When Ronald Reagan won the 1980 presidential election, conservative supporters in Washington rejoiced. At cocktail parties and meetings they congratulated one another and looked forward to prosperity under “Reaganomics.” They also noticed that they were wearing the same neckties, which featured the profile of Adam Smith.
Why were politicians and activists who prided themselves on patriotism parading the profile of an eighteenth-century Scotsman? Why not Theodore Roosevelt, Thomas Jefferson, or even Barry Goldwater? Could Adam Smith really be more relevant to contemporary economic crises than the thousands of economists and political leaders who had followed?
Adam Smith believed that his ideas would be relevant forever. This was a common trait of intellectuals in the eighteenth century, a truly revolutionary age. Political ferment began to bubble in France and America. By the time Smith wrote his greatest work, The Wealth of Nations, dealers were trading within the British Isles and across the seven seas, population was expanding, merchants were organizing small factories, and banking systems were spreading throughout Britain and the Continent. But the most powerful and profound revolution of the Enlightenment was sparked by thinkers probing for new explanations of the world around them. No wonder Smith once proclaimed in his lectures, “Man is an anxious animal.”1
From the Middle Ages until roughly the time of Columbus, theologians had dominated European intellectual thought. Church elders interpreted natural phenomena in accordance with religious doctrine. But in the century leading to Smith’s birth, more and more people began following the bold paths of Francis Bacon and Nicolaus Copernicus in searching for rational explanations for natural events. Eventually, scientists emerged independent of ruling churches, applying the “scientific method” for laws of nature regardless of controversial conclusions.
Galileo Galilei attacked the religious cliché that God gave man only two books, the Bible and nature. Claiming that the language of the book of nature was mathematics, Galileo proved by mathematics and experiment, without the help of holy scriptures, his law of falling bodies. Galileo knew that he was treading on treacherous ground and tried to avoid condemnation. Fearful when, in 1632, his telescope experiments confirmed Copernicus’s heresy that the earth revolved around the sun, he dedicated his findings to the pope. He was right about the earth. And he was right to fear the Church’s wrath, for a tribunal consequently condemned him “for vehement suspicion of heresy.”
Toward the end of his Discourse on Method (1637), René Descartes foreshadowed the explosion of thought in the eighteenth century by arguing that through practical science men can be the “masters and possessors of nature.”
The shining figure in the Enlightenment, though, was Isaac Newton. He pursued Galileo’s scientific quests, searching beyond religious texts for answers, which he revealed in his theory of gravity, laws of physical motion, and discovery of calculus. Newton seemed to portray God as a key player only at the beginning of time, as responsible for the world today as a pawnshop owner is after a pawned watch leaves the shop. The German philosopher Gottfried Wilhelm von Leibniz thought that Newton compounded the blasphemy by depicting God as a clumsy watchmaker.
Adam Smith was born into this movement. Like Galileo and Newton, Smith sought out cause-and-effect relationships. Before he touched economics, Smith tried to master astronomy and gave lectures on Copernicus. But soon he shifted his lens from planets to the orbits of people. He had one wish: to make sense of the seemingly chaotic clanging he heard in the streets, at the docks, and in the emerging factories.
Born in 1723, Smith grew up with his mother, Margaret, in Kirkcaldy, a small port located across the Firth of Forth from Edinburgh. His father, a comptroller of customs, had died months before his birth. Some men born without fathers reinvent themselves and make up their own world, like Tom Sawyer and Saul Bellow’s Augie March. Others search for a father figure somewhere else—for example, in the heavens. Smith managed to do both. We will later see that Smith’s concept of the “invisible hand” provides a natural order for all the confusion he saw about him.
Smith was a sickly lad who never married and spent a good part of his adult life living with his mother. Margaret was hearty, though, and lived to age ninety. When she died, he was distraught, writing, “I certainly loved and respected [her] more than I ever shall either love or respect any other person. I cannot help feeling . . . a very heavy stroke upon me.”2
Although it was not apparent from the Adam Smith neckties worn in Washington, Smith was an odd-looking Scotsman. He had a large nose, bulging eyes, a protruding lower lip, a nervous twitch, and a speech impediment. Smith once acknowledged his unusual features, saying, “I am a beau in nothing but my books.” A good student, Smith entered the University of Glasgow at age fourteen and later rode on horseback to Oxford to accept a scholarship at Balliol College. Like most other college students of his day, Smith intended to study theology and enter the clergy. Like many college students of any day, Smith complained about his teachers and wrote that “it will be his own fault if anyone should endanger his health at Oxford by excessive study.”3 He especially denounced the lecturers: “In the University of Oxford, the greater part of the public professors have, for these many years, given up altogether even the pretence of teaching.”4 More important, Smith lashed out at academic censorship and complained to friends that college officials had confiscated his copy of David Hume’s heralded Treatise of Human Nature. Although he was permitted to read all the ancient Greek and Latin classics, Smith was forbidden from reading one of the most potent works of his own time.
Despite academic restrictions, Smith was so influenced by Hume’s skepticism (A Theory of Human Nature is subtitled An Attempt to Introduce the Experimental Method of Reasoning into Moral Subjects) that he refused to continue preparing for the clergy. Instead, he returned to Kirkcaldy, where he later delivered popular public lectures on rhetoric and law.
In 1748, Smith returned to the University of Glasgow to teach logic. The next year he filled the chair in moral philosophy vacated by his former teacher Francis Hutcheson. A “campus radical,” Hutcheson had stirred administrators by refusing to lecture in Latin. The Presbytery then prosecuted him for spreading the following “false and dangerous” doctrines:
The standard of moral good is promotion of happiness to others.
It is possible to know good and evil without knowing God.
As we will see, Smith had absorbed many of Hutcheson’s dangerous declarations. Hutcheson stood nobly for academic freedom in the face of ruling dogma. Unlike Galileo, Hutcheson did not try to avoid censure by dedicating his teachings to the pope, which, in any event, would not have done much good in Protestant Scotland.
It is interesting to note that Smith’s ideas are usually associated today with conservative politics, yet because his intellectual roots were rather radical, some contemporary conservatives feel a bit uneasy about Smith. Anti-globalists and über-nationalists who denounce international trade blame Smith for the troubles they see. Libertarians, however, seek to place his capitalist theories on the same altar as God, Mom, apple pie, and democracy.
Far from following the sleepy style of the Oxford dons he had assailed, Smith the professor quickly gained a reputation for lucid lectures and concern for his students. Though he lectured, tutored, and held informal discussions, Smith also found time to serve as the college treasurer and later the dean of faculty.
Smith never taught a course in economics. In fact, Smith never took a course in economics. Nobody did. Until the nineteenth century, academics considered economics a branch of philosophy. Not until 1903 did Cambridge University establish an economics program separate from the “moral sciences.” Nonetheless, Smith squeezed his preliminary thoughts on economics into lectures on jurisprudence. The following notes, taken by a student, point to the genesis of his key analysis of labor later elaborated in The Wealth of Nations:
“Division of labor is the great cause of the increase of public opulence, which is always proportioned to the industry of the people, and not to the quantity of gold and silver, as is foolishly imagined.”5
So far we have discussed Smith’s education and his appearance but have avoided his personality quirks. It’s a touchy subject. Sigmund Freud observed that people have a tendency to puff up the status of their forefathers. He called this the “family romance.” Budding economists might be disappointed to discover that their forefather was not as intelligent as Newton, not as witty as Voltaire, and not as scandalous as Byron. In fact, despite the “family romance” tendency, economic historians admit that Smith was a bit of a bumbler. Although in his lectures Smith shared precise observations—pointing out that John Milton wore shoelaces rather than buckles—in his own life Smith noticed not much at all.
Professional economists are now weary of the many stories of Smith acting absentmindedly. Nonetheless, these tales can still amuse the beginning scholar.
One day while the Right Honourable Charles Townshend was in Glasgow, Smith took him on a tour of a tanning factory. While rhapsodizing on the merits of free trade, Smith walked right into a huge, nauseous pool of goop. After workers dragged him out of the goop, stripped him, and threw a blanket over him, Smith complained that he could never keep his life in order.
On another day, Smith climbed out of bed and began to walk. And walk. And walk. Fifteen miles later, the sound of church bells stirred him from sleep. The most famous economist of his time was found running back to his house, nightgown flapping in the breeze.
Even before Smith wrote The Wealth of Nations, he gained fame in 1759 with his book on ethical behavior, The Theory of Moral Sentiments. As sales burgeoned, he became known as “Smith the philosopher.” A Theory of Moral Sentiments followed in the Enlightenment tradition. Just as scientists searched for the origin of the solar system, Smith searched for the origin of moral approval and disapproval.
