Why Adam Smith Still Matters

Keynes may be the flavour of the month but the Sage of Kirkcaldy’s insights are more valuable than ever

Economy Features History Literature

 John Maynard Keynes is high in the list of bestselling books now. Adam Smith is not quite as popular. The reason is not that books from the 18th century tend to be a demanding read: Keynes’s General Theory of Employment, Interest and Money, although from the 20th century, is no piece of cake either. Instead, the present global financial crisis has made the godfather of classical economics look strikingly irrelevant in comparison with Keynes, the inventor of modern disequilibrium theory. Even worse, now that bankers are being castigated as the incarnation of greed, blindness and irresponsibility, the man who wrote in his famous Inquiry into the Nature and Causes of the Wealth of Nations that “it is not from the benevolence of the butcher, the brewer, or the baker” – or perhaps the banker in our day – “that we expect our dinner, but from their regard to their own interest” is again accused of being the chief advocate of heartless laissez-faire capitalism, a system that failed and had to fail. In this view, capitalism is nothing but a false religion, with Mammon as its god and Smith as its high priest. Critics worry that markets need a moral foundation that they automatically erode. They ridicule the naïve belief that free markets bring everybody happiness at no cost, a conviction allegedly lacking all philosophical underpinnings.

This is entirely off the mark. The last thing one can say about Smith is that he lacked philosophical depth. A moral philosopher, Smith was a figure of the Scottish Enlightenment, a progressive school of philosophy with members including Francis Hutcheson, David Hume and Adam Ferguson. Their approach was inspired by Isaac Newton, perhaps the greatest scientist ever. His deep persuasion was that simply observing reality enables us to discover the underlying natural principles. The Scottish Enlightenment thinkers aimed at shedding light on the laws governing human behaviour, and on their consequences for life in society.

Adam Smith was born in the fishing town of Kirkcaldy on the east coast of Scotland, across the Firth of Forth from Edinburgh. His father, who passed away before his son was born, had been a lawyer working as a comptroller of customs – a job that his son would later emulate when he became a commissioner of customs in Edinburgh. When Smith was only 14 years old, he enrolled at the University of Glasgow to study moral philosophy. With a scholarship, he was able to continue his studies at Oxford. Afterwards, under the patronage of Lord Kames, he started teaching at the University of Edinburgh until, in 1751, he obtained a chair of logic and then, one year later, the chair of moral philosophy at Glasgow. Smith was the quintessential intellectual of his era. Intensely intelligent, knowledgeable about everything, he was painstaking, a perfectionist, often confused and a day-dreamer.

Absent-minded he may have been, but naïve he wasn’t, let alone a cynic. Smith did not tolerate immoral behaviour. It would never have occurred to him that selfishness and greed might be viewed as being just normal – and even less that they might be morally laudable, let alone negligible. This differentiates him from Thomas Hobbes, in whose view man is a wolf to other men, and also from Bernard Mandeville, well-known for his poem “The Fable of the Bees”, in which he – half satirically, half seriously – claims that private vices result in public benefits. Smith strongly objected to this view. The proof of this attitude is his first widely recognised book, the Theory of Moral Sentiments, published on April 26, 1759-250 years ago.

In this work, which was based on his Glasgow lectures, Smith dedicates about 400 pages to nothing but questions of morality. He asks how it is that people recognise, through their interaction, what is virtuous. The Theory is a book on social self-organisation, clad in an analysis of moral psychology. It is all about how the moral basis for society evolves and what keeps it alive. It deals with sympathy, benevolence, conscience and self-control. The monograph was an immediate success.

Nevertheless, the Theory of Moral Sentiments is by no means a necessary moralistic counterweight to the allegedly morality-free Wealth of Nations. Both books stem from and unfold the same coherent logical system, though the Theory is wider in scope and more fundamental to Smith’s overall approach. The myth about the contrariness of the two books, the “Adam Smith problem”, is entirely unwarranted. The term was coined by members of the so-called Historical School, a specific German branch of economics from the 19th century with a strong empirical orientation but a serious weakness in abstract theory. In its uninformed view, Smith had simply changed his mind over the years. It is true that almost two decades elapsed between the first publication of the Theory of Moral Sentiments and the Wealth of Nations. But Adam Smith never left it at the first editions of his works. Both books underwent numerous rewrites and additions until the end of Smith’s life. He worked on them continuously and in parallel but never fundamentally changed his mind. His approach and the logical system that he built always stayed the same.

