The Online Library of Liberty

A project of Liberty Fund, Inc.

• Foreword
• Economic Liberalism the Classical View
• 1: The Classical Psychology of Liberalism
• 1: The Theory of Moral Sentiments
• 2: The Lectures
• 3: The Wealth of Nations
• 4: The Achievement of Smith
• 2: The Political Ideas of the Classical Economists
• 1: The Political Philosophy of Hume and Smith
• 2: The Paradox of Economic and Political Freedom
• 3: Human Nature, History, and Government
• 4: The Nationalism of the Economists
• 5: The Structure of Government
• 6: Economic Improvement and Social Progress
• 3: Liberalism In the Great Century
• 1: The Importance of the Nineteenth Century
• 2: The Practice of Policy
• 3: The Meaning of Economic Liberalism
• 4: The Ideas of Policy
• 5: The Theory of Policy In Mill

3

The Wealth of Nations

In The Wealth of Nations Smith developed in detail the idea of natural order. There the natural order is offered as the ideal organization of society. That is because it represents man’s greatest opportunity to realize his desire for freedom and his best effort to utilize for himself and for society his natural endowments. It is not ideal in being the handiwork of nature, because in fact nature has little to do with its origin or being. If this natural order was offered by Smith as the best of all possible worlds, as some critics have contended, it must be understood to be no different from the least undesirable of worlds. In it Smith placed the third economic man to appear in his writings. The behavior of individuals is brought into harmony by competition. But now competition is not the exclusive instrument of control, and the exceptions taken to it are numerous and substantial. Smith in The Wealth of Nations is conditional in his judgment, skeptical, and sometimes sardonic. He imputes no natural goodness to men. He implies that if anything is natural it is more than a little ignobility. Their behavior is made harmonious by a process of mutual negation. The evil they wish and do injures no one but themselves, and the vast energies which their self-seeking releases are turned to the nation’s advantage. The essential difference between this natural order and that described in The Theory of Moral Sentiments is in the conception of justice. Justice is no longer regarded as the charge of a benevolent deity but as the particular care of government which exists for the very mundane reason of protecting property.

AVARICE, INDOLENCE, AND ECONOMIZING

The economic man of Smith’s last work differs from his predecessors of the other two works by the very great power of his material self-interest. He is driven relentlessly to improve his material condition, there being scarcely an instant of his life when he is not looking about for ways of adding to his fortune. Smith is extravagant in emphasizing this interest. In one passage he makes government and law crumble before it; in another, it is a universal trait uniting all men of all lands in a common humanity of self-seeking; in still another, it is a biological fact independent of environment and transmitted through successive generations by heredity, as when he writes that the desire to better our condition comes with us at birth. These passages have formed the conventional impression of the economic man. It was summarized by one of the more entertaining of the critics of classical economics, Thomas Love Peacock, in Crochet Castle, where the formidable Rev. Dr. Folliott is made to say:

Despite the connotations of Smith’s statements, self-interest is not directed only to material ends. An individual may find his interest in coddling his vanity; in exercising a natural desire to deceive and impose upon others and a just as natural desire to be gulled himself, in upholding his social position; in furthering animosity against his fellows; in supporting prejudices even more mischievous against foreigners; or simply in indulging his indolence. Indeed, the economic man may turn his efforts away from acquiring wealth and toward satisfying any inclination that may strike him. But among all of his desires there is no desire to be just and benevolent—an omission which can hardly pass unnoticed in view of the cardinal place these virtues have in The Theory of Moral Sentiments. In The Wealth of Nations the personality traits of individuals motivate their economic conduct; the motivation is not, as in The Theory of Moral Sentiments, a moral sense. One instructively can examine the relationship between the trait of indolence and that of pecuniary self-interest, because the relationship tells us much about Smith’s final conception of economic psychology (namely, that expressed in The Wealth of Nations). Smith said men love their ease and find labor to be painful. That is different from his saying men are driven into pursuing wealth—different but not inconsistent. Between the desire for wealth and the desire for a life of ease, the former is the stronger. But avarice does not eliminate indolence, rather is conditioned by it. Men look for ways of minimizing the effort necessary for acquiring wealth. They are, therefore, confronted with the problem of using scarce means to achieve unlimited ends. The economic man is a great respecter of the maxim, It is better to play for nothing than to work for nothing—a maxim, one may remark, that expresses the psychological disposition at the basis of the labor theory of value and all “pain cost” doctrines. The psychological setting in which Smith placed the economic problem does not make the problem any more real. Even if men were not indolent, they still would wish to use their time as efficiently as possible. But a characteristic of the age in which Smith wrote was to trace all problems back to the data of human nature.

