Adam Smith was no Laissez-Faire Ideologue!

by Charley Dewberry


Today, economics plays a pivotal role in many arguments over social and political issues. On one side of the economic spectrum are individuals who focus on the issues of free markets and the limited role that government ought to play in economic issues. On the other side are individuals who focus on economic equality and the role government ought to play establishing that equality. I have interacted with individuals on both sides of the economic spectrum who, curiously, do agree on one thing: Adam Smith (1723-1790), the pioneer of political economy and author of An Inquiry into the Nature and Causes of the Wealth of Nations (commonly called The Wealth of Nations), was a laissez-faire (free-market) ideologue. I, however, do not agree with them.

When I ask people on both sides of the economic spectrum why they think Smith was a laissez-faire ideologue, they commonly reply that he supported the view that an economy works best when business is completely free (unfettered) from government control. They tell me that Smith argued that the best economic situation is one in which the government has no role in the economy because businessmen ought to be free economically to do as they please. Some sympathetic to capitalism and free-markets claim that this total freedom was Adam Smith’s primary point and that this freedom is a good thing. Some opposed to free-markets claim this freedom is a bad thing because a few individuals end up incredibly rich while many other people end up with virtually nothing. I would contend that individuals on both sides of this argument are wrong about Adam Smith—and the implications of his theory.

I am not interested in a scholarly defense of Adam Smith here, but I do want to show that Smith’s position is not only relevant today, but it provides common ground for dialogue between people with differing ideologies with regard to economics.

First, let us look at the term “laissez-faire.” French for “let do,” laissez-faire when applied to economics must be understood in the context of “mercantilism,” the economic doctrine that often focused on the ruler’s wealth, accumulation of gold, and government control of foreign trade. Jean-Baptiste Colbert (1619-1683) was the controller-general of finances under Louis XIV in France. Colbert’s goal was to micro-manage the economy to accumulate as much gold as possible, and thus he centralized France’s economy. He established export and import limits, set limits on some economic activities, and even specified standards for products in some industries. The story (apocryphal or not) goes that Louis XIV called a meeting with businessmen, and the businessmen proposed that the government “leave the economy to itself.” In the businessmen’s minds, leaving them free from government involvement and allowing competition to work would maximize the economic growth of the economy. A group of French economists opposed to Colbert’s policies, the physiocrats, used this notion of laissez-faire economics in their more general criticism of mercantilism. They argued that protecting France’s industries from competition by imposing tariffs and regulating labor by government and guilds inhibited the growth of agriculture and industry. In “laissez-faire” economics, then, the proper role of government in the economy is limited to protecting property and prosecuting violations of contracts; government ought have no other role in the economic sphere.

Although I do not believe Adam Smith was the laissez-faire ideologue that many people assume, there are reasons for thinking he sympathized with some of the principles of laissez-faire economics. He was very aware of the physiocrats, for example, having not only read their material but also having visited them. More importantly, though, Smith agreed—within limits, as we shall see—with two principles that are clearly in the laissez-faire camp: self-interest and competition free of government restrictions.

Self-Interest

Let us look first at the idea of self-interest. Some use Smith’s concept of the “invisible hand” to argue that he was a laissez-faire economist because he argued that the best interests of society are promoted through individual self-interest and that government therefore has no reason to restrict self-interest. They point to this famous passage in The Wealth of Nations [emphasis mine]:

But the annual revenue of every society is always precisely equal to the exchange value of the whole annual produce of its industry, or rather is precisely the same things with that exchange value. As every individual, therefore, endeavors as much as he can both to employ his capital in the support of domestic industry, and so to direct that industry that its produce may be of the greatest value; every individual necessarily labours to render the annual revenue of the society as great as he can. He generally, indeed, neither intends to promote the general public interest, nor knows how much he is promoting it. By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. (485)

Although Smith saw value in self-interest, he was not so naïve as to believe that individual self-interest always promotes the best interest of society. He recognized the real problems and dangers of unfettered self-interest. For example, he was highly skeptical of the motivations of businessmen. He did not believe that their self-interest naturally promoted the public good, as the following three examples will illustrate.

