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Adam Smith's idea of "invisible hand" refers to the self-regulating nature of the
marketplace where even though individuals acted to maximize their self-interest, it eventually
leads to a socially desirable outcome. The paper will discuss the first three chapters of Smith's
The Wealth of Nations. (Ahsan, 2012) The first part of the paper provides a summary of Book 1
of Adam Smith's The Wealth of Nations. The second part of the paper will discuss Book 1 in
relation to the articles by Economic Insights and The World Bank. The third part of the paper
tackles the assumptions, consequences and significance of concepts in Adam Smith's The Wealth
of Nations. This part of the paper will also discuss the application of the concepts advanced by
Smith to modern economics. The last part of the paper presents the conclusion.
Chapter 1 of Book 1 is entitled "Of Division of Labor." It begins with, "The greatest
improvement in the productive powers of labor, and the greater part of the skill, dexterity, and
judgment with which it is anywhere directed, or applied, seem to have been the effects of the
division of labor." (Smith, 1776) Smith emphasizes that the improvement of the dexterity of the
workman is directly proportional to the work that he can perform. (Smith, 1776) He further
explains that the advantage gained by saving the time commonly lost in passing from one sort of
work to another is much greater than it is usually imagined to be. (Smith, 1776) Smith also
presented the importance of machinery as it facilitates labor. (Smith, 1776) The examples
provided by Smith are expectedly appropriate to the time period he was writing. It will be noted
later on that the principles are still applicable to the modern concept.
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Chapter II talks about "Of the Principle which gives occasion to the Division of Labor."
In this chapter, Smith explains the interdependence between and among economic actors. He
mentions that the difference between the talents of each actor makes interdependence possible.
However, Smith also discusses how the coordination and cooperation is not motivated by the
desire to help and complete others but these emanate out of self-love of each actor. This self-love
of every individual creates the effect of benefiting the society as each self-love motivates one
another to fulfil another's self-love and therefore get what one ultimately desires. (Smith, 1776)
The end of the simultaneous actions by self-interested individuals would still be public welfare.
Chapter 3 is entitled, "That the Division of Labor is limited by the Extent of the Market."
The market is the limitation of the division of labor because it is the power of exchanging that
gives occasion to such division. Smith says that the extent of the market must be in proportion to
the riches of that country. (Smith, 1776) The benefit derived from exchange is what drives
economic actors to specialize and to increase the surplus when exchanging with others. (Butler,
2011) The author discussed specialization in the market which allows for bigger gains.
Smith has initially used the term "self-love" in Chapter 2 of the Wealth of Nations. This
same concept is delved into by Economic Insights, "Even more radical was Smith's belief that a
society composed of individuals acting in pursuit of their own interests would result in a stable,
free and more prosperous society that one regimented and planned by the state." (Economic
Insights) Because of this insight, the article labelled Smith as the first proponent of capitalism
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where economic actors would freely choose to interact and not be governed by strict rules of the
state. This argument is further strengthened by the article of The World Bank. The article by the
World Bank discusses how different countries (as economic actors) interact with each other to
ensure that the natural resources are used to cater the needs of the people. Just as Smith
originally discussed the difference in talents among individuals, the World Bank acknowledge
the difference in natural resources that are available in each state and further suggests that
managing natural resources is a key part of development strategies. (The World Bank, 2006) The
article by World Bank further reiterates the fact that government decisions on investments and
other business projects are self-motivated and aim to make the national products competitive in
The discussion of the "market" was first seen in Chapter 3 of The Wealth of Nations.
Smith characterizes the market as the extent of exchange among economic actors. For Smith,
economic growth is good and is achieved by the ever-widening application of the division of
labor, which is organized within markets and driven by rational self-interest. (Economic Insights)
Those nations that allow market forces to generate such growth will become wealthier, in Smith's
view, than those that follow the mercantile model of managed trade. (Economic Insights) Smits
has always been in favor of less government intervention to the market. However, this total lack
of intervention by the government should be limited. Smith also recognizes grounds for
legitimate governmental activity in society (Economic Insights): defense against external and
internal security threats, the formation of laws that prevent individuals from oppressing one
another and the provision of public goods that the market would not supply. These specific
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grounds are further tackled by the article of World Bank which is applicable to the modern
scenario.