How can a man who is interested chiefly in himself make moral judgments that satisfy other people? After all, each person stands at the center of his own system, just as the sun stands at the center of the planets. Does the sun care what the smaller planets think? Smith struggled with this paradox, asking himself why, if people are selfish, each town does not resemble the vicious state of nature that the political theorist Thomas Hobbes portrayed in Leviathan. Hobbes argued that man’s life is “solitary, poor, nasty, brutish, and short” until governments emerge.
Finally, Smith concocted a clever answer. When people confront moral choices, he said, they imagine an “impartial spectator” who carefully considers and advises them. Instead of simply following their self-interest, they take the imaginary observer’s advice. In this way, people decide on the basis of sympathy, not selfishness.
Many critics vilify modern economists for assuming only selfish motives, for caring only about costs and benefits, and for ignoring man’s more noble side. The economist is, they declare, a moral dwarf. The attack may apply to some—but not to Adam Smith. Not just aware of sympathy and sentiment, he devoted the entire book to these emotions. Furthermore, A Theory of Moral Sentiments pointed to many concepts developed by Freudian psychoanalysis more than a century later. Freud’s concept of the “superego,” the conscience that restrains humans from certain acts and makes them feel guilty when they do not listen, is not so far removed from the adviser that Smith described.
Smith’s reputation soared as his book spread throughout Britain and the Continent. Wealthy students, whose parents heard of the Scotsman’s achievements, left their schools in France, Switzerland, and Moscow to enroll at the University of Glasgow. Ben Franklin, who had invented swim fins and the Franklin stove, and had already flown his kite in a thunderstorm, came to visit. One imagines Smith in the twenty-first century, appearing on podcasts and television talk shows plugging his book. Given his chronic absentmindedness, he might have been an entertaining guest, especially appearing on late-night television in his nightgown. Smith certainly was not content to stay locked in an ivory tower. At Glasgow he mixed town and gown, meeting with bankers, merchants, and politicians. At the Political Economy Club, he tried to figure out how businessmen really operated. As we will see, he learned not to trust the motives of merchants.
Soon, even cosmopolitan Glasgow began to bore Smith, and he resigned his professorship in 1764 to become the tutor of the son of the late Duke of Buccleuch. The boy’s mother, the Countess of Dalkeith, had just married Smith’s admirer Charles Townshend, who later emerged as chancellor of the exchequer and found his way into history books when his taxes inspired some colonists across the Atlantic to make a teapot of Boston Harbor. Smith’s tutoring job involved touring Europe, helping the boy develop a proper polish, attending lavish balls, and accepting £300 per year plus expenses and a £300 per year pension (roughly twice his former income). Smith was not fond of what today we would call a “gap year.” The man who would never know a son or a father surmised that “by sending his son abroad, a father delivers himself, at least for some time, from so disagreeable an object as a son unemployed, neglected, and going to ruin before his eyes.”6 With the tutoring proposal in hand, Smith consulted his impartial adviser, who sympathetically approved. He took the job. Forced by the offer to leave Glasgow in the middle of the term, Smith attempted to refund the fees he had collected from his devoted students by grabbing the coats of young students, shoving cash into their pockets, and then shoving them away from him. The students refused and dumped the contents of their pockets back into Smith’s.
The first and the most boring stop on the tour was Toulouse, France. Smith’s displeasure recalls the old vaudeville line about spending a week in Brooklyn one night. Smith would have been happier with one week in Brooklyn, for at least they speak a form of English there, whereas Smith could hardly speak French. Instead of a week, they stayed for a year and a half. Samuel Johnson once said that nothing concentrates a man’s mind so wonderfully than knowing he is to be hanged in a fortnight. Toulouse was not quite a scaffold, but it did inspire Smith to concentrate and write about economics. In a rather humble letter to Hume, he reported, “I have begun to write a book in order to pass away the time.”7
After the south of France, the entourage moved on to Geneva, where Smith met Voltaire, and finally to Paris. Paris was bubbling with artistic and intellectual creativity. Smith enjoyed the theater, met exciting personalities, and discovered a vibrant school of economics known as physiocracy. Founded by François Quesnay, a court physician for Louis XV with friends in high places and a high opinion of himself, the physiocrats presented some rather simple ideas in inscrutable language and a mysterious chart called the Tableau économique. Quesnay gathered together obsequious disciples who called him master, father, “the Confucius of Europe,” and “the modern Socrates.”8 The physiocrats vigorously advanced the Enlightenment quest for the laws of nature, but they did not believe that man could completely control nature—only that people could thrive if they understood its laws. In fact, physiocracy means “rule of nature.”
The Tableau économique brilliantly illustrates physiocratic thought. Just as medical doctors such as Claude Bernard began dissecting the human body and charting the path of blood, Quesnay charted the circulation of income in the economy. Instead of hands, feet, arms, and legs, Quesnay saw the body politic as three naturally interdependent classes: farmers, artisans, and proprietors (landlords and other sovereigns). Unfortunately, he so riddled the chart with zigzags that only he seemed to understand it. Quesnay admitted that even his chief disciple, Mirabeau the elder, was too “bogged down in the zigzag.”9 Nonetheless, in sycophantic style, Mirabeau praised the table as an invention as extraordinary as writing.
Physiocrats energetically argued two points: first, that wealth arose from production, not from acquisition of gold and silver, as mercantilists thought; and second, that only agricultural enterprise produced wealth, whereas merchants, manufacturers, and other workers did not. On an economics exam they would score 50 percent correct. They rightly claimed that a nation that produces goods is wealthier than a nation that simply stockpiles precious metals, but they lose points by arguing that manufacturing, commerce, and service industries are “sterile,” unproductive, and mere shifters of wealth. Without zigging and zagging through the model, let us note that the physiocrats advocated policies to make agriculture, the only productive sector, even more productive. For instance, they urged the government to release the economy from trade restrictions, which kept farm rents artificially low and discouraged investment in land. Further, they proposed taxes on landlords, not to punish them, but because only they could afford to pay, for only they owned a “productive” sector of the economy. In sum, the physiocrats enthusiastically embraced the concept of private property and private gain but saw concomitant responsibilities for owners. After all, their analysis insisted, it’s only “natural.”
Adam Smith listened attentively to the Frenchmen. Their analysis confirmed some of his ideas, but he did not accept their pronouncements on productive and sterile sectors. Nor did Hume, who asked a friend to “thunder them, and crush them, and pound them, and reduce them to dust and ashes.”10
Perhaps Smith’s impartial conscience restrained him from wishing pulverization. Physiocracy is, Smith admitted, “with all its imperfections,” perhaps “the nearest approximation to the truth that has yet been published upon the subject of political economy.” But, he added with some condescension, it is “a system, which never has done, and probably never will do any harm in any part of the world.”11 Thus, he gently patted the powdered wigs of the physiocrats, who gave the world an innocuous doctrine.
In 1766, sorrow struck when the duke’s ill younger brother died in Paris. Smith’s tour ended, and he returned to Kirkcaldy via London. For the next ten years Smith worked on his book, traveled to the Literary Club in London to discuss ideas and hoist glasses with Edward Gibbon and Edmund Burke, and exchanged nasty vulgarities with Samuel Johnson and James Boswell. Johnson called Smith a “dull dog,” and Boswell deemed him an “infidel with a bag wig.” Despite their vitriol, Smith received rave reviews from conversationalists whenever he visited Paris.
Finally, in March 1776, The Wealth of Nations, that book Smith wrote to pass away the time, was published. Smith’s hero Hume praised it loudly but warned that popularity would come only slowly. For the first time Smith rejoiced in a Humean mistake. An instant success, the first edition sold out in six months. Robert Burns, whose poems give us “Auld Lang Syne” and “Mice an’ Men,” declared that he “could not have given any mere man credit for half the intelligence Mr Smith discovers in his book.”
But is it a good book? It is not only a good book; it is a great one. With the hubris that goaded the gods into striking down Greek tragic heroes, Smith stared confidently at the world and delivered nine hundred pages of analysis, prophecy, fact, and fable—most of it clear, charming, and aimed at helping the reader to understand. The Wealth of Nations introduces readers to the world of philosophy, politics, and business, with the sharp, skeptical, yet ultimately optimistic Smith as a guide. Just when the Industrial Revolution explodes, Smith confidently points to every player, from farmer to friar to merchant to shipper, masterfully making sense of the social upheaval. Furthermore, Smith approaches economic policy without a biased brief for a particular party or class. No one could accuse him of sycophancy or insincerity. Though he finally endorses the rise of the bourgeoisie, he warns society not to naively succumb to bourgeois blandishments. In a way, the 1776 publication of The Wealth of Nations brought forth a declaration of independence for economists.
