Book 1: Capitalism at Work: Business, Government, and Energy

1.1 A Worldly View
1.2 Adam Smith and Societal Order
1.3 On Bankruptcy Theory
1.4 Adam Smith and Public Policy
1.5 Self-Interest and Self-Sacrifice
Bibliography: Chapter 1 Internet Appendices

1.1 A Worldly View

Adam Smith’s father-like contributions to economics in The Wealth of Nations(1776) have been challenged, beginning from at least the 1950 publication of Joseph Schumpeter’s History of Economic Analysis. The most negative view, surprisingly, has come from the free-market Austrian-School economist Murray Rothbard, who concluded:

•	Smith was not the founder of economics (“a science which existed since the medieval scholastics and, in its modern form, since Richard Cantillon”);
•	Smith “originated nothing that was true, and that whatever he originated was wrong”;
•	Smith “was a shameless plagiarist, acknowledging little or nothing and stealing large chunks, for example, from Cantillon” (Rothbard, 1995: 435).

Schumpeter concluded that “the Wealth of Nations does not contain a single analytic idea, principle, or method that was entirely new in 1776” (184). But Schumpeter’s “cold and realistic eye” (Rothbard: 437) also saw in Smith what Rothbard did not: “Though the Wealth of Nations contained no really novel ideas and though it cannot rank with Newton’s Principia or Darwin’s Origin as an intellectual achievement, it is a great performance all the same and fully deserved its success” (185).

Conversely, Ronald Coase has called Wealth of Nations “the most important book on economics ever written, a work of genius” (1976a: 78). He added: “With its interrelated themes, its careful observations on economic life, and its powerful ideas—clearly expressed and beautifully illustrated—it cannot fail to work its magic. But the very richness of the book means that each of us will see it in a somewhat different way” (ibid.: 75).

For many—free-market economists and otherwise—Smith was a genius, andWealth of Nations was the greatest single work ever written in the social sciences. To them, Smith’s achievement combined systematic analysis with analytical realism (Clark, 65), “plain common sense” (Schumpeter: 185), and multi-disciplinary knowledge. It created an intuitively appealing description of market behavior and offered important findings and advice for public-policy debate. In Schumpeter’s view, Smith’s “very limitations” made the book what it turned out to be. “Had he been more brilliant, he would have not been taken so seriously. Had he dug more deeply, had he unearthed more recondite truth, had he used difficult and ingenious methods, he would not have been understood…. He was effective not only by virtue of what he gave but also by virtue of what he failed to give” (185).

T. D. Campbell observed that Smith’s “first criterion of a good scientific theory is that it should connect, or render more coherent, a large number of apparently dissimilar phenomena” (234). In The Theory of Moral Sentiments, Smith’s concept of direct sympathy, for example, explains “not only ordinary moral judgments, but the respect for authority, which lies at the root of political obedience, the motives which explain men’s efforts to achieve wealth and power beyond the requirements of bodily comfort and safety, the basis of family affection and patriotism, and the entire content of the civil and criminal law” (ibid.).

From this perspective, Smith’s multi-disciplinary approach was critical. His “remarkable range of subjects” included “economics and history; law and government; language and the arts, not to mention essays on astronomy, ancient logics and metaphysics” (Campbell and Skinner: 1). Smith also incorporated sociology in Theory of Moral Sentiments. “Smith was preoccupied,” explained Liah Greenfeld, “with … the constitution of society, the mechanisms of social integration, or, as it is often called, the problem of order—the all-important question of how separate individuals come to transcend themselves and constitute aggregate entities which give the impression of unity, and how they develop moral, that is, social (contributing to social integration) sentiments” (29).

F. A. Hayek warned his colleagues, “If you know only economics and nothing else, you will be a bane to mankind, good, perhaps, for writing articles for other economists to read, but for nothing else” (1944: 141). Adam Smith would surely agree. Compared to the natural-science litmus test, does it work? the Smith/Hayek North Star for social scientists would be: does it logically elucidate the workings of the world?

While Smith can be considered the father of economics and “the most famous of all economists” (Schumpeter: 181), economics did not truly become a science until the 1870s when the cost- or labor-theory of value, a precept of Smith’s classical school of economics, was overthrown. The marginalist revolutionrecognized that value was not based on the cost of production but on a person’s subjective estimation of what a particular (marginal) unit of a good or service was worth at a particular time and place. Fallacies and misplaced emphasis would continue to plague economics after this time, but the logic of human action would develop around the concept of individual valuation at the margin. The same marginal principle would be true for political decision-making, the subject of chapter 5, “The Business of Politics.”

