2. Adam Smith and Economic Progress

Thorstein Veblen (1898) criticized the classical authors for studying economics in terms of tendencies towards static equilibrium and not in an evolutionary sense. But the classical authors did not present these tendencies as definite end results since they believed in a process view of competition. Mill (1844) talked of disturbing causes which implied that economic laws and generalizations had to be stated with due qualifications and allowances. Henry Sidgwick (1887) later commended Mill’s approach of stating the classical doctrines in a guarded fashion.

See Chandra (2004a) for an account of the institutional basis of the division of labour and Chandra (2004b) for the critical assessment of the view that Smith was an equilibrium theorist.

Smith did not regard man as a “rational economic man” in the sense of utility (or profit) maximiser. The details of his broad approach to self-interest, which is based on a desire to better one’s condition, is taken up below in the next section.

Increase in skills of workers is akin to “learning by doing” which, in turn, is linked with the growth of employment opportunities resulting from capital accumulation, as noted by Eltis (1975, p. 427).

Buchanan and Yoon (2000, p. 43) argue that Ricardian explanation of trade in static terms (i.e., in terms of comparative advantage) led to Smith’s insights regarding growth and international trade, and their link with increasing returns, being almost forgotten. “To Smith, mutually beneficial exchange emerges because of specialization, which, in its turn, implies the presence of increasing returns to the size of the exchange nexus. In the Ricardian logic, by contrast, trade presumably emerges because productive resources differ in their ability to create economic value… Comparative advantage ensures mutuality of gain. But, in this explanation, there is no direct linkage between the size of the exchange network and the degree of specialization that is viable. There is no need to introduce increasing returns. Comparative advantage may be present even if there are constant returns to scale, both for the economy and for its separate productive sectors”.

Smith’s theory of international trade is also termed as “vent for surplus” theory.

Smith believed that the desire to better one’s condition does not arise to meet bodily needs which even an ordinary worker is able to satisfy. This desire in man arises to gain approval, admiration, and respect from his fellow men; by becoming economically successful he is able to rise in society.

As Coase (1994, p. 116) points out: “It is wrong to believe as is commonly done, that Adam Smith had as his view of man an abstraction, an ‘economic man’, rationally pursuing his self-interest in a single minded way. Smith would not have thought it sensible to treat man as rational utility maximiser”.

Physiocrats regarded agriculture to be the only productive sector and manufacturing as sterile. They thought that manufacturing only transformed the materials used as inputs without adding any value. Smith, though much influenced by physiocrats, regarded both agriculture and manufacturing to be productive. But he did state that in agriculture nature worked with man implying that in manufacturing it did not. His attitude towards rent as a “bounty of nature” also reflected a similar bias.

“People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices” (Smith 1776, I, p. 144).

“The proposal of any new law or regulation of commerce which comes from this order, ought always to be listened to with great precaution, and ought never to be adopted till after having been long and carefully examined, not only with the most scrupulous, but most suspicious attention. It comes from the order of men, whose interest is never exactly the same as the public, and who have generally an interest to deceive and even to oppress the public, and who accordingly have, upon many occasions, both deceived and oppressed it” (ibid., I, p. 278).

Nathan Rosenberg (1960, p. 557) lamented that, as a result of increasing formalization of economics as a discipline, the institutional content and preoccupations of Adam Smith’s Wealth of Nations had suffered a prolonged neglect. The widely held view that, if each individual is allowed to conduct his own affairs his own way it leads to a most rapid increase in the wealth of a nation, is not so much wrong as uninteresting. “By jumping directly from the conception of a man as a rational creature to the policy recommendation of laissez faire and all that, it completely short-circuits much of the substance of Smith’s work. By visualizing the human agent as engaged in the effort to maximize a single, unambiguous magnitude, two aspects of Smith’s book and the crucial importance of the interplay between them are ignored: (1) his much more elaborate conception of the conflicting forces which impel the human agent to action and, as a direct result, (2) his sustained enquiry into the ultimate impact, in terms of human action and its welfare consequences, of different kinds of institutional arrangements” (ibid., p. 557). Adolph Lowe (1975) also emphasizes the importance of institutions in the formation of which human choices play an important role: “Inexorable as the process of growth, the political and social conditions from which alone it can take off and by which it is sustained are not by themselves preordained. They are the product of history, but of history in which human choices in the form of political decisions play a decisive role” (ibid., p. 423).