First, Smith claimed that all corporations and the greater part of corporate law had been passed to keep prices, wages, and profits higher than they would be with free competition (142). Furthermore, these laws were supported by businessmen to increase their profits at the expense of the public.

Second, Smith argued that any time businessmen meet together they are likely to conspire against the public good:

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. It is impossible indeed to prevent such meetings, by any law which either could be executed, or would be consistent with liberty and justice. But though the law cannot hinder people of the same trade from sometimes assembling together, it ought to do nothing to facilitate such assemblies; much less render them necessary. (148)

And third, Smith was highly skeptical of the motivations of people who make their living from stock (profits):

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 the most suspicious attention. It comes from an order of men, whose interest is never exactly the same with that of the public, who have generally an interest to deceive and even oppress the public, and who accordingly have, upon many occasions, both deceived and oppressed it. (287-288)

From the prospective of laissez-faire economists, if traders and manufacturers (businessmen) could conduct their business in an environment of unfettered regulation, it would result in an economy that allows competition to work and business to maximize its growth over time. Adam Smith did not believe this. As he saw it, unfettered regulation of business would result in businessmen hijacking the economy to maximize their profits at the expense of society. This, he claimed, was what the mercantilists in England were doing. In Smith’s mind, this kind of self-interest at the expense of others was a real problem with laissez-faire economics, and he recognized that society somehow needs to protect itself from it. So while Smith saw the laissez-faire framework as useful when thinking about a perfectly working economy, he understood man’s nature too well to believe that it is a practical economic system.

Even so, opponents of capitalism often accuse Adam Smith of advocating views that result in a few individuals accumulating most of the culture’s wealth while many individuals have little or nothing. But, while it is true that inequality of individual wealth or value can be considerable, the inequality is not necessarily the result of a few becoming rich at the expense of the many. This rich-over-poor perspective assumes that the amount of wealth or value in a culture is fixed. So, for example, if the top one percent of the population has fifty percent of the wealth/value, then it logically follows that ninety-nine percent of the population must share the remaining fifty percent of the wealth/value. Or, said another way, if the few rich individuals are accumulating a greater proportion of the wealth, they necessarily do so at the expense of the many poor. But Smith did not believe that the amount of wealth/value in an economy is fixed.

As Smith saw it, when two people make a transaction to trade items of value, the result is an increase in total value. Initially, both parties are interested in trading something that they have for something else. For instance, I may have a surplus of food, but I would like to have some wood to build a house. If I can find someone who has wood who would like to exchange it for food, then a situation may result in which both parties end up with more wealth/value as a result of the transaction. This is a “win-win” situation. Both parties to a transaction need to arrive at mutually agreed upon terms of exchange, and, when the transaction is complete, both have greater wealth/value than before the transaction. The wealth/value of a society, then, results from the accumulated transactions within the society. To illustrate this point, let me ask this question: Would you rather be Henry Plantagenet, king of England in the twelfth century and arguably the wealthiest man in the culture, or a member of a family of four making $40,000 a year (at the poverty level in the U.S.) today? The poverty-level family has significantly more wealth/value than Henry Plantagenet had. The fact that a few individuals have vast fortunes does not in itself diminish the point that the global economy has made everyone in it wealthier.

However, it may indeed be the case that the rich few are gaining and maintaining their wealth at the expense of the rest of culture. In this case, Smith argues that government has a responsibility to protect the culture from this sort of “self-interest”—an idea not at all compatible with strict laissez-faire economics.

Competition

Now let us look at Smith’s advocacy of competition free of government restrictions, another point of agreement with laissez-faire economists. Smith clearly was against government policies that restrict competition. He argued that the ideal situation with regard to labor is for each individual to be free to employ himself and his capital as he wishes (The Wealth of Nations, 114). He also argued that government should not interfere with economic competition (142). He viewed governmental policies in Europe as having restricted competition by giving exclusive privileges (monopolies) to corporations, by establishing guilds that limited the number of workers in a trade, and by establishing corporations in order to keep prices—and consequently, wages—high.

