Adam

Smith:

Father of

Economics Seminar 3

R. Yuvindran, Sakina Sakdun,

Shruti Iyengar, Nur Rosmawati

Bte Abdul Majid, Claesson

Gustav David Johan , Duraku

Egzon, Chen Sheng Cristian

Gerard, Tan Wing DA, Sally

Liu

Table of Contents

1. Introduction

1.1. Who is Adam Smith?

1.2. Figures who influenced Smith

2. Smith’s Legacy in Economics & Moral Philosophy: Wealth of Nations Dissected

2.1. Labour as the Origin of Value

2.2. Labour Theory of Value

2.3. Value Dissected: Understanding Value in Use & Value in Exchange

2.4. Labour as a Monetary Measure

2.5. Market Price vs Natural Price

2.6. Labour Theory of Value’s growing support to the free market mechanism

2.7. Labour as a Cost of Production

2.8. Evaluation of Smith’s Theories

3. Smith’s Legacy in Economics: Relevance Today

3.1. Factors Leading to Economic Growth

3.2. Relevance of Smith’s Argument Today

4. Adam Smith: An Advocate of Laissez Faire Economics?

4.1 Defining Laissez-Faire

4.2 The Invisible Hand

4.3 Smith’s View of the Market

5. The Evolution of Smith’s Followers

5.1 Smith’s Popularity & Continuing Interest in his Work

5.2 Smith as a Pioneer-Classical Economist

5.3 Roots of Neo-Classical Economics

5.4Politics: Role of the Government

6. Conclusion

7. References

1.0 Introduction

Although it has been over 200 years since Adam Smith’s demise, his work has arguably had more

impact on modern economic policy than any other figure in economic history. While the

prescriptions of Karl Marx and John Maynard Keynes have hardly withstood the test of

time, the ideas of Smith are still, even today, regularly invoked and modern economic policy is

in fact measured against his principles. Even in the late 90’s, Smith's works were being translated

and distributed in Eastern Europe, and they have indeed been found to have a renewed relevance.

As Leo Rosten, rightly described Smith, “He was to economics what Newton was to physics, or

Darwin to the study of man: a giant in the kingdom of intelligence. The cheerful, absent–minded

master analyst of the great, invisible scheme that shapes a million variant acts and calculations

into the harmonious and beneficent whole, was far from being the desiccated priest of what

Carlyle would call “the dismal science.” In a nutshell, Adam Smith was an immensely respected

scholar of his day, and has continued to be a man greatly revered and followed to this day!

1.1 The Life of Adam Smith

Adam Smith (1723–90) was born on June 5th, 1723, in the burgh of Kirkcaldy across the Firth of

Forth from Edinburgh. His mother, Margaret Douglas, was the daughter of the laird of Strathenry.

His father, also named Adam Smith, died before his birth. He had been Clerk to the Courts

Martial and Councils of War in Scotland and Controller of His Majesty’s Customs in Kirkcaldy.

These were responsible positions with a steady income, which allowed him to provide for his

family. In his boyhood, he attended the Kirkcaldy Burgh School and lived in town with his

mother.

Kirkcaldy, Smith’s birthplace, was a trading center in Scotland and this gave him exposure to a

number of trades, including fishing, mining, iron-working, and trade in general. Smith also

witnessed the growing popularity of foreign commodities imported from the colonies, such as

tobacco and cotton, giving him further material for thought.

In 1737, at the age of fourteen, he entered the University of Glasgow, where he received his

undergraduate education. Smith studied moral philosophy under the remarkable Francis

Hutcheson, who was hugely responsible for shaping the ideas of, both David Hume and Smith, in

the fields of economics, ethics, and aesthetics. Robert Simson, the translator of Euclid’s Elements,

taught mathematics and Smith was particularly intrigues by this subject.

Upon graduation, Smith was awarded a Snell Exhibition (a sort of scholarship) to Balliol College,

Oxford, but he did not enjoy his stay there. He spent much of his time studying languages,

literature and science, to which his early essays on Johnson’s Dictionary, on Italian poetry and on

the History of Astronomy bear witness.

During his period in Edinburgh, he earned some money and gained a reputation for learning by

delivering public lectures. We know something of these presentations from his Lectures of

Rhetoric and Belles Lettres (Smith 1983). It was about this time that he first met David Hume,

who would become his best friend. In 1751, the University of Glasgow appointed him professor

of logic and, in the next year, professor of moral philosophy, the chair earlier held by Hutcheson.

In 1759, Smith was hired as a tutor for the son of a wealthy statesman, and, with his pupil, began

extensive travels of Europe. He met with David Hume in Paris, and went on to visit the South of

France and Geneva. He used these opportunities to reflect on the interaction of culture,

government, commerce, and economics, and to analyze various policy approaches and their

effectiveness. There after he published The Theory of Moral Sentiments. It analyzed those

passions which govern how people judge right and wrong. While we cannot suffer the pain or

enjoy the pleasure of other people, Smith argued, we have a natural sympathetic response to their

circumstance by imagining ourselves in their place. This moral sympathy is the basis of our moral

judgments. The Moral Sentiments earned him the approbation of the public. At the end of the

book, Smith announced the plan of his life’s work. Smith returned to London in 1766.

After educating his pupil, Smith retired to Kirkcaldy, the city of his birth, where he began his

work on The Wealth of Nations, which he devoted himself to even at the expense of his health.

During a long stay in London from 1773 to 1776, Smith enjoyed the company of a host of other

great thinkers, including Edmund Burke, Boswell and Sir Joshua Reynolds. Smith published The

Wealth of Nations in 1776, and it met with widespread and immediate success, and was translated

into many languages shortly after its publication.

After his publication, Smith was appointed to be the Commissioner of Customs. This position

endowed Smith with real political power and placed him in a position to put many of his ideas

into action. He also became an important voice on other issues, including trade restrictions on

Ireland. It was in 1790, during his time as Commissioner, that Smith passed away after he grew

exhausted during a particularly lively discussion with his intellectual circle of friends and

acquaintances.

1.2 The Figures Who Influenced Adam Smith

Many of Adam Smith’s ideas were derived and enhanced from the work of others. It is important

to understand where these thoughts were inspired from, and this section will elaborate more on

the people who had influenced Smith in his theories.

1.2.1 Science

From the point of view of Science, Smith was influenced by Isaac Newton. Newton, famous for

his theory of gravity, was a physicist, but he also dabbled in economics. In addition, he believed

in natural law as well. The book entitled “Journal of the History of Ideas” mentioned that Adam

Smith had applied Newton’s conception of nature in his work in economics, which basically

discussed about forming relationships with different types of variables and nature.

1.2.2 Moral Philosophy (Ethics)

In the point of view of Philosophy, The Third Earl of Shaftesbury, Anthony Ashley Cooper,

influenced Smith with his statement, “In all of us lie a moral sense and that altruism is natural and

pleasurable”. This statement was what influenced and contributed a large role to Smith’s “The

Theory of Moral Sentiments”.

Beside Shaftesbury, Smith was also influenced by another philosopher, named Bernard

Mandeville. Both of them actually shared two similar ideas. The first idea was about the division

of labor and the benefits of specialization. This means that people should specialize in one sector,

so that they are not only useful to one another, but the employment itself will have much greater

improvement in the same number of years. The second idea said that collective actions by

individuals would bring about collective benefits. Mandeville and Smith had the similar ideas on

this. However, Mandeville believed that people tend to be greedy, and thus when properly

channeled, it would lead to collective benefit. He even advocated politicians should keep the

passion of man going to derive this collective benefit. In other words, Mandeville believed that it

was the right channeling that would lead to collective benefit. On the contrary, Adam Smith

believed that it was the human nature to be ambitious that leads to collective benefits. He argues

that people have their self-interest to be better and through a collective action will lead to a better

outcome for everyone.

