An Interview with Adam Smith: Part 2

Part Two: Virtues, Markets, and the System of Natural Liberty[1]
     Read Part I here.

Thank you for agreeing to carry on our conversation; let's continue with the presentation of your moral theory.

I would like to emphasize that sentiments of consideration and respect for others are reflected in two relevant moral virtues, benevolence and justice. We carry out acts of charity because we are interested in the welfare of others, and we invoke the rules of justice because we resent acts that harm our life, property, and dignity. From this exchange of sentiments moral criteria are gradually formed: justice commands us not to harm others, and charity encourages us to promote their happiness.[1] Both contribute to setting up a peaceful and beautiful society.

There are other moral qualities that facilitate exchanges of approval and mutual respect. These virtues are particularly appropriate for those who seek to improve their lot, since for this purpose they need to exercise prudence, frugality, industriousness, sobriety, vigilance, circumspection, temperance, constancy, punctuality, patience, strength, and moderation, among other virtues.[2]

When I hear this enumeration, I think of the “bourgeois virtues,”[3] that is, the qualities that support the order of the free market. What other aspects of the relationship between economics and morals would you highlight?

The connection between economics and morals is essential for understanding the functioning of free and mutually beneficial social exchanges. Moral qualities underlie the necessary provisions to succeed in economic exchange: for example, prudence and frugality are virtues that favor savings, which allows for the availability of funds and in turn, creates the capital necessary to fund the extension of markets.

In particular, I would like to point out the importance of a work ethic, which is a corollary of the propensity to produce and exchange with others. Human beings were created to be active, to produce something, and to never be content to subsist on the basis of the benevolence of others (which encourages indolence). For example, “the poor man’s son”[4] understands well that he needs to work hard to improve his condition. Regardless of whether wealth will bring you happiness or not - I think it generally does not - the example implicitly illustrates the value of work ethics.[2] 

If I understand correctly, every type of work produces wealth…

Unfortunately, that is not the case. Productive work generates vendible goods and must be differentiated from unproductive work, which is not exchangeable in the market (for example, the work of public employees in the field of justice and war).[5] In contrast, productive work exchanged in the free market creates personal and general benefits, despite the obstructions caused by the “absurd regulations of commerce” and the “folly of human laws.”[6]

What are the factors that explain the existence or nonexistence of productive work in any society?

The laborious or idle character of a population will depend on the incentives related to the “encouragement of industry.”[3]  When subsistence depends on the work or capital earned through individual effort and creativity, it is necessary for the people to be sober and laborious. When income depends on other sources—such as inherited wealth, privileges and benefits obtained gratuitously, or a secured income—people will tend to become idle and dissolute.[7]

You spoke of prudence, frugality, and work ethics. Why are these virtues associated with the commercial era?

The commercial era was made possible thanks to the expansion of markets. The pre-commercial era was an era marked by legal monopolies, corporate laws, learning laws, birthright laws, etc. These regulations and prohibitions constituted impediments to the freedom to work and to dispose of the product of one’s own effort, and therefore incurred a violation of the “most sacred and inviolable” right to property. [8] Naturally, social and economic mobility was stifled. 

The social change introduced with the commercial era and the free movement of goods and services was phenomenal. Subsistence would no longer depend on the favor or protection of the feudal lord, but on the productive work and cooperation that the market process makes possible. Consequently, exchange relations were introduced and expanded, and the exercise of virtues became necessary to unleash the almost unlimited possibilities of personal progress. In this sense, the commercial era helped end the dependency practices of feudal culture and encouraged the strengthening of the virtues that favored evolution towards a society of freer people.

How would you sum up the success of the commercial era?

What we now know is that the commercial era produced a “revolution” leading to greater well-being and happiness without anyone organizing it. [9] If the historical experience is of any use, the success of the commercial society can be traced back to the expansion of free trade, by which each person offers the product of her work and obtains the produce of other people’s work. In the particular case of lower-income sectors, markets allow them to generate income with a view to economic independence.

The System of Natural Liberty

Current economics is the result of the contribution of several thinkers over time, but undoubtedly, you were the first to describe, analyze, and systematically promote the market process. Could you explain how that process works?

Compared to the other economic systems, the system of natural liberty is the one that creates better opportunities for people to make progress. There are necessary conditions for this to happen: people must be free to act to satisfy their own interests, markets should function without political regulations, and laws and institutions must be effective. It is not the function of the government to supervise or direct the particular industries to ensure the general welfare. Moreover, it is a hoax to assume that a government can live up to such a task, since in that regard “no wisdom or knowledge will ever be sufficient.” [10] I dare to affirm that any government that attempts to replace the market mechanism will fail. To cite just one historical example, the record of European famines between the 16th and 18th centuries shows that they were caused by wrong economic policies.[11]

Market processes depend on the division of labor. Could you elaborate on the relation between the two concepts?

In a primitive era, it was possible to observe a very rudimentary division of labor, but as population and markets extended globally, the exchanges resulted in a multiplication of the division of labor required to meet the increasing demand for diverse goods and services. 

Market processes and the division of labor are mutually reinforcing dynamics. The latter has the advantage of promoting specialization and innovation, which leads to greater production and the expansion of markets, which foster creativity and a further division of labor.[12] In a competitive market—one without political obstacles or privileges—the division of labor fosters efficiency in the production of goods, which is the real cause of the creation of wealth.

