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Economic Theories

Classical Economic Liberalism

-Adam Smith-

Alma Smarandache Economics and International

Affaires English teaching, 2nd year
Classical Economic Liberalism

Classical liberalism is a political philosophy and ideology belonging

to liberalism in which primary emphasis is placed on securing the freedom of the
individual by limiting the power of the government.

The philosophy emerged as a response to the Industrial

Revolution and urbanization in the 19th century in Europe and the United States.
It advocates civil liberties with a limited government under the rule of law, private
property, and belief in laissez-faire economic liberalism.

Classical liberalism is built on ideas that had already arisen by the end of the 18th
century, including ideas of Adam Smith, John Locke, Jean-Baptiste Say, Thomas
Malthus, and David Ricardo.

It drew on a psychological understanding of individual liberty, the contradictory

theories of natural law and utilitarianism, and a belief in progress.

Adam Smith

Adam Smith (5 June 1723 OS (16 June 1723 NS) 17 July 1790) was a
Scottish moral philosopher and a pioneer of political economy.

Smith has been commemorated in the UK on banknotes printed by two different

banks; his portrait has appeared since 1981 on the 50 notes issued by
the Clydesdale Bank in Scotland, and in March 2007 Smith's image also appeared
on the new series of 20 notes issued by the Bank of England, making him the first
Scotsman to feature on an English banknote.

Smith has been celebrated by advocates of free market policies as the founder of
free market economics, a view reflected in the naming of bodies such as the Adam
Smith Institute in London, the Adam Smith Society and the Australian Adam Smith
Club, and in terms such as the Adam Smith necktie. P. J. O'Rourke describes
Smith as the "founder of free market economics".

Smith is cited as the "father of modern economics" and is still among the most
influential thinkers in the field of economics today.
One of the key figures of the Scottish Enlightenment, Smith is best known for two
classic works: The Theory of Moral Sentiments (1759), and An Inquiry into the
Nature and Causes of the Wealth of Nations(1776). The last one, usually
abbreviated as The Wealth of Nations, is considered to be his magnum opus and
the first modern work of economics.

The Theory of Moral Sentiments (1759)

In 1759, Smith published his first work, The Theory of Moral Sentiments. He
continued making extensive revisions to the book, up until his death.

Although The Wealth of Nations is widely regarded as Smith's most influential

work, it is believed that Smith himself considered The Theory of Moral
Sentiments to be a superior work.

In the work, Smith critically examines the moral thinking of his time, and suggests
that conscience arises from social relationships. His goal in writing the work was
to explain the source of mankind's ability to form moral judgements, in spite of
man's natural inclinations towards self-interest. Smith proposes a theory of
sympathy, in which the act of observing others makes people aware of themselves
and the morality of their own behavior.

It provided the ethical, philosophical, psychological,

and methodological underpinnings to Smith's later works, including The Wealth of
Nations (1776), Essays on Philosophical Subjects (1795), and Lectures on Justice,
Police, Revenue, and Arms (1763) (first published in 1896).

The Wealth of Nations (1776)

Considered to be the liberalism Bible, it includes 2 volumes

divided into 5 books:

Book I: Of the Causes of Improvement in the Productive Powers of


Book II: Of the Nature, Accumulation, and Employment of Stock

Book III: Of the Different Progress of Opulence in Different Nations

Book IV: Of Systems of Political Economy

Book V: Of the Revenue of the Sovereign or Commonwealth

First published in 1776, the book offers one of the world's first
collected descriptions of what builds nations' wealth and is today
a fundamental work in classical economics. Through reflection
over the economics at the beginning of the Industrial
Revolution the book touches upon such broad topics as the
division of labor, productivity and free markets.

In The Wealth of Nations the main economic issues of the time

are approached: social wealth and its ways to enhance, division of
labor and the exchange, money and currency, goods value and
price, income distribution and its categories-salary, profit and
ground rent, nature, accumulation and the uses of capital,
international trade, economic policy systems, etc.

According to Smith, the increase in the wealth of nations is

determined by 2 factors, namely:

a) Increasing workers skills as a result of division of labor;

b) The relationship between productive and unproductive workers.

Regarding the first factor, Smith analyzed the division of labor,

which leads to an increase in labor productivity, and therefore,
leads to an increase in the wealth of nations. He was guided by
the idea that the creative source of wealth is human labor.
Regarding the second factor, Smith formulated the idea of
collective productive worker. He divided work into productive
work and unproductive work, based on the profit production
criterion, whatever the beneficial purposes are.