Francis Hutcheson, one of Smith’s lecturers teaching moral philosophy, influenced Smith of his

ideas and theories about philosophy as well. Smith being so impressed with Hutcheson’s ideas

was mentioned in Smith’s book entitled “The Theory of Moral Sentiments”. In that book, Smith

said, “…the late Dr. Hutcheson was undoubtedly, beyond all comparison, the most acute, the

most distinct, the most philosophical, and what is of the greatest consequence of all, the soberest

and most judicious.” Besides, Smith also mentioned about how Hutcheson’s works and ideas are

in both of his book: “The Theory of Moral Sentiments” and “The Wealth of Nations”.

1.2.3 Natural Law

The Father of Classical Liberalism, John Locke, who believed in natural law, said that labor

combined with nature during production was what gave the goods their value. Adam Smith was

so intrigued with this idea of nature, which was also known as Locke’s labor theory of property in

his book entitled “Two Treatises of Government”.

Another natural-law-believer philosopher named Jean-Jacques Rousseau also shared the same

idea with Smith. Rousseau believed that the human soul yearns to satisfy their self-interest yet

still be capable of showing pity, Smith believed the same, in that humans naturally look out for

their own interest, and at the same time, being social creatures, they naturally sympathise with

others. The similarities in their ideas imply that Rousseau’s influence on Smith’s ideas.

Lastly, Francois Quesnay, a French economist, advocated the notion of free trade, which later

continued by Adam Smith. During Quesnay’s period, French government favored protectionism,

in which they protected French manufacturers from foreign competition. And this increased the

costs of machinery for farmers to produce agriculture. Quesnay suggested reforming these laws

and liberating the economy from the government controls. During Smith’s time, Smith continued

with the notion of free trade. However, there were some arguments going on at that time. People

believed that exporting goods was beneficial, but importing goods from abroad was damaging.

People believed that importing would just reduce the quantity of gold and silver in a nation’s

vault. However, Smith argued that a nation’s wealth was not just about the quantity of gold and

silver, but it was the total monetary value of goods and services produced in the country. This is

the concept that is now known as the Gross Domestic Product (GDP).

2.0 Smith’s Legacy in Economics & Moral Philosophy: Wealth of Nations dissected-

Smith published a variety of papers, books and journals. However, the two most prominent ones

continue to be his, “Theory of Moral Sentiments” (1759), and “Wealth of Nations (1776).”

The Wealth of Nations in particular, published in 1776, is a careful, thorough, and brilliant

criticism of the mercantile system that governed economic policy in Great Britain during Smith's

life. It offers a perfect amalgam of sound observations of the market with elements of moral

philosophy and policy recommendations so as to create not just a criticism of mercantilism, but a

rich economics text that has prevailed upon centuries of scholars. It is here that Smith charts the

evolution of mercantile principles from the fall of Rome, through feudal times, and into the age of

commerce in which he was born. In Part 1 of this book, Smith begins his explanations with a

simple quote. He says, “The value of any commodity, therefore, to the person who possesses it,

and who means not to use or consume it himself, but to exchange it for other commodities, is

equal to the quantity of labour which it enables him to purchase or command. Labour, therefore,

is the real measure of the exchangeable value of all commodities”. He then elaborates on the

relationship between labour and price that he believes persists in the economy. However this

theory had a past to it. It evolved through the inspiration that Smith found from others’ ideologies.

2.1 Labour as the origin of value

Taking a leap into history we see, the traditional theory of value from Aristotle through Samuel

von Pufendorf was actually the idea that things have value because of their usefulness to

mankind. Even John Locke (1988 [1690]:294), who explained that most of the value of

commodities originated from the current labour and the past labour necessary for their production,

added that “the intrinsic value of things depends only on their usefulness to the Life of Man.”

He was known for distinguishing between the intrinsic value and the marketable value of things.

The market price of anything, Locke (1991 [1692]:254) thought, depended on “its quantity in

proportion to its vent, for this alone regulates the Price.” Ferdinando Galiani (1924 [1751]: 290)

extended Locke’s research and argued that labour “is the sole source of value,” while prices are

“regulated by the same principles of scarcity and utility.” Hence, both Locke & Galiani, found the

original source of value to be conceptually distinct from what regulated market prices: labour was

the origin of value, whereas supply and demand regulated market prices.

2.2 Labour theory of Value:

It is from here that Adam Smith adopted his philosophy of value. In his paradox of value, Adam

Smith repeated two concepts of values found in Aristotle: value in use and value in exchange. He

developed the labour theory of value from his predecessors, mostly from his friend David Hume.

Similar ideas can also be traced to Sir William Petty and Quesnay, who attempted to measure the

value of goods and in what proportion should they be exchanged for one another.

The labor theory of value argues that the value of a good is only related to the labor needed to

produce or obtain that good and not to other elements of production. He asserted that what is

bought with money is purchased by labour and thus is the standard by which value is to be

determined. Hence, labour is the origin of the value of output. Smith wrote in The Wealth of

Nations that:

The value of any commodity… to the person who possesses it, and who means not to use or

consume it himself, but to exchange it for other commodities, is equal to the quantity of labour

which it enables him to purchase or command. Labour therefore, is the real measure of the

exchangeable value of all commodities. (p.30)

According to Smith, a good that requires one worker three hours to produce should be able to

exchange for three of a good that takes one worker one hour to produce. As labor 'is the real

measure of the exchangeable value of all commodities', the ratio of quantities that are traded

should be inversely proportional to the ratio of labor sacrificed.

Labour, therefore, is the only universal as well as the only accurate measure of value by which we

can compare the values of different commodities at all times and at all places (p. 36).

2.3 Value dissected: Understanding Value in Use vs Value in Exchange

Smith defined the word value in two senses.

Value "in use" was the usefulness of the commodity, its utility. A classical paradox often comes

up when considering this type of value. In the words of Adam Smith:

“The word VALUE, it is to be observed, has two different meanings, and

sometimes expresses the utility of some particular object, and sometimes

the power of purchasing other goods which the possession of that object

conveys. The one may be called “value in use;” the other, “value in

exchange.” The things which have the greatest value in use have

frequently little or no value in exchange; and on the contrary, those which

have the greatest value in exchange have frequently little or no value in

use. Nothing is more useful than water: but it will purchase scarce any

thing; scarce any thing can be had in exchange for it. A diamond, on the

contrary, has scarce any value in use; but a very great quantity of other

goods may frequently be had in exchange for it.” (Smith 1976 [1776]:44–5)

While Value "in exchange" was the relative proportion with which the commodity exchanges

for another commodity (in other words, its price in the case of money).

Smith’s opinion of the usefulness of diamonds appears rather conventional and judgmental. Value

in use is an individual, introspective and subjective matter, which lies behind exchange; value in

exchange is an objective and social phenomenon, which is observed in the market.

The paradox of value therefore illustrates that use value is essential to exchange value, but does

not regulate it. This is a very important distinction and one that is often forgotten. Smith

elaborates that the things that have the greatest value in use, frequently have little or no value in

exchange; and, on the contrary, those which have the greatest value in exchange frequently have

little or no value in use.

He reiterates this distinction with the help of the classic example involving water and diamonds.

While nothing is more useful than water, he states nothing much can be exchanged for it.

Diamonds, on the other hand, may have no value in use, but their value in exchange is huge.