At another place Smith (ibid., I, pp. 411–12) writes: “The experience of all ages and nations, I believe, demonstrates that the work done by slaves, though it appears to cost only their maintenance, is in the end dearest of any. A person who can acquire no property, can have no other interest but to eat as much, and to labour as little as possible. Whatever work he does beyond what is sufficient to purchase his own maintenance, can be squeezed out of him by violence only, and not by any interest of his own”.

The balance of trade doctrine to enrich a country was advocated by an early mercantilist Thomas Mun (1664). According to Smith, nothing could be more absurd than this doctrine on which almost all regulations of commerce were founded.

Smith (ibid., I, p. 16) stated “that the accommodation of an European prince does not always so much exceed that of an industrious and frugal peasant, as the accommodation of the latter exceeds that of many an African king, the absolute master of the lives and liberties of ten thousand naked savages”.

See for example Milgate (1987, p. 105) who observes: “Equilibrium is, as Adam Smith might have put it (though he did not use the term), the centre of gravitation of the economic system – it is that configuration of values towards which all economic magnitudes are continually tending to conform”.

Smith (1776) observed that an increase in demand may raise prices in the short run, it never fails to lower them in the long run. “It encourages production, and thereby increase the competition of the producers, who, in order to undersell one another, have recourse to new divisions of labour and new improvements of art, which might never otherwise have been thought of” (ibid., II, pp. 271–72). Smith also stated that the natural effect of improvement was to lower gradually the price of almost all manufactures (ibid., I, p. 269).

The neoclassical conception of equilibrium ignores (or displays ignorance of) Mill’s “disturbing causes” and Young’s (1928) “counterforces”. The counterforces themselves may be so strong that the end result may not be equilibrium but disequilibrium. Even Marshall (1890) recognised this and placed his static analysis in an evolutionary framework which unfolds slowly.

In Smith competition does not lead to Pareto optimality or some optimal end result. See, for example, Reid (1989) who points out that competition as a process needs to be distinguished from competition in terms of certain optimizing properties like all markets clear, prices are equated to marginal costs and factors of production are rewarded in line with their marginal productivity. See also Blaug (1999) who talks about competition as a “process of rivalry”. He points out that it is this view of competition which the classical authors such as Smith, Marx, and Ricardo had in mind; it is only after Cournot’s notion of perfect competition, an end-state conception, that competition went down a new road. Even then Marshall, as well as the Austrians, subscribed to the earlier classical view of competition.

While some authors (e.g., Salter 1994) have suggested that Smith’s notion of justice is confined to commutative justice in the sense of having one’s body free from injury and liberty free from infringement in the tradition of natural law theories, others (e.g., Witzum 1997) argue that distributive justice cannot be divorced from Smith’s conception of justice as “Smith does not have a theory of rights which can be easily distinguished from his general ethics” (ibid., p. 242).

In Smith the tendency towards a falling rate of profit arises due to competition among capitalists and declining profitable opportunities as capitals increase. In contrast, Ricardo explained this tendency in terms of diminishing returns and land scarcity in agriculture. For Smith low profits were not a threat to growth as high profits not only destroyed parsimony of the business class but also signified a society going fastest to ruin. See also Winch (1997, pp. 396–97).

“A country which neglects or despises foreign commerce, and which admits the vessels of foreign nations into one or two of its ports only, cannot transact the same quantity of business which it might do with different laws and institutions. In a country too, where, though the rich or the owners of large capital enjoy a good deal of security, the poor or the owners of small capitals enjoy scarce any, but are liable, under the pretence of justice, to be pillaged and plundered at any time by the inferior mandarins, the quantity of stock employed in all the different branches of business transacted within it, can never be equal to what the nature and extent of that business might admit” (Smith 1776, I, pp. 106–7).

