Adam Smith was an 18th century Scottish economist, philosopher and writer who is considered the father of modern economics. But why is that? The main ideas of Adam Smith can be found in the following lines. These ideas should be familiar to anyone interested in society, economics and investing.
Smith opposed mercantilism and was a major proponent of laissez-faire or free market economic policy. In his first book, The Theory of Moral Sentiments, Smith proposed the idea of the invisible hand of the market. This is very well known to this day and is a certain prerequisite for the functioning of capitalism. It is based on the principle of the tendency of free markets to regulate themselves through competition, supply and demand and self-interest.
Smith is also known for developing the concept of Gross Domestic Product (GDP) and his theory of equalizing wage differentials. According to this theory, skilled, dangerous, or undesirable jobs tend to pay higher wages to attract workers to these positions. Smith was also aware that in a successful society it should be easy to borrow money and also to invest money. Both of these operations make the company and individuals more efficient and successful. Holding wealth in gold for the long term does nothing for the holder, much less the company. But, since you are still propably holding at least some money, here’s an article on how to protect it from inflation
Smith’s most important contribution to the field of economics was his 1776 book The Wealth of Nations.
Wealth of Nations
Although The Wealth of Nations is hailed as the first great work of political economy, it is in fact a continuation of the philosophical theme begun in The Theory of Moral Sentiments. The ultimate problem to which Smith turns is how the internal struggle between the passions and the “impartial spectator” – explained in The Moral Sentiments in terms of the individual – operates in the larger arena of history itself, both in terms of the long-term development of society and in terms of the immediate characteristics of the historical stage typical of Smith’s time.
The answer to this problem enters Book V. In this book, Smith proposes the idea that each civilizacion will pass through 4 main stages of development, unless it gets blocked by some kind of war, natural disaster/crisis, or hurtful government policies:
- the original hunter-gatherer state
- the second stage of nomadic agriculture
- the third stage of feudal or lordly farming
- the fourth and final stage of commercial interdependence
1. Why is the free market good?
Free market philosophy emphasises minimising the role of government intervention and taxes in free markets. Although Smith advocated limited government, he considered the government responsible for the country’s education and defense sectors. Thus, he agreed with the state.
From Smith comes the idea of the invisible hand of the market that controls the forces of supply and demand in the economy. According to this theory, each person, by taking care of himself, inadvertently helps create the best possible outcome for everyone.
The hypothetical butcher, brewer and baker in this economy hope to make money by selling products that people want to buy. If they effectively meet the needs of their customers, they will enjoy financial rewards. While they are in business to make money, they are also in business to provide quality services or products that people want.
Smith argued that this kind of system creates wealth for the butcher, the brewer, and the baker, thus creating wealth for the entire nation and society. It follows from the human psyche that a person would rather do more on his own than less on someone else’s. Business and tradesmen are thus the backbone of the economic system according to Adam Smith.
2. The invisible hand of the market
According to Smith’s belief and theory, a wealthy nation (we can also think of it as a society) is one that is populated by citizens productively working to improve themselves and address their financial needs. In such an economy, according to Smith, a person would invest his wealth in the enterprise that is most likely to help him achieve the highest return for a given level of risk.
The invisible hand theory is often presented as a natural phenomenon that drives the free market and capitalism towards efficiency through supply and demand and competition for scarce resources, rather than something that leads to individual welfare.
According to Smith, an institutional framework (setting up laws and a playing field) is necessary to guide people towards productive enterprise that benefits society. This framework consists of institutions such as the judicial system designed to protect and promote free and fair competition.
Some modern economist say, that the idea Smith presented, isn’t actually doable or even realistic, since Smith’s books completely ignore the human factor. Similar to other economical systems, the fact is that humans are unpredictable and may make unreasonable choices and decisions.
3. Gross Domestic Product (GDP)
The ideas contained in The Wealth of Nations gave birth to the concept of Gross Domestic Product (GDP) and changed the import-export trade. Before the publication of Wealth of Nations, countries declared their wealth based on the value of their gold and silver deposits.
However, Smith was very critical of mercantilism and therefore argued that countries should be evaluated based on their level of production and trade. Based on this concept, the GDP indicator was created to measure a country’s prosperity.
At the time of the publication of The Wealth of Nations, many countries were reluctant to trade with other countries. Smith argued that free exchange should be created because both countries benefited from this trade. Today, we would say it is a win-win situation.
As a result of this change in attitude towards trade, there was an increase in imports and exports. Smith also pushed for legislation that would make trade as easy as possible. His ideas thus set the stage for emerging globalisation and increased specialisation. Each country did what it was best at and had the best conditions for doing so.
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Why is Adam Smith called the father of economics?
Adam Smith is called the “father of economics” because of his theories on capitalism, the free market and supply and demand.
What books did Adam Smith write?
Adam Smith wrote The Wealth of Nations, A Theory of Moral Sentiments, Lectures on Justice, Police, Revenue, and Arms, and Essays on Philosophical Subjects.
What were Adam Smith’s three economic laws?
The law of self-interest, the law of competition, and the law of supply and demand were the three laws of economics written by Adam Smith.