The full title reveals the key to Smith’s masterpiece: An Inquiry into the Nature and Causes of the Wealth of Nations. Notice that Smith focuses on a particular goal: to uncover causal laws that explain how to achieve wealth. The title alone places him in the Enlightenment tradition. The text confirms the suspicion by explaining the laws that guide “economic actors” and then drawing the implications of these behavioral laws for society. “Economic actors” may sound somewhat technical, but Smith simply means people, for everyone at some point in the day is an economic actor. And just as there could be no Hamlet without the Prince, Smith could construct no economics without understanding people. In this he follows the leads of Machiavelli and Hobbes, each of whom saw men as they were, not as they should be. Hobbes spoke of life as “but a motion of limb. . . . For what is the heart but a spring and the nerves but so many strings; and the joints but so many wheels giving motion to the whole body?” (original emphasis). Man is scrutable and peccable.12
The important natural drives or “propensities” Smith discovers in human nature form the basis of his analysis and the foundation of classical economics. All humans want to live better than they do. Smith finds a “desire of bettering our condition, a desire which, though generally calm and dispassionate, comes with us from the womb, and never leaves us till we go to the grave.”
Between the womb and the grave “there is scarce perhaps a single instant in which any man is so perfectly and completely satisfied with his situation, as to be without any wish of alteration or improvement of any kind.”13 Then, Smith points to “a certain propensity in human nature . . . to truck, barter, and exchange one thing for another. . . . It is common to all men.”14
To increase the wealth of nations, Smith argues that society should exploit these natural drives. Government should not repress self-interested people, for self-interest is a rich natural resource. People would be fools and nations would be impoverished if they depended on charity and altruism. Smith states that man almost constantly needs help from others, but it is hoping in vain “to expect it from their benevolence only. He will be more likely to prevail if he can shew them that it is for their own advantage.” In the most cited passage in the history of economic thought, Smith proclaims: “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.”15 Even those who enjoy slaughtering cattle, brewing beer, or baking cakes would not want to do it all day if they were not compensated. Smith never suggests that they are motivated only by self-interest; he simply states that self-interest motivates more powerfully and consistently than kindness, altruism, or martyrdom. Put succinctly: Society cannot rest its future on the noblest motives but must use the strongest motives in the best possible way.
But if everyone charges ahead in his own direction, why does society not resemble anarchy, something like a complex highway intersection with broken traffic lights? Shouldn’t we hear a frightening crash when self-interests clash? If roads cannot be safe without a traffic authority designating who shall move, can a community survive without a central planning authority to decide who produces and what is produced?
Yes. Not only will it survive, but the community will thrive far more than any community with central planning. More surprising, it will surpass both in output and social harmony any economic system based on altruism. Smith had studied astronomy and embraced the idea of a natural harmony in the planets, even if each planet moved in its own orbit. People, he thought, could move in different paths yet harmonize and help each other—but not intentionally. In his classic statement, Smith announces that if all seek to promote their self-interest, the whole society prospers: “He . . . neither intends to promote the publick interest, nor knows how much he is promoting it. . . . 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.”16 That “invisible hand” becomes the transparent symbol of Adam Smith’s economics.
Yet Smith did not rest his argument on any apparition. The invisible hand merely symbolizes the true orchestrator of social harmony, the free market. Friedrich von Hayek, one of the twentieth century’s most vigorous proponents of the free market, said that if the market system had not arisen naturally, it would have been proclaimed the greatest invention in human history. For market competition leads a self-interested person to wake up in the morning, look outside at the earth, and produce from its raw materials, not what he wants, but what others want. Not in the quantities he prefers, but in the quantities his neighbors prefer. Not at the price he dreams of charging, but at a price reflecting how much his neighbors value what he has done.
Let us start with our self-interested neighbor John as an example. In contrast to Adam Smith, John wakes up in his own bed, rather than in the town square. While reading the newspaper, John admires the lovely wood sculpture of a vulture that hangs above his dining room table, as if ready to swoop down on table scraps. John really enjoyed carving the vulture. An idea strikes him: Why not sculpt more vultures and sell them? After all, the specially treated wood imported from Tasmania would only cost $50 per vulture, and he can sculpt one per week. He decides to sell the vultures for $200 each, since big profits could make him rich and bring him the things he dreams of, like big cars and riotous vacations in Acapulco. Most important, though, he loves sculpting.
He begins working and rents a shop, inviting neighbors and local art critics to a gala opening. They laugh. He cries. They think the vulture sculptures are hideous. He cries louder. No one buys. Finally, his mother offers $49 for one. He gives in—and goes out of business. The invisible hand gives a “thumbs-up” approval. Why?
Instead of producing something his neighbors wanted, John produced what he wanted. Instead of charging a price they were willing to pay, John charged an exorbitant amount. But in John’s case, no one would pay him as much as it actually cost him to produce the vultures. Didn’t John have to charge more than his costs? No. The answer is not to charge more, but not to produce at all! Why should the invisible hand approve of John going out of business? To make the sculptures, John used up scarce resources. The earth gives us only so much to work with. If John used the valuable Tasmanian wood, no one else could. The invisible hand forces people to give up if they do not produce something more valuable than what they started with. John took $50 worth of wood, carved it up, and gave the world vultures worth less. Societies cannot afford to squander resources by subtracting from their value. People who take wood and produce Stradivarius violins or crutches for the disabled increase the value of those resources and enrich society. They deserve applause from the invisible hand. John deserved a punch.
Back to the drawing board for John. He pours a cup of tea, curses the vulture above his dining room table, and slams his fist down. Tea jumps out of the cup onto the table. Now he curses himself for spilling tea on the new table he made just a month ago. Inspiration strikes again. Why not, he asks, build tables and sell them? A bit wiser now, he finds a lumber mill that will supply wood to him at a cost of about $100 per table. Carving, planing, and fitting will take about two weeks per table. His time, he figures, is worth $200 per week, based on his previous job as a carpenter. Taking into account tools, rent, and other incidentals, he calculates the total cost per table at roughly $575. John window-shops for similar dining room tables and discovers he could sell the tables for $585. Not only will he be able to pay himself $200 per week, but he will also earn a profit.
The invisible hand finally gives John a thumbs-up. He’s taken scarce resources and brought forth something more valuable than what he started with—not according to his own tastes but according to society’s.
So far we have seen the invisible hand encourage and discourage production. But Adam Smith also shows us how the market regulates prices. Remember that Smith’s characters are self-interested. Why does John not raise his table prices above $585 to increase profits? He cannot. If John boosts his prices, profits will plunge, because people will simply bypass his shop and buy from competitors who charge less. Of course, all the furniture makers could get together and agree to raise prices. But even if they were able to agree, other self-interested people would see the high profits in the furniture business and open shops. Such entrepreneurs could earn enormous profits by underselling and stealing business away from the cartel.
Prices and profits signal to entrepreneurs what to produce and what price to charge. High prices and high profits sound alarms in the ears of entrepreneurs, screaming at them to start producing a certain good. Low profits or losses grab the businessman by the shirt collar and shake him mercilessly until he stops producing.
Prices and profits are not simply abstractions, though. What does it really mean if profits are high? It means that people need or want a product. When homeowners and automobile drivers decided they preferred streaming audio devices to compact disc players, demand rose for the streaming-device technology and producers were able to charge more. In turn, compact disc manufacturers responded to the signals by producing fewer players; workers shifted from one type of factory to another; and the price returned to normal. Between 2000 and 2018, the number of CD sales plummeted by 90 percent, while the cost of listening to a song also decreased.17 Consumers bought fewer CDs in 2018 than they did in 1987, when Dirty Dancing hit the charts. Likewise, in 2004 Blockbuster video had more than nine thousand stores worldwide. Today there is one remaining outpost that attracts tourists nostalgic for the 1990s to Bend, Oregon. Despite the churn in the video industry, the cost of watching a movie at home is cheaper. Over the past decade, prices for personal computers and flat-screen TVs have dropped, not only because costs have dropped, but also because so many high-technology manufacturers have entered the competition for profits. In the long run, no industry should earn more than a normal profit. The free market automatically induces self-interested Johns to satisfy strangers. No central planner need call, no taskmaster need coerce.
