the revenue enjoyed under the protection of the state, an
idea that has been coined the ability-to-pay principle or the benefit principle in modern
discourse.
The second maxim is that taxes should be stable and transparent. Current federal tax policy
deviates significantly from this maxim, as temporary provisions are constantly expiring or being
reenacted, often with short notice, and sometimes retroactively.
The third maxim is that taxes should be levied when convenient. Two policies stand out as being
good observances of this maxim: 1) the three and half months given between the end of the tax
year and the April 15 federal income tax filing deadline, and 2) the federal net operating loss
deduction system, which allows companies to carry forward losses for 20 years and back for two
years.
Finally, the fourth and final maxim is that taxes should be levied with the lowest possible waste,
or what modern economists would call deadweight loss. Smith has a very expansive definition of
waste, including not just costs of administration, but costs to the taxpayer of emotionally or
economically draining auditing processes, or costs in the form of foregone growth because
entrepreneurs choose not to enter a heavily-taxed enterprise.
In the end of his analysis, Smith concluded that it was best promote a laissez-faire policy for
improving economic welfare because as productivity increased, made possible through
expanding markets and resulting opportunities for specialization and division of labor, everyone
would be better off. He was also led to this laissez-faire conclusion based on the assertion that
economic progress came from the accumulation of capital and that a "natural" flow of capital
could contribute to overall economic welfare. Furthermore, free, competitive markets and
harmonizing forces of the "invisible hand" would help capital be directed or employed in a
productive manner. From this perspective, Smith believed that government interventions,
including unnecessary regulations, monopolies, subsidies, et cetera, would therefore tend to
misdirect these capital flows and diminish economic welfare. Hence, the role of government, in
his view, should be restricted to provide for national defense and security, the enforcement of
contracts or administering justice, and to provide a certain amount of infrastructure and public
works/services.

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