Today, Adam Smith is widely regarded as the founder of modern economics and free-market capitalism. However appropriate and accurate, such characterizations can be misleading. Smith never referred to his ideas as “capitalism” (or “free enterprise” or “laissez-faire”) and we cannot reduce his thought to the idea that government power must be minimized and commercial freedom maximized. In fact, those who study Smith notice that the economic system he advocates is not his ultimate or primary purpose. A commercial society with the right institutions aimed at enriching ordinary consumers and producers does more than make a nation wealthy. Free commerce, for Smith, is a means to promoting a polity that successfully maintains liberty by giving individuals incentives to restrain their behavior. A market economy and the democratic prosperity it engenders is valuable because it promotes the virtues—moderation, honesty, reliability, discipline, and civility—on which liberal society depends. As the late University of Chicago professor Joseph Cropsey put it, “Smith advocated capitalism because it makes freedom possible, not because it is freedom.”  Smith’s economic thinking developed from an understanding of human psychology, man’s capacity for moral virtues, and the proper ends of political life. Smith may be the founder of modern economics, but he was foremost a moral philosopher.

Human Nature

As is true of earlier enlightenment philosophers, Smith says (in his Theory of Moral Sentiments) that his moral system is based on a sober look at how human beings actually behave rather than on the principles of “a perfect being” who exists only in the imagination. The foundation of Smith’s view is that man is ruled by the self-regarding passions and appetites. The primary goals of human beings, he writes, are “self-preservation, and the propagation of the species…Mankind are endowed with a desire for those ends, and an aversion the contrary.” While man is distinguished from lower animals in part by his capacity for reason, our reason is a handmaiden of our appetites.

Although a man’s dominating concern is for his own interest, we also have a natural sympathy that inclines us to restrain our socially pernicious impulses. Smith writes: “How selfish soever man may be supposed, there are evidently some principles in his nature, which interest him in the fortune of others, and render their happiness necessary to him, though he derives nothing from it except the pleasure of seeing it.” Natural sympathy operates by compelling an individual to reflect on his behavior in light of his fellows’ circumstances and experiences.

Smith admits, however, that benevolence is undependable. “Man has almost constant occasion for the help of his brethren, and it is in vain for him to expect it from their benevolence only.” Benevolence may be “the sole principle of acting in the Deity,” but the same cannot be said of “so imperfect a creature as man.” Man can sympathize with others, but he cannot be persuaded by rational arguments that benevolence is more important than his own interests. Indeed, that benevolence conflicts with man’s individual needs is obvious in the dynamics of the market. As Smith writes at the beginning of The Wealth of Nations: “We do not appeal to the benevolence of the butcher and baker, but to their self-interest and advantage to gain the ends of society.” Thus, Smith lowers the bar from the Christian conception of charity to a more practical and material understanding of benevolence.

Morality, Justice, and Reputation

A major puzzle in Smith’s thought is how to reconcile the possibility of moral judgment with his insistence that man is fundamentally self-regarding, a conundrum that nineteenth-century German scholars called “Das Adam Smith Problem.” Smith’s famous “impartial spectator,” a doctrine he lays out in his Theory of Moral Sentiments, is the beginning of the answer. Any action can be tested by an agent’s conscience, which is guided by a hypothetical spectator who shares the fundamental qualities of most human beings. The spectator reminds the agent that all other men share (and therefore have the right to pursue) the same passions. Every moral agent should ask: Would a spectator looking over my shoulder empathize with my behavior? It is incumbent on the agent to temper and restrain his actions in a way that would satisfy the spectator.

Judging according to an impartial spectator is harmonious with self-interest because each man is deeply concerned with his reputation. Healthy self-regard is the humble concern to keep one’s good name and avoid the contempt of others. Such good reputation is accessible to most human beings. Happiness is the “consciousness of being loved,” not the rare exercise of the full scope of Aristotle’s ethical virtues. As Smith says, “In ease of the body and peace of the mind, all the different ranks of life are nearly upon a level.”