Adam Smith delivered on his promise to show how the invisible hand regulates output, price, and profit. But the cheery Scotsman also promised to teach us what increases the wealth of nations. If he failed to answer that question, he’d score no higher than the physiocrats. Happily, he won again with a neat three-word answer: division of labor. Smith argued his case logically and empirically. The empirics come to life as he describes a pin factory, again in one of the most famous passages in economic thought. Mark Twain said that classics are books everyone owns but no one ever bothers to read. Even more sad, classics often become rather boring clichés, and we can miss the force and drama they packed when they originally appeared. Imagine the initial power of the following passage, for it appeared before factories were common and when groups of only three or four people produced most of the world’s goods:
A workman not educated to . . . the trade of the pin-maker . . . could scarce, perhaps, with his utmost industry, make one pin in a day, and certainly could not make twenty. But in the way which this business is now carried on, not only the whole work is a peculiar trade, but it is divided into a number of branches, of which the greater part are likewise peculiar trades. One man draws out the wire, another straights it, a third cuts it, a fourth points it, a fifth grinds at the top for receiving the 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 the important business of making a pin is, in this manner, divided into about eighteen distinct operations, which, in some manufactories, are all performed by distinct hands . . . I have seen a small manufactory of this kind where ten men only were employed, and where . . . each person . . . [averaged] four thousand eight hundred pins a day. But if they had all wrought separately and independently, and without any of them having been educated to this peculiar business, they certainly could not each of them make twenty, perhaps not one pin in a day.18
Just by specializing and dividing the tasks, one day’s output can explode by 400,000 percent! How can Smith possibly explain this? Are we about to be introduced to the invisible foot or another impartial ghost who actually works for us while we sleep? To be fair to Smith, he never promised a 400,000 percent leap in every situation. But he did proclaim three ways in which division of labor lifts output: First, each worker develops more skill and dexterity in her particular task. Second, workers waste less time changing from one task to another. This makes sense, especially if changing tasks forces one to change uniforms, tools, or location. And third, specialized workers will more likely invent machinery to help with the particular task they focus on daily. Smith believed that workers, rather than engineers, often propel invention:
A great part of the machines made use of in those manufactures in which labour is most subdivided, were originally the inventions of common workmen, who, being each of them employed in some simple operation, naturally turned their thoughts towards finding out easier and readier methods of performing it. Whoever has been much accustomed to visit such manufactures, must frequently have been shewn very pretty machines, which were the inventions of such workmen.19
Notice that while Smith begins by praising division of labor for its heightened productivity, he ends up crediting division of labor for technological advancement.
From the mid-1970s until the late 1980s, when the Japanese stock market bubble burst, business consultants, economists, and business writers studied Japanese factories in quest of the secret behind their successes that toppled the “Big Three” automakers in Detroit and bankrupted U.S. tech firms like Polaroid and Compaq. In some ways, Japanese workplaces appear less divided and less Smithian, employing work circles rather than assembly lines. Yet Japanese businesses claim that their workers invent and innovate much more than their American counterparts do. The glorification of Japanese methods has inspired some emulation and a few fables, such as the tale of the Japanese, French, and American corporate executives, each sentenced to death. The executioner offers a final request. The Frenchman says, “I’d like a bottle of cabernet sauvignon and a feast featuring escargot, pheasant, and crème brûlée.” The Japanese executive responds, “I’d like to give a lecture on the merits of Japanese corporate management.” Finally, the American gives his last request: “Would you please kill me before the lecture on Japanese management?”
To spark efficiency, jobs should be divided by task, Smith submitted. But he warned that division of labor leads to a divergence in wage rates for different tasks. Smith’s complex hypotheses for wage rates preclude a neat and concise discussion. But he did give economic theorists cogent grounds for explaining why one group gets paid more than another:
A job may entail disagreeable conditions, and thus few accept employment unless wages compensate them (“compensating differentials”). A window washer at the top of the Empire State Building receives more than a busboy who wipes down a Formica lunch counter. Of course, the window washer also gets a better view.
Some jobs require special training. Courtroom stenographers earn more than bailiffs.
An irregular or insecure job may pay more. Construction workers receive more per hour than other similarly trained laborers because weather conditions prevent them from working as many hours.
When high degrees of trust are required, wages rise. Because lay persons cannot assess the value of a diamond, many people feel more comfortable buying from a pricey but trustworthy store like Tiffany’s than from a discounter.
When the probability of success is low, the payoff for success will be high. Lawyers in civil suits often accept cases on a contingency—that is, they get paid only if they win. But if they do win, they can earn even more than stenographers. Smith did not believe that all economic actors displayed perfect rationality. He suspected that people in risky professions overestimate their chances of success and therefore end up with lower incomes than they expect.
Smith never promised that division of labor alone brings wealth to a nation. Free trade among manufacturers, suppliers, towns, and cities is also necessary. What good are ten thousand pins if they cannot be traded because of restrictions or high transportation costs? The manufacturer might as well make twenty or perhaps none. Furthermore, division of labor can take place among towns, not just among workers in a factory. Particular towns can specialize, just as particular individuals can. Boise may produce wheat while Boston produces Bose headphones. The point is, the wealth of a nation grows if markets expand—that is, if more and more areas are hooked up to trade routes.
Consider the United States in 1750. Trade routes along the Eastern seaboard delivered goods relatively smoothly from Baltimore to Boston, yet settlements west of Pennsylvania had to fend for themselves. A self-sufficient settlement is analogous to a pin worker who must cut, bend, attach, and deliver by himself. In the United States, as transportation routes over rivers and land developed and distribution costs shrunk, more and more towns could be brought into a common market, boosting the wealth of the individual communities and of the nation as a whole. In fact, as the maritime industry built safer ships and developed better navigational skills, it drove down shipping costs over the Atlantic, which invigorated the colonies and Britain throughout the eighteenth century. Even the defeat of pirates contributed to the wealth of nations.
Emersonian self-reliance may be part of the American psyche, but the American pocketbook fattened in spite of it.
While pleading for free trade, Smith insisted that England would gain from trade if it could buy a good from another country for less than the cost of producing that good in England. The English might not like the French, but if a bottle of French white wine costs one pound and an English counterpart costs two pounds, England is foolish to produce wine. France has an “absolute advantage” in wine. Of course, if French wine costs twice as much as English wine, England is foolish to buy French wine. Smith’s point is well taken, for why should England waste scarce resources that could be used to produce wool at a lower cost than France rather than grapes at a higher cost? According to Smith, nations should import only those products in which another country has an absolute advantage. (Keep Smith’s argument in mind, for David Ricardo shows true brilliance when he reforms it and persuades almost all economists thereafter that trade can enrich a nation, even when no other country produces more cheaply.)
Using his overcoat as an example, Adam Smith cited all the varied and geographically divided laborers who together made it possible for him to stay warm: shepherds, wool sorters, wool combers, dyers, spinners, weavers, merchants, and sailors (presumably elements of his coat were imported). Most striking, none of these laborers had to know each other, know Smith, or know why Smith wanted a coat. All they needed to know was that the wage for shepherding or dyeing was high enough to make their labor worthwhile; that is, someone was willing to pay them for contributing to the final product. Hayek would take Smith’s argument further in an important article, pointing to the dispersion of information as one of the biggest obstacles for society. No central planner could possibly gather all the information needed to decide whether society should produce a coat for Adam Smith; and even if he had all the information, it could change. But the market-price system tells individuals all they need to know. Hayek uses the example of tin in the following passage:
Assume that somewhere in the world a new opportunity for the use of . . . tin, has arisen, or that one of the sources of supply of tin has been eliminated. It does not matter for our purposes—and it is very significant that it does not matter—which of these two causes has made tin more scarce. All that the users of tin need to know is that some of the tin they used to consume is now more profitably employed elsewhere, and that in consequence they must economize tin. There is no need for the great majority of them even to know where the more urgent need has arisen. . . . If only some of them know directly of the new demand, and switch resources over to it, and if the people who are aware of the new gap thus created in turn fill it from still other sources, the effect will rapidly spread throughout the whole economic system and influence not only all the uses of tin, but also those of its substitutes and the substitutes of these substitutes, the supply of all the things made of tin, and their substitutes, and so on, and all this without the great majority of those instrumental in bringing about these substitutions knowing anything at all about the original cause of these changes.
A striking quotation from the philosopher Alfred North Whitehead emblazons that point: “It is a profoundly erroneous truism, repeated by all copy-books and by eminent people when they are making speeches, that we should cultivate the habit of thinking what we are doing. The precise opposite is the case. Civilization advances by extending the number of important operations which we can perform without thinking about them.”20 Through symbols and signals that we do not understand, we take advantage of the knowledge of others.
Hayek also applies his “ignorance” argument to attack the utopian hope of an economy based on complete altruism. An individual is the world’s foremost expert on what she wants. Nobody else knows better; nobody else can better judge the effects of alternative choices on her achieving what she wants. Therefore, people should look after their own interests. If all sought to do “the public good,” they would have to know as much about everyone else as themselves. Jill, a saintly woman, may love Jack, whom she has never met; but how does she know what he wants and how much he values what he wants? Suppose Jill and Jack are both altruists. Jill is selling her house. Since she loves Jack, she wants to sell the house to him for only $100,000. Since Jack loves Jill, he would not dare pay so little. He offers $200,000. She refuses and offers to accept $110,000. Insulted that she refuses his gift, Jack insists on $210,000. We do not know where this will end, which is precisely Hayek’s point. No market signals emerge, and society loses the ability to allocate scarce resources, because nobody admits how much they value the house. As Adam Smith put it: “By pursuing his own interest he frequently promotes that of the society more effectively than when he really intends to promote it. I have never known much good done by those affected to trade for the public good.”21
Hayek’s logic was influenced by his teacher Ludwig von Mises, who argued against socialism in 1920 on the grounds that no government could perform all the calculations needed to organize an efficient economy. Von Mises was the leader of the Austrian school of economics, which took a laissez-faire view and was very skeptical of mathematical models. Because von Mises believed that economic truths were self-evident and opposed models based on real data, his views fell out of favor until fairly recently. Today, neo-Austrians try to expand on his work and that of his Viennese teachers, Carl Menger and Eugen von Böhm-Bawerk.
