ADAM SMITH AND THE WEALTH OF NATIONS
Seventeen seventy-six marked the publication in England of one of the most influential books of our time, The Wealth of Nations. Written by Adam Smith, it earned the author the title «The Father of Economics».
Smith objected to the principal economic beliefs of his day. He differed with the physiocrats who argued that land was the only source of wealth. He also disagreed with the mercantilists who measured the wealth of a nation by its money supply, and who called for government regulation of the economy in order to promote a «favorable balance of trade».
In Smith's view, a nation's wealth was dependent upon production, not agriculture alone. How much it produced, he believed, depended upon how well it combined labor and the other factors of production. The more efficient the combination, the greater the output and the greater the nation's wealth.
The heart of Smith's economic philosophy was his belief that the economy would work best if left to function on its own without government regulation. In those circumstances, self-interest would lead business firms to produce only those products that consumers wanted, and to produce them at the lowest possible cost. They would do this, not as a means of benefitting society, but in an effort to outperform , their competitors and gain the greatest profit. But all this self-interest would benefit society as a whole by providing it with more and better goods and services, at the lowest prices. To explain why all society benefits when the economy is free of regulation, Smith used the metaphor of the «invisible hand»:
«Every individual is continually exerting himself to find the most advantageous employment for whatever capital he can command. It is his own advantage, and not that of society, which he has in mind, ...but he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention, for the pursuit of his own advantage necessarily leads him to prefer that employment which is most advantageous to society».
The «invisible hand» was Smith's name for the economic forces that we today would call supply and demand, or the marketplace. He sharply disagreed with the mercantilists who, in their quest for a «favorable balance of trade», called for regulation of the economy.
Instead, Smith agreed with the physiocrats and their policy of «laissez faire», letting individuals and businesses function without interference from government regulation or private monopolies. In that way, the «invisible hand» would be free to guide the economy and maximize production.
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The Wealth of Nations goes on to describe the principal elements of the economic system. In a famous section, Smith turned to the pin industry to demonstrate how the division of labor and the use of machinery increased output.
«One man draws out the wire, another straights it, a third cuts it, a fourth points it, a fifth grinds it at the top for receiving the head; to make the head requires two or three distinct operations...»
Although modern technology has improved the methods by which pins are produced, the principles pertaining to the division of labor remain unchanged.
Similarly, other sections dealing with the factors of production, money and international trade are, as meaningful today as when they were first written.
TEXT 6
DAVID RICARDO (1772—1823)
Classical Champion of Free Trade
David Ricardo is one of history's most influential economists.
Born in England, Ricardo made a fortune on the London Stock Exchange. This wealth gave him the time to write and to serve in Parliament's House of Commons. His most famous work, Principles of Political Economy and Taxation (1817), marked him as the greatest spokesman for classical economics since Adam Smith. [
Ricardo is especially famous in international economics for demonstrating the advantages of free trade. Free trade is a policy in which tariffs and other barriers to trade between nations are removed. To prove his point, Ricardo developed a concept we now call the principle of comparative advantage. Comparative advantage enabled him to demonstrate that one nation might profitably import goods from another even though the importing country could produce that item for less than the exporter.
Ricardo's explanation of comparative advantage went as follows:
Portugal and England, both of whom produce wine and cloth, are considering the advantages of exchanging those products with one another.
Let's assume that:
• x barrels of wine are equal to (and therefore trade evenly for) y yards of cloth.
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• In Portugal 80 workers can produce x barrels of wine in a year. It takes 120 English workers to produce that many barrels.
• 90 Portuguese workers can produce y yards of cloth in a year. It takes 100 English workers to produce y yards of cloth.
We can see, Ricardo continued, that even though Portugal can produce both wine and cloth more efficiently than England, it pays them to specialize in the production of wine and import English cloth. This is so because by trading with England, Portugal can obtain as much cloth for 80 worker-years as it would take 90 worker-years to produce themselves.
England will also benefit. By specializing in cloth, it will be able to obtain wine in exchange for 100 worker-years of labor rather than 120.
As a member of Parliament, Ricardo pressed the government to abandon its traditional policy of protection. Though he did not live to-achieve that goal, his efforts bore fruit in the 1840s when England became the first industrial power to adopt a policy of free trade. There followed 70 years of eсonomic growth during which the nation became the world's wealthiest industrial power.
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