“It deserves to be remarked, perhaps, that in the progressive state, while the society is advancing to the further acquisition, rather than when it has acquired the full complement of riches, that the condition of the laboring poor, of the greatest body of the people, seems to be the happiest. It is hard in the stationary, and miserable in the declining state. The progressive state is in reality the cheerful and the hearty state to all the different orders of the society. The stationary is dull; the declining melancholy” (ibid., I, pp. 90–91). Smith further stated that the liberal reward of labour, though results in an increase of population, also increases the industry of the people (ibid., I, p. 91).

See also Blaug (1997, p. 60) who points out that Smith’s faith in the invisible hand had nothing to do with allocative efficiency à la Walras and Pareto. Effort to enlist Smith in support of the “fundamental theorems of welfare economics” is a “historical travesty of major proportions”. Smith had a process conception of competition instead of an end-state conception. Moreover, a decentralized competitive price system had dynamic effects in enlarging markets and promoting the division of labour.

Schumpeter (1954, p. 187), in fact, indirectly criticised Smith for placing too much emphasis on the division of labour. As is well known, Schumpeter’s (1911, 1942) theory of growth is based on the central role of the entrepreneur as an innovator and adaptor of inventions. In his theory of creative destruction or economic change, demand factors like the size of the market or the resulting specialization (or the division of labour) do not find any mention. His emphasis is mainly on supply factors such as new technology, new methods, new products, new sources of supply, and new organization (large-scale units). Thus the competition that matters is not price competition, and agency making for economic change, as noted by Rosenberg (2002, p. 10), is innovation defined broadly to include more than technological innovation.

However Schumpeter (1954, pp. 184–87) also stated that there was nothing original about Smith’s treatment of the division of labour or indeed any other idea contained in the Wealth of Nations. Smith, being a methodical professor, performed the role of “co-ordination” extremely well. He never went beyond “plain common sense” and “never moved above the heads of even the dullest readers”. He was full of “trivialities and homely observations” and never taxed the “reasoning power” of his readers. Further: “His very limitations made for success. Had he been more brilliant, he would not have been taken so seriously” (ibid., p. 185). Cannan (1929, p. 96) also noted that Smith’s treatment of the division of labour is neither original nor complete. See also Groenewegen (1977, 1987), who points out that Smith’s account of the division of labour contains a number of weaknesses.

See, for example, Buchanan (2008, pp. 23–24) who notes that the “division of labour” may more inclusively translate as “specialization”. He also noted that Adam Smith’s pin-factory example has created confusion among economists who have come to associate specialization with economies of scale. This close association need not be present at all, and introduces ambiguity in the distinction between economic and engineering aspects of relationships.

This apparent priority to agriculture does not arise as result of favours to that sector but as a result of market-determined higher rates of return, as noted by Reid (1989) and Hollander (1971).

Cannan (1976) quoting from Lectures (Cannan 1896) which Smith read at Edinburgh during the winter of 1750–1751, and which according to Dugald Stewart contained “many of the most important opinions of the Wealth of Nations”, points out that “Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism, but peace, easy taxes, and a tolerable administration of justice; all the rest being brought about by the natural course of things” (ibid., p. xI).

For the view that Smith was a “market-failure pioneer”, see Hollander (2013). Hollander also approvingly refers to J.S. Mill who had depicted Robert Lowe as “an enemy of political economy” for attributing a simplistic version Laissez faire to Smith.

See also Chandra (2020), pp. 47–48.

At another place Young stated: “[N]o first rate economist ever was an upholder of laissez faire – though some second rate economists were: e.g., Bastiat” (Young 1990, p. 26).

Smith was clearly aware that the provision of public goods cannot be left to the market. See, for example, Musgrave (1976, p. 298) for the view that Chapter I of Book V could be treated “as a fore-runner of the modern theory of social goods”.

See, for example, Thomas Wilson (1976) who observes: “Smith’s concern with results and motives led him to recognize that all may gain from activities in which the various participants are guided only by self-interest” (p. 77).

Smith stated that when commerce is introduced in any country probity and punctuality always accompany it. The traders deal so often that they find honesty is the best policy (See Cannan 1776, p. xxx).