Adam Smith and Free Market Capitalist Economics
Adam Smith (1723-1790) was the leading economic theorist in the 18th century. His economic theories argued against the common mercantile economic practices of the period. He is considered the father of modern capitalism.
Adam Smith quick facts
Nationality: Scottish (British)
Lived: 1723 to 1790 during the early Industrial Revolution
Wrote: The Wealth of Nations–one of history’s most famous set of economic theories
Central beliefs: Limited role for government in markets and trade
Long-term impact: Ideas shifted beliefs on trade away from protectionism and toward free trade
Smith's Economic Beliefs
In his book the Wealth of Nations, Smith advocated the following.
- The wealth of an economy is the value of how much it produces (agriculture, manufacturing, and services).
- Government should limit its roles in regulating commerce and trade to promote the most wealth creation.
- Economies function best when competition among buyers and sellers sets prices.
- Self-interest leads to prosperity.
The role of the government in the economy: Smith believed the government had a crucial but limited role in the economy.
Things necessary for economic success but not profitable or possible for private businesses to manage
- A nation’s military defenses
- The promotion of education
- The building of infrastructure
- Laws to prevent anti-competitive business behavior such as monopolies
Smith also noted that government regulations and interventions into the economy to reduce poverty are acceptable. He wrote that
“When the regulation, therefore, is in support of the workman, it is always just and equitable; but it is sometimes otherwise when in favour of the masters (business owners).”
Government limits on the free purchase and movement of goods
- Government set prices
- The granting of trade and production monopolies
- Tariffs that are used to limit imports
Adam Smith and mercantilism: Adam Smith was critical of mercantilism. The mercantilist nations believed that the more gold and silver they acquired, the wealthier they were. Smith argued that this economic policy was foolish and actually limited the potential for “real wealth,” which he argued came from producing more agriculture, goods, and services.
Main Ideas of Mercantilism
Main Ideas of Adam Smith
Wealth is gold and silver
Wealth comes from increasing production of agriculture, goods, and services
Limit imports and maximize exports
Trade restrictions on imports and exports hurt nations’ economies
Import tariffs (taxes) on imported goods to raise prices of foreign products
Limit tariffs to promote free trade
Closed-loop trading between colonies and mother country
Free trade among nations
* Free trade is when International trade is left to its natural course without tariffs or other restrictions by governments.
The rise of Transnational Companies, Business, and Finance
As western nations industrialized and European imperialism expanded into Africa and Asia, international businesses and large banking and finance corporations expanded. The rise of capitalism and the decline of mercantilism in the industrial powers also supported this expansion.
Trans-national businesses are companies that do business around the world. Modern companies are based in one country but often produce and sell products across the globe. By the late 19th century, the first modern transnational businesses became more common.
Historical trend: The first trans-national companies were the trading companies that started in the 17th century. The most famous was the British East India Company.
Unilever: Unilever is one of the world’s largest companies. In 2009, they employed over 155,000 people and had revenue of over 50 billion dollars–larger than many country’s entire economies. Unilever brands can be found in homes worldwide and include Ax, Bryers, Hellmann’s, Lipton, Pure Leaf, Klondike, and Q-tips.
Unilever began as two separate companies. The first, Lever and Company, was founded in England and created the first branded soap, named Sunlight. The second company was Jurgens. Based in the Netherlands, Jurgens invented margarine: a cheap butter substitute made using animal fat.
By the early 1900s, the English Lever and Company exported their products globally. The company had factories in South Africa, Europe, Canada, Australia, and the United States. As their business expanded, ensuring access to raw materials was vital to growth. In 1906, the company opened a palm plantation in the Solomon Islands.
Hong Kong Shanghai Banking Corporation (HSBC): The Hong Kong and Shanghai Corporation was a transnational corporation founded in 1865 in Hong Kong and Shanghai to finance foreign trade between Asia and Europe. Today the company has over 34 million customers in 66 countries.
The company focused on financing exports of the following:
- tea and silk from China
- cotton and jute from India
- sugar from the Philippines
- rice and silk from Vietnam
The company also bought large amounts of silver from San Francisco. In its first decade, the bank opened branches in Yokohama in Japan, Ho Chi Minh City in Vietnam, Manila in the Philippines, and Kolkata in India. Within ten years of its founding, the company was present in seven countries across Asia, Europe, and North America.
New financial instruments and institutions
Stock markets are where individuals buy and sell shares (portions) of companies. Companies sell their stock shares on stock markets to raise money to expand and operate their business from the investors who buy the shares. When companies make money, shareholders who bought their stocks on stock markets keep the profits.
The first stock market: Stock markets started with European expansion into the Americas and Asia during the 16th and 17th centuries. The capital required to take a transoceanic journey was more than anyone or two merchants could raise. To raise money, trading companies sold shares to investors. Companies split profits from trading expeditions between investors. The Dutch and British East India Companies were a few of the first successful joint-stock companies that traded on early stock markets.
- The first stock market was the Amsterdam stock exchange, which opened in 1602. The Dutch East India Company established the exchange to sell its shares.
- The American stock exchange opened on Wall Street in 1772.
- The first stock exchange opened in London in 1773.
Stock markets financed the industrial revolution: Industrial factories and infrastructure expansions like steamboats and railways required large amounts of money. New industrial companies used stock markets to finance their business growth.
Limited Liability Corporations (LLCs)
Limited liability companies (LLCs) started in Germany in 1892. LLCs allow individuals to start companies quickly and cheaply. LLCs protect owners from lawsuits that might arise out of the running of business operations. LLCs also allow owners to only pay taxes once on the business’s profits. Before LLCs, the businesses would have to pay taxes twice, once on business profits and then again on the owners on the income. Those who start businesses are also financially protected if the business fails and ends in bankruptcy. Combined, these aspects of LLCs made starting businesses easier and less risky.
The Rise of Consumer Capitalism
As industrialization grew urban wealth, high-end shops opened in wealthy urban neighborhoods. These shops sold expensive fabrics, furniture, clothes, art, and home goods. Customers who could afford these products were industrialists, factory and business owners, factory and business managers, doctors, and lawyers. Only the upper-middle classes and wealthy could afford to shop in these shops.
Shopping as social status: The stores in which people shopped determined social status. Throughout the 19th and early 20th centuries, most consumer goods were unaffordable for most people. Items that are today considered standard, such as fashionable clothing, books, art, and home furnishings, were only found in the homes of upper-class customers. Elite individuals wanted to be seen shopping in pricy shopping areas and displaying goods from luxury retailers in their homes.
Mass market products: In the second half of the 18th century, companies such as Unilever began producing commodities and daily household use products that were within reach of more consumers.
Luxury goods were still far off for most working-class people. These products supplied basic needs.
- Produced by Unilever, Sunlight Soap was affordable at a relatively low price (originally a few pennies a bar).
- Sunlight Soap’s marketing campaign focused on preaching the gospel of cleanliness, which appealed to both upper-class individuals and working-class members in manual labor jobs.
- Sunlight Soap marketed itself as “pure” and “unadulterated” by chemicals, which appealed to urban industrial residents living and working in environments polluted by industrial pollution and waste.
Much of the consumption among the working classes took place in local neighborhood stores and stalls. Companies marketed products the working class bought directly to their working-class communities.