Authors: David Smith
Free Lunch (5 page)
We have come a long way and we are not even through the main course yet. I know the feeling, however, when you are halfway through a prestige dinner with the speeches still to come, and you are wondering uncomfortably whether you can make it until the end. I also hate excessively long chapters. It is time for a quick comfort break, and then to welcome a very special guest.
In many ways our first celebrity guest is a brave choice. While few economists would quarrel with the choice of Adam Smith (1723–90) as the father of modern economics, many might hesitate before inviting him along as a speaker. This eighteenth century Scot was almost a parody of the absent-minded professor. Anecdotes that have been passed down through the years tell of him putting bread and butter into a teapot, pouring hot water on it, and then wondering why the tea tasted so foul. Or of him being so engaged in a philosophical discourse while walking along that he stumbled into a tanning pit. Born in Kirkcaldy on the Firth of Forth a few months after the death of his father, the town’s customs controller (in the days when the post was grander than now), Smith never married, although he refers approvingly in print to the beauty of ‘potato-fed Irish prostitutes’ in London. He was no oil painting, as he himself admitted. While in later life women courted his mind, they had to overcome his big teeth and bulging eyes. One female French novelist declared him to be ‘ugly as the devil’. His private passions have to be a source of speculation because he ordered all his papers to be destroyed on his death.
Smith, like many great thinkers, was not, it seems, a great speaker. Burdened with a harsh voice and an occasional stutter, he was also an unforgiving lecturer. Having spent a miserable few years in Oxford as a student, he chose his native Scotland to pursue his academic career. His lectures in Glasgow used to start at 7.30 in the morning, begin hesitantly, and then last for hours, with Smith addressing the ceiling rather than the students. He was sometimes seen carrying on such debates with himself out loud, on street corners. Absent-minded he may have been but he was also hugely influential. Two centuries after his death his ideas returned to prominence across the world but, in particular, with the election of Ronald Reagan in America and Margaret Thatcher in Britain. Thatcher was said to carry a copy of Smith’s
The Wealth of Nations
in her legendary and capacious handbag. The Adam Smith Institute in London (on whose website those with stamina can read the 900-page work) came to the fore as an advocate of privatization and pro-market policies. The collapse of communism and the triumph of capitalism at the end of the 1980s could be seen as a victory for Smith over Karl Marx.
Timing is everything
As far as economists were concerned, Smith had never gone away. It may seem like a conceit to think that economics began in 1776 with the publication of his great work which, to give it its full title, was
An Inquiry into the Nature and Causes of the Wealth of Nations
(in his lifetime it was outsold by his other main work,
The Theory of Moral Sentiments
). There was economics before Smith, now known as pre-Adamite economics. Ancient civilizations had their economic thinkers, as did the Renaissance. Like all great thinkers Smith has been accused of lifting some of his best ideas from his predecessors and near contemporaries. Certainly he was fortunate in some respects. He was offered and accepted a lucrative sinecure from Charles Townshend, a fan of
The Theory of Moral Sentiments
and one-time Chancellor of the Exchequer, who invited him to become tutor to his teenage stepson, the Duke of Buccleuch. On taking up this role, in which he began the twelve-year period of the writing of
The Wealth of Nations
, Smith travelled widely with his pupil, and was able to tap into economic thinking elsewhere in Europe. French economists such as François Quesnay were influential. He also spent time with Voltaire.
The important thing about
The Wealth of Nations
, however, hugely ambitious as it was in scope and size, is that it presented the first synthesis of economics in its entirety. It explained why nations should trade with each other and benefit from doing so (opposing the view of the earlier mercantilists who had favoured trade restrictions in the belief that protectionism preserved economic advantage for some countries). It provided an explanation and a justification for the minimum interference by government in free markets within countries. It told governments how they should go about the process of raising taxes. It explained how the industrial revolution then in progress would raise prosperity, most notably as we shall see with his famous example of the pin factory.
That, perhaps, helps explain Smith’s influence more than anything. He came at a turning point in economic history. Published in the year of American independence and the beginning of a new world order,
The Wealth of Nations
also coincided with the start of a process in which industrialization was to provide unprecedented growth in wealth. This, a step-change compared with the economic stagnation of the agricultural age, was also to raise questions about how that wealth should be distributed among the population. Smith, a product of the Enlightenment, provided a template for economic thinking through and beyond the industrial revolution that utterly changed previous notions about the way societies worked.
But what, out of the multi-volume
Wealth of Nations
, should we take as important? Is it Smith’s rules, or canons, of taxation, centred on ability to pay? Is it his theory of value? Is it his belief that governments should concentrate on certain basic functions, because most public services are ‘unproductive’, and that public works such as roads or bridges should be paid for by tolls or fees, not out of general taxation? Important though these are to students of the history of economic thought and in some cases to policymakers today, and while it is the done thing at this point to recommend that people read the full work themselves (few do), there are three things we should carry with us from Smith.
The division of labour
Smith was writing at a time when there were very few factories in Britain. Those that did exist were mainly powered by water. The industrial revolution had barely begun. Yet he promised to demonstrate how economic changes could occur that would bring ‘universal opulence which extends itself to the lowest ranks of the people’. First among these was the division of labour. The pin factory, mentioned above, demonstrates very simply how this operates. Suppose, Smith said, a pin factory employed ten people, each engaged in the entire process of making a pin. The factory would certainly produce pins, perhaps a few hundred a day, but it would not do so very effectively. Now look at the way it actually worked in his day: ‘One man draws out the wire, another straightens it, a third cuts it, a fourth points it, a fifth grinds it at the top for receiving a head; to make the head requires two or three distinct operations; to put it on is a peculiar business, to whiten the pins is another; it is even a trade by itself to put them into the paper.’
