The Scottish Enlightenment is the name given to the remarkable flourishing of intellectual activity in what, at the time, was a very backward part of Europe. It was sufficiently remarkable that even contemporaries were aware of it. David Hume was not alone in observing, in 1757, that it ‘really is admirable how many Men of Genius this Country produces at present’.1 The universities in Edinburgh, Glasgow and Aberdeen were central to this activity, out of which arose some of the eighteenth century's most notable contributions to economic thought (and to social thought more generally).
The social thought associated with the Scottish Enlightenment had several features which, if not unique, were taken further in Scotland than by thinkers in other countries. It was secular. It did not deny the tenets of established religion (such denial was still dangerous at this time, especially for people in university positions and in the early decades of the century), but it focused on the mundane, everyday aspects of reality. It was also committed to detachment and scientific objectivity rather than to orthodoxy. The thinkers of the Scottish Enlightenment were consciously the heirs of Bacon, Newton and the scientists of the seventeenth century, as well as inheriting important elements of natural-law philosophy. In addition, and more distinctively, the Scottish Enlightenment had a clear social and above all historical focus. Its writers were aware that different societies had different customs, and they sought to discover the causes of these. In this they were following Montesquieu's Spirit of the Laws (1748), a work Hume was responsible for translating into English. However, the Scottish writers – in particular Adam Smith – went further than Montesquieu in that they also sought to explain how human societies changed. They sought to provide an account of the history of civil society.
A major theme in these studies was that human nature was the same at all times. History, Hume argued very clearly, could be used to discover what these ‘constant and universal principles of human nature' were.2 The writers of the Scottish Enlightenment, however, also sought to examine the changing environment in which human nature operated. Man's action could change the environment and produce a new situation in which behaviour was different, even though the underlying human nature had not changed. The Scottish writers were led to the view that society had progressed through several historical stages. Primitive society was based on hunting and gathering the fruits of nature, without any antecedent social organization. Pasture followed from the domestication of animals and, because property could now be appropriated, led to inequality and differences in social status. This was followed by the agrarian stage, in which land became regarded as property that could be appropriated. This was the stage in which inheritance became important. The legal system developed accordingly. Finally there was the exchange economy, in which society became divided into classes who gained their livelihoods in different ways. Division of labour raised productivity and also made people more dependent on each other. This was an evolutionary theory of social organization in which economics, politics and law were all bound up together.
The fact of social evolution led both to a belief in progress and to a historical relativism. Adam Ferguson (1723–1816), a historian prominent in the Scottish Enlightenment, could write that ‘the present age is perfecting what a former age began; or is now beginning what a future age is to perfect’.3 Such an outlook had clear political implications. The Jacobite rising of 1745, which attempted to restore the Stuarts to the throne, was backward-looking; the future lay elsewhere. At the same time, however, the writers of the Scottish Enlightenment became convinced that it was important to judge societies according to the customs of each society's own age. It was inappropriate to judge them according to the customs of modern society.
One factor behind the Scottish Enlightenment was an awareness that Scotland was backward in comparison with the south and east of England. The Scottish supporters of the 1707 Act of Union had hoped that the act would stimulate their economy. They were also confronted with the dramatic contrast between the relatively developed Lowlands and the very backward Highland regions. However, despite union with England, Scotland remained different in key respects. The Church of Scotland was Presbyterian, with a Calvinist emphasis on decisions made by the individual. More importantly, the Scottish legal system was, unlike the English, based on Roman law. Natural law, not common law, was fundamental. Feudal elements had survived (as was still the case in the twentieth century). There was thus great interest in comparisons with England, where Roman law was not recognized.
Francis Hutcheson (1694–1746), who held the chair of Moral Philosophy at Edinburgh from 1729 until his death, is generally regarded as the originator of the Scottish Enlightenment. However, he owed much to his predecessor Gershom Carmichael (1672–1729). It was Carmichael who had introduced the German natural-law philosopher Samuel Pufendorf to Scotland, publishing an edition of one of his most important works together with a set of substantial and influential notes. The link from Aristotle to Adam Smith came through Pufendorf and Carmichael. Carmichael's doctrine that the value of a commodity depended both on the commodity's scarcity and on the difficulty of acquiring it, and that a good could be of value only if it was either useful or imagined to be useful, was very squarely in the Aristotelian tradition.