Some may argue that what is good for one country may not be beneficial for all…

I entirely disagree with that idea. What is valid for a personal and a national economy is also valid for trade between nations. I will be emphatic on this point: against mercantilist and interventionist policies, I advocate freedom in international trade. Admittedly, there might be occasional exceptions to this policy, “which can be pardoned only in cases of the most urgent necessity.”[13]

Paraphrasing the title of my book, the wealth of nations does not consist in having a surplus trade balance, but in increasing the real value of what is produced in any one country through the productive work of its inhabitants and those who choose to exchange with them.

What is the main obstructions to the functioning of market processes?

Politics is always the main problem to overcome. Unfortunately, the list of governmental obstructions to markets is extensive: in addition to regulations of labor and corporate privileges, regulations of trade adversely affect the general welfare by making less optimal use of the resources available. [14]

Such regulations are usually the result of producers who have “persuaded” the government to grant them trade privileges. In addition to being inefficient and expensive, regulations affect the majority of consumers and other producers by increasing smuggling and unemployment.[15]

In what other ways do governments obstruct the proper functioning of markets?

Well, taxation is always a burden on markets. Public officials tend to ignore, forget, or discard some fundamental premises in regard to the justice and utility of taxation. The criteria to be followed in tax matters are quite simple. First, tax rates should not be arbitrary or inconvenient for the taxpayer. Second, taxes must be as low as possible. The tax pressure should not be an excessive cost for production, so as not to discourage industry or encourage tax evasion.[16] Sadly, historical experience shows that these criteria have not been respected and that governments tend to drain money from people’s pockets.

Finally, another problem that affects the proper functioning of markets is the waste of public sector spending, which can even ruin a country. I don’t really know what is worse--the “prodigality, misconduct and extravagances” of the government or “the errors of the administration.”[17]

Labor and commercial political restrictions, excessive spending, and high tax pressure remain in force today. It seems that public officials have not read your texts, despite the fact that in 2007 the British government issued a twenty-pound note with your profile on it. What would you say to a young person who sees that note for the first time?

I am glad to know that my intellectual contributions have been recognized by the British government, which is quite ironic since I always tried to demonstrate the danger that most government interventions represent for the proper functioning of the market. For example, since we are talking about money, I would like to refer to the persistent problem of the devaluation of currencies at the hands of governments, and of illegitimate public indebtedness.

When I describe the historical processes by which an official seal appeared on the metals used as means of commercial payment, I do not hesitate to state that everywhere “the avarice and injustice of princes and sovereign states, abusing the confidence of their subjects, have by degrees diminished the real quantity of metal, which had originally been contained in their coins.”[18]

You see, devaluations have always served political interests. In the days of the former Roman Republic, a majority of people with lower resources became indebted thanks to the patricians, who granted them loans in exchange for their political support; eventually, the currency was devalued in order to liquidate those debts and preserve that support.[19]

In addition to these condemnable practices, I also criticize the high level of public indebtedness. Governments never take into consideration with what funds and at what cost they will pay government debt. I suppose that public officials act like any other economic agent: when they can borrow easily, they ignore the need to save (that is, to spend less).[20] Such is the monetary and fiscal policy of unfairly lavish governments, insensitive to the cost of their irresponsibility in the long run.

Let’s move now to the analysis of the example of the pin factory, which also appears on that twenty-pound note.

The example of the pin factory illustrates the process of the division of labor, and it indirectly refers to the benefits created by specialization, which has led to an Industrial Revolution. I think it is important to refute a certain critical analysis that insists on pointing out the supposed negative consequences of free markets, completely overlooking the enormous benefits in terms of higher productivity, greater levels of employment, and more wealth generation.

Some critics no longer question the ability of markets to create wealth, but blame them for growing social inequality. They propose adopting a progressive tax on capital. What do you think of these theories?

Well, those theories are outright wrong. The goal of a sound economic policy should be to allow individuals to generate revenue and secure the conveniences of life and to supply public revenues for the government to effectively fulfill its limited functions.[21] The focus of economic policy should not be to combat inequality, since the latter is the inevitable result of the use of different talents and capacities exchanged in the market. Moreover, the inequality of fortunes that arises from the development of different individual capacities is in some ways “useful”[22] to promote individual and general progress, if considered as both the incentive and the result of the drive for bettering our condition.

In addition, to propose a progressive tax on capital is to completely ignore economic history and theory. Capital is the factor of production with greater mobility. Therefore the owners of capital will always tend to escape quickly from the “mortifying and vexatious” reach of tax-collecting agencies. The flight of capital will in turn produce a fall in production and in employment levels. In short, any attempt to make a forced transfer of capital resources will have negative generalized consequences.[23]

[1] TMS 262.
[2] TMS 166, 201, 304; LJ 338.
[3] McCloskey (2006).
[4] TMS 106, 181.
[5] WN 330-331.
[6] WN 540.
[7] WN 335-337.
[8] WN 138; TMS 84.
[9] WN 422.
[10] WN 687.
[11] WN 526.
[12] WN 13-24; LJ 491.
[13] WN 538.
[14] WN 135,151; 452-453.
[15] WN 459,733.
[16] WN 825-827.
[17] WN 342-343.
[18] WN 43.
[19] WN 931-932.
[20] WN 911.
[21] WN 428.
[22] LJ 338.
[23] WN 927-928.