The Theory established Smith’s excellent scholarly reputation. It was so overwhelming that Charles Townshend – who was later to become Chancellor of the Exchequer – offered him a generously endowed position as the tutor of his young stepson, the Duke of Buccleuch. Smith accepted and started touring Europe with his pupil. The journey lasted three years. In France, Smith encountered an intellectually inspiring group. He met Benjamin Franklin, who served as Ambassador to France and later became one of the Founding Fathers of the US. He had discussions with Voltaire, Turgot and Quesnay. More and more, he reflected on economic questions. When the European journey came to a premature end, Smith returned home to Kirkcaldy, where he spent ten years working out his new economic theory. When the Wealth of Nations finally came out in 1776, it was a revolution – and an immediate success, too. The first edition was sold out within six months.

The Wealth of Nations is no ideological pamphlet – quite the contrary. It is an analytical treatise on the logic of the market, taking individual actions as the starting point of observation and explanation. Smith explains the workings of incentives. He differentiates between individual morality and the deontological laws applicable to complex systems. He sheds light on the rise and use of the division of labour. He justifies free trade, arguing still in terms of absolute advantage, however, not “comparative advantage”. It took several decades and David Ricardo to find that out. Smith also attempts to construct a theory of value – his one big failure. Based on the cost of labour, this approach later opened an avenue for Karl Marx.

Smith’s major works both take the same methodological route, using parallel premises and leading to analogous results. Smith’s approach is typical of the empiricism that was in vogue during the Scottish Enlightenment. He describes meticulously that which is – and not so much that which should be. He looks at people’s behaviour and tries to deduce universal laws from what he sees. Since man is a social animal, the observations focus on human interaction.

In his writing, Smith demonstrates how important realism and absence of prejudice is to him. He doesn’t depict people in a better light than they deserve, and he also doesn’t make them more evil than they are. In both his major works, Smith starts from the rather noncontroversial idea that man simply acts purposefully and is better placed to decide for himself than any other person or entity. In the Theory of Moral Sentiments, he also makes one essential psychological assumption: we are naturally endowed with a capacity to share and understand another person’s emotions and feelings, that is, with a capacity for empathy (in the language of his time, he uses the word “sympathy”). “How selfish soever man may be supposed, there are evidently some principles in his nature, which interest him in the fortune of others, and render their happiness necessary to him, though he derives nothing from it except the pleasure of seeing it.”

Smith also believes that everybody naturally aims at pleasing others. “Nature, when she formed man for society, endowed him with an original desire to please, and an original aversion to offend his brethren. She taught him to feel pleasure in their favourable, and pain in their unfavourable regard.” Even more, we want to make sure we deserve a positive verdict. We actively educate ourselves so that we can hope to be truly praiseworthy. In Smith’s ingenious thought experiment, we do that by relying on a fictitious “impartial spectator” – who is nothing else but our own conscience.

It is no coincidence and no misnomer that the title of the book mentions “moral sentiments”. Smith is not interested in reason, but in feelings, or sentiments, as a source of knowledge about moral propriety. It is through the immediate reaction of others that we recognise or feel what is good and virtuous, through the reciprocity that we are granted or denied, and through our own “impartial spectator’s” praise or reprimand. Of course, the “impartial spectator” knows only as much as we do ourselves. The relevant difference is, however, that the “impartial spectator” is able to step back a little, to refrain from short-term calculations, and to reflect soberly. It is he who confronts impulses, sentiments and feelings with rationality. For this, we are required to be capable of imagination and sympathy: we need to put ourselves in someone else’s shoes. We must imagine how someone else would look at us – not if that someone else was in our own position, with our own baggage and environment, but with the position, experience and environment proper to that someone else.

The existence of “impartial spectators”, together with our naturally given sympathy, allow for an ongoing feedback process both between different people and also within the individual, between the “ego” and the “superego”. This feedback process generates the moral views, categorical imperatives and other norms, conventions and informal rules that become relevant in society. It is in this process also that ambition is socially generated and supported – even in the purely materialistic realm. “It is because mankind are disposed to sympathise more entirely with our joy than with our sorrow, that we make parade of our riches, and conceal our poverty.” The intensity of all moral views differs according to a spatial pattern that we all know: the further away someone is from us, either in physical or in psychological terms, the less we care. Our innate self-interest makes us look after ourselves first: “Every man…is first and principally recommended to his own care; and every man is certainly, in every respect, fitter and abler to take care of himself than of any other person.” After ourselves, we then care more about our family than about some unknown stranger. Solidarity is a key value in the small group, while the anonymous “great society” refers us back to our enlightened, rule-bound self-interest. Smith states this as a fact. He merely explains it – and refrains from judging. In his positive approach, this is the course of nature.

