What would Adam Smith do?

What would Adam Smith do?

I read Adam Smith’s “An Inquiry into the Nature and Causes of the Wealth of Nations” my junior year at Georgia – yes we actually had to read books when I was in college. It changed my life by reinforcing my decision to major in economics rather than going to law school. Although the concept of marginal analysis was not present in the book, the brilliance of explaining the benefits of trade, the woes of mercantilism, wealth building, free markets, the division of labor, comparative advantage and productivity made perfectly good sense to me. I was astounded to find all of this in a book published in 1776. Smith is our greatest economist and everyone that followed has only been expanding on his ideas and basic principles. If there are non-truths in the Wealth of Nations, please point them out to me because I don’t know of any. 

Smith was the father of laissez faire. Smith said that individuals acting in their own self interest created a greater benefit to the economy than actions taken by the government. This is Smith’s “invisible hand.” In that the government did not have a profit motive, it had no incentive to minimize costs which necessarily lead to waste. Smith was not opposed to the government but argued that markets were more efficient and less wasteful. But government had an important role. Government was responsible for national defense, the administration of justice, enforce private property rights and the provision of public goods. Why? Because of the mispricing of “public goods” by the free market. A public good is one where there is market failure which is a precise term meaning that markets will misprice a public good.

Consider the following. Although individuals and collections of individuals could theoretically provide for the national defense, the market solution would be suboptimal. This is because national defense is a public good and would be subject to market failure if not funded by the government. I once asked my students that if they could dictate how much of their taxes could go for national defense, how much would they allocate? I got answers from 20 percent to 90 percent. I told them the correct answer was zero. The reason being that if I contributed zero I would get defended as much as the person who contributed 100 percent. I said that if the Russians sent missiles to Oak Ridge, our military would not say “Ignore the missile that is going to hit that house with the red roof because he did not allocate any of his money for defense.” Thus why pay for a good if you can get it for free?

The same is true with other public goods such as infrastructure. Yes you could have toll roads throughout your city and toll booths at the entrance to each neighborhood. But it would be frightfully inefficient. So collect tax revenues and let the government build them and maintain them. In the same vein, Smith advocates a role for government in education. Here it is the investment in human capital that benefits future generations but is paid for by the current one. Although I have the feeling that Smith might favor publicly funded private education, his view is that education is a public good.

As to the administration of justice Smith says that the duty of the government is to protect  “as far as possible, every member of the society from the injustice or oppression of every other member of it, or the duty of establishing an exact administration of justice.” No argument there.

Lastly, individual private property and property rights are essential to Smith. Here again the individual acting in their own self interest further the welfare of the society. Smith is against constraining trade both domestically by individuals and by businesses as well as constraint of trade by one country toward another. Hear that Donald Trump? Government’s role is to see that markets operate freely without collusion and cartels. Smith opposed cartels, which were legal in his day. He famously said that when businesses gathered to talk amongst themselves it was to restrict competition to keep prices high and profits high. Thus, a role of government was to foster competition by preventing constraint of trade which is ironic since much of today’s government restricts competition.

Thus, given the state of the government today, one would ask “What would Adam Smith do”?  Smith would likely say that if the government is outside its prescribed roles, then its actions are necessarily wasteful and harmful to the economy. The spending on such projects is simply wasteful. That spending is financed by issuing government debt which raises market interest rates and makes borrowing more expensive in the private sector. The harmful impact is that there will be less capital accumulation and lower levels of economic growth. There will also be higher levels of inflation lowering the real income of residents. Thus when Smith would look at the budget slashing and federal employment rollbacks coming from Trump and DOGE, Smith would pooh pooh them unless the cuts were permanent. Currently, all the budget slashing and people being laid off is only temporarily. If the government agency remains on the books, then a new administration could easily resuscitate it. Trump must eliminate the agency but without congressional approval, this seems unlikely.

Thus Trump and Musk’s efforts are only transitory and short term in nature. Adam Smith would call for the complete elimination of much of today’s government. Trump while trying to restrain the growth of the government by downsizing its current components is doomed to fail. The real task is to limit the scope of government which will in turn limit its size. This would mean eliminating most of the cabinet level agencies completely. No more departments of education, energy, transportation, commerce, interior, agriculture and labor. No more HHS. No more HUD. No more veterans’ affairs. It would mean preventing the agencies from expanding their mission and reach. How many undersecretaries do we really need? Do you know that there are over 4,000 presidential appointed positions in the federal government? Adam Smith would be appalled at a government spending $7 trillion a year. The fact that we are not appalled is a sad commentary on how we have allowed the government to grow like Topsy with politicians handing out billions for purposes related more to their own welfare rather than the public good.