1.2 Adam Smith and Societal Order

The Theory of Moral Sentiments (1759) and The Wealth of Nations (1776) are complementary. The former explains moral order with passing reference to economic order; the latter economic order with passing reference to moral order (Viner: 119). Smith recognized the moral and economic as reinforcing (Skousen: 23–24) and the result of the same evolutionary process (Otteson: chapter 7). Thus, there is no “Adam Smith problem” (as some have charged) betweensympathy and self-interest as drivers in the marketplace (Otteson, 3–8). Dougherty ties the two books together to show that Adam Smith—and capitalism itself—had a “soulful side” (6).The two sides of the Smithian coin can be appreciated in the buildup to the most famous sentence in Wealth of Nations:

It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages (1776: 26–27).

In the preceding discussion, Smith attests to the interrelatedness of the market economy where all serve all:

In civilized society [man] stands at all times in need of the co-operation and assistance of great multitudes, while his whole life is scarce sufficient to gain the friendship of a few persons (1776: 26).

Ronald Coase makes the above point, challenging the alleged Adam Smith problem and concludes:

The great advantage of the market is that it is able to use the strength of self-interest to offset the weakness and partiality of benevolence, so that those who are unknown, unattractive, or unimportant will have their wants served. But this should not lead us to ignore the part which benevolence and moral sentiments do play in making possible a market system (Coase, 1976b: 115).

Some scholars have claimed that the invisible hand was just an aside to Smith—even “a mildly ironic joke” (Rothschild: 116). Smith did use the invisible hand metaphor only once in Wealth of Nations and espoused different roles for government in the economy, discussed in Section 1.4 below. However, Smith’s repeated defense of the power and benefits of self-interest; the natural order of markets; the unintended, spiraling consequences of government intervention; and the often negative outcomes of altruism reinforce the general notion of spontaneous order in the marketplace, or, more poetically, the guidance of the invisible hand.

1.3 On Bankruptcy Theory

By the early eighteen century, English bankruptcy law:

offered absolution to honest bankrupts while retaining criminal punishment for dishonest ones…. For the first time, honest commercial debtors would be shielded from imprisonment, freed from liability for their debts, and returned to the market to compete again (Mann, 2002: 46–47).

Adam Smith accepted this common law notion of bankruptcy protection, whereby the obligations of a debtor who is unable to repay creditors were legally forgiven so long as this inability did not result from fraud, in which case the debtor became a criminal. English jurist William Blackstone concurred, explaining how Acts of God causing commercial nonperformance should not leave the debtor at the mercy of the creditor.

But should bankruptcy really be a safe haven for nonperformance? Within a capitalist framework, another view has emerged: that the act of nonpayment is fraud per se. In this view, the creditor holds an open-ended claim against the debtor until repayment occurs or there is mutual consent about new terms or total forgiveness.

Libertarian theorist Murray Rothbard has argued for a new view of bankruptcy law as follows:

Would bankruptcy laws be permissible in a libertarian legal system? Clearly not, for bankruptcy laws compel the discharge of a debtor’s voluntarily contracted debts, and thereby invade the property rights of the creditors. The debtor who refused to pay has stolen the property of the creditor. If the debtor is able to pay but conceals his assets, then his clear act of theft is compounded by fraud. But even if the defaulting debtor is not able to pay, he has still stolen the property of the creditor by not making his agreed-upon delivery of the creditor’s property. The function of the legal system should then be to enforce payment upon the debtor through, e.g., forced attachment of the debtor’s future income for the debt plus the damages and interest on the continuing debt. Bankruptcy laws, which discharge the debt in defiance of the property rights of the creditor, virtually confer a license to steal upon the debtor (1982: 142).

The basis of the Rothbardian position is a libertarian theory of property rights, which asserts that individuals are free to act and use property so long as they do not coercively interfere with another person or that person’s property. States Rothbard:

The libertarian creed rests upon one central axiom: that no man or group of men may aggress against the person or property of anyone else. This may be called the “nonaggression axiom.” “Aggression” is defined as the initiation of the use or threat of physical violence against the person or property of anyone else (1978: 23).

Under this theory, a contract is an agreement by which one person’s entitlement is consensually transferred to another. But there is one exception in the title-transfer theory of contract to preclude the voluntary act of entering oneself into slavery. “A person cannot alienate his will, more particularly his control over his own mind and body,” Rothbard states. “Since his will and control over his own person are inalienable, then so also are his rights to control that person and will” (1982: 135).

