Adam Smith (1776) in The Wealth of Nations  argued that while the free market may appear to be chaotic and unrestrained it is actually guided by an invisible hand producing a variety and the right amount of goods. According to Smith although human motives are driven by selfishness and greed, competition in a free market benefit society by keeping prices low while building incentive for a wider variety of goods and services. Smith, however, was wary of business-men and argued against the formation of monopolies. Smith is regarded  as the father of our market economy, it  therefore seems appropriate to revisit his (1776) An Inquiry into the Nature and Causes of the Wealth of Nations to gain insight into what may have went wrong, and to find possible solutions on how to fix our economic woes.

Smith (1776) discussed three main concepts as the foundation  of free market economies (1) division of labor, (2) pursuit of self-interest, and (3) freedom of trade. A division of labor simply means creating more jobs. For example, when a business produces a pair of shoes, one person may sew the materials together, one person may build the heels for the pair of shoes, and  one person may attach the sole, and so on. Instead of having only one person building the complete product, divided among many, more people would have jobs thus members of society would have more prosperity because more people would have incomes. Smith believed that a division of labour would effect a great increase in production.

 The second concept that Smith discussed was the pursuit of self-interest. This concept has profound implications to a free market economy. It is the driving force that leads businesses and consumers to act. Imagine that different people or consumers have different interest and different needs at different times. Thus when all consumers with their different needs at different times interact in the market place and wide variety of businesses are affected by different transactions and different products and services at the same time. One may argue that self-interest stimulate free market diversity from a business as well as from a consumer perspective. This enables a strong market economy and more business will thrive.

The third element of freedom of trade enables the free flow of goods free of trade barriers and tariffs. Arguably, this will provide goods and services at lower costs. One cannot discuss freedom of trade however without incorporating comparative advantage. Please watch for our next discussion where we will expand on Adam Smith’s argument by introducing  David Ricardo on comparative advantage and international trade.

It seems appropriate to reflect on Smith’s words in view of our economic woes today. A bailout plan in excess of $700 billion  has been enacted to revive our economy, but will it work and if so how? Consumers and businesses do not have the money to  spend to energize the market economy. Of course one way of obtaining monies for spending is by getting credit. Credit will increase purchasing power which in turn will effect the market economy. There is one problem however, the economic conditions have already destroyed the credit ratings of many consumers. If people do not have satisfactory credit ratings they get credit or loans from the $700 billion bailout plan. This is possible where  Adam Smith  comes in with a possible solutions based on his arguments and theories.

One  passage that has been often  quoted from Smith’s (1776) Wealth of Nations is

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.

Surviving this economic crisis means that consideration must be given to the number of people that have lost satisfactory credit ratings and who have lost their purchasing power. Many people do not have access to credit because of bad credit ratings. To change this situation and to restore consumers purchasing power, financial institutions and businesses must consider their own interest. Without the ability to make loans banks are out of business. To be back in business financial institutions must now consider the availability of funds, and the accessibility of those funds by consumers. Under favorable circumstances and considerations purchasing power will be restored where people will once again move to the different product and services to carry on daily living. Thus the invisible hand will once again effect the great free market economy. J

Reference

Smith , A (1776) An inquiry into the nature and causes of the wealth of nations.

University of Chicago Press. ISBN 0226763749

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