For Smith, the ideal functions of government were few and well defined. In his classic work, An Inquiry into the Nature and Causes of the Wealth of Nations , written in , Smith outlined three important government functions: national defense, administration of justice law and order , and the provision of certain public goods e.
Clearly, government has grown beyond the bounds of these simple duties. Some would argue that government has expanded because of necessity, that modern society requires redistribution of wealth for stability and regulation to constrain the excesses of an unfettered market.
Many believe it is unrealistic for government in the twenty-first century to adhere to the limited roles envisioned by Smith. We have our doubts about these arguments. When we examine evidence on this question, the findings are striking. We first categorize national government expenditures according to whether or not Smith would support them.
Under the category Smith would support, we include expenditures on national defense, administration of justice, transportation, and education. We consider social expenditures on Social Security, Medicare, health, income security, and labor and social services beyond the bounds that Smith would support. The Americans also had to ship their exports on British ships. Regulations prohibited transporting woolen products from one colony to another.
Laws made it illegal for Americans to operate steel-making furnaces. Government-licensed monopolies like the East India Company held the exclusive right to sell goods like tea to the Americans. According to Smith, these and hundreds of other restrictions benefited British special interests.
Smith concluded that to achieve economic growth and social betterment, Britain should sweep away its network of government economic privileges and restrictions. Let the "free market mechanism" operate on its own without government intervention, Smith advised.
Adam Smith advocated a limited role for government. But he recognized significant areas where only it could act effectively. Smith saw the first duty of government was to protect the nation from invasion.
He argued that a permanent military force, rather than citizen militias, was necessary to defend any advanced society. Next, he supported an independent court system and administration of justice to control crime and protect property. Smith favored "public works" to create and maintain an infrastructure to promote the free flow of commerce. These works included such things as roads, bridges, canals, harbors, and a postal system that profit-seeking individuals may not be able to efficiently build and operate.
The following is a simplified version of the economic system Adam Smith believed would emerge once governments ended their oppressive mercantilist policies. A man builds a cloth-making factory, hires workers, and divides their labor into many specialized operations. The factory owner is motivated by self-interest, profit, maybe even greed.
Others, however, are also building factories to make and sell cloth. They all have to compete for the money of the buyers whose self- interest is to buy cloth at the best price. Buyers bid up the price of the cloth when the supply of cloth is low and their demand for it is high. But when there is an oversupply, the buyers can pick and choose and refuse to purchase high-priced cloth. The factory owners then have to reduce their prices to attract more buyers. Economists call this the "law of supply and demand.
Additional innovative divisions of labor, maybe brought on by new machinery, motivate others to invest in more factories.
But they must compete to hire more workers. The "law of supply and demand" applies here, too, and wages go up. Higher wages lengthen the lives of workers and their children.
The population grows, which increases the supply of workers. Wages then stop rising. But, soon another division of labor wave occurs, producing more economic growth and the need for even more workers. Wages go up again. The cycle repeats itself. Families now can afford to buy demand more cloth and lots of other products. The factory owners make more profits. Everybody wins and society as a whole improves. The cloth factory owner never intended to improve society; he just wanted to make money for himself.
It is true that Smith thought they might be justified, but he was fairly skeptical. He wrote:. There may be good policy in retaliations of this kind, when there is a probability that they will procure the repeal of the high duties or prohibitions complained of.
The recovery of a great foreign market will generally more than compensate the transitory inconveniency of paying dearer during a short time for some sorts of goods. To judge whether such retaliations are likely to produce such an effect does not, perhaps, belong so much to the science of a legislator, whose deliberations ought to be governed by general principles which are always the same, as to the skill of that insidious and crafty animal, vulgarly called a statesman or politician, whose councils are directed by the momentary fluctuations of affairs.
When there is no probability that any such repeal can be procured, it seems a bad method of compensating the injury done to certain classes of our people to do another injury ourselves, not only to those classes, but to almost all the other classes of them.
When our neighbours prohibit some manufacture of ours, we generally prohibit, not only the same, for that alone would seldom affect them considerably, but some other manufacture of theirs. This may no doubt give encouragement to some particular class of workmen among ourselves, and by excluding some of their rivals, may enable them to raise their price in the home-market.