The significance of Hutcheson's view of human nature is made clear in his criticism of Mandeville. Bernard Mandeville (1670?-1733), was a Dutchman who settled in England in 1699 and became notorious for The Grumbling Hive: or Knaves Turned Honest (1705), a twenty-six-page poem that was later expanded into The Fable of the Bees: or Private Vices turned Public Benefits (1714). This aroused a public outcry for, not only did it argue for free markets and competition, it was also a forthright attack on puritan morality according to which abstinence was a virtue and luxury consumption a vice. Mandeville challenged the notion that Christian morality was what held society together.
Mandeville's Fable was about a large, prosperous hive, well stocked with bees. Vice abounded, in that all the bees were driven by lust and vanity. Wealth was unequally distributed, but all the bees, even the poorest, were better off than they would otherwise have been. The reason was that high consumption created employment. Every bee was kept busy attempting to satisfy another's demands. Even crime and fraud provided opportunities for honest employment – burglars provided employment for locksmiths. Despite prosperity and economic growth, however, the bees felt insecure. Then one day a puritan moral revolution broke out. Crime and military spending ceased, and luxury was spurned. The result was unemployment and the collapse of entire industries. Many bees fled the hive.
The moral of the tale was clear. People are naturally selfish, but in a well-ordered society they will be induced voluntarily to do what is best. Private vices produce public benefits. Vices should not be encouraged, but they should be recognized and turned to good effect. Mandeville did not advocate laissez-faire, however. The market could be allowed to coordinate much economic activity, but he still favoured regulation of foreign trade in order to create employment and to stock the nation with money. There were also many projects that the government could undertake to provide employment for the poor. Mercantilist ideas thus coexisted with his recognition of the importance of the market.
Hutcheson's criticism of Mandeville challenged the assumption that men were purely self-interested. Men were, Hutcheson claimed, altruistic and cared for their fellows. This meant that Mandeville was wrong to argue that luxury spending was needed for nations to prosper. Men would seek to ensure that other people had the goods they needed, and so there would be no need for luxury spending till all demands for necessary goods were satisfied. Whereas Mandeville had assumed that people were selfish, Hutcheson, like many of his fellow Scots, viewed people as driven by a variety of motives. These included the desire to look after oneself, feeling for others, and the desire to better one's condition. As one might expect from someone influenced by Pufendorf and Carmichael, Hutcheson had a supply-and-demand theory of value, and this was taken up a few years later by Sir James Steuart (see pp. 117–21). Hutcheson also emphasized the importance of the division of labour, so important to Adam Smith (see pp. 121–9), combining this with a labour theory of property derived from Locke.
David Hume (1711–76) is now best known for his philosophical writing, but to his contemporaries he was known as a historian, for his History of England (1754–62). A historical perspective permeates his approach to economics, contained in a series of nine essays published in 1752 as part of a volume of Political Discourses. In view of contemporary scepticism about the value of abstract reasoning in economics, it is interesting to note that Hume opens this group of essays with a defence of applying what he calls ‘refined and subtile' reasonings to such ‘vulgar' subjects as commerce, money, interest, taxes and public credit. He appeals to his readers not to be prejudiced against what he has to say merely because his ideas are ‘out of the common road’.4 The public good, Hume argues, depends on a multitude of causes, not on chance and the caprices of a few individuals. This means that the type of historical account that one might give to explain, say, foreign policy, is inappropriate to this subject matter, and that more general reasoning, that may yield unfamiliar conclusions, is required.
Hume's concern in these essays is with the greatness of a state. He starts by distinguishing between this and the happiness of the state's subjects. The latter will be increased by luxury consumption and will thus be reduced if the state diverts resources from this into defence and foreign ventures. In this sense, there is a trade-off between the happiness of the people and the power and influence of the state. However, luxury spending is important to the state, for it is necessary to persuade people to work. This is why manufacturing is needed – the manufacture of luxury goods provides husbandmen (farmers) with an incentive to work more than the minimum amount required to subsist. Without such an incentive, they would prefer to be idle for much of the time. This desire for luxury goods benefits the state because, if husbandmen are producing a surplus over what they need for their subsistence, resources are available to which the sovereign can lay claim in order to raise fleets and armies. In a society of self-sufficient farmers, there would be no surplus available to be appropriated. Hume supports this claim with evidence from ancient Greek and Roman history.
