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Mar 12, 2013

Free Markets Series E9: Adam Smith and The Birth of Economics

The year 1776 saw the publication of Adam Smith’s magnum opus, An Inquiry into the Nature and Causes of the Wealth of Nations. As Lawrence W. Reed points out in this enlightening interview, Smith was arguing against the flawed but widespread ideas of mercantilism.

Take the notion that there is a fixed amount of wealth in the world, an idea that led rulers to colonize and conquer foreign lands in order to extract that wealth. Smith explained that instead of fighting to grab a bigger piece of the pie, people could bake a bigger pie through trade, investment, production, free prices, and entrepreneurship. He also attacked the obsession with precious metals, arguing that it is not gold and silver that make a nation wealthy, but rather goods and services.

Of course, Smith’s most famous idea is that of the invisible hand, by which the self-interest of individuals is channelled toward activities that are constructive and beneficial to others. Did the invisible hand drop the ball in the recent financial crisis? According to Lawrence Reed, people who make this argument need to do their homework. “The 2008 crisis was the fault not of the invisible hand, but of the iron fist. It was the fault of government.” From artificially low interest rates to state-encouraged subprime mortgages to monopolistic ratings agencies not doing their job, government had its fingerprints all over the crisis.

Similarly, explains Reed, the rise of China does not invalidate the insight that the invisible hand trumps centralized control. “In the last 30 to 40 years, China has allowed a significant degree of economic freedom, and lo and behold, their economy’s taken off.” It is this increased freedom, not the remaining controls, that explains China’s recent growth spurt.