In order to better understand how the economy of the United States came to be the comprehensive force it is today, we must first explore the very ideals such an economy was founded on.
The idea of Capitalism was first derived from Adam Smith’s renowned work, An Inquiry into the Nature and Causes of the Wealth of Nations. Capitalism is an economic system characterized by private or corporate ownership of capital goods, by investments that are determined by private decision, and by prices, production and the distribution of goods that are determined mainly by competition in a free market.
The words “free market” are what make capitalism an ideal. Laissez-faire economics has fallen by the wayside over the years due to human greed, deceit, and deception. But if this ideal was actually able to be implemented, the economy in general would be far less volatile, and during times of necessary economic change, we would see more natural and stable fluctuations.
In order for Smith’s free market economy to work, three major concepts need to be accounted for. They are:
1. DIVISION OF LABOR: where each individual performs a specific task based on his talents and these tasks, in turn, create better efficiency in the workplace. Meritocracy stresses the importance of allowing individuals to achieve what their “God-given” talents will allow them to without the interference of outside forces (i.e. the government). Smith believes that these outside forces are only looking to build larger societal outcomes and eventually lead to inefficiency in the division of labor, inhibiting progress altogether.
2. MAN’S PURSUIT OF SELF INTEREST/”INVISIBLE HAND” THEORY: in a free market, an individual benefits from their community by acting solely in their own self-interest, and equates self-interest to general interest. An individual who maximizes his own personal revenues is also maximizing the revenues of society as a whole. Even though Smith argues against the belief that self-interest is necessarily bad, he doesn’t believe that self-interest is always good. He criticizes individuals who act only out of greed and ignore the whole, mainly targeting tradesmen. Nevertheless, while Smith believes that human motives are often selfish and greedy, natural competition would benefit society as a whole regardless. The “invisible hand” also refers to the market’s ability to rectify itself in poor situations without government interference. Smith attempts to prove this in his discussion of “natural price”.
3. FREEDOM OF TRADE: Smith attacks mercantilism as a whole throughout the book, but more specifically the notions that protectionist tariffs, and having large reserves of bullion, economically benefit a nation. Smith also observes a mercantile transaction, which ultimately leads to one party of the transaction losing. Smith believes that a well-strategized trade would always benefit both parties involved. To him, sellers and buyers are in similar positions. They both are trying to get rid of something they no longer want and value what the other party has more than what they have. So upon exchange, they both benefit.
In the last Chapter in Book 4 of The Wealth of Nations, Smith argues against the common belief that government intervention leads to prosperity and growth. He states that government intervention leads to disarray in the capital income decreasing the real value of a country’s goods of production.
“Every man, as long as he does not violate the laws of justice, is left perfectly free to pursue his own interest his own way, and to bring both his industry and capital into competition with those of any other man.”(Book 4, Chapter 9) According to Smith, as long as one obeys the laws governing the society, he should be free to pursue his own interests and compete in the workplace. Government is not needed to establish freedom, because freedom establishes itself naturally.
There are three duties he believes governement should have in a free society:
1. Protect society and maintain peace.
2. Protect members from each other in the event competition is unnatural or one party is corrupt.
3. Maintain public works on the best interest of the whole.
Throughout The Wealth of Nations, Smith makes clear the fact that money is not, in any way, synonymous with wealth. This concept is the single virtue understanding of a free market, and the system of capitalism. While money offers us a means of exchange for goods, real wealth is not measured by how much paper money, or silver and gold a country has, but rather by the amount of commodities or products that country possesses. Here, Smith goes against the traditional mercantilist theory that the more money one has, the more wealthy one is. Mercantilists use bullion, held by the state to represent their economic assets. The problem with this is that the value of gold and silver fluctuates based on its quantity, so the more gold in circulation, the less valuable it is. Instead, according to Smith, money is to be used as a medium fo exchange, and as a benchmark to measure the real value of goods; its value is based entirely on its scarcity.
Smith’s theory, that a country’s wealth is derived from the amount of goods it possesses is represented in the modern-day concept of Gross Domestic Product (GDP). GDP is used to measure the value, or the size of a country. It is measured by the country’s market value of all final goods and services produced in a year. At the end of the year, all of the world’s countries are expected to report their GDP. Until about fifteen years ago, the United States used an alternative measure for its value- Gross National Product (GNP). GNP measures the output of American companies in a year, regardless of their location. Smith’s theory associates these changes in thought to the existence of a free market. Unfortunately, Smith vision of a “free-market” is only an ideal, and does not exist, due to it’s extremity, some two hundred years later.
***All ideas and quotes expressed in this passage came from a paper i wrote on capitalism entitled “The Benefits of a Free Market Economy.” All ideas presented are my own interpretation of Adam Smith’s Wealth of Nations.***