Out of the relationship between avarice and indolence Smith developed his view of economic behavior, calling on certain other traits as the occasion required. In the interest of efficiency, men specialize their efforts and engage in exchange. Specialization enables an individual to impose on others a portion of the disagreeable labor which is inseparable from the pursuit of wealth. Far from scrupling to impose on others, he is led to it naturally. The economic man values his specialized talents in proportion to the amount of toil they enable him to escape and to shift upon others. He values his own product not by the labor it cost him but by the labor he would have to expend if he were to produce himself what he obtains in exchange. The labor he would have to use to produce what he buys is always greater (certainly never is less) than the labor he uses to produce what he sells. Viewing labor effort in this subjective way is perhaps a clue to the ambiguity in the more technical aspect of Smith’s theory of economic value. The view makes clear some of the statements in the first book of The Wealth of Nations where “labor command” and “labor quantity” are used interchangeably. Others, unfortunately, resist this interpretation.

The belief that man is naturally inclined to impose on others is of more significance, however, in suggesting a different view of economic motivation than for the light it may throw on the labor theory of value. This inclination can be taken as something that supports specialization and in other ways promotes economic activity, or it can be taken as a disposition that finds a reward in its own exercise. Smith occasionally verged on saying that men engage in specialization because it is an outlet for their egoism, which is to say that labor is its own gratification and not a means to something else. It cannot then be painful—unless individuals are afflicted with some sort of perversity which drives them to make life unpleasant for themselves or for others. Though Smith was skeptical of the quality of human motives, he seems not to have been interested in ferreting out perversity. His suggestion that the market is governed by egoism is significant for anticipating the modern notion that economic activity can be its own reward, that it often has the character of a game played more for its intrinsic interest than for its prize.

Smith, however, did not pursue the idea. He placed specialization predominately at the service of pecuniary desires and he made egoism the ultimate motive of all behavior. He strongly suggested that if men are observed closely, whether on the market, in politics, in the classroom, or in casual association, their self-seeking will reveal itself. Among the lower classes, egoism is necessarily directed toward making a living, and the behavior of the workers is governed mainly by economic circumstances. Their success in acquiring the materials of life has much to do with their moral and intellectual merit. If they escape poverty and are secure about the future, the masses will turn to the practice of virtue and wisdom. If, however, they are poor and uncertain about tomorrow’s wage, their need to make a living will overwhelm all other interests, and any other activity will be beyond their power. What Smith implied is that for the greatest part of the population, happiness, truth, beauty, and goodness depend on real income. This idea, one should notice, is just the opposite of the idea expressed in his first work that wealth does not bring happiness and that those who pursue it will be disappointed.

Although their behavior is more thoroughly colored by it and their outlook is wholly dependent on it, the common people are not alone in being materialistic. The same characteristic is disclosed in men of all classes and nowhere more certainly than in their political behavior. This is apparent in Smith’s remarks on government, the point of which is that cupidity explains most conduct—or, more accurately, misconduct. When he said that avarice is the occasion for most wrongdoing, he was repeating what his age took from Cicero, one of its political mentors. Cicero said that men usually are led to do wrong by their egoism and that “in this vice, avarice is generally the controlling motive.”6

Notably missing from The Wealth of Nations is the ingenuous psychological explanation of sovereignty which is in The Theory of Moral Sentiments and is intimated in the Lectures. In its place, there is a theory of government which at times is materialistic enough for an economic determinist. The pathetic political man of Smith’s first work is pushed aside by a calculating individual who respects the authority of government because it protects his wealth—or because he thinks it does. Although he agrees to respect the property rights of everyone, especially those who are richer than he, he does so only because he fears that disrespect for authority will expose him to the cupidity of those beneath him.

