ADAM SMITH: THE WEALTH OF NATIONS

Copyright © 1996 R.J. Kilcullen

See also

Lecture: Adam Smith on Moral Sentiments
Reading Guide: Adam Smith, Theory of the Moral Sentiments
Reading guide to Adam Smith, The Wealth of Nations

Today's lecture is about Adam Smith's statement of it. The full title of Adam Smith's most famous book is: An Inquiry into the Nature and Causes of the Wealth of Nations. On the nature of the wealth of a nation there isn't much. It is the fund which supplies 'the necessaries and conveniencies of life' ('Introduction and Plan of the Work', in Cannan's edition p. 1). What is necessary? What is convenient? He assumes we know. 'Wealth' is derived from 'weal', well-being in a general sense. The well-being, in the general sense, of a nation is obviously not simply a fund of necessaries and conveniencies. In Adam Smith 'wealth' already has a narrower sense. It seems also that wealth consists in things consumed privately by individuals or families. In ancient Athens a theatre would have been among the 'necessaries and conveniencies of life'; this is something all citizens used together for a shared activity. Aristotle says that a sort of friendship exists among fellow-citizens, and that friendship requires the sharing of life. Adam Smith's nation seems to be more a collection of individuals who take their 'necessaries and conveniencies' home and consume them privately.

Some later writers - e.g. Jeremy Bentham - explain wealth as 'the means of happiness'. Adam Smith did not think that individuals are much happier for being wealthier. People perhaps imagine that goods will make them happier and seek them for that reason, but they are deluded. And the delusion is a good thing, Adam Smith thinks, because without it people would not work. See TMS in Raphael, vol. 2, pp. 241-4. He seems to think that work and production is an end in itself. Again there is a contrast with Aristotle, who thought that a rational person would not seek possessions beyond those necessary or useful for living a worth-while life. Adam Smith seems to think that the indefinitely increasing production of things to be consumed by individuals is good, whether it makes them happier or not, whether of not it helps them live worth-while lives.

The degree of the wealth of a nation is the 'greater or smaller proportion' of the mass of 'necessaries and conveniencies' 'to the number of those who are to consume it'. He does not say who those are, but he must mean the whole population, in various degrees. Some consume more than others. The wealth of a nation, conceptualized in this way, is an average. 'But this proportion', between goods and consumers, 'must in every nation be regulated by two different circumstances; first, by the skill, dexterity, and judgment with which the labour is generally applied; and, secondly, by the proportion between the number of those who are employed in useful labour, and that of those who are not so employed' (WN, 'Introduction and plan', p. 1). In other words, average wealth depends on the productivity of labour and the level of employment. He is not thinking of cyclical changes in employment, but of the fact that in modern civilized and commercial nations there is a leisured class. The level of employment - the differentiation between the leisured classes and the productive workers - Adam Smith mentions, but he does not theorize about it. It is the other point that interests him: the productivity of labour. This is in fact the main topic of four of the five books into which the book is divided. What he has to say about the causes of the wealth of nations is mostly about that: nations have become wealthy because labour has become more productive.

In a modern discussion of productivity there would be much about technology and training. But Adam Smith does not say that labour in modern nations is more productive because of machinery, or because the workforce is better educated. He says that it is more productive because it is more specialized; tasks have been divided and subdivided until anyone can easily learn to do any job and do it well. The division of labour leads to invention, and it makes it easier for a worker to learn and become skilled at the job. (This is not the same thing as education: in fact, as Adam Smith points out, the division and sub-division of tasks stupefies the worker.)

The plan of the book

Book 1 of the Wealth of Nations is concerned with 'the causes of this improvement in the productive powers of nature, and the order, according to which its produce is naturally distributed among the different ranks and conditions of men in the society' ('Introduction and plan', p. 1). (Wealth is distributed as wages, profits and rent, which are discussed in book 1, but not nearly as thoroughly as they were later by 19th century economists.) An important point to notice in this book is that the extent of the division of labour is limited by the extent of the market (chapter 3). The more people there are involved in mutual exchange, the more specialized each can be.

