(This essay was published in Hong Kong Economic Journal on 27 November 2013)

 

This is the first of two essays developed from two recent dinner talks I gave on 14 and 15 November 2013 in connection with the campaign to restore Panmure House in Edinburgh – the last residence of Adam Smith (1720-1793), the Scottish moral philosopher and pioneer of political economy. The campaign is led by Lord Richard Scott, the tenth Duke of Buccleuch, and Professor Keith Lumsden of the Edinburgh Business School. Supporting the Panmure House Campaign is a stellar advisory board of twenty Nobel laureates in economics chaired by Professor Orley Ashenfelter of Princeton University.

 

Adam Smith was born in Kirkcaldy, Scotland. He entered Glasgow University at the age of fourteen and later also studied at Oxford. Smith preferred Glasgow, however, because he thought Oxford’s curriculum was antiquated and the teachers were lazy since, in contrast to Glasgow, their salary did not depend on the number of students taught.

 

Smith later earned a professorship at Glasgow University in 1751, but resigned in 1763 to become the private tutor and travel companion of Henry Scott, the young Duke of Buccleuch. For the next three years they lived together in France and travelled to Switzerland.

 

Private Vice Public Cirture

 

In Europe, Smith came into contact with his contemporary Voltaire, the intellectual architect of the French Enlightenment, and other leading figures like Benjamin Franklin, Francois Quesnay, and Anne-Robert-Jacques Turgot. In 1766, he returned to Kirkcaldy, Scotland. Smith spent the next ten years working on his study of political economy. In 1778, he was appointed commissioner of customs and lived in Edinburgh at Panmure House until his death. He never married.

 

Smith was one of the key figures of the Scottish Enlightenment. He was author of The Theory of Moral Sentiments (1759) and An Inquiry into the Nature and Causes of the Wealth of Nations (1776). The latter, usually abbreviated as The Wealth of Nations, is considered the first modern work of economics. It earned him an enormous reputation and would become one of the most influential works on economics ever published.

 

Scholars have traditionally perceived a conflict between Smith’s two books. The Theory of Moral Sentiments emphasizes sympathy for others, while The Wealth of Nations focuses on the role of self-interest. The contradiction is apparent rather than real. In The Wealth of Nations, Smith develops his study of political economy by focusing only on one aspect of human nature to explain how a market economy driven by the self-interest of individuals can yet promote the public interest. But in The Moral Sentiments he explores in greater fullness all other aspects of human nature to develop a more complete theory of how human society can survive and flourish.

 

Smith foresaw that the growing complexity of modern commercial society meant the bulk of inter-personal dealings would be with strangers. A commercial society’s coherence – its social bonds – would not depend on love and affection. People could co-exist socially with those to whom they were emotionally indifferent and where sympathy was absent. Smith famously said:

 

“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. Nobody but a beggar chuses to depend chiefly upon the benevolence of his fellow-citizens.”

 

Smith’s analysis of the modern market economy was novel in three ways. First, he made it clear that the ‘wealth’ lay in the well-being of the people and not that of the sovereign. He criticized Mercantilist ideas (重商主義思想) as fallacious for associating the wealth of a nation with the accumulation of precious metal by running a balance of trade surplus. The accumulation of precious metal advocated by the Mercantilists benefited the sovereign, who wanted gold to finance wars but not to improve the welfare of the people. He challenged the protectionist trade policy of his times as misguided. His ideas were revolutionary in his day.

 

Second, he articulated the idea of an “invisible hand” to describe the impersonal coordination mechanism that almost seamlessly matched producer supplies with consumer demands in changing markets where participants are strangers. Driving this ever changing order is the self-interested propensity of individuals to truck, barter and exchange. In modern economics language it is the theory of how competition in the market can promote the welfare of the people in society. For the invisible hand to work it has to be underpinned by the rule of law, which he called justice and had developed more thoroughly in The Theory of Moral Sentiments.

 

Third, and arguably the most important idea that he proposed on the first page of The Wealth of Nations, is the division of labor as the source of productivity gains and higher incomes. Smith famously argued that the difference between a street porter and a philosopher was as much a consequence of the division of labor as its cause.

 

Plato was the first to have pointed out in The Republic that the division of labor in a polity stemmed from initial differences in skills among individuals. But Smith went beyond Plato and in effect showed that even in the case of identical individuals there would still be an incentive for them to choose to specialize in different tasks in order to enhance future productivity. Individuals would over time reap the benefits of specialization. Smith saw the division of labor as a process to create and expand differences in skills and increase productivity.