Smith addressed the motivation for economic activity, the causes

of prices and the distribution of wealth, and the policies the state
should follow in order to maximize wealth.

The Invisible Hand

Smith wrote that as long as supply, demand, prices, and

competition were left free of government regulation, the pursuit
of material self-interest, rather than altruism, would maximize the
wealth of a society through profit-driven production of goods and

An "invisible hand" directed individuals and firms to work toward

the nation's good as an unintended consequence of efforts to
maximize their own gain. This provided a moral justification for
the accumulation of wealth, which had previously been viewed by
some as sinful.

Smith's statement about the benefits of "an invisible hand" is

certainly meant to answer Mandeville's contention that "Private
Vices ... may be turned into Public Benefits".

It shows Smith's belief that when an individual pursues his self-

interest, he indirectly promotes the good of society. Self-
interested competition in the free market, he argued, would tend
to benefit society as a whole by keeping prices low, while still
building in an incentive for a wide variety of goods and services.

In the interconnection between microeconomics and

macroeconomics, Smith considered that the market is the
invisible hand that ensures rational distribution of resources and
the spontaneous regulation of the economys normal functioning.
In the market individual and social interests are harmonized.

Smith used the term "the invisible hand" in "History of

Astronomy" referring to "the invisible hand of Jupiter" and twice
each time with a different meaning the term "an invisible hand":
in The Theory of Moral Sentiments (1759) and in The Wealth of
Nations (1776). This last statement about "an invisible hand" has
been interpreted as "the invisible hand" in numerous ways.

There is a fundamental disagreement between classical and

neoclassical economists about the central message of Smith's
most influential work: An Inquiry into the Nature and Causes of
the Wealth of Nations. Neoclassical economists emphasize
Smith's invisible hand, a concept mentioned in the middle of his
work and classical economists believe that Smith stated his
program for promoting the "wealth of nations" in the first

Nevertheless, he was wary of businessmen and warned of their

"conspiracy against the public or in some other contrivance to
raise prices". Again and again, Smith warned of the collusive
nature of business interests, which may form cabals
or monopolies, fixing the highest price "which can be squeezed
out of the buyers".
Smith also warned that a business-dominated political system
would allow a conspiracy of businesses and industry against
consumers, with the former scheming to influence politics and

Smith states that the interest of manufacturers and merchants

"...in any particular branch of trade or manufactures, is always in
some respects different from, and even opposite to, that of the
public...The proposal of any new law or regulation of commerce
which comes from this order, ought always to be listened to with
great precaution, and ought never be adopted till after having
been long and carefully examined, not only with the most
scrupulous, but with the most suspicious attention."

Adam Smiths Paradox

The paradox of value (also known as the diamondwater paradox)

is the apparent contradiction that, although water is on the whole
more useful, in terms of survival, than diamonds, diamonds
command a higher price in the market.

Adam Smith used the comparison of diamonds and water to make

a distinction between what he called "value in use" and "value in

The word VALUE, it is to be observed, has two different

meanings, and sometimes expresses the utility of some particular
object, and sometimes the power of purchasing other goods
which the possession of that object conveys. The one may be
called "value in use;" the other, "value in exchange." The things
which have the greatest value in use have frequently little or no
value in exchange; on the contrary, those which have the greatest
value in exchange have frequently little or no value in use.
Nothing is more useful than water: but it will purchase scarcely
anything; scarcely anything can be had in exchange for it. A
diamond, on the contrary, has scarcely any use-value; but a very
great quantity of other goods may frequently be had in exchange
for it.

(Adam Smith - An Inquiry into the Nature and Causes of the

Wealth of Nations)

Adam Smith denied a necessary relationship between price and



The ideas that became associated with Smith became the

foundation of the classical school of economics. His work served
as the basis for other lines of inquiry into the economics field,
including ideas that built on his work and those that differed.

His main emphasis was on the benefit of free internal and

international trade, which he thought could increase wealth
through specialization in production. He also opposed restrictive
trade preferences, state grants of monopolies, and employers'
organizations and trade unions. Government should be limited to
defense, public works and the administration of justice, financed
by taxes based on income.
Smith's economics was carried into practice in the 19th century
with the lowering of tariffs in the 1820s, the repeal of the Poor
Relief Act, that had restricted the mobility of labor, in 1834, and
the end of the rule of the East India Company over India in 1858.











Victor Stefan Doctrine Economice, Editura SITECH, Craiova,