Though this instance may not hold in today’s day and age, it still illustrates his point optimally. In

his book, Wealth of Nations he writes:

“The real price of every thing, what every thing really costs to the man who wants to acquire it, is

the toil and trouble of acquiring it. What every thing is really worth to the man who has acquired

it, and who wants to dispose of it or exchange it for something else, is the toil and trouble which it

can save to himself, and which it can impose upon other people. “(Wealth of Nations Book 1,

chapter V)

What is perhaps most interesting, though, is the changeable nature of value. If you had dragged

yourself out of the desert after five days, what would you value more: diamonds or water? Water

is by far the cheapest commodity and yet it is one of the few things we can’t live without. While

diamonds, most of us can easily live without. The irony about Smith’s examples is that “need”

against “want” is highlighted, and the subsequent potential for exploitation.

David Ricardo and Karl Marx similarly claimed that utility was essential to value, but that it did

not determine prices. The air is useful, for example, but free. Smith did not connect utility with

price, because he did not have a utility theory of consumer demand.

2.4 Labour as a Monetary Measure

While money is the most commonly used measure of value, smith was ambivalent about this. In

his opinion, the value of money is uncertain as it fluctuates across different time periods and

prices of commodities are a mere reflection of the nominal price which is not a precise

representation of the real purchasing power of the money. In contrast, value of labor 'is the real

measure of the exchangeable value of all commodities as it is directly proportional to the real

price of the commodities’. This is the standard Adam Smith set for the value of a good being

exchanged, and this value can be taken as the price of the good being exchanged. Smith wrote:

“But when barter ceases, and money has become the common instrument of commerce, every

particular commodity is more frequently exchanged for money than for any other commodity . . .

Hence it comes to pass, that the exchangeable value of every commodity is more frequently

estimated by the quantity of money, than by the quantity either of labour or of any other

commodity which can be had in exchange for it. Gold and silver, however, like every other

commodity, vary in their value, are sometimes cheaper and sometimes dearer, sometimes of easier

and sometimes of more difficult purchase.... Labour alone, therefore, never varying in its own

value is alone the ultimate and real standard by which the value of all commodities can at all

times and places be estimated and compared. It is their real price; money is their nominal price

only” (pp. 32-33). Therefore Smith has described that no matter how indispensible money as

become as a medium of exchange, it is an imperfect measure of value, especially over long

periods of time and that labour is the better measure of value.

However, there are certain practical and theoretical difficulties in the labour theory of value. It is

difficult to measure the value of labour quantitatively. While the value of labour is commonly

measured in hours, quantity of time spent on the work does not accurately reflect the actual

amount of hard work the person put in. An hour of labour varies across industries depending on

the level of technology and productivity of the worker. Smith revealed his awareness of these

issues in his book where he states:

“It is often difficult to ascertain the proportion between two different quantities of labour. The

time spend in two different sorts of work will not always alone determine this proportion. The

different degrees of hardship endured, and of ingenuity exercised, must likewise be taken into

account. There may be more labour in an hour’s hard work than in two hours easy business… But

though labour be the real measure of the exchangeable value of all commodities, it is not that by

which their value is commonly estimated. It is often difficult to ascertain the proportion between

two different quantities of labour.... In exchanging indeed the different productions of different

sorts of labour for one another, some allowance is commonly made for both. It is adjusted,

however, not by an accurate measure, but by the haggling and bargaining of the market, according

to that sort of rough equality which, though not exact, is sufficient for carrying on the business of

common life” (p. 31).

2.5 Market price versus natural price

In Wealth of Nation, Smith discusses the natural and market price of commodities. Essentially, he

pointed out the difference between actual (market) price and natural (equilibrium) price. The

actual price or market price is determined by the interaction of supply and demand in the short

run.

The market price of every particular commodity is regulated by the proportion between the

quantity that is actually brought to market and the demand of those who are willing to pay the

natural price of the commodity, or the whole value of the rent, labour, and profit, which must be

paid.

On the other hand, the natural price or equilibrium price is determined by long run cost of

production. There are two important characteristics of natural price in smith’s theory, which refers

to natural price as an equilibrium value, and it is largely consistent over the long run. This means,

the long run supply curve is horizontal. With this characteristic, price of commodities will

gravitate towards the natural price in the long run and this natural price is determined by long run

supply curve, which is affected by the value of labour. Since labor in the eyes of Smith represents

all the value of a good, firms will only produce more when what they get from selling the goods

can cover the value of the good, which is the cost of labor. Hence a supply curve emerges from

the corresponding relationship between prices and labor costs.

The natural price, therefore, is, as it were, the central price, to which the prices of all commodities

are continually gravitating.

2.6 Contribution of Labour Theory of Value to the Growing Support for Free Market

Mechanism

Free market is a market structure in which the distribution and costs of goods and services, wage

rates, interest rates — along with the structure and hierarchy between capital and consumer goods

— are coordinated by supply and demand unhindered by external regulation or control by

government or monopolies. Smith’s labour theory of value does contribute to the growing support

for free market mechanism.

Though the market price of every particular commodity is continually gravitating towards the

natural price, sometimes, particular incidents, natural disasters and regulations, may keep the

market price high for a long time period (above the natural price). “Regulation” is referring to

laws and restriction imposed by the government. The “incidents” here refer to events that cause

information to be withdrawn from either seller or buyers, such as trade secrets. For example, if

there were an increase in effectual demand, suppliers would want to protect this secret so that they

are able to enjoy the higher profit. Such incidents will results in price rising above the natural

price. However, Adam smith felt that little could be done about this and that trade and

manufacturing secrets could not be kept for very long anyway. Once people know about the

increased profit, it would tempt new rivals to sell their goods in the same way and the market

price would soon be reduced to the natural price as the gap between effectual demand and supply

is bridged.

But government intervention or ‘regulation’ could keep actual price above natural prices

permanently. Such government interventions will result in distortion in the free market, pushing

prices above the natural price in the long run, keeping the market away from the equilibrium. The

British economy in Smith’s day imposed restrictive measures that prevented many markets from

reaching equilibrium, thereby limiting the volume of trade leading and thus, retarding economic

growth.

A monopoly granted either to an individual or to a trading company has the same effect as a trade

secret. The monopolists, by keeping the market constantly under stocked, would never fully

supply to meet the effectual demand. With an excess of effectual demand, they would be able to

sell their goods at a price much higher than the natural price, and their emoluments, whether they

consist of wages or profits, greatly above the natural rate. In a mercantilist economy, government

is the source of monopoly privileges. Acting as a monopoly, government can set price way above

the natural price and thus distorting the free market mechanism, which will affect the growth of

the economy.

Therefore, Smith’s labour theory of value clearly supports his idea of a free market mechanism

with the consequences of not adhering to such a mechanism fully explained by him.

2.7 Labour as cost of production

For civil society, Smith maintained that all production is due to labour. He also kept his labour

sacrifice as a measure of value. With that, he introduced a cost of production theory to determine

the determination of market prices.

As soon as stock has accumulated in the hands of particular persons, some of them will naturally

employ it in setting to work industrious people, whom they will supply with materials and

subsistence, in order to make a profit by the sale of their work, or by what their labour adds to the

value of the materials.

(Smith 1976 [1776]:65–6)

Notice that it is labour, not capital, that “adds to the value of materials.” Capital is simply

accumulated labour. “In this state of things,” Smith (1976 [1776]:67) pointed out, “the whole

produce of labour does not always belong to the labourer”, implying that the whole produce is due

to labour. Labour is the origin, source or cause of value. Smith (1976 [1776]:67) also added, “As

soon as the land of any country has all become private property, the landlords, like all other men,

love to reap where they never sowed, and demand a rent even for its natural produce.” Material

things are gifts of nature. While the whole annual produce in civil society is still due to labour

alone, its exchangeable value is divided among the labourer, the landlord and the capitalist.

In Smith’s terminology, the annual produce of labour and the exchangeable value of it are two

equal, but conceptually distinct, magnitudes. The annual produce of society equals the total labour

necessary for production, where labour alone produces all commodities, land being a gift of

nature, whereas, in civil society, the exchangeable value of that produce is distributed as wages,

profit and rent.