Milton Friedman follows in the Smith-Hayek tradition. If you pick up a copy of his book Free to Choose, you will see a picture of Friedman holding up a pencil as a symbol of the wonders of free trade. No single person, Friedman insisted, knows how to make a pencil.22 To make a pencil, you must learn how to chop down a big tree in Oregon. But first you would need steel for the saw. So you would book a flight to an iron mine in Brazil and strap on a miner’s helmet. Then make your way to Pittsburgh to figure out how to turn iron ore into steel. Do not forget the pencil’s metal tip, graphite center, and rubber eraser. They require trips to Sri Lanka and Indonesia. After all that traveling and learning all the chemistry, engineering, and foreign languages necessary for the transactions, do you think you could you churn out a single pencil for the thirteen cents that Dixon Ticonderoga charges, whose pencils also come in a handy cardboard box with attractive graphic printing and attract faithful fans? (George Lucas wielded a Dixon Ticonderoga before he gave Luke Skywalker a lightsaber, and Willy Wonka writer Roald Dahl would sharpen half a dozen each morning before his first morning scribble.)23 Remarkably, not the iron miner, the tree chopper, the rubber farmer, nor the graphic artist ever has to gather together in a conference room to conjure up the miracle of the pencil. No central planning bureaucrat needs to direct the operation. The price system and the invisible hand of the market coordinate all this. And in your lifetime, have you ever heard of a shortage of pencils? Or price gouging by pencil makers? Pencils are surely a trivial matter (unless you show up without one on the morning of your SAT test). But far more sophisticated examples, from an aspirin (one penny for each pill) to an airline jet engine ($11 million), come to us through the same mechanism. Over time, markets drive producers to deliver better products and better prices.
Although Smith constantly praised free trade and the causes of merchants, he was not a hired gun of the bourgeoisie. The Wealth of Nations bristles with criticism of merchants. Nor is it a brief for the rich. Smith vigorously praised free trade and division of labor because he was convinced that they helped the common man even more than they helped the prince:
Without the assistance and cooperation of many thousands, the very meanest person in a civilized country could not be provided. . . . Compared, indeed, with the more extravagant luxury of the great, his accommodation must no doubt appear extremely simple and easy; and yet it may be true, perhaps, that the accommodation of a European prince does not always so much exceed that of an industrious and frugal peasant, as the accommodation of the latter exceeds that of many an African king, the absolute master of the lives and liberties of ten thousand naked savages.24
As do his followers, Smith fondly suggests that under a market system, even the poor and the politically impotent can prosper. In contrast, under a centrally guided system, political power determines economic position: only the friends of the king and lords can grow rich. Again, Milton Friedman expanded on Smith’s point in his Capitalism and Freedom, arguing that the market system reduces effective racial or ethnic discrimination because consumers buy from whoever offers the best price, not from whoever offers the proper prayer or complexion; and on the other hand, he points out that under a socialist system, a member of a minority group must gain the political favor of a planner in order to advance.25
Friedman’s beliefs remain controversial, and critics have offered many counterexamples, suggesting, for instance, that corporate executives promote minority workers only if they score highly on such “soft” variables as “leadership ability” and “personality.” Furthermore, critics insist that economic power can translate into political power through campaign contributions, leaving the economically poor without a political voice. Friedman accepts the latter point but hurls it back at his critics by arguing for a smaller government that is barred from interfering in most economic events. The debates rage, and the literature expands.
Although Smith was confident that he had exposed the secrets to greater wealth, he was not driven to establish an infallible catechism. He readily admitted some faults in dividing labor, and again, he proved himself sensitive to more than costs and benefits. Recall that his first love was moral philosophy. A firm believer in the influence of physical conditions on the human mind, Smith feared that an assembly line could rob workers of their intelligence and spirit: “The man whose whole life is spent in performing a few simple operations, of which the effects too are perhaps, always the same . . . has no occasion to exert his understanding, or to exercise his invention in finding out expedients to removing difficulties. . . . He, naturally, therefore loses the habit of such exertion, and generally becomes as stupid and ignorant as it is possible for a human creature to become.” In one of his paternalistic moments, Smith recommended public education as a remedy for public dullness, because educated workers are more likely to invent and to exercise their minds while performing physical tasks. Said Smith: “For a very small expense the publick can facilitate, can encourage, and can even impose upon almost the whole body of the people, the necessity of acquiring those most essential parts of education.”26
At this point, let’s summarize The Wealth of Nations. Adam Smith saw labor as the chief engine of economic growth, accelerating when (1) the labor supply increased, (2) labor subdivided, or (3) labor quality rose through new machines. As long as new ideas for profitable investment and invention continued to spring from imaginations and free exchange was permitted, economic growth would go forward. And most important, the general public could enjoy a higher standard of living. The Nobel Prize–winning economist Paul Samuelson, whose disagreements with Milton Friedman fill volumes, reexamined Adam Smith’s growth theories using modern mathematical techniques, finding that if “inventions keep recurring . . . profit rates and real wage rates average out above their subsistence levels.” Samuelson announced “the happy finding that Adam Smith comes through with flying colors from a modern post-mortem.”27
Adam Smith was no ivory-tower theorist. He wanted the world to follow his precepts, and he eagerly met with politicians and power brokers. He was thrilled when Prime Minister William Pitt took his advice or when opposition leader Charles James Fox quoted him and called the “truth” of his work “indisputable.” He would have forgiven Fox for quoting famous passages without having read any of his books. In The Wealth of Nations, Smith speaks with prescience and sympathy toward the American colonies. He was disappointed that English leaders could not see that the colonies would win their fight for independence and become “one of the greatest and most formidable [empires] that ever was in the world.”28
President Harry Truman once begged for a one-armed economist. Why? He was “damn tired” of economists who said that “on the one hand, we could . . . but on the other hand maybe.” Adam Smith had two hands, but he confidently pointed his finger at the best policies for the polity to follow. He warned legislators that special interests would press hard against those measures that increase the wealth of nations. His warning should still resound in parliaments and congresses throughout the world. Smith’s free-market approach to economics did not condemn him to the naive optimism of Voltaire’s Dr. Pangloss, who lives “in the best of all possible worlds” despite all the evidence surrounding him. On the other hand, he was not, as speechwriter William Safire so alliteratively put it (through the lips of Spiro Agnew), a “nattering nabob of negativism.” Instead he recognized obstacles and showed how to avoid them. Let us look at two policy concerns.
Domestic Trade Restrictions. Recall the competitive market system described earlier, in which entry into an industry forces prices and profits down to the cost of production plus a normal return on investment. Smith saw that sometimes merchants clearly took home exorbitant profits. Why didn’t his model work? Smith described two different scenarios that explain excess profits.
In the first case, entrepreneurs cannot enter the outrageously profitable industry simply because of natural phenomena. For example, only the land near Jerez, Spain, can grow the proper grapes for sherry. Enterprising Englishmen cannot grow grapevines for sherry around Buckingham Palace, even if the royal family volunteers to crush the grapes with their own royal feet. Thus, landowners in Jerez may enjoy high profits. Of course, entrepreneurs could try to persuade people to drink port instead, which would erase the exorbitant profits.
What if the royal family could manage to grow grapes for sherry in their English garden at Buckingham Palace? Should they be able to call the brew “sherry”? The European Union insists on protecting many agricultural items from geographical copycats. For example, champagne can be produced only in Champagne, France. No doubt, Italian winemakers can figure out how to age grapes for a champagne product, but they would be arrested if they slapped the word “champagne” on the label. Instead they call their fruitier, bubbly wine Prosecco, from grapes grown north of Venice. But do not feel sorry for the Italians. Only they can legally produce Parma ham, while only the French can call a blue cheese Roquefort. A consortium of Parmigiano-Reggiano cheese makers in Italy specifies exactly how many hours cows may be milked and what portion of milk may be devoted to cheese-making.29 And as you would guess, only the Swiss can make authentic Swiss cheese, despite the availability of hole-punch machines all over the continent.
By limiting competition, these “geographical indicators” and trademarks keep profits higher for traditional producers and prices higher for consumers.30 A salesman for Kraft’s cheap, canned, parmesan-cheese sprinkle would not receive a warm welcome at a pizzeria in Parma. Champagne producers in France know that Prosecco and California sparkling wines can be made more cheaply and can perform rather well in blind taste tests against their bottles. The European bureaucratic insistence on agricultural protection could be called a “reign of terroir”—“terroir” meaning the “character of the terrain.” It is caught up in a heartfelt, nostalgic notion that produce is tied to the land and to the cultural traditions of a place. Kalamata olives taste like Kalamata olives because the soil, the rains, and the sweat of the Greek worker make it so. One does not have to look hard to spy the word “culture” in “agriculture.”
