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Why Did Adam Smith Give the State Limited Role in the Economy?
Adam Smith believed that, “Government should limit its activities to administer justice, enforcing private property rights, and defending the nation against aggression” (Mark Skousen, 2016). Smith advocated for free markets and believed that government intervention was not necessary to control the economy as the forces of market competition would allow the economy to function in the most efficient way; this is the notion of the invisible hand. He agreed with ‘laissez-faire’ believing that a pursuit of self-interest would ultimately benefit all individuals if they were left alone, leading to allocative efficiency being achieved and more wealth being created. This being said he did not reject the state and gave them important roles in external protection, internal protection and building and maintaining certain institutions in order to provide an environment that would allow for policies that he believed would maximize the wealth of nations.
Smith gave the state such a limited role in the economy as he believed all systems of political preference cause scarce resources to be employed less economically than would have otherwise been the case (D. A. Reisman, 1998). In Smith’s eyes, in order to maximize productivity, the market must be controlled by market forces if nations want to be as successful as possible and become wealthier. Smith thought that the government would repress self-interested people, and self-interest motivates more powerfully and consistently than kindness, altruism or martyrdom (Todd Buchholz). So, the state shouldn’t intervene in order for everyone to be able to pursue their maximum self-interest resulting in the economy achieving the maximum productivity attainable. This being said, due to Smith’s focus being on achieving maximum productivity and wealth, it is often assumed that he would accept inequality as a trade-off for a more prosperous economy- this is not true. By virtue of the design of his policies inequality was impeded without sacrificing the wealth of nations; in fact, Smiths key policies work against the concentration of wealth (Deborah Boucoyannis, 2014).
Another reason Smith gave the state a minimal role in the economy is because inefficiencies would be created due to policy makers making decisions that would not benefit individual workers or businesses. Policy makers have missing information and are not as knowledgeable about individual circumstances as the people that are directly involved; this lack of information will restrict prosperity of individuals and businesses and there will be a deadweight welfare loss. Another flaw that Smith identified is that government workers always get rewarded regardless of their effort/success; he believes that policy makers will become negligent and this will augment the allocative inefficiency they already create. Furthermore, Smith believed the state would favor the rich. Public policies generate the most economic rent for those favored by the policies. Policy makers themselves are wealthy, so they are likely to create policies that favor the rich which are not in the best interest of the majority of the population. Rent-seeking behavior of policy makers would compromise the ability of the state to create an environment where all individuals could fully pursue their own self-interest; the state has an incentive to keep money for itself and become more powerful as then it will then have more influence and control over the citizens of the country and the functioning of the economy (Arthur A Goldsmith, 1995).
Smith gave the state a role in both internal and external protection. He wanted the state to provide a military to protect against foreign aggressions, and also police and law to protect against domestic aggressions. As the economy grows the importance of having a strong military increases due to the fact richer nations are more likely to be targeted by other nations. In ‘The Wealth of Nations’ Smith says individuals must be protected from ‘injustice and oppression’ (Wealth of Nations) within society; he believes the state must provide internal protection in the form of police/ law and order. He believed that the government must civilize society and sustains its civility (Werner Bonifield, 2013). Without a civil society Smith’s ideas are not possible – ‘the invisible hand’ would not prevail if there was social disorder. The importance of justice was emphasized by Smith and as a philosopher you could say Smith’s job was teaching governments to think of themselves as the custodians of the invisible hand (Nicholas Phillipson, 2011). This would promote an environment in which individuals can strive to maximize their wealth which will in turn maximize the size of the economy. The third role Smith gave the state was to erect and maintain certain public institutions that would be advantageous to society. He was specific about what should be classified as a public good; if private agents did not have an incentive to maintain the good then it should be upheld by the state. Some examples of goods Smith believed the state should provide are transport infrastructure and basic education. He believed basic education should be a right and could be used to help reduce inequality. Smith said there was very little difference in the intelligence of the rich and the poor, so access to education would mean everyone had the ability to prosper.