The basis for Hume's argument about commerce and wealth is the theory that labour is the basis for wealth and that labour will be supplied only if people have an incentive to do so. He writes, ‘Every thing in the world is purchased by labour; and our passions are the only causes of labour.’5 Manufacturing is valuable because it enables labour to be stored up, available for use in times of need:
[M]anufactures encrease the power of the state only as they store up so much labour, and that of a kind to which the public may lay claim, without depriving anyone of the necessaries of life. The more labour, therefore, is employed beyond mere necessaries, the more powerful is any state; since the persons engaged in that labour may easily be converted to the public service. In a state without manufactures, there may be the same number of hands; but there is not the same quantity of labour, nor of the same kind. All the labour is there bestowed upon necessaries, which can admit of little or no abatement.6
For much the same reason, foreign commerce is valuable. It increases the stock of labour in a nation.
Having established that the strength of a state depends on labour and commerce, Hume proceeds to demolish the argument that money is wealth. Money, he claims, is simply ‘the oil which renders the motions of the wheels [of trade] more smooth and easy’.7 There is no benefit to be had from having a greater quantity of money, for prices will be higher in the same proportion. The only exception to this is that, if gold and silver are plentiful, the sovereign will have more resources that can be drawn upon in times of war. In other respects, a large quantity of money is a disadvantage – higher prices will cause manufacturing industries to shift abroad, where costs will be lower. Labour will be lost to the state. Hume was thus opposed to the use of paper money, for this harmed manufacturing without the offsetting benefit of raising the state's stock of gold and silver.
However, although the quantity of money was of no importance, a rising money supply did make a difference – inflation could be beneficial. ‘Accordingly we find, that, in every kingdom, into which money begins to flow in greater abundance than formerly, every thing takes a new face: labour and industry gain life; the merchant becomes more enterprising, the manufacturer more diligent and skilful, and even the farmer follows his plough with greater alacrity and attention.’8 The explanation was that, although money raises prices, it does not do so immediately. There is thus an interval during which the money supply has increased by more than prices, and during this interval industry will be stimulated. Conversely, a falling money supply will have damaging effects on industry – a conclusion that Hume was able to support with much historical evidence.
Hume concluded that the best policy was to keep the money supply continually increasing. However, he was strongly opposed to trying to do this through ‘mercantilist' policies. Attempting to maintain a balance-of-payments surplus would be self-defeating, for the inflow of money would raise prices, causing manufacturing to go abroad, thus undermining the policy. He likened money to water in the sea: it is possible to raise the water level in one region only if it is cut off from the rest of the sea. If there is communication between different regions, money will, like water, find its own level. The only effect of mercantilist policies, therefore, was to interfere with trade. Furthermore, if one wanted to increase reserves of gold and silver for use in wartime, the right method was to hoard it, not to spend it. If money disappeared from circulation into hoards, it would no longer affect prices. This was in contrast with the mercantilist view, exemplified by Mun, that the purpose of increasing the money supply was to increase the circulation.
Many themes from the work of Hutcheson and Hume can be found in the book that has been described as the first systematic treatise on economics in the English language, the full title of which was An Inquiry into the Principles of Political Oeconomy: Being an Essay on the Science of Domestic Policy in Free Nations, in which are Particularly Considered Population, Agriculture, Trade, Industry, Money, Coin, Interest, Circulation, Banks, Exchange, Public Credit and Taxes (1767). The title introduced into English the term ‘political economy’, a translation of the term ‘œconomie politique' used by Antoyne Monchrétien (c. 1575–1621) in the title of a book published in 1615. This was to become the standard name for economics as the subject began to achieve a separate identity during the nineteenth century. The English book was also the first work to use the phrase ‘supply and demand' to explain how prices were determined:
The nature of demand is to encourage industry; and when it is regularly made, the effect of it is, that the supply for the most part is to be found in proportion to it… And when it is irregular, that is, unexpected, or when the usual supply fails,… [this] occasions a competition among the buyers and raises the current, that is, the ordinary prices.9
This explanation of prices was followed up with a detailed account of competition. Particular attention was paid to what the author called ‘double competition’, in which there was competition both between buyers and between sellers. This was important because it set upper and lower limits to price and caused the interests of different individuals to balance each other. This balance, however, vibrated, with the result that buyers and sellers could not observe it exactly. Their decisions had to be based on the price for which they expected to be able to resell the goods. The conclusion was drawn that forestalling (buying goods in order to resell them when there was a shortage) was a crime because it diminished the competition that ought to take place and that would ensure that goods sold for their real value.