• No thing in use by man, for power or ill,
• Can equal money. This lays cities low,
• This drives men forth from quiet dwelling-place,
• This warps and changes minds of worthiest stamp,
• To turn to deeds of baseness, teaching men
• All shifts of cunning . . .

These lines of Sophocles express the idea that was a starting point for most of the political speculation of the seventeenth and eighteenth centuries. The Enlightenment infused the idea with a faith in the capacity of men to know that their long-range interests required them to respect authority and to know that these interests were more likely to have a satisfactory outcome in an environment governed by the free market.

SELF-INTEREST AND DISHARMONY

When Smith passed from discussing social activity in the large to examining its minutiae, he again stressed the power of the pecuniary interest and was quite frank in noting that it frequently had undesirable consequences. Because the remuneration of lawyers and their clerks was proportioned to the length of the documents they prepared, they so extended them as to confound the language of the law. Since university professors received a guaranteed stipend, they were lax in their instruction, and education fell into a wretched state. Wealthy families of the time engaged traveling tutors for their sons—than which nothing could be worse for both tutor and pupil, Smith declared (possibly out of experience because he had been a traveling tutor). But to allow the pecuniary interest to operate among the clergy would produce a particularly odious form of competition, because if the income of a clergyman were to depend on the size of his congregation the advantage would go to those who played on the superstition of their charges, leaving religion to suffer and zealotry to flourish. About the value of competitive behavior in the professions, Smith was pragmatic. In certain instances, such as education, he felt that pecuniary sanctions had been too far removed, while in others he was opposed to applying them—at least to applying them as strongly as in the market for ordinary goods and services.

But Smith did more than question the social merit of the desire for gain. In the passages that were not expressly about economic policy he often questioned the power of the desire and occasionally its very reality. There are few chapters in The Wealth of Nations which do not in some way qualify the idea that the acquisitive instinct is relentless and invincible. The economic man is much affected by his environment and most liable to passing fancies. He is, Smith observed, a very vain creature. Although vanity is an expression of egoism it does not lead him to a successful maximizing of economic values. Indeed, it often defeats the pecuniary interest, turning men away from prudent investment to an ostentatious use of wealth. They carry their pride to the market place and take absurd risks with their fortunes. Smith observed that a common failing, not only of the vain but of every person in tolerable health and good spirits, was to overestimate the chance of gain, to regard himself a favorite of fortune. Sometimes, however, conceit is restrained by the desire for security, especially after a few spectacular failures have chastened an individual’s conceit. He then may be averse to taking even a reasonable risk. In addition, there are other traits which stifle or divert the operation of the pecuniary interest, such as irrationality, error, ignorance, indolence, and inertia. All of them turn an individual away from the most economic use of his talents and occasionally from gratifying any desire whatever. Of the many examples which Smith provides, two may be cited. A merchant may so avidly desire to monopolize the market that he fails to anticipate the monopolistic behavior of others, and all may find their avarice disappointed. Individual workers do not always seek out the market in which the highest wages are paid, because they may be ignorant of alternative opportunities or they may be held to their jobs by sheer inertia.

The environment of an individual as well as his distinctive psychological traits modifies the expression of the acquisitive instinct. Smith stated again in The Wealth of Nations that the form in which agricultural land was held during the Middle Ages impeded economic progress and the accumulation of capital. He observed that social custom casts some occupations into disrepute and makes for differences in wages and profits—differences which could not exist in an impersonally perfect market. Finally, the form of government and the character of the laws interfere with the maximization of returns, this influence being shown most clearly in national animosity against foreigners and unavoidably in the requirements of national power.

One can easily cite many more instances in which the pecuniary interest fails to operate perfectly or does not operate at all. These however should be sufficient to show that the economic man of The Wealth of Nations was not the creature he is reputed to be. Indeed, in those passages where Smith is not exposing the futility of political efforts to restrict the pecuniary interest he is as often as not explaining that the interest either operates imperfectly or to the disadvantage of society. The “uniform, constant, uninterrupted effort of every man to better his own condition” is in fact not uniform, is inconstant, and frequently interrupted; the acquisitive instinct which “comes with us from the womb, and never leaves us till we go into the grave” is really not that basic at all.