Thus, Smith stated:

The whole of what is annually either collected or produced by the labour of every society, or what

comes to the same thing, the whole price of it, is in this manner originally distributed among some

of its different members. Wages, profit, and rent, are the three original sources of all revenue as

well as of all exchangeable value.

(Smith 1976 [1776]:69)

Overall, even though the price of most commodities is now paid out as wages, profit and rent,

Smith still believes that labour sacrifice is a measure of value in civil society.

2.8 Evaluation of Smith’s Theories

The above beliefs that Adam Smith laid out are quite comprehensive and give us an all-round

perspective of his thought process. However a further evaluation of his theories allows us to

understand their applicability and practicality, especially in today’s scenario.

2.8.1 Evaluation of Market Prices

The analysis of the market and natural price by Smith shows how the economy possesses a self-

righting mechanism, provided the pursuit of self-interest is constrained by the conditions of

perfect competition. Hence, Smith’s theory of the “invisible hand” is just a theoretical analysis

that only holds true where anyone can enter or quit any occupation or business at any time. It does

not apply to the world of imperfect competition with manufacturing secrets, monopoly grants,

exclusive privileges of corporations, statutes of apprenticeships and similar restrictions.

Adam Smith felt that little could be done about the variability of nature and that trade and

manufacturing secrets could not be kept for very long. This was because once people knew about

each other’s profits, it would tempt the new rivals to increase their stocks which would lead to the

market prices be reduced to its natural price as effectual demand is being fully supplied. Also,

similar to manufacturing secrets, granting monopoly access into the market would restrict the

quantity produced below effectual demand, leading to higher prices due to excess demand.

Nonetheless, since markets do not and cannot spontaneously provide justice and security, state

action is necessary for the production of public goods. Smith argued that the state should provide

certain public works and institutions, such as roads, bridges and education. In other words, Adam

Smith has a balanced view as to what the free market has to offer and also its shortcomings.

2.8.2 Evaluation of Labour Theory of Value

Even though Adam Smith improved the theory of value, there are still deficiencies in his

arguments. Firstly, it is difficult to accurately compute labour. Adam Smith himself also realized

this limitation of his theory: 'The difference different degrees of hardship endured, and of

ingenuity exercised, must likewise be taken into account.' He came to realize that labour does not

consist of mere number of hours worked. The value of labour is often found in the risk a worker

has to bear or the prior training he has to acquire that makes his labour more exclusive. And all

these quality improvement cannot be effectively translated into a number. But Smith did not seem

to bother about this limitation very much, probably because he assumed that workers were

homogenous and such discrepancy in quality of labour was dismissed as a minor problem in an

otherwise workable theory.

Secondly, the labour theory of value gives undue emphasis to labour, ignoring contribution from

other sources such as land, energy and entrepreneurship of a capitalist. His theory was only valid

in a primitive state where labour represented most, if not all, the form of input. However, as

society advances, other sources of input, especially the invisible entrepreneurial and risk taking

spirit of capitalists comes into play. We reward capitalists for taking risks in a form of profit

which should also be counted as part of the value of a good.

Thirdly, Smith’s theory only focused on “effectual demand”, which is backed up by the ability to

pay. He did not consider the demand by those who cannot afford to pay for the commodities, for

example demand for clothes by poor people. Alfred Marshall’s concept of a demand schedule,

which explained the negative relationship between price and quantity demanded, was something

very hard to be conceived by Smith and his contemporaries. Thus, although Smith furthered his

supply analysis, he did not contribute much to make the market demand analysis more holistic.

Despite the fact that Wealth of Nation was published in 1776, the concepts are still relevant in the

modern economy. In his labour theory of value, actual price gravitation towards the natural price

implies that long run supply curve is horizontal. This type of long-run supply curve is still

accurate in industries characterized by constant cost of production. Besides industries with

constant cost of production, today’s economist also recognizes that many industries produce

under condition of increasing costs and a few actually produce under conditions of decreasing

costs of production.

As a whole, what set Smith apart from his ancient predecessors was his shift of emphasis from an

arbitrary notion of justice, which often resulted in dictation of prices, to a more realistic theory of

value that was at least grounded by its way of measuring the value of commodities. Therefore,

labour theory of value represents an advancement from other theories of value. Even though

labour does not represent all the value of a good, the theory at least partially reflects part of the

value of a good that requires labour input and the resulting price computed from the labour value

can at least cover and compensate the toil of workers. Because of this consistency of reality,

Smith's theory of value is more 'just' and 'natural' than many of the older theories that were

nothing more than willfully conceived and imaginative schemes proposed by some scholars or

some men in authority. Due to this inherent consistency of reality, the labour theory of value

removed the need for artificial interference in the setting of prices according to a perceived notion

of social justice. Prices are set 'naturally' in accordance with the amount of labour used. This is a

liberating concept that put the central planners out of business. This is a move towards greater

market orientation in which prices are set independent of the will of authority.

His theory at the same time also undermined the justification for government-protected monopoly

where prices were set artificially high, way above the 'natural price' to which the actual price of a

good should gravitate without government interference.

3.0 Smith’s Legacy in Economics: Relevance Today

While the Labour Theory of Value was considered as Smith’s masterpiece, his most prominent

and currently relevant piece of writing revolves around his explanation of economic growth and

how it is caused.

3.1.Factors leading to Economic Growth

It is again, in the Wealth of Nations that Smith expounds, economic growth came mainly from the

division of labor, which allowed for efficiency and productivity. With greater production

individuals, companies, and even entire nations could enjoy wealth; Smith defined this wealth as

the capability to enjoy the necessities, conveniences, and amusements of life

Smith therefore insists, the principal causes of economic growth are ambition, the division of

labour, the balance of labour, the supply of labour, capital accumulation, and foreign trade.

3.1.1 Ambition

In his inquiry into the causes of economic growth, Adam Smith did not overlook the role of

human psychology, and proposed that there are two innate and unchanging characteristics of the

human psyche.

The first feature was mentioned in The Theory of Moral Sentiments, where he said that humans

are principally interested in things nearest to us, and less concerned with things further away. We

would therefore primarily look after ourselves, and are more capable of doing so than looking

after others: “Every man… is first and principally recommended to his own care; and every man

is certainly, in every respect fitter to take care of himself than of any other person” (Smith, 1759).

The second feature of human psychology, which actually followed from the first, was proposed in

The Wealth of Nations. Smith stated that we all have a desire to improve our condition: “The

desire of bettering our condition is a desire which, though generally calm and dispassionate,

comes with us from the womb, and never leaves us till we go to the grave” (Smith, 1776). The

quote is suggestive of a desire that is innate and almost of a biological nature.

Smith was careful to distinguish between self-interest and unbridled selfishness, and knew that a

prevalence of selfishness would degenerate a society into chaos. However, self-interest would be

kept in check by twin forces. In the moral sphere, self-interest would be kept in check by the

“sympathy” of individuals. In the economic sphere, it would be restrained by competition. This

was Adam Smith’s solution to the Hobbesian Dilemma, in which a country without government

controls would spiral into chaos, causing human life to be “nasty, poor, brutish and short”

(Ekelund & Hebert, 2013).

Self-interest, to Smith, was a natural means to further the good of society. By furthering one’s self

interest without even intending to serve the public interest, public interest is itself furthered

through the “invisible hand”: “By pursuing his own interest he frequently promotes that of the

society more effectively than when he really intends to promote it” (Ekelund & Hebert, 2013;

Smith, 1776).

3.1.2 Division of Labour

Adam Smith saw division of labour as the main cause of economic growth (Library of Economics

and Liberty, 2008). He illustrates the gains from division of labour in his pin factory example,

describing how productivity is greatly increased when there is specialization: “Each person…

might be considered as making four thousand eight hundred pins in a day. But if they had all

wrought separately and independently, and without any of them having been educated to this

peculiar business, they certainly could not each of them have made twenty, perhaps not one pin in

a day” (Smith, 1776).