But what a person can alienate are the rights to his property; thus, the theory of contract rights must be reduced to the theory of property rights. States Rothbard: “The right to contract is strictly derivable from the right of private property, and therefore the only enforceable contracts (i.e., those backed by the sanction of legal coercion) should be those where the failure of one party to abide by the contract implies the theft of property from the other party” (1982: 133).

Under libertarian theory, a loan is a temporary transfer of a property right (money) from one individual to another. When the loan falls due, the title to that amount of money is transferred from the borrower back to the lender. So failure to repay the loan is tantamount to theft, a criminal act even though there was no intent to commit a crime because, in one libertarian economist’s words, “The debtor who fails to honor fully the creditor’s claim is at that point in illegitimate possession of the creditor’s property” (White: 283).

1.4 Adam Smith and Public Policy

Adam Smith was wary of government intervention and provided numerous examples of the invisible hand at work to support open markets backed by the laws of justice. Government activity was described in The Wealth of Nations as “useless and hurtful” (456), “absurd” (343, 539), and “folly” (540). Smith warned about “political arithmetick” (534) and the “extravagance of government” (343).Yet Smith was not a proponent of a strict separation of the economy and government, or laissez-faire (Viner: 59, 144–55; Rothbard, 1995: 465–69). Smith advocated a role for government in:

•	Setting interest rate ceilings (1776: 357);
•	Partially funding elementary education (1776: 758–61);
•	Constructing roads, bridges, canals, and harbors (1776: 723–31);
•	Minting coinage and issuing credit (1776: 554–55); and
•	Establishing the Post Office as a monopoly (1776: 818).

Other interventions, such as government subsidies to domestic shipping, were justified as aids to national defense, a major exception. “The loophole Smith allowed for government to intervene in the economy, insofar as defense trumps opulence, has become a gap large enough to fit many a protectionist truck through” (Fleischacker: 268).

Yet Smith’s forest is more important than the trees. “What counts is the work as a whole—its scope, conception and execution, the spirit that animates it and the place it has had in history,” one Smith critic stated (Lerner: v). Smith’s logic argued against most government activism, the most important being monopoly grants under which some business firms suppressed competition from other firms, whether another domestic supplier or a foreign merchant. Adam Smith clearly differentiated between free-market capitalism and political capitalism (although he did not use these terms). Thus Smith might well have agreed with one twentieth-century historian who reported: “Adam Smith’s invisible hand had been thwarted time and again when business interests demanded [political] favors” (Moore, 1974:12).

Smith also saw the general danger of government intervention—when an unintended consequence inspires another intervention and “another disorder” (Smith, 1776: 472).

Smith’s “system of natural liberty” was utilitarian, not rights based. The Wealth of Nations espoused policies that Smith saw as offering the greatest good to the greatest number of people. Smith was not a natural-rights theorist who might have opposed government involvement on principle (Rothbard, 1995: 439, 465). This explains why Smith endorsed different government functions outside of enforcing the laws of justice. But had he witnessed the positive experiences of voluntary organizations in the nineteenth century and the negative experiences of government intervention in the twentieth, Smith could well have revised his thinking.

1.5 Self-Interest and Self-Sacrifice

Adam Smith viewed self-interest as natural and desirable, distrusted selflessness, and cautioned against government activism. Yet Smith also stated that “the wise and virtuous man” should at all times sacrifice his private interest “to the public interest of his own particular order or society” (1759: 235). Those interests, in turn, should be sacrificed to the “greater interest” of government, and government’s interest should be subordinate to the interests of the universe, as revealed by God (ibid).

These views can be reconciled by placing Smith’s idea of self-interest in the context of his understanding of virtue. Traditionally, the four cardinal virtues espoused by philosophers were courage, justice, prudence (practical wisdom), and temperance (Den Uyl: 1). Prudence and temperance promoted self-interest, aided by courage and tempered by justice. Philosophers close to Smith, such as Francis Hutcheson and David Hume, tended to focus on benevolence and civility as primary virtues, but these virtues (contrary to their contemporary meaning) supposedly encapsulated all four of the traditional virtues (Den Uyl: 123–24). Adam Smith took an intermediary position, sometimes speaking of benevolence as the fount of all virtue, but also focusing specifically on prudence as his primary virtue. This Smithian prudence has been described as comprising the qualities of a banker, one who is “conservative, cautious, frugal, industrious, serious, lacking excesses, dispassionate, and the like” (Den Uyl: 130).

