Read the first pages of Ideas

Adam Smith, beyond the invisible hand

Smith is remembered above all for the pin factory, the division of labor, and the invisible hand that coordinates without anyone giving orders. Here we are interested in something else. Smith did not stop at explaining how markets work. He tried to build a complete theory of the wealth of nations. And that is where his thinking becomes most interesting for the history of ideas.

Smith did more than observe that markets coordinate. He asked why an economy grows. His answer was that growth depends on three elements. The division of labor, which lets each worker produce more by specializing. The accumulation of capital, which improves tools and machinery. And the extent of the market, because the bigger it is, the more specialization it allows. The three feed one another.

This seems obvious today. It was not obvious in 1776. Most earlier thinkers, the mercantilists, believed that a nation’s wealth depended on how much gold it piled up in its coffers. Smith said no. Wealth was productive capacity, the real goods and services a country is able to generate, not the precious metals it keeps.

There was something subtler in Smith that is often forgotten: his theory of value. He distinguished between value in use and value in exchange, in the famous paradox of water and diamonds. Water is essential to life and is worth little. Diamonds are dispensable and are worth a fortune. Smith never managed to resolve the paradox completely. A satisfying answer would take a century to arrive, courtesy of the marginalists.

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His attempt at an answer, however, shaped the whole discipline for a hundred years. Smith thought that the exchange value of a thing was determined, at bottom, by the labor it took to produce it. In a primitive society, he said, if killing a beaver costs twice the effort of killing a deer, one beaver will be worth two deer. And although he himself acknowledged that in a developed economy the price is made up of three parts that have to be added together (wages, the profits of capital, and the rent of land), he planted the seed of the idea that labor is the real measure of everything. That seed would sprout in Ricardo and, half a century later, hand Marx the lever he was looking for. The whole story of this chapter and the next fits inside that unresolved ambiguity.

And it is worth recalling something the caricature tends to erase. Smith was not the naive champion of the free market that many imagine. He deeply distrusted businessmen, and not in passing: he wrote that people of the same trade seldom meet together without the conversation ending in a conspiracy against the public, and that any legislative proposal coming from merchants should be listened to with the greatest suspicion. He warned against monopolies, against perpetual patents, against the trade corporations that barred the way to apprentices. For him, competition was the indispensable condition. Without competition, the invisible hand guides nothing.

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In fact, the Smith who emerges from his two books read together bears little resemblance to the one quoted in speeches. Seventeen years before The Wealth of Nations he had published The Theory of Moral Sentiments, a treatise that opens by asserting that human beings care about the fortunes of others, and that we judge our own conduct by imagining how an impartial spectator would see it. So what he wrote was not a hymn to selfishness. He wrote that in the specific realm of exchange, you do not need to appeal to the baker’s generosity to get your dinner, because self-interest is already enough to coordinate. And he readily accepted that the state should do what the market does not: justice, defense, public works, and a basic education paid for out of public funds. He even argued that taxes should fall proportionally more heavily on the rich. Anyone who claims him today as a standard-bearer against the state is quoting half an author.

David Ricardo and comparative advantage

The next giant of classical economics was a very different man. David Ricardo was born in 1772 into a family of Sephardic financiers from Amsterdam who had settled in London. He became extraordinarily rich on the stock exchange. And then, almost as a hobby, he set about solving economic problems.

His most famous contribution is comparative advantage, which he published in 1817. His idea is that a country gains by specializing in what it is relatively better at and trading, even if another country does everything better in absolute terms, because what matters is opportunity cost. England gives up less by producing cloth than by producing wine, and that is why both countries come out ahead from trade.

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This idea is still the theoretical foundation of international trade two hundred years later. But it has a weakness that the classical economists themselves did not see clearly. The theory says that every country gains from trade. It says nothing about how those gains are shared out within each country, or about the workers who lose their jobs when an industry moves to the other side of the border. What is true for a whole nation need not be true for every person in it.

Ricardo also developed a version of the labor theory of value, the idea that the value of a good depends, ultimately, on the quantity of labor needed to produce it. That idea would later be inherited by another thinker, with consequences Ricardo could not have imagined.

There is another contribution of his, less famous and more uncomfortable, that is worth knowing because it explains why economics was called “the dismal science” for a century. Ricardo believed that the division of wealth among the three classes of his time was bound to go wrong. As the population grows, ever poorer land has to be farmed, so producing food becomes more expensive, and that whole increase is pocketed by the landowner in the form of rent, without his having done anything. Wages tend toward the bare minimum for subsistence, the capitalist’s profits are squeezed, and the landlord grows fat at everyone else’s expense. His practical conclusion was to fight the Corn Laws, the tariffs that made imported grain more expensive in order to protect English landowners. Notice the detail: the greatest theorist of free trade defended it, in his day, as a weapon against the rentiers of his own country. And another of his readers would take that model of opposing class interests much further.

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Malthus, the prophet of disaster

Thomas Malthus was an Anglican clergyman. In 1798 he published an essay that made him famous and hated in equal measure. His thesis was simple and terrifying. Population grows in a geometric progression, doubling again and again. Food production grows in an arithmetic progression, much more slowly. People multiply; food does not.

The logical conclusion was grim. Humanity was condemned to recurring cycles of famine, disease, and war, which would cut the population back until it fit once more within the available resources.

Malthus was not inventing anything especially original. But he formulated it with relentless clarity. And for a while the data seemed to prove him right. The Industrial Revolution had not yet unleashed its capacity to multiply food production.