Smith posited that there are three advantages to the division of labour. Firstly, each worker

increases in skill and dexterity since he/she is narrowly focused on only one task. Secondly, time

is saved as workers would not need to move from one task to another. Thirdly, it leads to the

invention of machinery. This is because a worker is more like to think of ways to accomplish a

task faster when all of his attention in consumed by that task alone (Ekelund & Hebert, 2013).

However, Smith points out that the different occupations that result from the division of labour

“seems to arise not so much from nature, as from habit, custom and education” (Smith, 1776).

The division of labour thus results not from natural endowments, but from doing and training.

This implies that each person is a tabula rasa at birth and can learn to take up any occupation, an

idea that runs counter to that of Plato’s belief that the division of labour results from natural

endowments.

Smith goes on to say that it is trade that makes the division of labour possible: “…it is the power

of exchanging that gives occasion to the division of labour…” (Smith, 1776). For example, a

shoemaker would not choose to specialize in making shoes, unless it was possible to trade the

shoes for food, clothing and shelter that he would need (Mr University, 2012).

Despite’s the advantages of the division of labour, Smith stated that ‘’the division of labour is

limited by the size of the market.” Smith makes this clearer when he said: “When the market is

very small, no person can have any encouragement to dedicate himself entirely to one

employment” (Smith, 1776). This makes intuitive sense when we look at an example of an ear,

nose and throat specialist. In a small town, one would hardly find such a specialist because there

are simply not enough people to justify the presence of such a service. In other words, larger

markets increase the incentive to specialize. When markets are large, there is also an incentive to

invest in machinery to increase productivity, which lowers cost per unit. According to Smith,

these larger markets can be created when there is trust and good government, free trade, a feasible

geography (i.e. cities and sea coasts), and natural liberty (Mr University, 2012).

3.1.3 The Balance of Labour

To Smith, “national wealth” (or GDP in today’s context) was measured by “the exchangeable

value of the annual produce of the land and labour of the country”, with the essence of wealth in

the form of the production of physical goods only (Smith, 1776). This led Smith to make the

distinction between two types of labour: productive and unproductive labour (Ekelund & Hebert,

2013).

Productive labour produced tangible goods of some market value, whereas unproductive labour

produced intangibles such as services performed by lawyers, physicians, musicians, the military,

and government bureaucracy. Smith himself even considered his occupation of a teacher to be a

form of unproductive labour (Ekelund & Hebert, 2013).

Smith spoke of services as having no lasting value by citing the example of a servant:

“His services generally perish in the very instant of their performance, and seldom leave any trace

or value behind them for which an equal quantity of service could afterwards be procured”

(Smith, 1776).

If revenues are not saved but instead spent on services, less capital is accumulated from savings

(the only means to accumulate capital). This inhibits economic growth since capital accumulation

is necessary for sustaining economic growth: “A man grows rich by employing a multitude of

manufacturers; he grows poor by maintaining a multitude of menial servants” (Butler, 2012;

Smith, 1776).

Due to the negative connotations of the word “unproductive”, it may come across that Smith was

criticizing services as useless when he called them “unproductive”. However, he was merely

distinguishing between enterprises that increased aggregate net investment, and enterprises that

only served household needs and thus did not further economic growth (Ekelund & Hebert,

2013).

3.1.4 The Supply of Labour

To Adam Smith, growth comes from labour. As mentioned in the previous section on the labour

theory of value, the demand for labour necessarily increases with an increase in the wages fund:

“The demand for those who live by wages, therefore, necessarily increases with the increase of

the revenue and stock of every country, and cannot possibly increase without it” (Smith, 1776).

Say’s Law followed from this idea that savings are not hoarded. Say’s law implies that it is

irrational to hoard money, as inflation may reduce the value of money: “Nor is he less anxious to

dispose of the money he may get for it; for the value of money is also perishable” (Economics

Help, 2013; Say & Prinsep et al., 1859).

The increase in wages brought about by an increased demand for workers allows workers to

spend more on wage goods, thus increasing aggregate demand and output in the next production

period. The supply of labour to match an increased demand therefore brings about economic

growth.

Consequently, Smith claimed that increased wages was an effect and cause of economic growth:

“To complain of it is to lament over the necessary effect and cause of the greatest public

prosperity” (Smith, 1776). Smith then cites the dismal case of underemployment and poverty in

China, the result of a stagnant economy: “…the poverty of the lower ranks of people… far

surpasses that of the most beggarly nations in Europe” (Smith, 1776).

A higher average wage causes workers to propagate more, thus increasing their number.

However, population growth does not continue unrestrained because a larger population strains

the wages fund. Therefore, in the long run, as mentioned in the section on the labour theory of

value, the average wage tends towards the subsistence level (Ekelund & Hebert, 2013).

3.1.5 Capital Accumulation

In Smith’s economics, capital refers to factory buildings, machinery, inventories and the ‘wages

fund’.

While division of labour starts the process of growth, capital accumulation sustains it, and is itself

an essential part of economic growth (Ekelund & Hebert, 2013; Adam Smith Institute, 2014).

Capital accumulation expands the wages fund, which can then be used to hire more workers, thus

increasing national output. Workers deplete the wages fund over time as they receive advances for

their subsistence during the process of production. When the production period ends, the goods

produced are sold, usually at a profit. This replenishes and increases the wages fund through

profit earned. Over time, profit accumulation increases the stock of capital, so that more workers

are supported and more output is produced in the next production period. The cycle perpetuates

itself, with capital accumulation sustaining it (Ekelund & Hebert, 2013).

However, Smith said that that savings is the precondition for the increase in capital: “Parsimony,

and not industry, is the immediate cause of the increase of capital” (Smith, 1776). By saving

instead of consuming, not only can more labour be hired, but new machinery can be invested in,

which enhances the division of labour. The more that is saved and invested, the more efficient

production becomes, leading to greater output. (Adam Smith Institute, 2014; Mr University,

2012)

Smith went on to warn that capital could be lost, through blunders or theft, or wasteful and

extravagant government spending. Therefore, governments should allow their people to

accumulate capital with the confidence that they can enjoy the prosperity it yields. They should

also be aware that taxation and spending may deprive a nation of its productive capital (Adam

Smith Institute, 2014).

3.1.6 Foreign trade

Adam Smith felt that unregulated foreign trade was another ingredient for economic growth.

Given that different countries have absolute advantage in producing different types of goods, he

believed this should be taken advantage of so that goods could be bought from the cheapest

market available: “It is the maxim of every prudent master of a family, never to attempt to make

at home what it will cost him more to make than to buy… If a foreign country can supply us with

a commodity cheaper than we ourselves can make it, better buy it of them with some part of the

produce of our own industry, employed in a way in which we have some advantage” (Smith,

1776). This meant that if wool could be produced in England at a lower cost than in France, and

France could produce wine at a lower cost than in England, then it would be beneficial for both

parties to exchange these goods. Government restrictions on trade would only make countries

poorer. (Economictheories.org, 2014)

Smith was critical of the mercantilists who saw government regulation of foreign trade as a

necessary means to maintain a “favourable” balance of trade, so that a country could accumulate

as much bullion as possible by selling to other countries more than they buy from other countries.

The mercantilists were misguided in thinking that a country’s wealth was measured by its

holdings of precious metals. To Smith, money was simply a medium of exchange, and people

want money because of the things they can buy with it. Furthermore, Smith felt that most wealth

is created and consumed domestically, and that the movement of precious metals in and out of a

country is unlikely to lead to the demise of a nation (Butler, 2012; Adam Smith Institute, 2014).