The author of the book was Sir James Steuart (1712–80). He was part of the Scottish Enlightenment, but stood apart from other writers in that he was a Jacobite, and supported the 1745 rebellion. Sent by Charles Edward Stewart, the Young Pretender, as an ambassador to France, Steuart remained in exile after the defeat of the Jacobites at Culloden, not returning to Scotland until 1763. During this period he travelled widely in Europe.
Steuart's experience during his exile influenced his book. He became very sceptical about general rules concerning political matters, on the grounds that everything needed to be considered in relation to the circumstances of the country in question. Different countries had different customs, and these needed to be taken into account. He thus wrote that the merit of his book, in so far as it had any merit, arose from ‘divesting myself of English notions, so far as to be able to expose in a fair light, the sentiments and policy of foreign nations, relatively to their own situation’.10 Continental influences account for Steuart's emphasis on the role of the statesman (used as a shorthand for the king, Parliament, or whoever was ruling a nation). His book was, as he put it, ‘addressed to a statesman’, even though its object was ‘to influence the spirit of those whom he governs’.11 This went against the prevailing mood, which was in favour of liberty and playing down the importance of state action.
Steuart's historical perspective echoed that of Hutcheson, though he distinguished only three stages in history: hunting and gathering, agriculture, and exchange. Growth was seen in terms of an increase in population, this being limited by the supply of food. In the first stage of history, population was limited by the spontaneous fruits of the earth, but, when ‘labour and industry' were applied to the soil, a further quantity of food could be produced, enabling a larger population to be supported. However, if farmers were to be induced to produce more than they needed for their own consumption, there had to be a market for their produce – the third stage. This led Steuart to state two principles:
[1] Agriculture among a free people will augment population, in proportion only as the necessitous are put in a situation to purchase subsistence with their labour… [2] That agriculture, when encouraged for the sake of multiplying inhabitants, must keep pace with the progress of industry; or else an outlet must be found for all superfluity.12
These principles, he claimed, were confirmed by experience. We can see him here arguing for a balance between the more extreme views of mercantilist support for industry and Physiocratic support for agriculture – views that he would obviously have encountered during his stay in Europe.
Like Hume, Steuart saw a close link between labour and wealth. However, in line with the trend in English economic thought from the late seventeenth century, he placed much greater emphasis on the need to keep people employed. He recognized that employment would fail from time to time, and he believed that the state should seek to mitigate this as much as possible. Maintaining employment required that there should be a balance between supply and demand: ‘The greatest care must be taken to support a perfect balance between the hands in work and the demand for their labour.’13 Demand must be neither too high nor too low, and it was the statesman's duty to see that this was achieved.
Steuart had what has come to be called a ‘Malthusian' view of population growth. Procreation was not the same as multiplication of the population, for, if the birth rate were too high, fewer children would survive. It followed that population could grow in response to the demand for labour, but only if agriculture could produce more food. There were, however, limits to what agriculture could provide, the main one being rising agricultural costs. Rising food prices would raise the price of subsistence and hence wage costs. The statesman would then be caught in a dilemma between encouraging ‘expensive improvements of the soil' (which require high food prices) and cheap imports which enable wages costs to be kept low. This dilemma could be resolved, Steuart argued, only by ‘right application of public money’.14 This is one example of the ways in which Steuart believed that the state might have to use government spending or alterations to the money supply in order to achieve a balance between supply and demand. Public money could be used to raise demand and reduce unemployment, but care had to be taken not to lean too far the other way.