In the Wealth of Nations, Smith again couches his analysis in the terms of a feedback process in society. While the Theory of Moral Sentiments basically describes an ongoing process of exchange in the market for norms, Smith now turns to the market in the more narrow sense: the market for goods and services. In the Theory of Moral Sentiments, he now posits that there exists a “propensity in human nature…to truck, barter, and exchange one thing for another.” In order to feel this impulse to trade, one must not only own something to give in exchange, one must also desire something that someone else possesses. In the Theory of Moral Sentiments, what man strives for is praise. In the Wealth of Nations, it is some good or service. In both cases, this leads to exchange processes. For transactions really to take place, however, reciprocity is needed. In the small group, reciprocity is brought about through emotional ties and immediate social control. In the great society, these immediate mechanisms are replaced by conventions, rules of just conduct and institutions that have grown spontaneously and which are brought to us through tradition. This brings stability. It is for this reason, and this reason only, that Smith can write with regard to the “butcher, brewer and baker” that “we address ourselves not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages”. By no means does this amount to a sanctification or even an endorsement of selfishness and greed. It is only the description of practical action in the abstract context of the great society.

The marvel is that the spontaneous system gives rise to a harmony of interests. Smith shows that the individual “neither intends to promote the public interest nor knows how much he is promoting it…By directing his 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…led by an invisible hand to promote an end which was no part of his intention”. The corollary of this is every distortion or discontinuation of spontaneous co-ordination must be sterile. This includes excessive redistribution after the fact. “Great nations are never impoverished by private, though they sometimes are by public prodigality and misconduct. The whole, or almost the whole public revenue, is in most countries employed in maintaining unproductive hands…Those unproductive hands…may consume so great a share…that all the frugality and good conduct of individuals may not be able to compensate the waste and degradation of produce occasioned by this violent and forced encroachment.”

The often-quoted “invisible hand”, Adam Smith’s totemic expression, is not the hand of God. The term just names the impersonal forces of spontaneous order. It is a system that, without asking much, manages to solve the enormous task of social coordination. The spontaneous order thus resulting from social interaction is what Smith, in his Wealth of Nations, calls the “obvious and simple system of natural liberty”. This universal insight is by no means a naïve promise of happiness. All it promises – and that is no small thing – is social co-ordination. This system is a dynamic one that leads to results determined by the spontaneous interplay of individual forces within a framework of evolved or intelligently crafted rules, or the law. Smith is optimistic that the results of this interactive process are on the whole desirable.

Some scholars have attributed Smith’s optimism to his alleged Deism. He seems to show a belief in a Creator who has endowed the world with certain natural laws accessible to human reason, but who refrains from intervening in the course of worldly events. True or false, this is no founding pillar of Smith’s system. Smith places the individual dispositions and actions of men at the baseline of his analysis. If these dispositions and actions cannot be traced back to providence but are instead triggered by secular social learning or simply sheer evolution, this doesn’t invalidate his logical result. The masterpiece that matters is the social co-ordination achieved through interaction, and the generation of useful institutions that channel life in human society.

What is crucial, however, is reciprocity. It is only this requirement that guarantees the harmony of interests. Correspondingly, Smith does indeed see cases in which this mechanism doesn’t work. In the Theory of Moral Sentiments, he warns us not to give in to vanity and self-conceit, for example, and in the Wealth of Nations he describes the impairing effect of privilege. Undeniably, business people will always be tempted by monopolies or cartels. This is held in check by their inherent instability. Monopolies or cartels can be stable only when they are supported by a privilege granted by the authorities. A similar point concerns selfishness and greed. Selfishness is self-interest out of bounds. Usually, in market exchange, selfishness and greed are checked by the simple necessity of finding a transaction partner. Often, however, political measures are taken that boil down to making people more greedy than is natural-for example, through “quantitative easing” in monetary policy, through a generous social policy without any regard to what is affordable or not, through a lack of tight controls. When that is the case, the natural check on greed breaks down. We then observe excessive behaviour and its devastating social results.

Regrettably, Smith was unable to conclude the third large project that he had been working on throughout his life: a theory of government. In his “obvious and simple system of natural liberty”, this is the only gap. It is not a small one. The answer to this question is fundamental for the current debate – in a situation where our Western civilisation seems to have come to a crossroads as more interventionist power is reclaimed for government, in which nationalisation and re-regulation are going unquestioned, and in which politics is generally gaining a new self-confidence. The question has to do with the natural harmonisation of interests. Is there any way in which the interests of government are spontaneously aligned with the interests of the governed? Is political action possible without destroying the checks and balances of the spontaneous order? Smith doesn’t give us an answer. Maybe he had found that there was no such way.