3.2 Relevance of Smith’s argument today

Smith focused on six main principles in his Wealth of Nation series; namely ambition, division of

labour, balance of labour, supply of labour, capital accumulation and foreign trade, as we saw

above. However one wonders whether these causes are still relevant in today’s context, and if yes

then to what extent and how? Smith has always been said to be the most significant influence in

the economics of today, and the discussion below only further adds to this claim.

3.2.1 Ambition: Relevance Today

Smith’s idea of ambition to drive market behaviour forms the base for the principle of demand

and supply. This motivating force is self-interest and it is a concept that many still believe to be

apt today.

Developing countries have a inclination to become better off, a social desire to maximise per

capita income - following Smith’s second feature of human psychology. China and India are good

examples of how this desire is exhibited, by building more infrastructure and generating more

business opportunities, and they have been greatly successful so far with large GDP growth.

China was even experiencing positive economic growth during the aftermath of the 2008 financial

crisis.

However, his statement of that legislation and regulations are ‘unnecessary and undesirable’ is

highly irrelevant in how there are market inefficiencies. There are a large number of positive

externality goods - like education - that are being underconsumed, and over consumption of

negative externality goods - like smoking and burning forests. The burning of forests in Indonesia

is a famous example of the latter.

3.2.2 Division of Labour: Relevance Today

Smith believes that division of labour plays a huge factor in economic growth, especially so for

specialisation. This means that nations should focus on what they are good at, keep doing it and

obtain things that they are not good at from others who are good at it. Developing nations follow

this pattern of specialisation because they lack the resources for higher level process, like specific

skills, advance machinery and infrastructure. They should specialise as the alternative would

waste their limited resources. Moreover, specialisation adds value to the productivity of the

employed, especially so for less developed countries (Weinhold and Rauch, 1997).

Smith’s three benefits from specialisation are relevant in developing nations. First, there are

increase in skills due to workers gaining tacit knowledge from having hands-on in specific fields.

They would be able to develop these skills greatly due to in-depth experience. Second, it helps to

reduce production time as specialisation can greatly improve efficiency of human labour. Also,

with specialisation, people would be experts in their field of choice and be more capable to

develop machinery and other innovations.

3.2.3 Balance of Labour : Relevance Today

There is empirical correlation between the degree of indsutrialisation and per capita income in

developing countries (Szirmai, 2009), showing that manufacturing benefits less developed

societies. Moreover, it offers special opportunities for both embodied and disembodied

technological progress (Cornwall, 1977 This is important for developing economies and nations

to ‘catch up’ to the developed nations. It empowers LDCs with skill sets that can be carried on to

other sectors - that is, they form the fundamental building blocks for future development and

growth. China is one such success story; garnering a growth rate of 10.4% in 2010. It became a

huge manufacturing industry, leveraging on its large population to develop a low cost leadership

to incentivise companies to manufacture in China.

However, services become increasingly important as a nation becomes more developed. When

economies industrialize, manufacturing employment and output both rise rapidly, but once

manufacturing’s share of GDP peaks—at 20 to 35 percent of GDP—it falls in an inverted U

pattern, along with its share of employment (Tybout, 2000). He goes on to reason that as wages

rise, consumers have more money to spend on services, and that sector’s growth accelerates,

making it more important than manufacturing as a source of growth and employment. This means

that services leads to higher GDP in the long run. For developing nations that are at the cusp of

being a First World nation, they should shift towards including more services.

3.2.4 Supply of Labour: Relevance Today

Smith states that labour itself fuels economic growth. In that sense, more people being employed

increases economic growth. Generally, this is true for both developing countries and developed

countries - represented by the long run aggregate supply model widely used in economics. More

employed leads to more resources available for the market and thus helps to generate growth.

Should developing nations rely solely on their human capital? No. Firstly, there is brain drain to

larger and more developed nations. They comprise mainly of the youths and smarter people

looking for better and easier opportunities and lifestyle. (insert footnote) This leads to not only

less human capital numerically but also less talents. Thus, developing nations are fighting to gain

economic growth while their people are leaving, and should look to alternative methods for

growth.

Secondly, smaller developing nations might reach their healthy natural unemployment rate faster.

This would restrict the amount of growth that is solely from the number of people working. As

such, they should find other methods for economic growth instead of relying on sheer number of

people employed.

There are arguments about how too much employment can cause inflation, but this is not a big

problem for developing nations who are far away from reaching their maximum level of

employment.

3.2.5 Capital Accumulation: Relevance Today

This is relevant in today’s period; advancements in technology has greatly helped economic

growth in developing nations. They lack many infrastructures and machinery that are prevalent in

developed nations. This cause them to be less effective and less efficient in the way they conduct

activities (Aschauer, 1989). Thus the increase in capital helps to increase productivity, generate

more growth. Smith’s relevance is further proven by the positive trend between GDP per capita

and capital stock per worker (Summers and Heston dataset, 1990).

However, Smith did not state a difference between quantity and quality, merely that nominal

numbers would have more growth. In the current period, quality would be more valuable for

growth.

Moreover, capital accumulation can lead to widening of the income gap. There is a saying of ‘The

rich gets richer, the poor gets poorer’. This illustrates the ability for those with wealth - in this

case, the developed nations - to be able to garner more capital due to greater purchasing capability

and have a higher level of growth than less developed countries. Thus Smith’s theory is not

relevant because capital accumulation is probably a minor step but is not enough for less

developed nations to catch up to the developed nations.

3.2.6 Foreign trade: Relevance Today

In today’s highly globalised and interconnected world, trade is done everywhere, and many

developed and developing countries have benefited from it. In these countries, absolute poverty

has declined by over 120 million (14 percent) between 1993 and 1998 (IMF, 2001). From this,

there is evidence that trade is relevant for today’s developing nations.

Moreover, developing nations would find that benefits from foreign trade can exceed the costs.

Smaller nations who are unable to produce certain goods - like rice, due to lack of fertile land -

can buy from those who has specialisation or competitive advantage in producing something.

Trade increases the amount of resources that a country can use and thus enables them to consume

beyond their budget constraints, leading to growth. The increased growth that results from trade

tends to raise the incomes of the poor in roughly the same proportion as those of the population as

a whole (Dollar and Kraay, 2001). This in turn can generate more income for the latter nation’s

poor, create more jobs for unskilled workers and reduce the income gap.

4.0 Adam Smith: An Advocate of Laissez-Faire Economics?

In addition to carrying the title of “Father of Economics,” a lesser remembered name coined for

Smith was that of,” The Laissez- Faire Advocate.” Excessive regulation of colonial trade by

parent countries alarmed Smith, and he wrote The Wealth of Nations, mainly as a reaction to the

mercantilist system, as we mentioned before. In this book, Smith describes the five main stages he

saw in the historical evolution of society: the state of hunters, the state of nomadic agriculture, the

state of feudal or manorial farming, and the state of commercial interdependence. The final stage

was the system of perfect liberty, and it became known as laissez-faire capitalism. The shift from

one stage to another, according to Smith, was induced by the desire for self-betterment and guided

by reason. He went on to elaborate that human beings are driven by passion, but at the same time,

regulated by reason. From this observation, he concluded that human involvement in economics is

"led by an invisible hand...without knowing it, to advance the interest of the society."

However, Smith’s reputation as an advocate of laissez-faire capitalism, caused debate over

whether this is an overstated misreading of his philosophy. The purpose therefore of the next few

passages is to uncover the truth to the debate.

4.1 Defining Laissez-faire

According to Wikipedia, laissez-faire refers to “an economic environment in which transactions

between private parties are free from government restrictions, tariffs, and subsidies, with only

enough regulations to protect property rights… The phrase laissez-faire is French and literally

means “let (them) do”, but it broadly means “let it be”, “let them do as they will”, or “leave it

alone””. In addition, Investopedia explains laissez-faire as “an economic theory from the 18th

century that is strongly opposed to any government intervention in business affairs, Sometimes

referred to as “let it be economics”. People who support a laissez-faire system are against

minimum wages, duties, and any other trade restrictions.”

