Adam Smith is still relevant. But not for the reasons they taught us in school and college

It is commonly believed that Smith argued for free markets and therefore minimal government intervention in economic affairs. Such a view is entrenched in popular economics textbooks, both at the school and college levels. For example, look at the following extract from Gregory Mankiw’s Principles of Microeconomics.

“In his 1776 book An Inquiry into the Nature and Causes of the Wealth of Nations, economist Adam Smith made the most famous observation in all of economics: Households and firms interacting in markets act as if they are guided by an 'invisible hand' that leads them to desirable market outcomes. One of our goals in this book is to understand how this invisible hand works its magic. As you study economics, you will learn that prices are the instrument with which the invisible hand directs economic activity. … There is an important corollary to the skill of the invisible hand in guiding economic activity: When the government prevents prices from adjusting naturally to supply and demand, it impedes the invisible hand’s ability to coordinate the millions of households and firms that make up the economy.”

Using the weight of Smith’s legacy, Mankiw is suggesting that microeconomics provides the analytical framework underpinning the "invisible hand".

By the way, Smith uses "invisible hand" only thrice in all his writings—and only once in the Wealth of Nations! Moreover, as Tony Aspromourgos, a distinguished scholar of Smith, puts it, "invisible hand" is “the action of an unseen causal process in which behavior at the level of individuals generates systemic outcomes or effects at the level of the economy (and polity) as a whole.”

The idea of supply and demand as schedules is not present in Smith. Prices of commodities are determined by quantities of labour commanded, and not by recourse to supply and demand schedules. In the "natural" operation of the economy, there is no tendency to the full employment of labour. And finally, because education is viewed as necessary for all, Smith prefers that it be supplied by the government. Thus, the dominant view of Smith, as represented in Mankiw, is wrong.

Smith’s economics and The Theory of Moral Sentiments

Those interested in Smith’s economics ought to also read The Theory of Moral Sentiments published in 1759. Smith contributed to the Scottish Enlightenment, to which moral philosophy was central. Francis Hutcheson, the moral philosopher, was Smith’s teacher at Glasgow and David Hume was a friend.

In the 1760s, Smith met François Quesnay, the pioneer of Physiocratic thought, in France. It is believed that this meeting was decisive in Smith’s 1776 treatment of capital and profits, where the latter was conceptualized as a rate of return on capital advanced.

Smith is rightly credited for having put forth economics (or political economy as it was then called) as a separate study or discipline. He did this by assembling concepts that were already found in French and British political economy into a coherent whole. These concepts include labour theory of value, division of labour, rate of profit, subsistence wages, social surplus.

For him, the aims of political economy were to meet the material needs of the people and that of the government. Defence, education, law and transport were areas which the government ought to provide.

Smith was critical of feudal and mercantilist arrangements. In the first, the landowners exercised too much economic power. And in the second, the big businesses and the government colluded. Smith questioned the dominant socioeconomic arrangement of his time and he favoured liberal capitalism.

Smith is certainly no free market apologist. Moreover, he recognized the discontents of liberal capitalism. That the employers wield more power than the workers. That "division of labour" is limited by the "extent of the market". That is, technological progress by itself cannot drive economic growth. That "division of labour" is often repetitive work that has negative consequences on their cognitive capacity. To address these discontents, Smith recognized the importance of labour unions and economic planning.

Smith for today

The imparting of "moral sentiments" through formal and informal avenues of learning is essential for a flourishing society. In The Theory of Moral Sentiments, Smith wrote: “All the members of human society stand in need of each other’s assistance, and are likewise exposed to mutual injuries. Where the necessary assistance is reciprocally afforded from love, from gratitude, from friendship, and esteem, the society flourishes and is happy.”

Contrary to the dominant view of Smith found in economics textbooks and popular literature, he understood the importance of identifying sources of economic power so that countervailing measures could be undertaken (whether by groups of individuals and/or by the government). People, especially from privileged social groups, wield power via the community, the market and the state.

Of enduring value is Smith’s approach to economics, built on concepts such as social surplus and social classes, that is radically different in methodology and content from that of mainstream economics. Hence, when I teach courses on macroeconomics, economic growth, and history of economic thought, I introduce students to the ideas of Adam Smith that are faithful to his writings.

Let me end with a question that I often pose to my students: what is the additional insight that Robert Solow’s Nobel Prize work provides to our understanding of economic growth over that of Smith’s work?