When Smith wrote of the great power of material self-interest, what he probably meant to do was to describe a tendency of behavior; and when he said this interest was beneficent, he probably meant that to control it was risky. The beneficence in fact depends mainly on environment. He observed that if obstacles were placed in the way of the pecuniary interest there would result a great waste of resources. That, he believed, had happened in the medieval era. Because men had little opportunity of turning their efforts to profit, they were indolent. The resulting economic loss was a misfortune, and so too was the kind of moral atmosphere that indolence and dependence breeds. In writing of his own age, Smith implied that its superiority lay in the measure to which the pecuniary interest was given a wider area of freedom and operated under more equitable laws. Freedom brought an increase in the wealth of the nation, and with the general plenty that ensued there was, he felt, an elevation of moral and intellectual standards.

Nevertheless he did not offer his age as a model. It was neither ideal nor the best to be had. This conclusion is implied in his strictures against the economic behavior of his times and in those remarks in which he intimates his conception of the ideal as opposed to the economic man. Where Smith’s age failed to achieve all within its power, its failure was the result of stifling the pecuniary interest or of allowing it to operate unequally. Hence, his condemnation of political attempts to control the “industry” of individuals; his excoriation of monopoly, as a denial of the equality of a competitive market; his clearly evinced sympathies for the poor as victims of the inequitable effects of “industry,” and his implied proposals for something resembling progressive taxation.7 These criticisms were the negative side of his conviction that the free market is the best possible method of organizing—and controlling—economic activity. If there is a free market, the expression of the pecuniary motive usually produces a desirable effect. However, if the market is not free the result may be outrageous, and the only remedy for too little freedom may be even less of it. If, for example, society is so unfortunate as to practice slavery and is averse to abolishing it, Smith suggests that the proper policy is for the government to interfere with the free use of property rather than to look on indifferently while the master treats the slaves as he pleases. The faith in a benign arrangement of social relations, which is manifested unequivocally in The Theory of Moral Sentiments and often ascribed to Smith’s last work as well, is disclosed in The Wealth of Nations only in the belief that economic freedom can produce a harmonious (i.e. acceptable) social order. Although far from ideal, the order is the best within man’s limited capacity.

But man’s poor powers left Smith restive. In going over the more critical passages of The Wealth of Nations, one feels that Smith’s private ideal was different from what he urged on the world. He was dismayed by much economic behavior even when it was competitive. He reiterated in his last work all of those deficiencies of the enterprise economy which he had put down in the Lectures: the feeble sense of justice, the disregard for wisdom, the flamboyant use of wealth, the indifference to social responsibility, the dispirited outlook of the lower classes. The good life, according to Smith, seems to have meant the performance of good works and the cultivation of knowledge. His aversion to the habits of businessmen had become so pronounced in his final work as to leave little doubt that however practicable he thought competition to be, he did not thereby approve of the psychological traits that produced it. “Of the money-making that depends on troublesome going about and seeing people and doing business” he had little use, no more than Plutarch ascribes to the Spartans under Lycurgus. If there is a common theme running through all of Smith’s works, it is an underlying disquietude with the moral and intellectual tenor of a commercial society. In view of the uses to which The Wealth of Nations has been put and of the place it gave Smith in history, this is paradoxical. The philosopher who did more than anyone to justify the ways of the free economic man found him personally distasteful.

THE COMPETITIVE HAND

The natural order which is the achievement of the economic man is a system that on examination turns out to be almost identical with the conception of perfect competition in modern price theory. Exchange to be effective must be impersonal, Smith stated in demonstrating the folly of bilateral trade. There must be mobility of factors of production and a free movement of goods between regions and countries. Buyers and sellers must know the conditions of the market in order for their activity to have the most desirable effect. Finally, there must be many buyers and sellers.8 All that is missing, as a student of price theory will notice, is a homogeneous product.