Laissez-faire economics therefore, is an economic system in which there is a competitive market

economy where prices are determined by supply and demand. The economy is ‘free of any

government intervention’ in the strictest sense – except for the establishment and enforcement of

property rights. The market therefore is left to work off the principle of market forces to self-

regulate, which is, undeniably, a Smithian idea.

4.2 The Invisible Hand

Another aspect of his theory on capitalism is the term he coined to explain the natural workings of

human in the market: “The Invisible Hand.” Although the exact phrase was used only three times

in Smith's own writings, and even so in quite different ways, this concept is probably what he is

most famous for.

As defined by Investopedia, “The Invisible Hand” is “a natural phenomenon that guides free

markets and capitalism through competition for scarce resources”. In his book, The Wealth of

Nations, Smith wrote about someone who chose domestic products instead of foreign ones. A

quote with regard to this reads, “... 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”

(Smith, 1776). He meant to illustrate the behavior of consumers that they often will, and should,

only act for the benefit of themselves. But even as they engage in such a behavior, the society

unintentionally benefits.

In another quote Smith mentioned that “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...” (Smith, 1776) That is, the producers’

main intention is not to merely sell us food because they want to feed us, but because they want to

earn money. Similar to the explanation above, although producers seek to fulfill their true self-

interests, ultimately they would still feed the masses. As a result of this, the society gets to enjoy

increased well-being.

4.3 Smith's View of the Market

Adam Smith's way of assessing at the market might seem ordinary for us in this present time, but

in the 18th

century, it was quite revolutionary. Smith's main belief was that by the work of the

invisible hand, competition in the free market would lead to proper pricing in the economy, thus

higher output and incomes (especially the incomes of the poor), and the population would benefit

(Henry, 2008). Smith liked to use the phrase “the benefit of the people”. Many economists have

later translated this as “efficiency” even if the term almost never was used by Smith himself.

Smith was against government activities that operated against promoting national prosperity,

namely “bounties, duties and prohibitions to foreign trade; legal monopolies; and laws of

succession hindering free trade in land”, because he believed these to be “detrimental to the

nation's economic health” (Viner, 1927). Hence, it can be concluded that Adam Smith believed

in the laissez-faire system, at least to some extent.

4.3.1 How to Regulate the Market

While it is claimed that Adam Smith was a supporter of the laissez-faire system, he regularly

contradicts himself in his statements and beliefs by saying that the government must have a role

in the economic system, a least to a limited extent. Smith believed that the government should

maintain certain aspects of the economy that cannot be directed or controlled freely. However, he

still proposed that the market should function under some rules and regulations that could serve as

moral guidance for the market participants. Some examples of this were that he promoted the use

of paper money in banking, enforced contracts by a system of justice, and tried to ensure that

wages are paid in money instead of goods.

But what was probably his biggest violation of the laissez-faire system, was the idea of setting an

interest ceiling at 5 per cent. He claimed that this was “the price commonly paid for the use of

money by those who can give the most undoubted security” (Smith, 1776) which is also known as

the interest rate commonly charged to individuals with good credit ratings. He believed that this

would prevent speculators and overspending consumers from obtaining any loans at all and thus

restricting the funds for only those who were capable of using it more productively.

4.3.2 The Role of the State

Apart from the previously mentioned market activities, Smith also saw a place for government

intervention in certain public works that would enable what Smith believed was the general good

of the society. According to Rothbard (1995), examples of these government interventions could

be a government-run education system with the purpose of creating obedience among the

population. We can see clear evidence of this in the following statement, where he says that “An

instructed and intelligent people besides are always more decent and orderly than an ignorant

and stupid one.” (Smith, 1776)

Furthermore, Smith also wanted to discourage the consumption of liquor, which he believed to be

a “demerit good”. He argued that consumption of liquor has a negative impact on the population

and thus, the nation’s economy. Therefore, he called for heavy tax on production and retail sale

on all liquor beverages (Rothbard, 1995).

Other public works the government should provide, as Smith mentioned, included the prevention

of diseases from spreading among the population, preservation and cleanliness of roads and

streets and implementing a military defence (Smith, 1776).

4.3.3 Did Adam Smith believe in laissez-faire?

Finally, this section will conclude if Adam Smith was in fact, a firm believer in the laissez-faire

system or not. It might seem that whenever Smith’s work is discussed, a common conclusion

about him will be that he was a firm believer in laissez-faire. Nevertheless, as mentioned and

elaborated above, it can be seen that Smith was not that firm in his belief as a lot of people might

assume him to be. For that reason, it is noteworthy to look at the concepts of “Hard laissez-faire”

versus “Soft laissez-faire”. These terms are coined by John F. Henry in 2008. ”Hard laissez-faire”

is when there is “No need for the social order in the economy to be maintained by the

government”. The government's only task is to establish and enforce property rights (Henry,

2008). “Soft laissez-faire”, on the other hand, “….advocates limited government intervention in

the economy itself, including violations of the supposed law of markets” (Henry, 2008).

Therefore, an individual who firmly believes in the laissez-faire system can be considered a “Hard

Laissez-faire” supporter. On the other hand, a person who is a “Soft Laissez-faire” supporter is

open to interpretations. He can be mistaken easily to be someone who does not advocate the

laissez-faire system at all, for the extent of advocating limited government intervention is not

clearly defined.

Considering these definitions, it is relatively simple to say that Adam Smith believed in laissez-

faire. For instance, when he described the importance of the invisible hand, where he stated that

the government should not intervene in the market, but instead let it takes its natural course so as

to allow the economy to eventually reach equilibrium on its own. Yet, he contradicts himself by

stating that in some cases the government should intervene. Examples of these are educating the

population, establishing a nation’s military defense, cleaning the road and prevent diseases from

spreading among the people.

Thus, the perpetual debate of Smith and whether or not he believed in Laissez-faire substantially,

we believe, is difficult to determine based on the data available.

5.0 The Evolution of Smith’s followers

Smith was in actuality considered a mystery that was unsolvable. Many found the enormous and

unprecedented gap between Smith's exalted reputation and the reality of his dubious contribution

to economic thought, quite puzzling.Despite this and his contradicting and intricately woven ideas

and theories, Smith was still a hugely celebrated economist.

5.1 Smith’s Popularity and the Continuing Interest in His Work

From shortly after his own day, he was thought to have created the science of economics

virtually de novo. Books on the history of economic thought, would invariably start with Smith as

the creator of the discipline of economics. And all along, any errors he made were understandably

excused as the inevitable flaws of any great pioneer. Smith, as a figure of influence himself,

would have his economic thought and contributions become the platform for the development of

subsequent economic ideas, market mechanisms and theories by later economists in his time and

thereafter.

5.1.1 Reasons for Adam Smith’s Popularity

Even as most of Adam Smith’s ideas were derived many others’ ideas, he was, not only popular

during his time, but just as well-known to this day. The reason for his popularity is that his work

was the most systematic in the study of economics at that time. Not only in the past, but Smith’s

comprehensibility and relevance of his theories are applied to the real world until today. His

theories lasted the longest than any other economists. And also, his work gave the most basic

fundamental to the modern economics. Because of that, he was then called “the Father of

Economics”.

In addition, although there is no so-called “Smithian” model or theory, Adam Smith provided the

basic fundamental ideas of “growth” in his book “The Wealth of Nations” and also provided

critique of human’s behavior in another book entitled “The Theory of Moral Sentiments”. All of

these invoke thought and serve a reflection of improvements to be made thereafter.