Smith’s moral system is based on rights rather than duties: the natural instinct of sympathy cannot overrule man’s concern with his own interests. Justice cannot be based on benevolence but, rather, is based on man’s natural rights, especially our right to preserve our lives. The fear of death is “one of the most important principles in human nature,…the great poison to the happiness, but the great restraint upon the injustice of mankind, which, while it afflicts and mortifies the individual, guards and protects the society.” The fact that all men have the same rights places limits on individual behavior. Man is led by his passions, but his passions—including the desire for a good reputation—stimulate adherence to rules of justice that demand decent regard for others.

Commerce and the Public Interest

Smith’s economic system is the link between his understanding of individual well-being and the public interest. As he saw it, under a free commercial system, the desire to increase personal well-being coincides with collective well-being. Smith’s society is not based on self-preservation narrowly understood but on the desire to increase material satisfaction. As he puts it in The Wealth of Nations, “an augmentation of fortune is the means by which the greater part of men propose and wish to better their condition.” The social life of Smith’s commercial society is dominated by “the uniform, constant, and uninterrupted effort of every man to better his condition.”

The idea that self-regard can coincide with public interest is encapsulated in Smith’s well-known metaphor of the “invisible hand,” which he uses in his writings on three separate occasions. In the Theory of Moral Sentiments, he writes:

[The rich] consume little more than the poor, and in spite of their natural selfishness and rapacity, though they mean only their own conveniency, though the sole end which they propose from the labours of all the thousands whom they employ, be the gratification of their own vain and insatiable desires, they divide with the poor the produce of all their improvements. They are led by an invisible hand to make nearly the same distribution of the necessaries of life, which would have been made, had the earth been divided into equal portions among all its inhabitants, and thus without intending it, without knowing it, advance the interest of the society, and afford means to the multiplication of the species.

The notion of the invisible hand points to the core contribution of Smith’s economic system: the reorientation of commercial life around the voluntary, disciplined, civil exchange between individual consumers and producers. In the mercantilist economies that were prevalent before and during Smith’s time, national prosperity was based on accumulating gold and silver through legal protections of highly organized commercial interest groups. Prices were set by guilds and wages set by commissioners. By contrast, in Smith’s free market, national prosperity is propelled by countless smaller transactions by private-market players who direct their energies to pleasing the consumer rather than their political patrons. The producer is forced to direct his efforts this way because his product has value only insofar as the consumer believes it is valuable. “By directing that industry in such a manner as its produce may be of greatest value, [the producer] intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.”

Smith understood that market efficiency is best achieved by the division of labor. In a famous image of the “very trifling manufacture” of pins (which Smith borrowed from the fifth volume of the Encyclopédie), Smith demonstrates a 4,800-percent productivity increase when the process is broken into 18 specialized tasks. Smith was sensitive to the non-material costs of the division of labor—a theme seized upon by subsequent critics, including Karl Marx. But as he explained in The Wealth of Nations, such efficiency makes the ordinary day-laborer in a commercial society wealthier than a powerful king in an economy without the division of labor.

Liberal Republicanism

While the invisible hand suggests that individual and collective well-being can coincide,. Smith does not claim that this happens automatically. In fact, he believes that educational and political institutions are necessary to direct our passions constructively.

The goal of education is to inculcate virtues that promote self-command, the discipline to delay gratification and secure one’s lasting interests. “Self-command,” he says, “is not only itself a great virtue, but from it all the other virtues seem to derive their principal lustre.” Self-command promotes industriousness, prudence, civility, and reliability—those qualities that Smith’s market system depends on and encourages.

Smith’s promotion of a free market corresponds with his harsh judgment about the pernicious effects of governmental extravagance. Government ministers are “the greatest spendthrifts in the society.” It is thus in the interest of both the nation and its citizens for the government to focus on its own expenses and leave private men to their own affairs. Smith’s wariness of government expenditures is not guided by hostility to government as such, but by his commitment to maintaining liberty, the core principle of his regime.