Europe is not the only place that imposes geographical indicators. Try brewing Kentucky bourbon in New Jersey and you may be chased down by a Paducah sheriff and his shotgun. In general, though, the United States has a more lenient view of geographical trademarks and has tried to negotiate through the World Trade Organization for weaker standards. It is a tough negotiation. When modern European politicians try to water down the rules and regulations, they face a backlash of terror. In 2019, French farmers suspected that French president Emmanuel Macron was loosening restrictions that keep out South American beef. They launched battalions of tractors rumbling through Bordeaux to protest. Macron was lucky. In the 1990s, the French agriculture minister was chased through the streets of Paris by farmers wielding pitchforks. Please note that this pitchfork chase took place in the 1990s, not the 1790s.
Nostalgia plays a role in this passion. In Proust’s Remembrance of Things Past (1913), the narrator Marcel drowns in a flood of feelings as he dunks his baked madeleine in his tea. He tries to recall the memories of youth: “After the people are dead, after the things are broken and scattered, taste and smell alone . . . remain poised a long time, like souls, remembering, waiting, hoping amid the ruins of all the rest.” In a modern economy, as commerce and science allow us to enjoy more food, live longer, and climb to a higher standard of living, we also may feel as if we are losing something. Marcel remembers a fresh-baked madeleine. Today I am more likely to eat a madeleine delivered by truck to a Starbucks or sold in a wrapper by Nabisco. Perhaps we miss the taste of an earlier day—or the artisans who conjured up those tastes. Despite the higher standard of living, we might occasionally feel the nostalgic twinge. I call this feeling “melancholia madeleine”; for amid the hustle of modern times and the beeping of devices, we all sometimes feel like Marcel.
But is it better to call off modernity and to swear off international trade? The last time Europe tried “buying local,” it was called the Middle Ages. But even in medieval times, residents invited traveling merchants to set up shops in town squares. Modern consumers have the luxury of year-round, 24-7 access to goods grown, gathered, stitched, or forged from every continent but Antarctica, unless you are Mr. Popper looking for a penguin. In the 1940s, a Cole Porter lyric recalled an ex-lover who was not worth the ransom on “asparagus out of season.” Isn’t asparagus now available year-round, along with kiwi, sushi, and farm-raised branzino?
The second case Smith pointed to is more pernicious. Abnormal profits may persist when small groups of merchants join in pacts to keep prices high. “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 diversion to raise prices,” he wrote.31 According to Smith, devilish pacts among merchants are usually not strong enough by themselves. Therefore, the traders entice government to do the work of the devils. Conspiracies will usually not prevent market entry unless the government supports the cartel. Smith fired salvos at many contradictory restrictions that limited trade and the division of labor for the benefit of identifiable groups. Apprenticeship laws and guilds especially choked competition. Smith described one fatuous result: a coach maker could not legally make wheels for his coaches, but a wheel maker could make coaches to place on top of the four wheels he made! If wheel makers could prohibit competition through law, they could charge high prices. Besides the Statute of Apprenticeship, Smith also disparaged the English Poor Laws. To get relief, citizens had to fulfill residency requirements, which meant that they could not fluidly move from industry to industry or town to town as demand changed for different types of laborers. Smith viciously lashed out at monopolies granted by the government, which, by “keeping the market constantly understocked, by never fully supplying the effectual demand, sell their commodities much above the natural price, and raise their . . . wages or profits.”32
And how has Smith’s fear of conspiracy been addressed on this side of the Atlantic? The United States has been more concerned with monopolies and oligopolies (a small group of firms that together dominate an industry) than with apprenticeship rules, which were never as common in America as they were in Europe and Asia. Every high schooler learns about robber barons, those nineteenth-century industrialists like Vanderbilt, Carnegie, and Rockefeller who stomped on competitors and ruled over trains, steel, and oil. In 1898, William McKinley launched the trust-busting era to bring down the titans of the time, a program later enforced by Theodore Roosevelt. But here is what many schoolbooks leave out: during the robber-baron era (often defined as 1865 to 1900), consumer prices in the United States were flat to falling, while per capita GDP steadily rose. It is hard to understand why those barons would have used their sweeping power to increase output and cut prices. Economic theory teaches us that monopolists do the opposite. The answer: their market power was not permanent and they were constantly fighting off invaders, which required them to keep prices down. Nonetheless, American economists and politicians feared that large corporations could protect themselves from competition and thereby rake in high profits. Thus, over the years, the government dragged into court thousands of corporations, which kicked and screamed through their lawyers, and sued them for price-fixing and restraining competition under the Sherman Antitrust Act and the Clayton Act. Further, the Justice Department frequently tried to block corporate mergers. Trust-busting continued throughout the twentieth century. The Nixon administration launched a thirteen-year breakup fight against IBM (alleging that Big Blue was monopolizing the computer business) before slinking away in 1982. IBM doesn’t even make personal computers anymore. In 2005, the Federal Trade Commission battled a merger between Blockbuster and the Hollywood Entertainment video company, apparently worried that these hapless firms were locking up the VHS and DVD markets. (Was the FTC protecting consumers against those pesky VHS players that kept blinking “12:00”?) Throughout the 1970s, some economists and law professors, frequently the former students of University of Chicago dons Milton Friedman, George Stigler, and Richard Posner, contended that while price-fixing was evil, “bigness” through mergers may not be, for bigness does not necessarily prevent entry and may, in fact, foster efficiency.
Amazon and Walmart are the two biggest retail companies in the world. Walmart was started by Sam Walton, a crafty, penny-pinching guy from Arkansas who named his first store Walmart because he didn’t want to spend money to buy the extra letters to spell out Sam Walton’s 5-10.33 Jeff Bezos launched Amazon by selling books in his garage and warned early investors that there was a 70 percent chance he would go bankrupt. Instead, Bezos became the richest man in the world. From modest beginnings, these two retailers have grown into far-flung enterprises that have rewritten the rules of retail and driven storied competitors like Toys “R” Us, Barneys, and Kmart into bankruptcy court. Nonetheless, their principal impact on consumers has been to drive prices lower.
Many contemporary scholars maintain that old-fashioned trustbusters look at the market too narrowly. Modern competition includes foreign corporations, not just domestic ones. As evidence, they can point to the failures of General Motors in the 1980s versus the victory of Hyundai, a Korean car manufacturer that within months of landing on America’s shores drove right through Detroit and left skid marks on GM’s balance sheets. In the television market, Sony crushed Zenith and RCA, before Samsung and Sharp stole market share from Sony. Motorola dominated early cellphones in the 1990s but seldom shows up now except in a game of trivia.
In the 1990s, the hottest antitrust case was launched by the Justice Department against Microsoft. The government’s antitrust regulators argued that Microsoft’s monopoly on computer operating systems permitted it to block competitors from getting their products in front of consumers. Many journalists analogize Microsoft founder Bill Gates to John D. Rockefeller, suggesting that by monopolizing the computer system, Gates can act as Standard Oil did by cornering the market in oil. Microsoft opponents cheered when one of the leading Chicago School thinkers, former judge and Yale professor Robert Bork, issued a brief attacking the monopolist. After dramatic video footage of Bill Gates, then the world’s wealthiest man, fidgeting on the witness stand, Microsoft settled the case with the Department of Justice. Yet, to the regret of Microsoft’s opponents, the settlement did not force the company to rip out the guts of its software code, or prevent it from tying new programs to its Windows program. In fact, the settlement did little more than obligate Microsoft to “share” its interfaces with others. Quite often, while lawyers argue in court, new leaps in technology make courtroom solutions both obsolete and wasteful. At the very moment Gates was held hostage in Seattle, Steve Jobs was in Cupertino unveiling the iMac and plotting to rip open markets with the iPhone and iPod.
In a remarkable commencement address at Stanford, Steve Jobs recalled dropping out of college on his way to challenging IBM: “I didn’t have a dorm room, so I slept on the floor in friends’ rooms. I returned Coke bottles for the five-cent deposits to buy food with, and I would walk the seven miles across town every Sunday night to get one good meal a week at the Hare Krishna temple. I loved it. And much of what I stumbled into by following my curiosity and intuition turned out to be priceless later on.”34 For more than thirty years, the Justice Department was attacking IBM. But it took a dropout like Steve Jobs, not starchy antitrust lawyers, to create more intense competition.
The world economy is as ferociously competitive as ever. Many barriers to entry in the modern economy are falling, not rising. Invaders are poised nearly everywhere, threatening to steal market share. Procter & Gamble owned a 70 percent share of the men’s razor market until some daring dude launched the Dollar Shave Club with an outrageous YouTube ad called “Our Blades Are [Expletive] Great,” which went viral in 2012 and attracted millions of subscribers. Amazon is scaring firms in various sectors, not with higher prices but with lower prices and quicker delivery—even delivery by drone.