The most obvious criticism of Malthus is that he was wrong. Agricultural technology advanced much faster than he foresaw. Fertilizers, mechanization, and the Green Revolution of the twentieth century fed billions of people who, by his calculations, should have starved.

Before dismissing him altogether, two qualifications are worth making. Being wrong about the timing does not mean he was wrong about the logic. The planet’s resources are finite, and no one has yet shown that technology will always be able to offset the growth of demand. And his influence has not disappeared. A good part of ecological economics and of the debate over the limits to growth owes something to that pessimistic clergyman.

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What remains is the darkest part of this story, which is what his theory was used for. From Malthus’s logic people deduced that helping the poor was counterproductive: if you fed them, they would have more children and the problem would come back worse. That reasoning served as intellectual cover for toughening the English Poor Laws of 1834, which sent entire families to the workhouses, and it weighed on the British response to the Irish famine of the following decade, in which around a million people died while food went on leaving the island. Malthus did not defend those measures in those terms, and that has to be said. But it is an early and brutal example of something that will reappear throughout this book: an economic theory never stays on the blackboard. As soon as it leaves it, someone uses it to justify what they already wanted to do.

Say, Mill, and the classical architecture

Jean-Baptiste Say, a French economist, added another piece to the classical edifice. Say’s law, formulated at the beginning of the nineteenth century, states, simplifying quite a bit, that supply creates its own demand. When someone produces something, it generates income for the workers, the suppliers, and the investors. That income is spent, and in being spent it creates demand for other products.

If Say’s law is true, prolonged recessions are impossible. Any imbalance would be temporary, because the market corrects itself. This idea dominated economics for more than a century, until the Great Depression put it on the ropes: with a quarter of the labor force out of work for years, it was hard to argue that the imbalance was temporary.

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John Stuart Mill brought the classical era to a close. The son of the economist James Mill, he was a child prodigy educated with an intensity that bordered on cruelty. He learned Greek at three. He read the classics at seven. And at twenty he suffered a nervous breakdown that forced him to rethink almost everything he believed.

Mill systematized classical economics in his Principles of Political Economy of 1848. But he also pushed it in new directions. He distinguished between the laws of production, which he regarded as natural and fixed, and the laws of distribution, which he regarded as social and therefore open to change. Put another way: the market produces wealth according to rules beyond our will, but how that wealth is shared out is a human decision.

It is worth pausing on the reach of that sentence, because it is probably the most subversive idea classical economics produced. If distribution is a decision and not a physical law, then inequality stops being a natural fact that can only be accepted with resignation and becomes something a society is responsible for. At a stroke, that opens the door to progressive taxation, inheritance taxes, collective bargaining, and the entire welfare state. The strictest supporters of laissez faire (“let it be done,” the idea that the state should keep out of the economy) never forgave him for it: Mill had granted them that the market produces better than anyone, and at the same time had taken away their argument that the outcome of distribution is untouchable.

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And Mill carried that consistency much further than he is usually given credit for. He ended up calling himself a socialist, though of a very particular kind: he did not want the state to take over the factories, but wanted the workers themselves to own them, in cooperatives competing with one another in the market. He defended individual freedom against the majority in On Liberty, of 1859, arguing that the only legitimate limit on what a person does is harm to others. And in 1869 he published The Subjection of Women, in which he argued that the legal subordination of women was a barbaric relic and that no country that kept it could call itself free. He wrote it at a time when such views earned ridicule in Parliament, where he served as a member. For him, economics was never a discipline separate from moral philosophy: it was part of it.

Strengths and limits of classical thought

Classical economics laid the foundations of the discipline. Some of its ideas are still standing two hundred years later. Comparative advantage. The division of labor. Coordination through prices. They are analytical tools that no later school has discarded entirely, not even the ones that criticize the classical economists most.

But the classical economists also had blind spots of real consequence.

They took it for granted that markets tend toward equilibrium, that recessions are short, and that the economy regulates itself. The Great Depression of 1929 would show that this is not always true, and that mass unemployment can last for years.

They paid little attention to distribution. Ricardo did see that landowners, capitalists, and workers had conflicting interests. But the classical economists, in general, assumed that growth would end up benefiting everyone. Historical experience shows that this sharing out is not automatic.

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They treated economics as a science of universal laws, when many of their conclusions depended on very specific institutional assumptions, those of nineteenth-century England. What held for Manchester did not necessarily hold for every place and every age.

And they left behind something worse than a blind spot: the labor theory of value, which Smith and Ricardo defended in different versions, was a time bomb. If the value of things depends on the labor needed to produce them, an uncomfortable question arises. What happens when the person doing the work receives less than their labor is worth?

These men also need to be seen in their own world. The classical economists lived through a brutal transformation. The Industrial Revolution was pulling millions of people off the land and putting them into factories. Cities were growing at an unprecedented speed. Wealth was multiplying, and so was misery. Smith wrote about the well-being of nations, not of the rich. Ricardo worried about wages. Mill defended women’s rights when that was almost unthinkable. They were not indifferent to the fate of ordinary people.

Their tools, however, had a limit. They saw the big aggregates: national output, trade between countries, the growth of the whole. They did not always see the specific people behind those figures. They knew that trade creates wealth, but they did not always stop to ask who ended up keeping it.

That question, who keeps the wealth, was inherited by the schools that came afterward. And the answer would depend a great deal on whom you asked.

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