Economics is full of interesting thoughts. If only some of our economists had not aspired to become rocket scientists, we would have seen economics emerge as one of the most straightforward subjects. However, ignoring the double talk and complex mathematical equations, economics still has much to offer. There have been economists, who by sheer force of their thought, have moulded the way we look at the world. One such economist who is often credited with starting a new era of thinking and who is also referred to as the father of modern economics is Adam Smith.
Johnny: Adam Smith? Does he need any introduction?
Jinny: That’s right. Adam Smith needs no introduction. No discussion about economics can be complete without talking about Adam Smith and his thoughts which became popular as what we know as “classical economics”. For those not familiar with it, classical economics refers to the work of some of the great economists who developed theories about free markets, laissez-faire and competition in the 18th and 19th centuries. Apart from Adam Smith, the “classical school” also includes names such as David Ricardo, Thomas Malthus and John Stuart Mill, who added new dimensions to the basic structure. The foundation of classical economics was laid by Adam Smith in his most popular work, An Inquiry Into the Nature and Causes of the Wealth of Nations (1776), which is also simply known as The Wealth of Nations. The book documents industrial development in Europe and provides one of the most interesting explanations of how the free market works. One particular reference to the “invisible hand” has become so popular that an entire body of thoughts about free markets is called the “invisible hand theory”.
Johnny: What did Adam Smith imply when he talked about the invisible hand?
Jinny: Even Adam Smith would not have imagined that a reference to the invisible hand would attract so much interest. He explained in his book that people are steered towards unintended common good as if they were being guided by an invisible hand. He used this metaphor in Book IV of The Wealth of Nations in the context of domestic versus foreign trade but subsequent interpretations have made this phrase popular beyond its original context. It can be used to explain in general how the free market is able to achieve common good. Adam Smith believed that it’s certainly not charity that motivates a baker to make bread or a butcher to supply meat. On the contrary, it’s self-interest which keeps the wheel of the free market rolling. The idea is that each person by looking after his own interest inadvertently helps in creating the best outcome for all. It is neither their intention, nor do they know about promoting common good while pursuing their own interest.
Illustration: Jayachandran / Mint
Johnny: But how come people are able to promote common good when they are not even aware about their intention?
Jinny: The butcher, brewer and baker only know this much that it is in their best interest to do what they are doing. But they are led by the invisible hand to promote an end that was not part of their intention. The entire economy is best served when everybody is motivated by one’s own self-interest. In other words, we can say that the invisible hand is always there to guide free economies in the right direction. The theory seems to be saying that any kind of intervention in the free market would be contrary to the natural market dynamics. Left to themselves, markets are fully capable of finding a natural equilibrium. In such a system, the role of government, as suggested by Adam Smith, would be limited to providing only basic necessities such as the defence of the nation, universal education, physical infrastructure, enforcement of legal rights and punishment of crime. All in all, it’s a recipe for laissez-faire. In this respect, the theories proposed by Adam Smith stand in sharp contrast to Keynesian economics, which favoured government intervention during times of recession.
Johnny: So that’s what the wealth of the nation is all about.
Jinny: You should not presume that the wealth of nations is only about the invisible hand or free market economics. What it brings to forefront is specialization or division of labour among individuals. People bring prosperity for their country when they focus on what they are best able to do. Likewise, countries bring prosperity to the entire world when they focus on their core strengths. Adam Smith recommends free trade among different countries based on what they are best able to produce. But that’s not all. The concept of division of labour also leads us to the system of assembly line production. Adam Smith cited the example of pin production. One man undertaking 18 steps required to make a pin could make a handful of pins every week, but if the 18 steps were performed in assembly line fashion by 10 men, then the production could jump to thousands of pins every month.
Johnny: That surely sounds like the magic of the invisible hand. The whole is larger than the sum total of its individual parts.
Who:Adam Smith is often called the father of modern economics for starting a new era of thinking.
What: Smith advocated free trade, laissez-faire and competition through his most popular book, The Wealth of Nations.
How: He believed that each individual promotes common good of the society by following his or her self interest.
Shailaja and Manoj K. Singh have important day jobs with an important bank. But Jinny and Johnny have plenty of time for your suggestions and ideas for their weekly chat. You can write to both of them at email@example.com