Given such an attitude, it is not surprising that Steuart did not accept the quantity theory of money. The theory of the relationship between money and prices proposed by Montesquieu and Hume, he conceded, was ‘so simple, and so extensive, that it is no wonder to see it adopted by almost everyone who has written after them’. However, he argued that ‘in this, as in every other part of the science of political economy, there is hardly such a thing as a general rule to be laid down’.15 The reasons he gave for this were that demand and competition determined prices, and that these depended on wealth and on the circumstances of the economy, not on how much coin people happened to have:
Let the specie of a country, therefore, be augmented or diminished, in ever so great a proportion, commodities will still rise and fall according to the principles of demand and competition; and these will constantly depend upon the inclinations of those who have property or any kind of equivalent whatsoever to give; but never on the quantity of coin they are possessed of.16
Throughout his Principles, Steuart emphasized the role of the statesman. It would, however, be a mistake to see him either as a totalitarian planner or as someone who was simply looking back to a pre-market era. Not only did he assume people to be self-interested, he regarded this as essential if government policy were to be effective:
The principle of self-interest will serve as a general key to this inquiry; and it may, in one sense, be considered as the ruling principle of my subject… This is the main spring, and only motive which a statesman should make use of, to engage a free people to concur in the plans which he lays down for their government… [W]ere every one to act for the public, and neglect himself, the statesman would be bewildered, and the supposition is ridiculous.17
One can see from this passage that Steuart lies firmly in the approach to politics that goes back, through Hobbes and Locke, to Machiavelli.
For a few years, Steuart's Principles was well received. Hume welcomed the book, and Steuart's advice was sought by the British government. However, the book rapidly fell into oblivion, at least in Britain. The main reason was clearly the publication of Adam Smith's Wealth of Nations only a few years later. Smith's work caught the public imagination far more effectively than Steuart's, and Smith adopted the effective rhetorical strategy of completely ignoring the earlier book. Part of the reason, however, may have been Steuart's rambling style, which did not always make his message clear. In Germany, however, where Steuart's mercantilist ideas found a more receptive audience, the book continued to be read, and his discussion of supply and demand received considerable attention in the early nineteenth century (see p. 146).
Adam Smith (1723–90), who came from an influential Scottish family, was a student of Hutcheson's and, after a year holding the chair of Logic, held the chair of Moral Philosophy at Glasgow from 1752 to 1764. During this time he lectured on rhetoric and belles-lettres, jurisprudence and moral philosophy. His work on economics arose out of this, and formed part of a broader inquiry into the science of society. This inquiry was squarely in the tradition of the Scottish Enlightenment, with its focus on history and on the foundations of civil society. The book that sustained Smith's reputation for subsequent generations, dominating nineteenth-century economics as did the work of no other economist, was An Inquiry into the Nature and Causes of the Wealth of Nations, first published in 1776, the year of the American Declaration of Independence. In Smith's lifetime, however, his reputation was based not on this book, but on The Theory of Moral Sentiments, published in six editions between 1759 and 1790. Smith regarded both books as part of his broader inquiry into social science. The relationship between the two books was described at the beginning of the sixth edition of The Theory of Moral Sentiments:
In the… first Edition of the present work, I said, that I should in another discourse endeavour to give an account of the general principles of law and government, and of the different revolutions which they had undergone in the different ages and periods of society; not only in what concerns justice, but in what concerns police, revenue and arms, and whatever else is the object of law. In the Inquiry concerning the Nature and Causes of the Wealth of Nations, I have partly executed this promise; at least so far as concerns police, revenue and arms. What remains [is] the theory of jurisprudence.18
This last part of his project was never completed.
The main concern of The Theory of Moral Sentiments was with the criteria on which moral judgements can be based. Smith thus explored the basis for the sense of propriety, the sense of approbation, and judgements of merit and virtue. A key element in his approach was provided by the concept of sympathy – the ability to see things from someone else's point of view, and to see our own behaviour from the perspective of an impartial spectator. The reason why this is relevant to social science is that, in undertaking this inquiry, Smith was exploring the question of what makes it possible for men to live in society. How is it that selfish desires can be restrained in order to prevent men from injuring one another? The simplest answer is the desire to please others – a desire for the approbation of other people. We view our own behaviour from the point of view of the impartial spectator, and act accordingly. This motive, however, will not be strong enough. When we contemplate our actions before we act, ‘eagerness of passion' – the desire to do things – will bias our judgement. After an action has been taken, on the other hand, the desire not to think badly of ourselves will lead to bias. Neither beforehand nor afterwards, therefore, can we take an unbiased view of our actions. Further guidance is needed. This is provided by moral rules – generalizations from our experience of what types of action are approved of and disapproved of. However, moral rules are in themselves insufficient and need to be backed up, in some cases, by positive laws.
