The Wealth of a Nation

By Pia Varma

So what now? Before you reach for "The Dummies Guide to Getting America Back on Track" let me suggest another book. In fact, it happens to be the same book the Founding Fathers used when they were laying the foundation for this country. It’s called An Inquiry into the Nature and Causes of the Wealth of Nations, now simply referred to as The Wealth of Nations.

Enter Adam Smith: eccentric, reclusive and absent-minded. He never married, he lived with his mother and he often talked to himself. Yet he emerged as one of the leading intellectual heavyweights of the Anglo-Scottish Enlightenment. In fact, many call him the father of modern day economics.

In 1776, Smith published The Wealth of Nations, introducing the world to a brand new concept: Free Market Economics. That same year, across the pond, Thomas Jefferson, George Washington, John Adams and others were planning a revolution that would lead to the formation of what would become the wealthiest nation, a nation based entirely around Smith’s free market principles. But this wasn’t a coincidence.

The Scottish-born Smith had a profound influence on the Founding Fathers. Benjamin Franklin was his personal friend and James Madison was a big fan. Alexander Hamilton borrowed heavily from Smith in his own magnus opus, Report on Manufactures, and there are numerous references to Smith in the letters of Thomas Jefferson. Incredibly, George Washington’s signature was actually found in a 1789 edition of The Wealth of Nations.

Although Smith, himself, never ventured to the American colonies, there is no doubt that his ideas were being bounced around by these men over beers in Philadelphia’s City Tavern or in the debates at Constitution Hall.

But where did Smith’s ideas come from and what were they?

The forces that brought the ideas of Adam Smith to the Founding Fathers in Philadelphia had been set in motion centuries earlier, since the 14th Century re-emergence of Democracy and Republicanism in Italy. The simple concept that an individual could find truth without the aid of God and the Holy Roman Church had empowered the people of Europe, pulling them out of the Dark Ages and kick-starting a vibrant Renaissance.

Hungry for more knowledge, man leaped from one step of human pro-gress to another; the Renaissance became the Elizabethan Era, the Elizabethan Era was followed by the Age of Reason and the Age of Reason became the Age of Enlightenment. By the time the Age of Enlightenment rolled around, classical liberal ideas were in full force. New concepts such as inalienable rights and the acknowledgement of slavery’s immorality were being discussed in coffee houses and political salons across England, Scotland and America. Passions ran wild, and political activism was at its height. English author Thomas Paine had emigrated to the American colonies and was arguing for the rights of man. Edmund Burke and the radical Whigs in England were fighting against the abuses of King George III, just like their counterparts and allies in the American colonies.

By 1776, the stage was set for Adam Smith to introduce his free market ideas. The Wealth of Nations became an instant success, shattering the status quo and throwing a wrench into the power structure. Word about The Wealth of Nations travelled quickly from Scotland to England and throughout Europe, making its way across the Atlantic to the American colonies. The first edition was sold out in six months.

But what were these ideas that shook up the world? Essentially, Smith regarded Man as a rational being who, by acting in his own self-interest, would work to move society forward: "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." In the same way, the Founders emphasized the individual’s right to his own life, liberty and pursuit of happiness. Jefferson promised in his first inaugural address that the U.S. government "shall leave [its citizens] otherwise free to regulate their own pursuits of industry and improvement, and shall not take from the mouth of labor the bread it has earned."

Smith wanted to find the right institutional framework that would turn his vision of a society where individuals traded freely into a reality. This framework became a Constitutional Republic, where laws protecting inalienable rights reigned supreme and no majority could vote those rights away. Both Smith and the Founders believed that this framework of laws would best enable individuals to "truck, barter, and exchange one thing for another," without interference from the state. The view of the world suggested in The Wealth of Nations is that monopoly power can’t exist without assistance of government.

Smith based his arguments on a very simple idea, that there exists an invisible hand guiding the economic development of society, and this invisible hand functions best when left alone. This invisible hand is made up of all productive members of society, and naturally spreads wealth and increases quality of life. When a government attempts to engineer markets with regulations, subsidies, protectionist policies, sanctions, special licenses, tariffs, taxes and stifling programs, it will always lead to unintended consequences. The Founders took note of this and made specific provisions and clauses in the Constitution, preventing the state from interfering in interstate commerce and promoting the general welfare of the people. They, too, under-stood that the economic system that provided the greatest good for the greatest number of people was the free market system.

At the time, this was an extremely revolutionary idea. Before Smith came along, nation-states had been laboring under a mercantilist system, believing that there was a finite amount of wealth in the world, which must be gobbled up as quickly as possible. In their view, life was a zero sum game; only winners and losers. Spain, England, Portugal, France and others were in constant competition. Wars were waged and marriages and other alliances were formed in this quest for power, dominance and wealth. The primary goal was to have a favorable balance of trade; exports greater than imports, with the difference being settled in gold or IOUs. To a mercantilist, wealth equaled gold and a favorable balance of trade meant more gold.

Smith stated that it is incorrect to think that the wealth of a nation depends upon its holdings of precious metals. Rather than Spain and England competing with each other to grab up resources, it would be in each of the countries’ best interests for them to both be thriving nations. It would mean more customers for their goods and services. Nations could trade with one another and everyone would win. The Founders adopted this worldview and made it the bedrock of U.S. foreign policy.

Smith called this concept Absolute Advantage. He argued that if England can produce a commodity such as cotton at a lower cost than Spain, and if Spain could produce another commodity, such as grain, at a lower cost than England, then each country should stick to doing what it does best and trade; costs go down and quality goes up.

But the idea of Absolute Advantage is not limited to the foreign trade. It also applies to trade within a country. Smith explained that a major contributing factor to the wealth of a nation was the productivity of labor. He went on to say that productivity of labor depended on the division of labor. In the same way that nation-states should stick to doing what they do best, so, too, should individuals specialize in a skill or craft and trade with one another. As labor becomes more divided and specialized, productivity increases and costs go down. The Founders implemented a system of government that enabled individuals to fill needs in the market and contribute to the wealth of the nation.

But, today, America is at a crossroads, choosing between the free market system advocated by Adam Smith and the Founding Fathers and mercantilist policies that dominated the world for centuries. In many ways, Americans still hold on to mercantilist ideas. Our leaders desperately try to protect domestic industries with tariffs, subsidies and other protectionist policies, hoping it will maintain our status as a world leader. They have been on a mission to create shovel-ready jobs for the hundreds of thousands of people who are out of work as opposed to allowing the invisible hand of the market to determine labor needs.

It’s unclear which direction America will take in the future. But the simple reality is that the Founding Fathers adopted the ideas in The Wealth of Nations when they laid the foundation for America, and the United States of America went on to become the wealthiest nation.

You can’t really argue with results.

 



<< Return to the September 2010

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