Those workmen, however, who suffered by our neighbors prohibition will not be benefited by ours. On the contrary, they and almost all the other classes of our citizens will thereby be obliged to pay dearer than before for certain goods. Every such law, therefore, imposes a real tax upon the whole country, not in favour of that particular class of workmen who were injured by our neighbours prohibition, but of some other class.
Today, vouchers and school choice programs are touted as the latest reform in public education. But Adam Smith addressed the issue more than two hundred years ago:.
Were the students upon such charitable foundations left free to choose what college they liked best, such liberty might contribute to excite some emulation among different colleges. A regulation , on the contrary, which prohibited even the independent members of every particular college from leaving it, and going to any other, without leave first asked and obtained of that which they meant to abandon, would tend very much to extinguish that emulation.
And because more of his ideas have lasted than those of any other economist, some regard Adam Smith as the alpha and the omega of economic science. David R. Henderson is the editor of The Concise Encyclopedia of Economics. He is also an emeritus professor of economics with the Naval Postgraduate School and a research fellow with the Hoover Institution at Stanford University. He earned his Ph. Smith , part I, section I, chap. The Nixon and Ford administrations responded by introducing price controls to limit the cost of gasoline to American consumers.
The goal was to make cheap gas available to the public. Instead, gas stations had no incentive to stay open for more than a few hours. Oil companies had no incentive to increase production domestically.
Consumers had every incentive to buy more gasoline than they needed. Large-scale shortages and gas lines resulted. Those gas lines disappeared almost immediately after controls were eliminated and prices were allowed to rise.
While it is tempting to say the invisible hand limits government, that wouldn't necessarily be correct. Rather, the forces that guide voluntary economic activity toward large societal benefit are the same forces that limit the effectiveness of government intervention. Boiling the principles Smith expressed regarding the invisible hand and other concepts down to essentials, Smith believed a nation needed the following three elements to bring about universal prosperity.
Smith wanted people to practice thrift , hard work, and enlightened self-interest. He thought the practice of enlightened self-interest was natural for the majority of people. In his famous example, a butcher does not supply meat based on good-hearted intentions, but because he profits by selling meat. If the meat he sells is poor, he will not have repeat customers and, thus, no profit. Therefore, it's in the butcher's interest to sell good meat at a price that customers are willing to pay, so that both parties benefit in every transaction.
Smith believed the ability to think long-term would curb most businesses from abusing customers. When that wasn't enough, he looked to the government to enforce laws. Extending upon self-interest in trade, Smith saw thrift and savings as important virtues, especially when savings were used to invest. Through investment, the industry would have the capital to buy more labor-saving machinery and encourage innovation. This technological leap forward would increase returns on invested capital and raise the overall standard of living.
Smith saw the responsibilities of the government as being limited to the defense of the nation, universal education, public works infrastructure such as roads and bridges , the enforcement of legal rights property rights and contracts , and the punishment of crime. The government would step in when people acted on their short-term interests and would make and enforce laws against robbery, fraud, and other similar crimes. He cautioned against larger, bureaucratic governments, writing, "there is no art which one government sooner learns of another, than that of draining money from the pockets of the people.
His focus on universal education was to counteract the negative and dulling effects of the division of labor that was a necessary part of industrialization. The third element Smith proposed was a solid currency twinned with free-market principles. By backing currency with hard metals, Smith hoped to curtail the government's ability to depreciate currency by circulating more of it to pay for wars or other wasteful expenditures.
With hard currency acting as a check on spending, Smith wanted the government to follow free-market principles by keeping taxes low and allowing free trade across borders by eliminating tariffs. He pointed out that tariffs and other taxes only succeeded in making life more expensive for the people while also stifling industry and trade abroad. To drive home the damaging nature of tariffs, Smith used the example of making wine in Scotland.
He pointed out that good grapes could be grown in Scotland in hothouses, but the extra costs of heating would make Scottish wine 30 times more expensive than French wines.
Far better, he reasoned, would be to trade something Scotland had an abundance of such as wool, in return for French wine. In other words, because France has a competitive advantage in producing wine, tariffs aimed to create and protect a domestic wine industry would just waste resources and cost the public money. It lacks proper explanations for pricing or a theory of value and Smith failed to see the importance of the entrepreneur in breaking up inefficiencies and creating new markets.
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