If people are held together by mutual affection and give each other the support that they need ‘from gratitude, from friendship, and esteem’, society can flourish. However, Smith argued that such motives are not necessary:
Society may subsist among different men, as among different merchants, from a sense of its utility, without any mutual love or affection; and though no man in it should owe any obligation, or be bound in gratitude to any other, it may still be upheld by a mercenary exchange of good offices according to an agreed valuation.19
A commercial society can flourish even though people do not have strong affections for each other. On the other hand, this is emphatically not the same as saying that a society can flourish if there are no limits to behaviour:
Society, however, cannot subsist among those who are at all times ready to hurt and injure one another… If there is any society among robbers and murderers, they must at least… abstain from robbing and murdering one another. Beneficence, therefore, is less essential to the existence of society than justice. Society may subsist, though not in the most comfortable state, without beneficence; but the prevalence of injustice must utterly destroy it.20
This is the context for the Wealth of Nations. Smith is exploring how a commercial society can prosper, even though men are pursuing their own interests. He is, however, assuming a framework of justice, without which society would be destroyed. The society he is talking about differs from a Hobbesian state of nature in that men are assumed to be guided by morality and restrained by a just legal system. Within this framework Smith explains the benefits that arise from a system of liberty.
More clearly than any previous writer, Smith was concerned with the process of economic growth. Of the five ‘Books' that make up the Wealth of Nations, the first discusses ‘the causes of improvement in the productive powers of labour' and how produce is distributed among the different classes of society. Book 2 considers capital accumulation, and Book 3 what Smith calls ‘the different progress of opulence in different nations’. He then turns to government policy, offering in Book 4 critiques of both the ‘mercantile system' and the ‘agricultural system' (Physiocracy), and in Book 5 a discussion of government revenue and taxation. Taken as a whole, the work is a vast compendium of theory, economic history and policy advice. Its variety and range provide part of the explanation of why economists have been able to interpret it in very different ways.
The most important cause of economic growth, Smith claimed, is the division of labour. On introducing the idea, he illustrated it with a ‘very trifling manufacture' – pin making. He pointed out that, without being trained in the industry and without the assistance of the right machinery (and both training and machinery were the result of division of labour), a worker could probably make no more than one pin per day and certainly no more than twenty. In contrast, in the modern industry, where the task of making a pin was divided into eighteen different operations (drawing the wire, straightening it, cutting it, grinding it, putting the head on, whitening the pin, putting the pins into paper, and so on), a team of ten men could make upward of 48,000 pins per day. Division of labour was, Smith claimed, carried furthest in the most advanced countries.
However, although Smith introduced the division of labour by considering its application within a single factory, just as important for his case was the social division of labour, where different people perform different tasks, obtaining what they need through exchange. The division of labour, he argued, was ‘the necessary, though very slow and gradual consequence of a certain propensity in human nature… to truck, barter, and exchange one thing for another’.21 This led him to the proposition that the division of labour was limited by the extent of the market. In a village, people had to perform for themselves many of the tasks that, in a city, would be performed by specialists. A country carpenter, Smith observed, was not only a carpenter, but a joiner, a cabinetmaker, a wood carver and a wagon maker, each of which would be a separate trade in a larger market. The development of water transport, Smith observed, was crucial to this process of opening up more extensive markets.
Having established the link between economic growth and the expansion of markets, Smith then turned to the question of how markets operated. This took him into the fields of value and the distribution of income. Three concepts are particularly important to his analysis of these problems. The first is the distinction between the real and the nominal prices of commodities. In an exchange economy it is more convenient to use money than to engage in barter and, as a result, prices are measured in terms of money (the nominal price). However, the real price of a commodity is ‘the toil and trouble of acquiring it’. This is a quantity of labour, not a quantity of money – though, given the problems involved in measuring labour, it might best be measured in terms of other commodities. Variations in the value of gold and silver would cause the nominal and real prices of commodities to differ from each other. It is the real price that matters and that his theory of value sought to explain.