 

There are limits to the division of labor, however. The gains from obtaining productivity gains depend on how large the production run is. It would make little sense to pursue extensive division of labor if one were producing only to meet the needs of one single village. But if one were producing for the whole nation or an entire continent then the much larger size of the market would be a powerful incentive to specialize further.

 

This led Smith to conclude famously that the division of labor is limited by the extent of the market. The implication of this idea is that the gains from extending the market would lead to sustained increases in productivity. Smith had made the case for using free-trade to drive world prosperity. The economic gains from globalization in the past two and a half centuries were in principle all foretold in the first few passages of The Wealth of Nations.

 

For those connected to the global market, free trade creates employment opportunities, raises worker productivity, and expands consumer choices. But extending the market also leads to a process of creative destruction – the creation of new things leads often to the destruction of old things as they became replaced. Globalization brings many benefits but it can also lead to the loss of old jobs.

 

As someone living before the dawning of the capitalist era, Smith perceived the enormous potential of markets in raising the standards of living of the ordinary people. He was much more wary of the power of governments in suppressing competitive markets to promote state monopolies for their own selfish reasons, and as a result preventing those in poverty from bettering their lot. And in Smith’s days the government did not yet possess the power to issue fiat money and to burden society with massive public debts.

 

The global spread of trade and capital flows in the nineteenth century created prosperity for some but brought poverty to others. It also sadly ended in two world wars and the Great Depression in the first half of the twentieth century. The co-existence of job losses and job creation, prosperity and poverty, appears to be an unavoidable outcome of extending the market unless the adjustment process occurs very smoothly.

 

But this does not always happen and sometimes those who are affected are often the disadvantaged in society. Since the Great Depression, the benefits from free trade in goods and services, and more importantly those of free capital flows, especially financial capital flows, have been questioned from time to time as creating potentially very damaging economic conditions that markets cannot prevent or remedy by themselves.

 

Nowadays, the reputation of markets to function smoothly has lost some respectability despite their enormous ability to create wealth and alleviate poverty by raising the standards of living of ordinary people. Instead a new set of liberal ideas on why governments should be relied upon to regulate markets, minimize their excesses, and intervene in society to help the disadvantaged and unfortunate, have gained wider support. The ideal role of the state differs from the days of Adam Smith in that it has been expanded at the expense of the market. This is an issue of debate in modern society and opinions are often divided.

 

Smith is widely recognized today as the father of modern economics and capitalism. The term capitalism was not Smith’s creation, but that of his intellectual adversary Karl Marx, who wrote almost three-quarters of a century later and was captivated by the role of big machines in the modern economy (see Berg 1982). Smith and Marx held very different visions of how the modern economy works.

 

For Marx, the rise of machines, which he called capital, was the central feature of economic production and class relations in the modern economy, hence, the name capitalism. It is rather doubtful that Smith would have used the word capital to describe the distinctive feature of the modern economy – it would instead be the division of labor and the extension of the market.

 

According to Marx, the labor class had been cheated of the fruits of its labor by machines owned by business entrepreneurs, who received profits and interest. Marx associated machines with capital and identified their owners as capitalists. The machines themselves were seen to be the fruits of past labor or as the surplus appropriated by the capitalists.

 

Charlie Chaplin’s vivid rendition of Marxian exploitation in the movie Modern Times portrays machines as the central feature of the modern economy. The movie shows workers toiling under the suffocating and alienating oppression of big machines. It depicts capitalists as faceless, hidden, remote, rendering them a class rather than individuals with personalities.

 

The fixation on machines in Marxian analysis cannot provide a convincing analysis of the modern economy today. The compact individual notebook computer people possess today packs more computation power than the mainframe computer that occupied thousands of square meters of air-conditioned floor space in the university I studied at 40 years ago. Each of us today has our own notebook rather than toiling under a big mainframe, which we do not own.

 

The idea that machines are the central feature of a modern economy is simply no longer credible or convincing. Marx’s scientific analysis has been fully discredited and has few followers today, but his rhetoric continues to have a political and ideological following. It is, however, diminishing.

 

Smith’s thoughts on the proper functioning of society, including its treatment of the unfortunate, are not contained in The Wealth of Nations but in The Theory of Moral Sentiments. Although The Wealth of Nations is widely regarded as Smith’s most influential work, it is believed that Smith himself considered his earlier book to be a superior work. His goal in writing The Theory of Moral Sentiments was to explain why man is able to form moral judgments, in spite of his natural inclinations towards self-interest. Smith continued to revise his earlier work, which saw six editions, until his death. Therefore to understand the entire corpus of Smith’s writings it is necessary to refer to his first book, a subject I shall discuss next week.

 

References

Maxine Berg, The Machinery Question and the Making of Political Economy 1815-1848, Cambridge University Press, 1982

 

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