Competition is possible only in the presence of certain political conditions. In prescribing them Smith was decidedly negative. Laws must be established to make property secure, including the property each man has in his own labor, and security calls for an exact and equal administration of justice. The political reforms for which Smith asked did not call for the passage of as much new legislation as of the repeal of old, such as the laws supporting monopolies, the tariff and other restrictions on international trade, and the ill-conceived efforts of the state to regulate production and consumption. Let the governors look after their own affairs, and the people can be trusted to look after theirs—so Smith summarized his negative position. Actually many of the restrictions he wanted to remove had been allowed to lapse by the refusal of the courts to enforce them, even though the laws that authorized them had not been repealed.

It will be observed that the economic and political elements of the natural order are not the work of a divine power. They are produced by wholly secular forces. The harmony in this order comes from the mutual advantage of exchange. The advantage in turn comes from the specialization of labor and the exchange of its product. Specialization makes for an efficient use of resources. It does so by allowing each individual to cultivate his particular genius and so obtain maximum efficiency; by permitting him to produce as much as he pleases and so secure the disposition between effort and leisure most satisfactory to himself; and by allowing him to exchange his product for that of others of dissimilar abilities on terms satisfactory to all of them. Each man knowing he can exchange his product for that of others will exert his industry in order to obtain as much as possible for himself, and with all men doing this a “general plenty diffuses itself through all the different ranks of society.” This idea is usually criticized by disputing the contention that the maximizing of individual incomes necessarily maximizes the real income of society. An individual, it is pointed out, may obtain a greater income by restraining his industry than by exerting it. This is of course quite true, but it is not a refutation of Smith’s conception of natural harmony. Indeed, it confirms what he had to say. If competition does not rule, the restricting of effort may raise the incomes of monopolists, and that was why Smith opposed them.

The competitive harmonies reveal themselves on the market in the system of relative prices. As consumers, individuals pay the lowest possible prices for what they buy, and producers are able to sell at low prices because of the efficiency that competition forces upon them. The wages of labor rise to their natural level (that which permits the population to maintain itself), because no single employer can force them down. Capital, being free to enter the areas of greatest yield, becomes allocated to the most productive uses. Harmony, it must be repeated, is not produced by any benevolence inherent in individuals, or by the wisdom of government, or by the generous disposition of nature. It is the outcome of the pecuniary interest operating under conditions that make no other outcome possible. The famous invisible hand of The Wealth of Nations is nothing more than the automatic equilibration of a competitive market.9

There were two sides to Smith’s argument for competition. One was that competition serves the material interests of the individual. The other was that competition adds to the power of the state by increasing the national output. Both sides of the argument elucidate his thesis that only through freedom can the welfare of the nation be increased and can individuals realize their natural rights. In this sense did he believe that what was good for the individual was good for society.

He was not, however, optimistic about achieving such a social order. If the entrenched prejudices of the public against competition could be overcome there would remain the more formidable resistance of vested interests, the defeat of which he thought was very unlikely. This alone should dispose of the notion that he believed the competitive order was part of the ineluctable workings of benign nature. Not only was he far removed from such a faith but he was far also from having much confidence in the ability of individuals to know their own welfare. If he was at all optimistic, he was so only in thinking that the economic man, as frail as he was in understanding and frailer still in execution, still knew his interests better than his governors could know them, and in thinking that the economy would be better off if each individual looked after his interests in his own way.

There is still another qualification which must be made to the beneficence of the pecuniary interest. Even when the interest is expressed in a competitive market, it has only a tendency to produce a harmonious order. Smith did not say that competition invariably produces the greatest possible wealth and the most desirable distribution of it. (And of course he denied with even greater force that the operation of avarice is desirable in every kind of an environment.) In the most free of markets, individual enterprise will not find the supplying of certain indispensable goods and services to be profitable, and they must be supplied by the state or not at all. Apart from this failing, free enterprise divides the national wealth in a way that is deficient by most standards of distributive justice. Individuals will receive what they are worth on a free market, but the way in which the market values their services and the way in which they should be valued will be two very different things if power is unequally distributed.

[6] Cicero De officiis, trans. C. W. Keyes, i, 7.

[7] Adam Smith, The Wealth of Nations, ed. Edwin Cannan (New York, 1937), pp. 683, 794.

[8]Ibid., pp. 59-60, 128-129, 460.

[9] See F. H. Knight, “The Sickness of Liberal Society,” Freedom and Reform (New York, 1947), p. 377.