The second important concept in Smith's value theory is the breaking down of the prices of commodities into their component parts – wages, profits and rents, the returns to labour, capital and land. This is the basis for the third key concept: the distinction between the market price and the natural price of commodities. The market price of a commodity is the price it fetches in the market, which will depend on supply and demand. If supply is insufficient to meet demand at the going price, the market price will rise; if there is a surplus of goods, the market price will fall. Because prices can be broken down into their component parts, it follows that, if the market price rises, so too must at least one of the components of price. The natural price of a commodity is thus defined as the price at which labour, capital and land are all receiving their natural prices. It is, Smith argued, ‘the central price, to which the prices of all commodities are continually gravitating’.22 The mechanism that causes this to happen is competition. If, for example, the rate of profit in producing hats is higher than the natural rate of profits, and if capitalists are free to move their capital from one industry to another, they will move into hat-making. This will increase the supply of hats and bring the price of hats down to the natural price. Alternatively, if workers in mining are earning more than the natural rate of wages, other workers will become miners, pushing wages downward.
This mechanism is the basis for Smith's conclusion that the market can work like an invisible hand, causing people to produce what other members of society want, even when individuals have no intention to do anything for anyone else. It is the reason why self-interest can produce an outcome that is in the interests of society – why a commercial society can prosper even though people have no affection for each other. Its crucial element is what Smith called ‘liberty’, the freedom of individuals to move their capital and labour from one activity to another as they choose. It was a concern to promote liberty that led Smith to denounce mercantilist restrictions on industry and trade. Such restrictions would benefit particular individuals but would hinder the operation of competition.
Book 1 of the Wealth of Nations, with its emphasis on division of labour and the link between labour and wealth, falls squarely within the Scottish Enlightenment tradition. In Book 2, on the other hand, Smith emphasizes the role of capital in a way that makes him much closer to Turgot than to Hutcheson or Hume. A precondition for the division of labour, Smith contended, is the accumulation of what he called ‘stock’. This includes both the tools that workmen need and also the provisions that they need while they are working. If growth is to occur, stock has to be increased, and to achieve this it is necessary to employ labour productively. This leads to Smith's distinction between productive and unproductive labour.
The basic idea underlying this distinction is that productive labour ‘adds to the value of the subject on which it is bestowed’. It ‘fixes' itself ‘in a permanent subject or vendible commodity' that is there when the labour is finished, and which can then be sold to obtain more labour.23 Unproductive labour, however, does not add to the value of anything. Thus the labour of a manufacturer who adds to the value of the materials with which he works, or of the farmer who produces a tangible output at the end of the year, is productive. In contrast, the labour of the menial servant or even of the sovereign or judges or the army is unproductive. Given that all labour has to be maintained by annual produce, the accumulation of capital depends on the proportion of labour employed productively. Consider the extreme cases. If the entire labour force were employed unproductively, there would be no produce at all the following year. At the other extreme, if labour were all employed productively, produce must be higher.
The need for capital accumulation is the reason why Smith sees a link between saving and economic growth. ‘Capitals are increased by parsimony, and diminished by prodigality and misconduct.’24 He argues forcefully that there is no need for luxury spending to maintain demand, for savings are spent just as much as is expenditure on consumption goods:
What is annually saved is as regularly consumed as what is annually spent, and in nearly the same time too; but it is consumed by a different set of people. That portion of his revenue which a rich man annually spends, is in most cases consumed by idle guests, and menial servants, who leave nothing behind them in return for their consumption. That portion which he annually saves, as for the sake of profit it is immediately employed as capital, is consumed in the same manner, and nearly in the same time too, but by a different set of people, by labourers, manufacturers, and artificers, who re-produce with a profit the value of their annual consumption… The consumption is the same, but the consumers are different.25
In other words, saving (which for Smith means investment, for otherwise savers could not earn a profit, which is their objective) is employing productive labour, whereas consumption is employing unproductive labour.
Smith advocated what he described as the system of ‘natural liberty’, to be contrasted with the other two systems of political economy that he discussed: the mercantile system and the system of agriculture (Physiocracy). The main characteristic of this was the freedom of any individual to bring his capital into competition with that of any other man. He opposed monopoly, which in his day was normally the result of privileges granted by the government: ‘Monopoly… is a great enemy to good management, which can never be universally established but in consequence of that free and universal competition which forces every body to have recourse to it for the sake of self-defence.’26 Free competition would result in resources being moved into those activities where they were most needed. The individual would be ‘led by an invisible hand to promote an end which was no part of his intention’.27 Though Smith made little use of the phrase ‘the invisible hand' (it appears once in each of his major books), this can be seen as his contribution to the debate on what holds society together, opened up by Hobbes over a century earlier. However, Smith was not arguing for complete laissez-faire, for he saw an important role for government.