5.1.2 Applicability in Present Day

Smith’s works and contributions were given much attention due to their comprehensive nature, to

which many people found influential in his time and those which followed. To this present day,

some of his material of thought can still be applied. For example, as brought up in his book, The

Theory of Moral Sentiments, at least two out of the three characteristics of man can be seen to

still be relevant in economics today. In a free-market economy, the use or practice of rational self-

interest in moderation, coupled with justice, will inevitably bring about economic well-being or

benefits to the nation’s people as well as between nations. This can be seen in the world of

banking and finance, where the customers more often than not, display self-interest, for they wish

to gain private benefits. Meanwhile, as Smith had advised, there is a need for regulations to be

imposed (justice) as a precautionary measure to avoid the collapses of banks.

In his other book, The Wealth of Nations, economic growth was the key subject of Smith’s work.

Factors for economic growth showcased by Smith invoke realization and thought for the people

of his generation and those in later generations. Most of these factors might still relevant and

appropriate for application in the present day with appropriate translation.

5.2 Smith as a Pioneer Classical Economist

Due to Smith’s systematic and comprehensive study of economics up until his time, his economic

thinking became the foundation of classical economics.

A main theme in Smith’s works illustrates how liberty in the economy would result in

equilibrium; it is in man’s nature to be motivated to better themselves and to move up the social

scale. At the same time, however, it is also inherent in man to help others. This is termed as the

Invisible Hand theory where it is the idea of how human nature could bring about equilibrium in

the economy. The very popular quote explaining the term; “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, 1776).

In addition, the laissez- faire system coined by Smith is undoubtedly the other main theme of

classical economics. For this, it is believed that free markets regulate themselves naturally without

much intervention.

Smith’s work and contributions provided the platform for other economists to build upon his

ideas which later contributed to the world of economics just as well. Two of those whom Smith’s

work had inspired include the likes of David Ricardo and Karl Marx, who would later develop

theories and ideas that benefit the world. One of Ricardo’s important contributions is the theory of

Comparative Advantage which is in support of free trade. And one of Marx’s theory which is a

somewhat contrast from Smith’s is his concept of surplus value.

5.3 Roots of Neo-classical Economics

Another continued interest in Smith’s work can be seen in the development of neo-classical

economics. Following the classical era, came the neo-classical era. This can be regarded as

contemporary or mainstream economics as we know today. Several theories, market mechanisms,

and ideas were derived from the classical era, with the key figure of influence to be none other

than Adam Smith himself. These include the further development of the demand function, theory

of the value of a good, and the introduction of the concept of utility1. This is unlike its earlier

counterpart, which dealt mostly with the derivation of cost of production, or the supply function.

The era of neo-classical economics was the time of popular economists such as Alfred Marshall,

John Maynard Keynes, Milton Friedman, etc.

John Maynard Keynes, who is well-known to us as the founder of Keynesian economics had

Smith as one of his figures of influence. Keynes had used Smith’s works, tweaked it, and created

a new form of economic system. An example would be that he noted that some issues that had to

be solved in the short-run instead of waiting for the natural occurring long run equilibrium.

Keynes contrasted Smith’s ideas and modified them to adapt to current situation, for example,

during the period of the Great Depression. This will be further elaborated in section The Role of

the Government.

Another influential economist during the neo-classical era was Milton Friedman. Friedman is

well-known to be a supporter of Smith’s works and an advocate of the laissez-faire system. For

his research on the stabilization policy, Friedman had drawn inspiration from the works of Smith.

1 It is said that Smith’s Invisible Hand theory played a large role which stated that private benefits and social benefits

will be in equilibrium in a free-market, or when laissez-faire exists. From this idea, the concept of utility was

formulated.

Unlike Keynes, whom Friedman was usually against of his theories, Friedman built upon Smith’s

ideas to show relevancy in modern times. As Friedman pointed out in 1976, 200 years after Adam

Smith, “We are in a similar state today - except that we must broaden the “tribes” of

“monopolists” to include not only enterprises protected from competition but also trade unions,

school teachers, welfare recipients, and so on and on.”

5.4 The Role of the Government

With regards to the role of the government, Smith was well-known to be very critical of the state.

This could be due to the state of governance at the time which drove his displeasure towards it.

Smith believed that the economy will be better off with little to no government intervention. This

was because he saw the government to be ill-informed and ignorant. He thought the government

does not manage public assets effectively, does not know the true extent of trade in benefitting the

nation, does not take into account the poor, etc. As a result, he thought the government to be the

body that obstructs the nation from flourishing and does not promote the wealth of the nation.

However, Smith did acknowledge the need for the government, to a certain extent, to participate

in the economic system. He believed that the government should look out for and maintain certain

aspects of the nation or the economy that cannot be directed or controlled freely. These include

the need for the government to provide and maintain national defense, uphold justice by erecting

laws and regulations, and provide necessary public works such as roads, harbor, etc.

With regards to how Smith’s work influenced future economists, Keynes had considered Smith’s

concept of the roles of the government in the economy and contrasted it such that the government

is portrayed to be an important player in the economy, especially during times of crisis. In the

time of the Great Depression, Keynes noted that the minimal participation of the government

would not aid the nation out of trouble. Instead of merely providing or maintaining the three

aspects mentioned by Smith, i.e. defense, justice, public works, the government, as Keynes

believed, should intervene and implement various stimulus policies which could greatly benefit

the economy.

6.0 Conclusion

Having left us with an immense ocean of economic thought and knowledge, Adam Smith,

unknowingly gave his successors in the field of economics and philosophy, a strain of thought to

build on. Providing a whole new and inspiring paradigm to the evolution of economic thought, he

has established concepts that continue to be brought to light and used even today. To completely

summarize the beliefs, theories and integrated works of Smith is a colossal effort, for he has given

us so much to think about.

It is for this reason that our paper attempts to display the history and notable contributions of

Smith, by taking you on a journey through his most significant work. A thorough understanding

of Smith seems more plausible when one is to consider the evolution of his thought process,

which has been done here by discussing the four key aspects of Smith’s life, teachings and

consequences. Firstly, the labor theory of value and its support for the free market mechanism.

Secondly, the principle causes of growth mentioned in Wealth of Nations and its relevance to the

real world; Thirdly, Smith’s view on laissez-faire; And finally, Smith’s popularity, and the

continuing interest in his work.

Although some people might argue that Smith’s works is inconsistent or inaccurate when applied

to the present era, in contrast to later economic thought or economists, Smith still deserved much

credit; Not only has his imagination and foresight benefitted the world and provided a platform

for the subsequent development of economic ideas, market mechanisms, and theories, but he has

also contributed immensely to the evolution of philosophical, systematic, and comprehensive

economic thought which continues to be of great significance even today. This however does not

imply Smith was completely supported, for the simple reason that being a human himself, he

probably did not have any greater confidence in his chances of success than we have today.

Despite the continuous paradox of contradictions that we encounter while talking about Smith,

one cannot forget that he was responsible for advancing many of the theories from the past and

for synthesizing them into a holistic system in a way many younger economists found awe-

inspiring. Perhaps more important than the specific theories he proposed, was his philosophical

contribution to lifting laissez-faire and freedom of individual choices to a paramount position in

economic thinking. Scholars after him, in the subsequent two hundred years, continued their work

in the same vein, trying to explore deeper into market mechanism and its various elements.

Finally, his powerful metaphor of 'the invisible hand' may be the most lasting contribution he left

behind for his posterity.

In conclusion, like many of the past generations we find ourselves saluting this great man for the

depth of economic knowledge that he has contributed to the economic thought of the past, and for

the continuous case of contradictions that he manages to evoke in every concept explained,

encouraging us in his own way to question everything we learn and be willing to accept opposing

thoughts on the same matter, using it as a platform for debate and learning.

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