And so on. Specialization made each man much more effective. Even in what was essentially a manual process, without the machinery that was to shape industrialization, huge productivity gains could be achieved. The division of labour, in other words, raised the level of output per worker. Smith’s factory produced not a few hundred but tens of thousands of pins each day. It is interesting to think that it took until 1912, when Henry Ford applied his mass production methods to the building of the Model T at his Highland Park assembly plant in America, methods that meant the time it took to build a car was cut to just ninety-three minutes, for the full flowering of this particular division of labour to occur.
There was more to Smith’s division of labour, however, than a management consultant’s approach to factory organization. If we think about the pin factory, the key to raising the productivity of the workers and therefore their prosperity and that of the owners was specialization. But there was no reason, as Smith explained, to think of the possibilities of specialization as being limited to those within a single workplace.
What determines why some people do certain jobs and others do others? In general, people find something they are suited to and good at. What is best for me to do, to try to fix a problem with the plumbing in my house in my inexpert and laborious way? Or to write an article (or probably, given the prices London plumbers charge, two or three articles) to earn the money to pay for the services of a professional? The answer, to me at least, is fairly clear, as I hope it would be to the plumber if somebody asked him to pen an economics piece. The point is that it is much more efficient if each of us concentrates on what we are good at and trade those services. We buy pork chops from the butcher rather than attempt to kill the pig for ourselves.
Extending this division of labour a little further up the scale, it becomes clearly beneficial if there is specialization by firms. A modern car is made up of many hundreds of components manufactured by different firms. Such specialization enables the cost of the car to be much lower than if a single firm attempted to make every part. In the 1980s there was a revolution in British industry when manufacturing firms contracted out to independent suppliers many tasks, from cleaning and maintenance to distribution. They were following Adam Smith.
The process does not have to end within countries. The argument in favour of foreign trade, indeed of free trade, is essentially a division of labour argument. With the right investment in hot-houses and specialist equipment, Britain could in theory provide for all her wine needs and never import a drop from abroad. It makes more sense, however, to buy it from countries with the climate and expertise to do it better and more cheaply. The basis of trade is that countries specialize in the things they are best at. The gains from trade result from this specialization. This is why action to restrict trade usually impoverishes us all. What happens if a country is no good at anything? I’ll come back to that later.
The invisible hand
The part of
The Wealth of Nations
that every schoolchild knows – or if not they should – gives us Smith’s most famous idea. He wrote: ‘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 their self love.’
To understand it fully, it is necessary to tie it to another, related section which, in slightly edited form, reads: ‘Every individual who employs capital and labours neither intends to promote the public interest nor knows how much he is promoting it … he is led by an invisible hand which was no part of his intention. By pursuing his own interest he frequently promotes that of society.’
What was this invisible hand? Because of its later importance, you might think there are references to it dotted throughout the pages of
The Wealth of Nations
. In fact the above is the only one. Some writers have speculated that it could have had religious connotations; others that Smith unconsciously lifted it from Shakespeare’s
Macbeth
, where there is a reference to the ‘bloody and invisible hand’.
There is no need to get too fancy about this, however. What Smith was sketching out was the market mechanism, the laws of supply and demand we have already touched on, although it was left to later economists to fill in the details. This was no paean of praise to businessmen. Whenever they met ‘the conversation ends in a conspiracy against the public, or in some contrivance to raise prices’. The point was that the market did not let them get away with it, or at least not for long. Customers would abandon profiteers in favour of competitors offering lower prices. Attempts by groups of firms to fix prices by agreement – forming a cartel – would fail as long as it was possible for new firms to enter the market and undercut them. The invisible hand is the market, and through its operation the best possible, or optimum, outcome is achieved. Of course in any economy there will be lots of different markets, not only for all the various products and services, but also, for example, for labour. One of the great debates sparked off by Smith was, in fact, over labour. What was to stop workers being permanently exploited in this new industrial revolution, of being paid no more than necessary for the very basics of existence? Smith pointed out not only that competition for workers among employers would make this unlikely but also that the process of industrialization and of the development of mass market products would require that workers – as the new consumers – be paid above the subsistence level, and increasingly so. He was right. The market did not put an end to worker exploitation but the industrial revolution marked the start of the rise of modern mass prosperity. As we shall see, Karl Marx had rather different views on this.
Liberty
It is hard to overstate the importance of Smith’s contribution to economics. As its founding father he provided a template for it and an underlying philosophy that endures to this day – that economic freedom provides the best of all possible worlds, through the operation of the invisible hand. Attempts to interfere with that freedom by introducing restrictions or allowing monopolies to operate will make us all poorer than we need be. Governments, even if they mean well, will usually end up making things worse. This did not mean there should be no government at all – Smith favoured strong and clear laws, properly policed – but it did mean limiting its role. Smith would have had no truck with government being directly involved in the production process by owning firms.
When, advocated by the likes of Margaret Thatcher, Smith came back into vogue, it was easy to see why. The market, it seemed, had taken a back seat. The UK had in the thirty or so years since the Second World War become a heavily controlled economy and one in which the state played an increasingly dominant role. Monopoly power had been allowed to develop while, on the other side, unions operated a range of restrictive practices. The policies followed by the Thatcher governments, which involved the removal of controls, denationalization (or as it came to be known, privatization), and the ending of restrictive practices by both unions and employers added up to a classic recipe for restoring markets, for giving the invisible hand a chance to operate. Adam Smith would have been proud of her.