Book 2 'teaches of the nature of capital stock, of the manner in which it is gradually accumulated, and of the different quantities of labour which it puts into motion, according to the different ways in which it is employed' (ibid., p. 3). (Stock is pretty much the same as capital: more narrowly, capital is money, used among other things to buy stock - the physical prerequisites to production.) This topic is connected with division of labour: the accumulation of stock is relevant because it is presupposed to the further division of labour. 'Labour can be more and more subdivided in proportion only as stock is previously more and more accumulated' (introduction to book 2, pp. 291-2). Anything that impedes further accumulation therefore impedes further subdivision of labour.

What he is thinking of here seems to be something like this. If I want to specialize in producing some pieces of farm equipment, then I am not going to be growing my own food; someone else has to have put aside a supply for me to eat before I can stop producing my own to concentrate on producing something else. Similarly, if I am going to specialize in shaping the tool out of, say, wood, and not spend some of my time looking for the wood, then someone has to set aside a supply of wood before I can specialize to this extent. And so on: every further stage of specialization supposes that a stock of whatever things it needs has been set aside, before the worker can give up preparing those things to concentrate more narrowly on this precise stage of the process. So book 2 is concerned with the accumulation and allocation of stock, as the presupposition of further division of labour.

Book 3 is something of a digression. It tells the story I summarised last week, of how the improvement of labour productivity in rural occupations could not occur in Europe until towns and long-distance trade had developed, because of the importance of property as an incentive to improvement in production. The connection with earlier topics seems to be this, that the natural progress of wealth is from agriculture to manufacture - food is the first thing that has to be set aside before anyone can specialize in manufacture, and town manufactures use materials from the country. The natural course of the accumulation of stock (the topic of book 2) would therefore seem to have its starting point in the country. Book 3 explains why in Europe this was not so. (And elsewhere it might not be so.) Division of labour made more progress in town industries at first, because for political reasons the kings fostered self-government, and thus better government, in towns, while tyrannical landlords inhibited industry in the countryside. Thus book 3 prepares the way for book 4, by showing the importance of political factors in the development of the wealth of nations.

Book 4 is concerned with 'theories of political economy' that 'have had a considerable influence... upon the public conduct of princes and sovereign states', 'and the principal effects' - mostly bad - 'which they have produced in different ages and nations' ('Intro and plan', p. 3). The term 'political economy' is noteworthy. 'Economy' meant originally the direction of a household (Greek 'oikos' a house, 'nomos' a law). The management of a household involves especially getting supplies. Political economy is the corresponding art in relation to state. The two main theories of political economy with which book 4 is concerned are usually called the 'mercantile' and 'physiocrat' theories. The first was the theory that a nation's wealth is increased mostly by export industry, the other that it is increased mostly by agriculture. Both theories are still around. Reduced to a nutshell, Adam Smith's answer to both is that a nation's wealth is increased by whatever industry is most profitable: meaning, whatever industry produces the greatest surplus, available to support further division of labour. So the argument of book 4, to boil it down, is that government should not try to direct industry into export industry, or into agriculture, or in any particular direction, but should allow it to go in whatever directions private individuals find profitable. As he sums up the argument at the end of book 4: 'All systems either of preference or of restriction, therefore, being thus completely taken away, the obvious and simple system of natural liberty establishes itself of its own accord. 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...' (vol. 2, p. 208).

In fact this conclusion does not establish itself of its own accord, as soon as systems of preference and restriction are refuted. Book 4 refutes theories proposing that industry should be directed especially into export or into agriculture. This is not enough to show that the direction of industry should be left to private individuals. Once government has been freed from prejudices in favour of export or of agriculture, and taught that the only thing that matters is to maximise the surplus, why should not government direct industry into the activities appropriate to maximizing the surplus? To establish the system of natural liberty supplementary argument is needed to show that government guidance cannot improve upon the independent action of individuals seeking their own profit. It would have to be argued for example that government will not steadily seek to maximise production, but will be diverted to other ends, or that it cannot properly process information about how the goal is to be sought. Smith does suggest some such supplementary argument: By the system of natural liberty 'the sovereign is completely discharged from a duty, in the attempting to perform which he must always be exposed to innumerable delusions, and for the proper performance of which no human wisdom or knowledge could ever be sufficient; the duty of superintending the industry of private people, and of directing it towards the employments most suitable to the interest of the society' (ibid.).