Unlike laissez-faire economists, however, Smith recognized that government has more than a minimalist role to play. We have already seen that he believed that government must not allow businessmen to sacrifice the public good for their personal benefit. And although he was highly critical of government regulation granting monopolies to corporations and believed that economic growth is promoted when competition is not impeded, nevertheless he acknowledged that there are times when it may be best for the government to grant a monopoly to establish a particular trade (814).

In Book V of The Wealth of Nations, Smith outlined what he considered the appropriate expenses of the kingdom or state, which shows what role he thought government should play. These expenses include providing for national defense, maintaining an independent judicial system to protect property and rights, building and maintaining public works and institutions that are useful but not capable of bringing a profit to individuals (these public works do not include roads and canals, by the way), supplying forts or ambassadors that might be required by trade, and starting trade with another nation for political reasons (which might require duties or customs paid for by a tax). Finally, Smith also believed that the state should pay to educate the working class because, he argued, the specialization of labor had led to mind-numbing repetition for long periods of time, with the result that workers were not able to develop their minds (846). Smith believed that educating workers would benefit society and that the government ought to pay for it. From the list above, it is clear that Adam Smith thought government should play at least a minimal role in the economy.

Conclusion

We have seen that Adam Smith would agree with at least two principles of laissez-faire economics: (1) he believed that free, self-interested economic transactions promote the well-being of society; and (2) he was highly suspicious of government’s attempt to regulate the economy and competition. And both Smith and laissez-faire economists would agree that the goal should be a free-market economic system based on competition. But Smith’s views differ from those of laissez-faire economists in this respect at least: They believe that if businessmen are allowed to pursue their self-interest, and if the government’s role is limited, for example, to protecting contracts, then a free-market economic system based on competition and the fastest growth will naturally result. Adam Smith would not agree. He believed that businessmen will, in their self-interest, try to limit competition, and therefore another mechanism is necessary for a free-market system based on competition to work. That mechanism is government. So, for example, Smith would have supported the U.S. government’s breaking trusts when the end result of the largely laissez-faire economy from 1870-1900 was essentially monopolies. Smith believed government has an active role to play in maintaining a free-market system, whereas laissez-faire economists want government to “let it be.”

Smith, then, was no laissez-faire ideologue, and he was careful to distance himself from those who were—for example, when he critiqued the economic system proposed by the laissez-faire physiocrats (The Wealth of Nations, Book III, Chapter 9). And I find it especially noteworthy that he never uses the term “laissez-faire” in the more than one thousand pages of The Wealth of Nations, even though he interacted with the framework throughout much of his book. Those who are sympathetic to free-market capitalism err if they believe that Adam Smith favored “unfettered” economic activity. But opponents of capitalism also fundamentally misunderstand Smith’s perspective if they claim he was a laissez-faire ideologue whose views result in a few individuals accumulating most of the culture’s wealth while many individuals have little or nothing.

Yes, Adam Smith shares a number of assumptions with laissez-faire economists. He thought the laissez-faire framework was useful, but he also identified serious practical problems with it, in particular its ignorance of human nature. In fact, the strength of Smith’s arguments is his even-handedness and his willingness to identify problems with and to acknowledge exceptions to the principles of laissez-faire economics. Clearly, for him, laissez-faire was not an ideology. Not to acknowledge Smith’s numerous and significant departures from laissez-faire economics is disingenuous.

So then, while Smith was sympathetic to laissez-faire proponents, he was not totally committed to laissez-faire economics. He was not as rigid nor as minimalistic as laissez-faire economists advocate. He did not see laissez-faire principles as absolutes. But Adam Smith did provide a great context for dialogue about economics, practically possible policies, and solutions to problems.

Copyright April 2012 by McKenzie Study Center, an institute of Gutenberg College.

Charley Dewberry