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Adam Smith's The Wealth of Nations had a huge global impact

Adam Smith's The Wealth of Nations had a huge global impact

The Wealth of Nations described the industrialised capitalist system that overthrew the mercantilist system. Mercantilism stated that wealth was fixed and the only way to prosper was to hoard gold and tariff products from abroad.

The essence of Smith's thesis was that people's natural tendency for self-interest leads to prosperity. By giving people the freedom to produce and exchange goods and opening the markets to competition, people's natural self-interest would create greater wealth than with strict government regulations.


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The invisible hand

The invisible hand

The central thesis of Smith's The Wealth of Nations is that people's individual need to fulfil self-interest results in societal benefit. This free-market force became known as the "invisible hand".

However, the market that emerged from an increasing division of labour created inter-dependencies and promoted social welfare through individual profit motives. For example, the baker only produced bread and relied on one person for clothes, another for meat, and yet another for beer. The people specialising in clothes depended on the baker for their bread, and so on.


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The invisible hand versus the government

The invisible hand is not actually a distinguishable entity but the sum of many phenomena that occur when consumers and producers engage in commerce.

  • The invisible hand theorem suggests that the means of production and distribution should be privately owned and that trade will flourish organically without regulation.
  • The government affects the invisible hand, not the other way around. It is prescriptive and intentional and pursues defined goals through coercion.


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Government response to the Invisible Hand

The lack of market mechanisms frustrates government planning. This is also known as the economic calculation problem.

When people and businesses make their own decisions based on their willingness to pay money for a good or service, the information is captured. In turn, resources are automatically allocated toward the most valued ends.

Governments' interference causes unwanted shortages and surpluses. However, the forces that guide voluntary economic activity toward the benefit of societies are the same forces that curb the effectiveness of government intervention.


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The elements of prosperity

The elements of prosperity

Smith believed a nation needed three elements to bring about universal prosperity.

  1. Enlightened self-interest. He thought most people would naturally practice thrift, hard work, and enlightened self-interest.
  2. Limited government. Smith viewed the government's responsibilities as being limited to the defence of the nation, universal education, public works, the enforcement of legal rights and the punishment of crime.
  3. Solid currency and a free-market economy. Smith hoped backing the currency with hard metals would prevent the government from depreciating the currency.


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Smith's theories overthrow mercantilism

The Wealth of Nations is an influential book that started free-market economics but has some weaknesses. For example,

  • it is lacking proper explanations for pricing or a theory of value
  • Smith failed to notice the importance of the entrepreneur in breaking up inefficiencies and creating new markets

However, both opponents and beliers in Adam Smith's free-market capitalism have added to the framework. The theory gets stronger with each reformulation and continues to be a powerful force today.


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