The Adam Smith Illusion

“The problem is not simply that Smith was not the founder of economics.The problem is that he originated nothing that was true, and that whatever he originated was wrong.” -Murray Rothbard

Adam Smith (1723-1790), author of the iconic Wealth of Nations, is widely regarded as the “founder of modern economics”. His name is revered by self-described capitalists everywhere. He was Ronald Reagan’s hero. The famed Adam Smith necktie has been designated “the neckpiece of conservative Washington“. Indeed, the Adam Smith Institute in London calls themselves “the UK’s leading libertarian think tank” and proposes policy solutions very much in line with the traditional Austrian/free market tradition.

But was this social philosopher and quasi-economist really the great free marketeer he’s cracked up to be? The answer: definitely not. The real Adam Smith, though certainly an intelligent and seemingly well-meaning individual, was not a great economist and is often credited with far more than he deserves.

Among Smith’s most well-known “contributions” to economics was his illustration of the division of labor. While Murray Rothbard criticizes Smith’s “swollen” treatment of the division of labor as excessive and confusing, I tend to grant Smith more lenience–it was, indeed, from Smith’s colorful description that I and millions of other high-school students came to first understand the benefits of the division of labor. But Smith’s analysis is flawed nevertheless. When investigating the causes of the division of labor, Smith refused to acknowledge innate differences of natural talent and skill (and thus comparative advantage) between human beings as the reason for the division of labor, choosing instead to attribute the phenomenon to an innate desire within human beings to “truck, barter, and exchange”. As I will explain below, this notion flies in the face of certain indisputable truths about economic theory.

In reality, the division of labor is due to comparative advantage. This refers to “the ability of an entity (individual, company, or country) to produce a good or service at a lower opportunity cost than another one.” This difference in opportunity cost means it is most profitable for an individual or entity to work at what what he/she/it does best relative to everyone else. This gives rise to the division of labor, whereby individuals each benefit by capitalizing on their comparative advantage. Implicit in the idea of comparative advantage is the belief that there are innate natural differences between human beings (a proposition I hope we can all accept).

As Rothbard also points out, Smith’s analysis of the division of the labor was hyperfocused on division of labor within the firm, and failed to apply similar reasoning to international trade. This is simply another shortcoming of Smith’s analysis–one that unfortunately had the effect of encouraging the persistence of 18th century mercantilism.

Another flaw in Smith’s analysis is his perpetuation of the fallacy of “unproductive labor”. This is the belief that certain forms of labor is less productive (or indeed, entirely unproductive) than other forms. In Smith’s case, he believed labor on material objects is the only “productive” form of labor. I’ll leave the refutation of this flawed belief to Murray Rothbard (indeed, mine would be the similar, though only less concise):

“Smith’s bias in favour of material objects amounted to a bias in favour of investment in capital goods, since a stock of capital goods by definition has to be embodied in material objects. Consumer goods, on the other hand, either consist of immaterial services, or they get used up – consumed – in the process of consumption. Smith’s imprimatur on material production, therefore, was an indirect way of advocating investment in an accumulation of capital goods as against the very goal of producing capital goods: increased consumption. When discussing exports and imports, Smith realized full well that there was no point to amassing intermediate objects except that they eventually be consumed, that the only goal of production is consumption. But as Professor Roger Garrison has pointed out…Adam Smith’s Presbyterian conscience led him to value the expenditure of labour per se, for its own sake, and led him to balk at free market time-preferences between consumption and saving. Clearly, Smith wanted far more investment towards future production and less present consumption than the market was willing to choose. One of the contradictions of this position, of course, is that accumulating more capital goods at the expense of present consumption will eventually result in a higher standard of living unless Smith prepared to counsel a perpetual and accelerated shift toward more and more never-to-be-consumed means of production.”

It would appear that Smith’s failure was due to an underlying desire to appropriate more resources toward investment in future production than his fellow human beings were willing to appropriate, a sort of utopic vision on Smith’s part.

The above two points are by no means the only areas in which Adam Smith’s Wealth of Nations was fundamentally flawed, but there are the only two I shall highlight here. For more reading on this topic, see Murray Rothbard’s The Celebrated Adam Smith.

I’d also like to be known that my goal in writing this piece is not to detract from the pro-Adam Smith sentiments that pervade the free-market sliver of the American political spectrum. As long as the proponents of Smithian economics are advancing free market ideals in general and not what Smith actually wrote, the Smith bandwagon is one worth promoting. But where the Smithian-fixation is dangerous is when it crowds out the work of other economists who were (and are) far more capable defenders of the free market than Smith himself. Indeed, it may very well be Ludwig von Mises’ profile on the neckties of prominent right-wing American politicians were it not for Smith’s overinflated reputation. Such a phenomenon would at least facilitate a more robust defense of the free market in the American political theater than Adam Smith has to offer.

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