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The Wealth of Nations | Context

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Precursors: Locke, Steuart, and Hume

Adam Smith was not the first to write about the subject he termed political economy. In fact, The Wealth of Nations is filled with replies to other thinkers' views on the topic. Among the earliest such authors is the English philosopher John Locke, who weighed in on British monetary policy in the 1691 pamphlet, Some Considerations of the Consequences of the Lowering of Interest and Raising the Value of Money. In this short work, Locke argued against the further lowering of the legal interest rate, since lenders would not only ignore this artificial ceiling, but would also charge a premium for the inconvenience and danger of evading the law. This reasoning is endorsed by Smith in his own writings on interest (e.g., Book 1, Chapter 9 and Book 2, Chapter 4). In other respects, however, Locke endorsed a much more interventionist role for government in regulating the economy, as shown in his Several Papers Relating to Money, Interest and Trade, et cetera (1696). Like many writers of his time, he believed excessive importation of goods would deplete the country's reserves of gold, thereby creating economic turmoil. Smith scoffs at this notion.

Scottish author Sir James Steuart, although not mentioned by name in The Wealth of Nations, was surely known to Smith, since his economic treatise, Inquiry into the Principles of Political Economy (1767), was published by the same publisher Smith later used for his book. Steuart's work is notable for providing an early English-language definition of "political economy" by analogy with the more familiar "economy," or management of a private household. Like Locke, Steuart suggested an active role for government in encouraging domestic industry, with the aim of preventing producers in the home country from being undersold by foreign traders. He also promoted the idea of a government-backed paper currency in a time when banknotes were largely issued by private banks. Smith's letters reveal that The Wealth of Nations was partially intended as a point-by-point critique of Steuart's work and the principles it embodied.

A third writer frequently found in the margins of The Wealth of Nations is Scottish philosopher David Hume, Smith's friend and colleague. Economics was relatively low on Hume's considerable list of professional interests, but he did offer some brief remarks on interest and monetary policy in his Political Discourses (1752). Hume often illustrated his ideas by means of both historical examples and thought experiments—as Smith would later do in The Wealth of Nations. In refuting Locke's fears of a money shortage, for instance, Hume proposed a "miracle" in which everyone in Great Britain was suddenly given an additional five pounds sterling. The added supply of money, he argued, would more than double, but Britain would be far less than twice as rich, since prices would rise to absorb the extra cash. Likewise, a smaller supply of currency would not interfere with the ability to carry on commerce. Instead, the nominal price of goods would fall.

Smith and Mercantilism

With some notable exceptions, Locke and Steuart were both proponents of an economic philosophy known as mercantilism, which Hume critiqued, and which Smith steadfastly opposes in The Wealth of Nations. Central to mercantilism is the belief that a country's wealth can be measured in terms of the gold and silver it possesses in currency and bullion. Thus, in the mercantilist view, it is important to maintain a positive balance of trade with other countries, exporting more goods than one imports, and consequently importing more money than one exports. By Smith's time, these two central ideas had gained traction at the highest levels of British government and had come to affect nearly every dimension of its economic policy. For example, the Royal Mint allowed citizens to have their bullion converted into coins for free, hoping thereby to prevent the precious metals from leaving the country. Abroad, England—and later Great Britain—maintained treaties with gold-rich countries like Portugal in order to gain privileged access to the gold and silver being mined in the Americas. In addition, a complicated system of import and export laws governed which commodities could be brought into, and taken out of, Great Britain: some exports were banned outright, others taxed, and still others incentivized through a bounty paid to the exporter. One of Smith's great frustrations—and the subject of much cutting sarcasm within The Wealth of Nations—is the way in which mercantilist views had come to seem like common sense.

For Smith the hoarding of precious metals is counterproductive since the "cheaper" gold and silver seem to be, the more expensive all other commodities are. By a similar logic, he sees the attempt to establish a favorable balance of trade as doomed to failure: minimizing imports from one country—or of one type of goods—simply means increasing importation from other countries, or in other areas. Throughout The Wealth of Nations, Smith spares few opportunities to characterize these and other mercantilist objectives as pointless and self-defeating. His most strident and sustained critique of mercantilism, however, takes place in Book 4, where he offers a point-by-point takedown of the different mercantile policies adopted by the British government.

