Adam Smith was an 18th-century philosopher renowned as the father of modern economics, and a major proponent of laissez-faire economic policies. In his first book, "The Theory of Moral Sentiments," Smith proposed the idea of an invisible hand—the tendency of free markets to regulate themselves by means of competition, supply and demand, and self-interest. Smith is also known for his theory of compensating wage differentials, meaning that dangerous or undesirable jobs tend to pay higher wages to attract workers to these positions. But he is most famous for his 1776 book: "An Inquiry into the Nature and Causes of the Wealth of Nations." Read on to learn about how this Scottish philosopher argued against mercantilism to become the father of modern free trade and the creator of the concept now known as GDP.

Early Life

The recorded history of Smith's life begins on June 5, 1723, at his baptism in Scotland; however, his exact birthdate is undocumented. Smith attended the University of Glasgow at age 14, later attending the prestigious Balliol College at Oxford University. After returning from his education at Oxford, Smith embarked on a series of public lectures in Edinburgh. The success of the lectures proved a stepping stone to a professorship at his alma mater. He started with logic but later taught moral philosophy at the university. Those years spent teaching and tutoring ended up in the publishing some of Smith’s lectures in his 1759 book, "The Theory of Moral Sentiments." 

The foundations for the canvas of Smith’s work were laid during this year and resulted from his interactions with notable figures, associated with multiple fields. For example, he was friends with James Watts, inventor of the steam engine, as well as the philosopher David Hume. Smith moved to France in 1763 because he was offered a more remunerative position as personal tutor to the stepson of Charles Townshend, an amateur economist and future Chancellor of the Exchequer. It was during his sojourn in France that Smith wrote “An Inquiry Into The Nature and Causes of the Wealth of Nations”, which would ultimately cement his place in history. 

The Theory of Moral Sentiments

Smith is most famous for his 1776-piece, "The Wealth of Nations," but his first major treatise, "The Theory of Moral Sentiments," was released in 1759 and many of its ideas are still practiced today.  

Some may be surprised to learn that in this book, Smith, who is also known as the “Father of Capitalism,” discusses charity and human ethics extensively. While much of the philosophy behind Smith's work is based on self-interest and maximizing return, "The Theory of Moral Sentiments," was a treatise about how human communication relies on sympathy. The book extensively explored ideas such as morality and human sympathy. In the book, Smith argued that people are self-interested but naturally like to help others. He introduced the concept of an “inner man” and an “impartial spectator” responsible for guiding human action. Both help to reconcile passion with reason, which is a basis for economic systems and provide a basis for the creation of institutions within human society. The book also includes elements of social psychology along with our instinct for self-preservation. The former is mainly expressed through a shared morality and sense of justice. An excess of emotion can prove to be harmful to both; hence, the human instinct to curb emotions to a socially acceptable form.

An “impartial spectator” is in our mind when we interact with others. As humans, we have a similarly natural affinity for justice because it promotes the preservation of and propagation of society.   

While this may seem to be at odds with his economic views of individuals working to better themselves with no regard for the common good, the idea of an invisible hand that helps everyone through the labor of self-centered individuals offsets this seeming contradiction. 

The Wealth of Nations

Smith’s 1776 work, "An Inquiry Into the Nature and Causes of the Wealth of Nations," also shortened as "The Wealth of Nations," documented industrial development in Europe. While critics note that Smith didn't invent many of the ideas that he wrote about, he was the first person to compile and publish them in a format designed to explain them to the average reader of the day. As a result, he is responsible for popularizing many of the ideas that underpin the school of thought that became known as classical economics.

Other economists built on Smith's work to solidify classical economic theory, which would become the dominant school of economic thought through the Great Depression.

In this book, Smith discussed the stages of evolution of society, from a hunter stage without property rights or fixed residences to nomadic agriculture with shifting residences. A feudal society is the next stage. In this stage, laws, and property rights are established to protect privileged classes. Laissez-faire or free markets characterize modern society in which new institutions are established to conduct market transactions. 

Laissez-faire philosophies, such as minimizing the role of government intervention and taxation in the free markets, and the idea that an "invisible hand" guides supply and demand are among the key ideas Smith's writing is responsible for promoting. These ideas reflect the concept that each person, by looking out for him or herself, inadvertently helps to create the best outcome for all. "It is not from the benevolence of the butcher, the brewer, or the baker, that we can expect our dinner, but from their regard to their own interest," Smith wrote.

By selling products that people want to buy, the butcher, brewer, and baker hope to make money. If they are effective in meeting the needs of their customers, they will enjoy the financial rewards. While they are engaging in their enterprises for the purpose of earning money, they are also providing products that people want. Such a system, Smith argued, creates wealth not just for the butcher, brewer, and baker, but for the nation as a whole when that nation is populated with citizens working productively to better themselves and address their financial needs. Similarly, Smith noted that a man would invest his wealth in the enterprise most likely to help him earn the highest return for a given risk level. Today, the invisible-hand theory is often presented in terms of a natural phenomenon that guides free markets and capitalism in the direction of efficiency, through supply and demand and competition for scarce resources, rather than as something that results in the well-being of individuals.

"The Wealth of Nations" is a massive work consisting of two volumes divided into five books. It differs from “The Theory of Moral Sentiments” in one major regard. Along with the “inner man” who was supposed to control and regulate human passion, it relies on an institutional framework to steer humans towards productive pursuits beneficial to society. The undergirding to that framework is competition, which Smith defined as a “desire that comes with us from the womb, and never leaves us, until we go into the grave.” The framework consists of institutions like a justice system designed to protect and promote free and fair competition. 

The ideas promoted by the book generated international attention and helped drive the move from land-based wealth to wealth created by assembly-line production methods driven by the division of labor. One example Smith cited involved the work required to make a pin. One man undertaking the 18 steps required to complete the tasks could make but a handful of pins each week, but if the 18 tasks were completed in assembly-line fashion by ten men, production would jump to thousands of pins per week.

In short, Smith argues that the division of labor and specialization produces prosperity. “It is the great multiplication of the productions of all the different arts, in consequence of the division of labor, which occasions, in a well-governed society, that universal opulence which extends itself to the lowest ranks of the people,” states Smith in “The Wealth Of Nations."

Adam Smith Creates the Concept of GDP 

Ultimately though the ideas presented in "The Wealth of Nations," Smith changed the import/export business, created the concept of what is now known as gross domestic product (GDP) and argued for free exchange.

Before the release of "The Wealth of Nations," countries declared their wealth based on the value of their gold and silver deposits. However, Smith’s work was highly critical of mercantilism; he argued that instead countries should be evaluated based on their levels of production and commerce. This sentiment created the basis for measuring a nation’s prosperity based on a metric called GDP.

Before Smith’s book, countries were hesitant to trade with other countries, unless it benefited them. However, Smith argued that a free exchange should be created, as both sides trading become better off. This led to the increase in imports and exports and countries judging their value accordingly. Smith also argued for a limited government. He wanted to see a hands-off government and legislation conducive an open and free market. Smith did see the government responsible for some sectors, however, including education and defense.

The Bottom Line

Smith's ideas became the foundation of the classical school of economics and gave him a place in history as the father of economics. Concepts Smith pioneered, such as the invisible hand and the division of labor are now quintessential economic theories. Smith died on July 19, 1790, at age 67 but the ideas he promoted live on in the form of contemporary economic research and institutes like the Adam Smith Institute. In 2007, the Bank of England placed his image on the £20 note.