The main reason why government was needed was that the arguments of the Wealth of Nations presupposed a system of justice. Without justice, the system of natural liberty would be unable to function. Men would be insecure, continually being damaged by each other. Spending on the legal system and on the armed forces might be classified as unproductive, but it was nonetheless essential for the system to work. For Smith, to maintain law and order was therefore the first duty of the sovereign. It is worth noting that this involved some significant exceptions to the principle of laissez-faire. In particular, Smith supported the Navigation Acts (which severely restricted competition in shipping), on the grounds that they contributed to the strength of the Royal Navy.
Defence and justice, however, were not the only exceptions Smith saw to the principle of laissez-faire. The third duty of the sovereign was that of
erecting and maintaining those publick institutions and those publick works, which, though they may be in the highest degree advantageous to a great society, are, however, of such a nature, that the profit could never repay the expence to any individual or small number of individuals, and which it, therefore, cannot be expected that any individual or small number of individuals should erect or maintain.28
His main examples concerned transport (bridges, roads and canals) and primary education. However, although he argued the case for intervention, he sought to make use of tolls and fees wherever possible. This was for two reasons. He wanted users (for example of roads) to pay as much as possible, and he wanted employees (such as teachers) to have an incentive to do their work properly. Thus, immediately after saying that the cost of education might ‘without injustice' be met out of public funds, he declared that it would be better for it to be paid by those who benefited from schooling. His view was that privately provided education was, in his day, better than public education. He was scathing in his criticism of universities, in which teachers failed to teach and students failed to learn.
One area where Smith saw no role whatsoever for the government was in maintaining the level of employment. Writers from Misselden (in the early seventeenth century) to Steuart (writing only a few years before Smith) had seen the disruption that fluctuations in trade could produce and had sought to design policies that would mitigate the resulting underemployment. Mercantilist policies can be seen, at least in part, as attempts to reduce unemployment by increasing the circulation of money. The defence of luxury consumption by numerous writers in the seventeenth and eighteenth centuries was also a response to periods when demand was seen to be inadequate. Smith, on the other hand, with his doctrine that saving constituted spending, denied that there was a problem. If there were perfect liberty, men would move into an occupation where there was a demand for their services. Monetary economics thus played a minor role in Smith's system. This separation of monetary economics from problems of value, income distribution and growth stood in clear contrast with mercantilist ideas, and was to dominate economic thinking throughout the nineteenth century.
For contemporaries, as much as for subsequent generations of economists, the crowning achievement of eighteenth-century economic thought was Smith's Wealth of Nations. This arose out of the long-standing controversy over the role of Christian morality in holding society together to which Hobbes and Mandeville had made such dramatic contributions. Smith approached the question from the perspective of moral philosophy. He combined this with a focus on the interdependence of the various sectors of the economy. This was a pervasive theme in eighteenth-century thought, in both Britain and France, and it can even be found as far back as the sixteenth century (as in the Discourse on the Common Weal), but it was Smith's version of it that caught the imagination of his contemporaries. Over time, however, the origins of the Wealth of Nations in this debate over the morality of commercial society became forgotten, resulting in Smith's work being seen in a different light. He became seen as the advocate of laissez-faire – a perspective that would have surprised his contemporaries, who would have been aware how much further he was from such a position than, for example, many French authors.
Smith's debts to his predecessors and contemporaries are so great that some commentators have gone so far as to argue that the Wealth of Nations contains not a single original idea. Supply and demand as the explanation of value has a history too long to summarize briefly. Elements of the labour theory of value can be traced to Petty and to some scholastic writers. The phrase ‘division of labour' was coined by Hutcheson, and the concept was widely understood in Xenophon's day. The importance of capital was recognized by Turgot. The notion of a spontaneous order can be found in Mandeville and Cantillon. And so on. It was, however, Smith's interpretation of these themes that found its way into nineteenth-century economics, especially in Britain. This neglect of the past had significant costs. For example, subjective-value theory, though it remained strong in France and Germany, was pushed aside by Smith and most of his English followers, who minimized the role of demand in determining prices. The seeds were sown for what has come to be known as classical political economy and, within that, the Ricardian ‘detour’.