The gig economy, too, is delivering bargains. Airbnb has effectively added 25 percent to the number of available rooms in U.S. cities. Uber is worth more than Hertz and Avis. In the heyday of antitrust enforcement in the 1960s and 1970s, start-up firms needed to raise tens of millions of dollars to build factories and hire employees. Nowadays, firms with compelling intellectual property and strong leadership can take on market leaders with just a website, a few swivel chairs, and a single-serve coffeemaker.
Even areas that seemed entirely off-limits to the private sector attract competition. The hit movie Hidden Figures tells the inspiring story of black women who helped NASA do the math to get John Glenn into orbit. But even the risky, previously untouchable space sector has grown supercompetitive, with Bezos’s Blue Origin, Richard Branson’s Virgin Galactic, Elon Musk’s SpaceX, Boeing, and Arianespace vying for business.
Antitrust enforcement should focus on cases where mergers would damage consumers through persistently higher prices. For example, local hospital mergers tend to raise prices, and limping patients are not usually in a physical or psychological position to shop around.
Despite the low inflation environment of the past decade, the Trump administration has been more aggressive than its predecessors on trust-busting. The Trump Justice Department, for example, tried unsuccessfully to block a merger between AT&T and Time Warner, arguing that a merger could drive up the cost of consumers watching movies and television programs at home. The Federal Trade Commission sued Qualcomm for imposing allegedly onerous contract terms on Apple. This new concern about corporate powerhouses has received support in past years from some academic economists who have pointed to a rising concentration of market share in various industries. They have warned that rising prices are on the way.35
Nonetheless, it is extremely difficult to forecast the impact of corporate deals when technology moves so quickly. AT&T and Time Warner might someday display awesome powers, but the combined firm must grapple with the fact that 30 percent of millennials have “cut the cord” with their cable provider. Netflix, Disney, Hulu, YouTube, Amazon, and half a dozen others offer streaming services. Meanwhile, Snapchat, a nimble new content company, attracts 160 million viewers who watch more than 10 billion videos daily. Who is the underdog?
The greatest irony is already apparent, though. For a good part of the twentieth century, many eminent economists such as Joan Robinson, Edward Chamberlin, and John Kenneth Galbraith pronounced that Adam Smith’s simple world of perfect competition grew less relevant as the years went by and corporations swelled. Yet many modern economists insist that because of international competition Adam Smith’s vision grows more radiant and relevant every day!36
International Trade Restrictions. “What is prudence in the conduct of every private family, can scarce be folly in that of a great kingdom,” Smith wrote.37 Having proved the theory of absolute advantage, he mercilessly blasted merchants who lobbied for, and governments that surrendered to, demands for protection from foreign producers. Through tariffs or quotas, the government forces consumers to subsidize merchants, because consumers pay higher prices than necessary. Without foreign competition, domestic merchants raise their prices and profits. The forces that fight free trade look “like an overgrown standing army . . . formidable to the government, and upon many occasions intimidate the legislature.” Smith lamented that officials who opposed free trade were rewarded with flattering publicity, while those who battled for the public interest received insults and infamous abuse.38
In a quick debate, anti–free traders usually come up with pithier lines. Senator Bernie Sanders, an avowed socialist, calls free trade “a race to the bottom.” President Donald Trump called free trade agreements a “trade war on the American worker.”39 Some years ago I debated a boisterous union leader who literally took off his shoe and began slapping the lectern with it, eliciting cheers from a crowd gathered at a massive, dingy Chicago hotel. No doubt, the shoe was made abroad, which reinforced his point. Advocates for free trade usually need at least two sentences to make their point, with or without shoes.
The data does not prove that trade makes people more jolly, but it does make a compelling case that trade pushes up living standards. Perhaps the best way to look at the benefits is to ask, how many hours does an average person have to labor in order to get enough food to live and to buy the things they desire? In 1870, children typically began work at age 13. What was the retirement age? Death. People labored in the fields or factories roughly 3,000 hours a year and somehow managed to squeeze in 1,800 hours of household chores. They spent 61 percent of their waking hours working. By 1950, children did not work until age 17.6, and adults spent only 45 percent of the day on the job. Today, we start working at age 20, look forward to a 16-year retirement, and spend only 28 percent of our waking hours on the job.40 Child labor laws emerged in the early 1900s. Nowadays parents are more likely to worry that their children have not been exposed to even a part-time job and, therefore, lack a sturdy work ethic.
Before the Internet, American shoppers who did not want to get in their cars would flip through the Sears and J. C. Penney catalogs before placing their orders. Thankfully those old catalogs are still in libraries and allow economists to compare prices over time. In 1959, for example, an average worker would labor for about two weeks to afford a refrigerator. Today, it takes a few days’ labor. A vacuum cleaner would require more than a week of labor; today it takes less than one day’s labor.41 And while the United States has a wide disparity of incomes, poor households have surely benefited, too. In 1971 only about 20 percent of American homes owned a dishwasher and about 40 percent watched television in color. By 2005 about 40 percent of poor families no longer had to wash dishes by hand, 78 percent had air conditioning, and nearly all owned at least one color television. Other countries enjoyed similar wonders. As recently as the mid-1960s, one-third of British families did not own a refrigerator, which might explain the lingering tolerance for tepid beer.42
Countries that shun trade tend to stagnate or sink. After the Soviet Union imploded in 1991, I took a few days off from my job at the White House to visit Leningrad, which had just changed its name back to Saint Petersburg, Russia. Wandering through the flaking hallways of the Hermitage, I realized that communism’s problem was not failing to keep up with the rising standards of 1980s America but failing to keep up with the standards of 1917 Russia. Cuba’s GDP per capita was near the top of Latin America’s rankings before Fidel Castro’s revolution in 1959. Then as Cuba’s leaders confiscated private property and banned entrepreneurs from earning profits, Cuba slid to the bottom. Castro’s acolytes might blame the plunge on a U.S. trade embargo, but that makes my point: countries cut off from trade (voluntarily or not) stagnate. On average, Latin American living standards have doubled since 1959. Cuba’s per capita GDP has hardly budged.43 And when you see photos of skinny peasants pushing their vintage 1956 Chevy Bel Airs through dusty roads, you see who has to do the budging. Someday we might expect a more prosperous Cuba, provided Raúl Castro’s successors permit a more active entrepreneurial class.
In the 1800s, Japan’s fearsome Tokugawa shogun rulers felt shock, awe, and panic when English and Portuguese traders steamed into their harbors under a cloud of coal-fired power. The leaders had cordoned off Japan for hundreds of years but suddenly realized that their country was economically and militarily retarded.
The World Bank compared pairs of countries that chose starkly divergent paths in the 1980s and 1990s. The first of the pair opted to globalize, while the other stuck to its own bubble: Vietnam versus Burma; Bangladesh versus Pakistan; and Costa Rica versus Honduras. Those countries that opened up grew at an average pace of 3.5 percent in the 1980s and 5 percent in the 1990s. The isolated economies grew by merely 0.8 percent in the 1980s and 1.4 percent in the 1990s.44 Over time, when a country folds itself into a self-contained bubble, the economy grows stale and fetid, like a poorly aerated terrarium. Or a dank prison, which pretty much describes North Korea. After fighting in the Korean War subsided in 1953, the North was slightly wealthier than the South. In the 1950s and 1960s, the USSR, China, Poland, and even Albania sent massive aid to rebuild North Korea, on top of the Japanese-built factories north of the thirty-eighth parallel. Despite joint communist assistance, the South today is about twenty times wealthier, and South Koreans live ten years longer and stand several inches taller. The Koreans call it “the Miracle on the Han River.” North Korea does excel in a few categories: for example, executions without trial and infant mortality rate (six times higher). South Korea produces world-class Samsung flat-screen televisions, super-smart LG refrigerators, smooth-riding Hyundai and Kia cars, and charismatic K-pop singers who bring raving audiences to their feet around the world. What does the North produce? Death threats against Hollywood actors who star in dopey movies (like The Interview). And presumably the jumpsuits once worn by Kim Jong-il.
The free market is not a pain-free market. And we should admit that some people lose when a country opens its markets. It is hard to find a shoe that is made in America. In 2015 President Obama visited Nike’s headquarters in Oregon to cheer a new global trade agreement that he said would help Americans. If Obama looked down at his wristwatch in order to time his speech, he probably would not have seen “Made in USA.” The United States wristwatch industry is shrunken, having fallen first to the Swiss, then to the Japanese, then to the Chinese, and then to the Swiss again. Perhaps the Detroit-based Shinola company, named for a once-famous shoe polish, or Apple’s iWatch will bring it back (though most components come from Asia).