But in the modern economy the direction of industry is not left to individuals. Many firms are very large; their management organizes a great range of activities, employees are not individual profit-seekers but do as they are directed. (Why don't large firms 'privatise' all their departments, i.e. make them into independent firms, and then do business with them and their competitors 'on a level playing field' - and why don't the departments make their individual members into sub-contractors in competition with whoever else wants to put in a bid?) In modern society it is not the case 'that every man... is left perfectly free to pursue his own interest in his own way': most men, and women, do as the management says.

So is there an argument to show either that individual initiative would be more effective than initiative by large organizations (so that large firms should be broken up), or that although some large organizations may be good at directing industry, governments cannot be?

To finish with the plan of the book: Book 5 is about 'the revenue of the sovereign, or commonwealth' ('Intro. and plan, p. 3). The first four books have dealt with the revenue or wealth of the individuals of which the nation is composed, book 5 deals with the wealth of the nation as a political entity. It deals with the necessary expenses of government, taxation, and public debt. In this section the author discusses the public support of education and religion, the topic of the first lecture.

The system of natural liberty

The main argument of the book comes to a point in book 4. Wealth depends on division of labour, that depends on accumulation of stock, and that depends on profitability: so government's best contribution to the wealth of the nation is to leave individuals free to find the most profitable employment of their labour or capital. And as I just pointed out, some supplementary argument is needed to show that governments freed from false theories of political economy could not become the organizers of industry. What makes Adam Smith jump to his conclusion, I suspect, is the aesthetic and moral, and perhaps religious, pleasure he always takes in the thought of a system of nature designed by God in which individuals pursuing their own legitimate interests unknowingly contribute to the good of the whole.

'Every individual is continually exerting himself to find out the most advantageous employment for whatever capital he can command. It is his own advantage, indeed, and not that of the society, which he has in view. But the study of his own advantage naturally, or rather necessarily, leads him to prefer that employment which is most advantageous to the society'; IV.ii, vol. 2, p. 475.

'He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it'; ibid., p. 477. This is one of only two passages in which Adam Smith mentions the invisible hand - the other is in Theory of Moral Sentiments, in Raphael, British Moralists 1650-1800, vol. 2, p.244. Here he is talking about investment in domestic as against foreign trade, in TMS he is talking about the distribution of food. But here he says 'in this, as in many other cases', so it's fair enough to generalize, as expositors of Adam Smith generally do, and say that he thinks that a free market economy in which people seek their own private purposes is led by an invisible hand in directions beneficial to everyone. (There is a good summary in IV.vii part 3, p. 145-6: 'It is thus that the private interests and passions of individuals naturally...'. You will have notices that 'nature' and 'naturally' are among Adam Smith's favourite words. They are key terms Stoicism - the Stoic maxim was to live in accordance with nature. Adam Smith was an admirer of Stoicism - see his discussion of it in TMS, *. )

The invisible hand is God, the designer of nature as a system in which the interests of the parts harmonise in the whole (another Stoic idea). Adam Smith does not think that human beings are merely self-interested; when they engage in philosophical reflection they can appreciate and rejoice in, sympathize with, the beneficence of the divine designer: but part of the design is that generally people should pursue their own interest without thought of the whole. This is a beautiful thought, but notice there is no argument to back it up. He nowhere really shows that individuals' pursuit of their own interest is necessarily and always better for the public interest than action coordinated by government. In the earlier passage he says 'naturally, or rather necessarily', in the last passage he says 'frequently' ('By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it'). Well, which is it? Necessarily, or frequently, or merely sometimes - and under what conditions? And why think so?