Where is the Wealth of Nations? provides an overview of the wealth of each nation and
how the decisions by policy makers influence the movement of wealth and generation of more
wealth. (The World Bank, 2006) The production of more wealth can be attributed to an effective
and efficient government intervention because it is dependent on how the natural resources are
managed. Natural resources are special economic goods because they are not produced. As a
consequence, natural resources will yield economic profits - rents - if properly managed. (The
World Bank, 2006) Although it is encouraged by Smith that the market be allowed to move as
freely as possible, legitimate government actions are called for when the market and the self-
interested economic actors are unable to protect the resources on their own. Achieving
sustainable development which presents challenge and concerns to the natural resources would
be sufficient reason for monitoring by the government. (The World Bank, 2006)
Capitalism
The prevalent economic system amidst globalization and free trade is capitalism. It is
based on private ownership of the means of production, in which personal profit can be acquired
through investment of capital and employment of labor. Capitalism is grounded in the concept of
free enterprise, which argues that government intervention in the economy should be restricted
and that a free market, based on supply and demand, will ultimately maximize consumer welfare.
This is precisely the idea advanced by Adam Smith in The Wealth of Nations. (Columbia
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Capitalism does not presuppose a specific form of social or political organization: the
democratic socialism of the Scandinavian states, the consensus politics of Japan, and the state-
sponsored rapid industrial growth of South Korea while under military dictatorship all have
coexisted with capitalism. (Columbia Electronic Encyclopedia, 2013) Yet despite the capitalist
capitalist nations at least since the Great Depression in the 1930s. In the United States, it exists in
the form of subsidies, tax credits, incentives, and other types of exemptions. (Columbia
Electronic Encyclopedia, 2013) Though private production plays a major role in the economies
of Germany and Japan, both nations have had centrally planned industrial policies in which
bankers, industrialists, and labor unions meet and seek to agree to wage policies and interest
rates; these countries reject the idea of letting the market wholly determine the economy.
(Columbia Electronic Encyclopedia, 2013) Although Smith was not the origin of the term
capitalism, it is undeniable that his ideas have contributed to this economic system.
The determinants of wealth of nations have always been an interesting issue for policy
makers and economists. In economics, one of the most important subjects is to increase
economic growth and welfare of society. As one of the most important political economists,
Smith analyzed the dynamics of wealth of nations and welfare of individuals and societies by
providing for determinants of economic growth which include division of labor and human
Smith discussed that to explain the motivation for economic exchange in the market, one
does not have to invoke any objective other than the pursuit of self-interest. (Sen, 2010) Beyond
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self-love, Smith discussed how the functioning of the economic system in general and of the
market in particular, can be helped enormously by other motives. There are two distinct
propositions here. The first is one of epistemology, concerning the fact that human beings are not
guided only by self-gain or even prudence. The second is one of practical reason, involving the
claim that there are good ethical and practical grounds for encouraging motives other than self-
interest, whether in the crude form of self-love or in the refined form of prudence. (Sen, 2010) In
moving for a free market system, Smith did not intend to totally eliminate the function of the
government. Government is a regulator of the elements of the marketplace. (Ahsan, 2012) It can
intervene whenever the market forces do not serve public welfare and when the public interest is
already at stake.
Conclusion
It cannot be denied that Smith will forever be one of the classic economists whose
theories are still applicable nowadays. His concept of the invisible hand has led capitalism to
its peak. At press time, capitalism is still the prevailing economic system that is accepted by most
countries in the world. Furthermore, Smiths theory on market interaction out of self-love is still
present in the current era. To give an example, nation states form organizations and economic
blocs in order to ensure that economic interdependence will bring economic security to the
individual states. Although it is not in the bigger realm, the main foundation of economic
interdependence brought by modern concepts of fair trade and free trade, is still the concept of
self-love that has been first advanced by Smith. Today, states are self-interested actors that can
interact with other states, equally self-interested, to achieve a more efficient and effective
utilization of resources. Smith was a genius who was able to forecast economic activities using
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his primitive and medieval examples that fit the economy during the era when he was writing
References
Ahsan, A. (2012). Where was the Invisible Hand during the Crash? Vol. LXIV No. 2/2012,
Economic Insights - Trends and Challenges.
Ayhan, U. (2013). The Sentiments of Adam Smith Relating to Economic Growth as an Inspirer
to Modern Growth Theories. Trakya University Journal of Social Science. Jun2013, Vol.
15 Issue 1, p29-48. 20p.
Economic Insights. Adam Smith Capitalism's Prophet. Volume 7, Number 1, Federal Reserve
Bank of Dallas.