If we accept Smith’s basic theory, does he allow any exceptions to free trade? Yes, but not many. He pondered and rejected the “infant industry” argument, which asks for “temporary” tariffs just for the early years of development. Alexander Hamilton embraced the infant argument in the United States a few years later, and Japan would nurse an infant semiconductor industry two hundred years after that. Smith doubted that government could ever gather the political will to remove the subsidies once the industry matured. The industry would learn to scream and cry like a baby despite its adult appetite. Or, in a new version of the argument, the industry will wheeze and drool as a senile corporate citizen demanding help against competition. The U.S. steel industry has clamored for protection on both grounds, first as a dotard and lately as a born-again infant. But protection for steel can be particularly pernicious, because it drives up the prices of everything from dishwashers to dump trucks and impairs American exports of machinery.
In 2018, President Trump pulled the gates down in front of foreign steel makers, slapping tariffs of 25 percent on their sales to the United States. Auto and appliance makers quickly felt as if they were stuffed into a vise, as U.S. steel prices jumped up by about 10 percent. While Trump trumpeted that the tariffs spurred U.S. Steel to spend $1 billion upgrading a plant and led the industry to hire 12,700 more workers, think tank economists calculated that the higher cost of items such as autos, motorcycles, and washing machines was so burdensome to consumers that each new steel job cost the economy about $900,000.45
Smith had little sympathy for tariffs as reprisals against another country’s protectionism, for a retaliatory tariff only erased more potential wealth from the world. Of course, a successful reprisal that persuades the original transgressor to roll back is tautologically good. But how does one know a priori whether or not the retaliatory tariff will incite a third tariff? President Obama slapped 35 percent tariffs on low-end Chinese automobile tires and was surprised to find that the Chinese retaliated by jacking up tariffs on American chickens by 50 to 100 percent. As a result of a rubber dispute, poultry farmers in Maryland and Arkansas lost $1 billion in sales.46 The Great Depression of the 1930s surely deepened because nations erected high tariffs partly in retaliation for others. Smith snidely stated: “To judge whether such retaliations are likely to produce such an effect, does not, perhaps, belong so much to the science of a legislator . . . as to the skill of that insidious and crafty animal, vulgarly called a statesman or politician.”47
Although the United States clearly protects certain industries, politicians and economists often cite Japan as a flagrant violator of free trade. Two reprisal techniques are worth mentioning. Since Japan allegedly protects through its inscrutable regulations, Harvard economist Henry Rosovsky drolly suggested that Japanese imports enter the United States by way of customs agents in Boise, Idaho. Rosovsky would beef up the staff and extend their hours to nine to five, open only on Mondays, in months whose names end in “r.” In another case, John Connally, former governor of Texas, contended while campaigning for the Republican presidential nomination in 1980 that stronger measures were needed. He suggested completely blocking Japanese imports into the United States and telling them to “listen to their Sonys and sit in their Toyotas on the docks of Yokohama.” Connally, who spent millions on his campaign, received about the same number of votes in the United States as he would have in Yokohama.
Only occasionally Adam Smith’s free trade logic bowed to protectionist requests. For example, he allowed tariffs to counterbalance an internal tax on a domestic product. He also submitted to tariff pleas for national defense reasons by acknowledging that Britain’s safety demanded a healthy shipbuilding industry. He knew the story of Venice’s demise in the 1600s. Venice, once known as the Serenissima Repubblica di Venezia, gained great wealth as the hinge between Asia and Europe, engaged in trading spices, glass, books, and banking services (you can still admire the glass on the island of Murano). But the doges of Venice decided to outsource their military to French and Dutch mercenaries. The problem with mercenaries is obvious: if your enemy is willing to pay more, the sailors will turn their cannons on you. When the Ottomans dangled gold in front of the mercenary Venetian navy, the navy merely switched flags, Venice lost overseas possessions, and in 1615 mercenaries threatened to blow up the doge’s palace and murder its senators. In Othello, Shakespeare admires the brave Moor because he keeps his word in Venice, despite his tragic flaws and mercenary standing. Although Smith carved out such exceptions to free trade, he maintained that protection for domestic industries stunted “the growth of opulence.”
In Smith’s time, national defense was about cannonballs and muskets. In today’s technological world, we must ask, what is national security, anyway? When the coronavirus struck the United States in 2020, many American politicians and ordinary citizens were shocked to learn that a large proportion of U.S. antibiotics came from China, along with ventilators. If the deadly virus had hit China and the United States at the exact same time (rather than sequentially), would China have embargoed those items for its own population, leaving sickly patients in the United States to suffocate? In the face of the choking global pandemic, even free traders had to consider that such vital goods are not like children’s toys.
If government should not protect its industries, regulate labor, or distribute favors to merchants, what should it do? When would Smith release the manacles on the visible hand of government? Smith clearly defined the proper role for government: first, providing for national defense; second, administering justice through a court system; third, maintaining public institutions and resources such as roads, canals, bridges, educational systems, and the dignity of the sovereign.
The wearer of the Adam Smith necktie in 1980 generally believed in a limited national government, fewer social welfare programs, less government price regulation, and less federal intervention in and aid for local government affairs; the free market would provide most of what citizens require in life. When Ronald Reagan took office in 1981, his chief economic adviser reputedly joked, “Don’t just stand there. Undo something!” Though a trend toward deregulation began under the Carter administration with the Airline Deregulation Act of 1978, Reagan accelerated the pace, leaving natural gas, oil, and airline prices to the direction of the invisible hand, while abandoning Carter’s wage and price guidelines.
Despite Reagan’s initial victories, the deregulatory effort faltered when mighty maritime, trucking, and construction interests began battling the administration. After the first Reagan term, deregulation forces found more to cheer about in Moscow than in Washington. The cable television industry, for example, found Congress regulating it, then deregulating it again, depending on how angry voters were with their cable rates. The banking industry, though, successfully fought for new freedoms to link up with securities firms, while the federal government stayed mostly on the sidelines as the private sector launched the revolutionary Internet. By throwing open so many sectors to cutthroat competition, the government forced U.S. firms to get lean and tough—characteristics that served them well in the global market. During the 1990s, European and Japanese firms were not prepared to face such awesome competitors, and so U.S. companies gained world market share.
Opponents of deregulation frequently point out that countries like Austria and Norway are much more regulated than the United States is, yet families there earn about the same amount of money and seem just as happy. Therefore, they argue, government regulations must not hinder economic growth. The “Buchholz critique” addresses this point by arguing that a relatively unregulated economy like that of the United States produces more marketable innovations than other countries. As a result, even highly regulated nations benefit from the supercompetitive U.S. market. For example, the Internet was largely developed here, but now consumers throughout the world get to log on. Students as far away as Tibet use the advanced microprocessors developed by Intel in Santa Clara, California. If U.S. firms were as tightly bound as Tibetan firms, there would probably not be an Internet or a superfast microprocessor. Therefore, to simply compare economic levels among countries ignores the spillover effects, in which ideas and technologies slosh across borders, usually emanating from the freest economies.
Andy Warhol said that in the future everyone would be famous for fifteen minutes. Adam Smith has been famous for more than two centuries. How do we remember him? In the most revolutionary age of Western civilization, when the tumult of social rebellion, intellectual upheaval, and explosive economic growth baffled lesser men, Adam Smith gave the world order. He did not invent the market, nor did he invent economics. But he taught the world about the market and economics. For nearly seventy-five years, The Wealth of Nations supplied most of what economists knew.
Two hundred years after The Wealth of Nations, Smith’s ideas were resurrected and exalted. But what happened to Smith, the man who searched for a father and instead found a profession? He lived happily ever after. Truly. Ironically. Truly, because he socialized with the most famous men of his day, saw his book translated into almost every European language, earned honors throughout Britain and the Continent, and watched government officials assiduously take notes whenever he spoke. Ironically, because he spent the thirteen years before his death in 1790 working for the government as His Majesty’s commissioner of customs, a post similar to his father’s. Upon taking the position, Smith did the logical thing for a bachelor and looked into his closet for something appropriate to wear. He found, to his “great astonishment,” that he “had scarce a stock, a cravat, a pair of ruffles, or a pocket handkerchief” that was not considered contraband, furtively smuggled in from abroad.48 Faced with this comic situation, he took two actions: First, he burned the clothing. Second, he began a campaign to persuade the prime minister and his aides to snip the “unjust and oppressive restraints” on Irish and American imports.
Despite the cognitive dissonance of the job, Smith took pride in his post and was made an honorary captain of the city guard, marching through the streets with his cane propped over his shoulder like a soldier carrying his musket. He died on July 17, 1790, after musing to his friends that he must leave the room but would see them in “some other place.” That place is found wherever and whenever men and women show up at a market—whether a corner stand, an online auction, or a gleaming superstore. By proudly marching on behalf of trade, Adam Smith helped increase the wealth of nations.