Another role for the state was to administer taxation. In ‘The Wealth of Nations’ Adam Smith argued that taxation should abide by four principles: fairness, certainty, convenience and efficiency. He gives the state the role of administering taxation but to him the employment of tax accountants leads to a deadweight loss to society, so taxes should not be complicated and there should not be a huge amount of people employed in administering them. Generally, he thinks taxation should be proportional to how much a person benefits from living in society (Paul Mueller, 2016). However, he believes some taxes should fall disproportionally on the rich, such as taxes on luxuries. Smith does not want taxation to depress the self-interest of motivated workers, as he believes that will restrict the growth of the economy, so he wanted taxes to be as low as possible in order to meet the public needs of the nation. However, this does not mean he wants the poor to suffer. In ‘The Wealth of Nations’ Smith says, “no society can surely be flourishing and happy, of which the far greater part of the members are poor and miserable”. Despite his advocation for ‘laissez-faire’ capitalism he was not on the side of the rich- smith stated the way to measure a nation’s wealth is the ‘wages of the laboring poor’. According to Smith, the unconstrained operation of the system of perfect liberty improves the conditions of the poor as wealth for rich tends to trickle down to the lowest earners in society. The case of the turnpike tolls show that Smith was prepared not only to slate the rich but to slate their preferences as well. His attack on luxury, indolence and vanity implies a philosophical standard which identifies fairness with function and not with even-handedness (D. A. Reisman, 1998).
Smith did give the state an exceptionally limited role in the economy but he gave it one overarching goal: preventing social disorder by providing an environment where individuals could work to maximize their self-interest; without this the invisible hand would be undermined. Smith did not believe that the government would promote national prosperity if they played an active role in the operating of the market – he thought market forces should control supply and demand. Smith thought limiting state intervention would lead to economic growth which would benefit all of society, including the people on lower incomes as money should ‘trickle-down’ through the economy. Smith’s principle belief that people acted in their own self-interest, especially in economic terms, is the main reason why he gave the state such a limited role in the economy, as the intervention would simply reduce self-interest and the ‘invisible hand’ was enough to encourage individuals to act in ways that would mutually benefit the rest of society. Smith is not opposed to the government, he is simply opposed to certain activities of the government at the time, and the limited role he gave the state is the way he thinks the wealth of nationals can be maximized.
References
- Mark Skousen. (2009). The Making of Modern Economics. Retrieved November 2020 from https://krembol.ga/book.php?id=6sisXMv_AecC
- D. A. Reisman. (1998). Adam Smith on Market and State. Retrieved November 2020 from https://www.jstor.org/stable/40752070?refreqid=excelsior%3A6aa4460c24561bffee9dea632bdd2625&seq=1
- Todd Buchholz. (2007). New Ideas from Dead Economists. Retrieved November 2020 from https://ebookcentral.proquest.com/lib/exeter/reader.action?docID=5337961
- Deborah Boucoyannis. (2014). Contrary to Popular and Academic Belief, Adam Smith Did Not Accept Inequality as a Necessary Trade-Off for a More Prosperous Economy. Retrieved November 2020 from https://blogs.lse.ac.uk/politicsandpolicy/adam-smith-and-inequality/
- Werner Bonifield. (2013). Adam Smith and Ordoliberalism: On the Political Form of Market Liberty. Retrieved November 2020 from http://eprints.whiterose.ac.uk/67376/1/Adam_Smith_and_OrdoliberalismFinal.pdf
- Paul Mueller. (2016). Adam Smith on Public Policy: Four Maxims of Taxation. Retrieved November 2020 from https://www.libertarianism.org/columns/adam-smith-public-policy-four-maxims-taxation
- Arthur A Goldsmith. (1995). The State, The Market and Economic Development: A Second Look at Adam Smith in Theory and Practice. Retrieved November 2020 from https://onlinelibrary.wiley.com/doi/epdf/10.1111/j.1467-7660.1995.tb00568.x?saml_referrer
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