Smith does not espouse democracy in the sense of government grounded on universal suffrage, but his preference for republicanism is clear. He repeatedly praises Holland’s political order, and he attempts to demonstrate the virtues of constitutional arrangements (such as balance of powers) that protect individual liberties. His executive is separate from judicial power, and he gives the power to collect tax revenues to representative jurisdictions. Moreover, Smith opposes hereditary nobility, although he favors natural excellence. The best statesmen, he suggests, are those ambitious, public-spirited men “who were educated in the middle and inferior ranks of life, [and] who have been carried forward by their own industry and abilities.”

A central and recurring theme in The Wealth of Nations is that merchants should not be trusted with political power. “No two characters seem more inconsistent than those of trader and sovereign.” Not only do one’s own interests differ from the public interest, but merchants, “a profession no doubt extremely respectable, have generally an interest to deceive and even to oppress the public.” Merchants “can command obedience only by the military force with which they are accompanied, and their government is therefore necessarily military and despotical.” It is this argument that Smith’s younger contemporary Edmund Burke cited in his campaign against Britain’s East India Company.

In sum, Smith preferred a republican, commercial society, oriented around protecting liberty and promoting upward material mobility, and governed by ambitious, intelligent, self-made, and public-spirited statesmen. The best social order is one that moves in harmony with the natural goal of self-preservation and well-being in an open, decentralized, competitive marketplace.

The Role of Government

Smith’s stress on governmental frugality and commercial freedom should not be conflated with radical anti-government libertarianism. Smith does not say or assume that each man is completely capable of managing his own affairs. Indeed, as his discussion of banking in Book II of The Wealth of Nations indicates, Smith argues that some individual decisions ought to be checked by “the wisdom of government.” Moreover, free commerce depends on national security. In The Wealth of Nations, Smith stresses the government’s ability to maintain a military and directly fund its equipment. Despite Smith’s hostility to special mercantilist interests, therefore, he supports collaboration between industry and government when its purpose is national defense—even at the expense of economic prosperity. “Defence, he writes, “is of much more importance than opulence.”

Smith also acknowledges the importance of government action domestically. For the market in which all must engage to work, the government must enforce laws, including (and perhaps especially) contract laws. Smith also acknowledges the government’s importance in protecting patents and copyrights to encourage inventions. Further, Smith supports short-term retaliatory tariffs against other countries that maintain high tariff rates. Smith likewise supports taxation and governmental expenditure targeted at certain public benefits, such as roads and bridges.

Smith also argues for policies to ameliorate the condition of the poor, insofar as they may fail to live independently. “No society can surely be flourishing and happy of which the far greater part of the members are poor and miserable.” Moreover, the government must supervise and subsidize education for the poor. Smith supports progressively taxing luxuries rather than necessities, and high salaries rather than low wages. “It is not very unreasonable that the rich should contribute to the public expence, not only in proportion to their revenue, but something more than in that proportion.”

Nonetheless, Smith’s support for government intervention to help the poor is paired with the view that dependence is contrary to human flourishing. The purpose of commercial society, he makes clear, is to make everyone, including the poor, better off by promoting industriousness, not dependency. It is best if individuals can live from their own efforts. “Nobody but a beggar,” he writes, “chooses to depend chiefly upon the benevolence of his fellow citizens.” In general, commercial activity and the well-being it produces channels potentially destructive self-interest into relatively virtuous behavior. Such transformation of conduct relies on the pursuit of wages, not welfare.

For more introductory reading, see also:

Joseph Cropsey, Polity and Economy: An Interpretation of the Principles of Adam Smith, Westport: 1977.

Yuval Levin, “Recovering the Case for Capitalism,” National Affairs: 2010.