Adam Smith's Economics Theory

  Reviewed by: Michelle Seidel, B.Sc., LL.B., MBA
  Written by: Jayne Thompson      Updated November 21, 2018
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Virtually every country in the western world runs on capitalist principles, or the idea that private owners control a country's industry for profit. This idea can trace its roots to Adam Smith, an 18th-century Scottish philosopher who became famous by his influential book "The Wealth of Nations." Laissez-faire economics and the idea of an "invisible hand" guiding the free markets are among the fundamental ideas of Smith's writing.

Who is Adam Smith?

Adam Smith was an 18th-century teacher and philosopher who is widely regarded as the father of classical economics. His great legacy is the theory of laissez-faire economics which argues that, left to their own devices, people will always act in their self-interest, and those interests will inadvertently level out to create the best outcome for all. In 1776, Smith wrote the seminal work, "An Inquiry Into the Nature and Causes of the Wealth of Nations." This book popularized many of the ideas that have come to underpin modern capitalism.

Adam Smith Theory of Capitalism

Smith formulated the idea of an "invisible hand" – the notion that the markets, when left alone, will regulate themselves through the mechanics of self-interest, supply and demand and competition. By selling the goods that people want to buy, the business owner hopes to make money. If the owner is successful in making the right kind of products in the right volume, Smith argued, he or she serves their own best interest by reaping the financial rewards. At the same time, the owner is providing goods that society values and jobs for workers which creates wealth not just for the business owner, but for the nation as a whole.

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Adam Smith Theory of Free Trade

Building on the idea of the invisible hand, Smith argued for minimizing government intervention and taxation of the free markets. Government restrictions on trade such as quotas, tariffs and taxes interfere with supply and demand, he argued, and stop both sides from pursuing their natural tendency to do business. Smith wanted to see a hands-off or laissez-faire government that imposed no restrictions on the freedom of an individual to conduct his own business and industrial affairs. By this policy, businesses should be permitted to produce as much as they like and earn as much money as they can, without restriction. It is competition and supply and demand – the invisible hand – that controls, propels and regulates markets.

Adam Smith Theory of the Division of Labor

Smith believed that labor, specifically the division of labor through the specialization of tasks, was the key to prosperity. In "The Wealth of Nations," he gives the example of the amount of work required to make a pin. One man performing each of the 18 tasks needed to make a pin could only fabricate a handful of pins each week, Smith said. But if the 18 tasks were broken down in an assembly-line fashion, with 10 men each performing only a small part of the whole job, production would jump to thousands of pins per week. In short, Smith argued that the division of labor increased the economic growth of a country.

Why is Adam Smith's Work So Important?

Theories such as the invisible hand and the division of labor have become quintessential economic theories, and entire nations have built their economies according to Smith's principles. Smith placed much more faith in people and the markets than kings and governments, which paved the way for countries to move from land-based wealth towards one of self-correcting free production. Smith did not live to see the rapid and relentless change brought about by the modern industrial period and the recurring bubbles, crises and inequalities that have occurred since. His belief in the logic of the market endures, however, and Adam Smith's theory is still one to be reckoned with.

Arguments Against Adam Smith's Theories

While Smith's theories are seen by many as valid today, they were created in much more simplistic times. They don't consider the social good in their equations and see economic profit as a pure good. Smith generalizes government intervention as interference without merit, never taking into account the reasons for taxes and tariffs. Smith's views on the rights of business owners vs. the responsibility for social awareness are thoroughly one-sided, and a product of his time. While many parts of his work may be valid, they're basic and don't cover all of today's economic equations.

About the Author

Jayne Thompson earned an LLB in Law and Business Administration from the University of Birmingham and an LLM in International Law from the University of East London. She practiced in various “big law” firms before launching a career as a business writer. Her articles have appeared on numerous business sites including Typefinder, Women in Business, Startwire and Indeed.com. Find her at www.whiterosecopywriting.com.

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