Colonialism

By the time The Wealth of Nations appeared, England (later Great Britain) had been a colonial power for nearly two centuries. Its oldest, wealthiest, and most territorially-extensive colonies were those in North America, but other colonial holdings of note included several Caribbean islands and much of present-day India. This last region was governed indirectly through the powerful East India Company, and it would remain so until 1858, when the crown seized control of India following a revolt. Thus, although Britain had not yet achieved the globe-spanning empire it would attain in the late 19th century, colonial policy was a major preoccupation for British rulers and statesmen. In The Wealth of Nations, Smith gladly supplies an economist's perspective on the central issues, such as the nature of the trade relationship between a mother country and its colonies. The upkeep of colonies, he argues, is always enormously expensive, not least because they must constantly be defended from foreign aggressors. To convince his readers Smith points to an example within living memory: the French and Indian War (1754–63), which, by his reckoning, cost the British treasury more than a hundred million pounds.

Apart from his extended discussion of colonial policy in Book 4, Chapter 7, Smith offers many incidental remarks about the American colonies in particular. Their impressive growth seems, to him, to justify his theories concerning the causes of prosperity. Having completed his book in early 1776, he is quite aware of the open rebellion then underway, although he prefers to refer to it as "the late disturbances," or "the present disturbances." This is more than mere wishful thinking on Smith's part. He repeatedly urges the British government to find an amicable solution to the crisis rather than lose the colonies altogether. Ideally, Smith says, Great Britain will divest its colonies altogether and convert them into trading partners and military allies. As it stands, the colonies are a liability rather than an asset since they afford little revenue even in times of peace. Mercantile policies, such as trade monopolies, make the matter worse by redirecting and thereby stunting the growth of both American and British industry.

The extent to which Smith's classical economics affected British colonial policy remains unclear. Great Britain, it is sometimes argued, reached the end of its "First Empire" in the last quarter of the 18th century, just as Smith's ideas were gaining wider currency among academics and policymakers. This interval, however, was a temporary decline in colonial activity, not a decisive halt to the founding of new colonies. Probably the single biggest factor heralding the end of the First Empire was the loss of the American colonies, which declared independence mere months after Smith's book went to press—the "late disturbances," it seems, ran later than anticipated. This example, more than any historical illustration provided by Smith, might have persuaded British leaders that colonialism was a risky, costly gambit that could drain the mother country's resources. In reality, however, Great Britain began rebuilding and even expanding its colonial holdings before the ink was dry on the U.S. Constitution. Australia, for example, was aggressively settled from 1788 onward, and many new territories entered the British fold throughout the Napoleonic Wars (c. 1801–1815).

Economics since Smith

Although The Wealth of Nations is widely considered to be a milestone in economic literature, many subsequent economists have qualified, challenged, or even rejected Smith's ideas. In fact, from a modern point of view, Smith's work has some substantial blind spots in such areas as consumer behavior and price-setting. A few of the differences between Smith's views and those found in a typical modern economics text are discussed below.

Two of the biggest issues confronting Smith's system are irrationality and imperfect information. For the most part, Smith assumes his economic actors (the people working, buying, selling, and investing in his economic system) to be rational, goal-seeking individuals who wish to maximize profit. Those who act irrationally—meaning anyone who does not try to maximize revenue—are generally judged to spend wastefully and are sometimes ridiculed as "crazy." Modern theorists, however, generally recognize that economic behavior is motivated by many more factors than a simple desire for profit. In fact, virtually the entire field of behavioral economics is devoted to accounting for these so-called irrational tendencies using psychological and cognitive principles. Smith, it is true, hints at some of these behavioral aspects, such as the willingness of people to accept lower pay for doing easy, prestigious types of work. These tendencies, however, are confined to the margins of Smith's work, whereas in modern economics they are often front and center.

Likewise, Smith generally assumes his economic actors possess perfect information—or at least enough information to find the most profitable use for their time and money. Smith typically thinks of his actors as playing checkers, where all the pieces are on the table for everyone to see, rather than poker, where each player keeps their cards hidden from the others. He does, at times, acknowledge specific situations in which imperfect information is available—such as the discovery and protection of trade secrets. These, however, are much like the instances of irrationality noted above in that they are incidental, rather than fundamental to Smith's theory. As with the problem of rationality, modern economics has found various ways of dealing with imperfect information scenarios. Many approaches are based on the mathematical discipline called game theory, which formalizes decision-making as a sort of multi-player game (these games, despite having colorful names like "Princess and Monster," are generally a lot less fun than poker).
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