Smith’s recommendation that self-interest, and other partial interests, be sacrificed for the greater good of the state or the universe is limited by the extremely stringent condition that the nature of that greater good is objective and known. In the absence of such objective knowledge, Smith considers the pursuit of prudent self-interest to be the preferred course, even if it is not the most just. He writes:

This partiality [towards oneself and one’s own groups] though it may sometimes be unjust, may not, upon that account, be useless. It checks the spirit of innovation. It tends to preserve whatever is the established balance among the different orders and societies into which the state is divided; and while it sometimes appears to obstruct some alterations of government which may be fashionable and popular at the time, it contributes in reality to the stability and permanency of the whole system (1776: 231).

Ideal moral theory aside, in any actual contest between the evident prudence of self-interest and the less-than-certain justice of self-sacrifice, Smith chose prudence every time.

Bibliography: Chapter 1 Internet Appendices

 

Campbell, T.D. Adam Smith’s Science of Morals. London: George Allen & Unwin, 1971.

Campbell, R. H., and A. S. Skinner. General Introduction to An Inquiry Into the Nature and Causes of the Wealth of Nations, by Adam Smith. 2 vols. Indianapolis: Liberty Fund, 1981.

Clark, John Maurice. “Adam Smith and the Currents of History.” In Adam Smith, 1776–1926: Lectures to Commemorate the Sesquicentennial of the Publication of “The Wealth of Nations,” edited by John M. Clark et al., 53–76. Chicago: University of Chicago Press, 1928.

Coase, Ronald. “The Wealth of Nations.” 1976a. Chapter 6 in Essays on Economics and Economists, 75–94. Chicago: University of Chicago Press, 1994.

Coase, Ronald. “Adam Smith’s View of Man.” 1976b. Chapter 7 in Essays on Economics and Economists, 95–116. Chicago: University of Chicago Press, 1994.

Cohen, Patricia. “Teachers Wrap Lessons in Fiction.” New York Times, November 16, 2002, B7.

Den Uyl, Douglas. The Virtue of Prudence. New York: Peter Lang, 1991.

Dougherty, Peter. Who’s Afraid of Adam Smith? Hoboken, NJ: John Wiley & Sons, 2002.

Fleischacker, Samuel. On Adam Smith’s “Wealth of Nations”. Princeton: Princeton University Press, 2004.

Greenfeld, Liah. The Spirit of Capitalism: Nationalism and Economic Growth. Cambridge, MA: Harvard University Press, 2001.

Hayek, F. A. “On Being an Economist.” 1944. In What Do Economists Contribute, edited by Daniel Klein, 133–49. New York: New York University Press, 1999.

Lerner, Max. “Introduction.” In Adam Smith, The Wealth of Nations, edited by Edwin Cannan, v–x. New York: Random House, 1937.

Mann, Bruce H. Republic of Debtors. Cambridge, MA: Harvard University Press, 2002.

Moore, R. Laurence. “Directions of Thought in Progressive America.” In The Progressive Era, edited by Lewis Gould, 35–53. Syracuse, NY: Syracuse University Press, 1974.

Otteson, James. Adam Smith’s Marketplace of Life. Cambridge: Cambridge University Press, 2002.

Rothbard, Murray. For a New Liberty. New York: Collier, 1978.

Rothbard, Murray. The Ethics of Liberty. Atlantic Highlands, NJ: Humanities Press, 1982.

Rothbard, Murray. Economic Thought Before Adam Smith. 2 vols. Brookfield, VT: Edward Elgar, 1995.

Rothschild, Emma. Economic Sentiments: Adam Smith, Condorcet, and the Enlightenment. Cambridge, MA: Harvard University Press, 2001.

Schumpeter, Joseph. History of Economic Analysis. 1954. Reprint, New York: Oxford University Press, 1976.

Skousen, Mark. The Making of Modern Economics. Armonk, NY: M. E. Sharpe, 2001.

Smith, Adam. The Theory of Moral Sentiments. 1759. Edited by D. D. Raphael and A. l. Mcfie. Reprint, Indianapolis: LibertyPress, 1984.

Smith, Adam. An Inquiry Into the Nature and Causes of the Wealth of Nations. 1776. 2 vols. Edited by R. H. Campbell and A. S. Skinner. Reprint, Indianapolis: Liberty Fund, 1981.

Viner, Jacob. “Adam Smith and Laissez Faire.” In Adam Smith, 1776–1926: Lectures to Commemorate the Sesquicentennial of the Publication of “The Wealth of Nations,” edited by John M. Clark et al., 116–55. Chicago: University of Chicago Press, 1928.

White, Lawrence H. “Bankruptcy as an Economic Intervention,” Journal of Libertarian Studies 1 (4): 281–88 (1977).