See discussions, stats, and author profiles for this publication at: https://www.researchgate.

net/publication/318471587

Adam Smith and Government Intervention in the Economy

Research · March 2015

DOI: 10.13140/RG.2.2.15206.93767

CITATION READS
1 42,320

2 authors, including:

Sima Siami Namini

Johns Hopkins University
65 PUBLICATIONS   1,063 CITATIONS   

SEE PROFILE

All content following this page was uploaded by Sima Siami Namini on 17 July 2017.

The user has requested enhancement of the downloaded file.

 Review of the Wealth of Nations

Adam Smith and Government Intervention in the Economy

Sima Siami-Namini
Graduate Research Assistant and Ph.D. Student
Texas Tech University
May 14, 2015

Abstract

The main purpose of this paper is to address the government intervention in the
economy. It is considered the founder of modern economics. Adam Smith stated that the
free market is guided by an invisible hand and less government intervention in some
special area that could be efficient. He identified three major duties for government,
national defense, administration of justice, and the provision of public goods. But a lot
of issues happened to people during the Great Depression, and proposed new theories
about government interference in the society.

Introduction

The father of capitalism in his famous book, The Wealth of Nation, stated three ideal
functions that should be performed by government. In his classic work, the first function
of government is to create the internal Social Security regulations and also provide
national defense for protecting the society and all citizens from all the violence and
invasions or attacks forces from other societies. Secondly, the function of establishing
an exact administration of justice in the context of order and law. Thirdly, the function
of providing public goods and maintaining the related public Institutes which it can be
never for the interest of any specific individual or definite groups. A good example for
the latter is transportation, health, education, etc. However, it seems that government
interventions has grown beyond of these functions, and in fact, Adam Smith identified
a special role for government to involve in the economy. Today, the modern society has
considered the other functions for government to protect the society, and for instance,
redistribution of wealth and revenue and employment and economic growth and
sustainable development and stability in the economy are some of them. The concepts
like free market failure has been caused more interventions for government in these

1|P a g e
societies in all cultural, social and economic respects. In fact, the question is that how
the countries should solve the current issues and remove all concerns in achieving the
economic growth and redistribution of total revenue, to control of population growth,
to decrease of poverty and increase the standard of living, to control of inflation and
liquidity, tax collection, management of natural resources like oil, and gas and allocation
of scarce resources between economic sectors and the similar issues, if they want to
follow the Adam Smith's insights about free market in managing the society, and believe
to this point that there is invisible hand or market forces to perform in a good way to
reach the equilibrium, and trust to free market and accept the ideal functions of
governments. But in fact, what were the reasons for opposing to government
intervention in the Societies? The next section will be address to this subject.

Adam Smith

Adam Smith argued against monopoly, mercantilism, and feudalism. He believed that
the economy should be allowed to run on its own using free market forces and without
any government intervention. In his opinion, the economy could create wealth and
improve efficiency through the invisible hand. He argued that any government
intervention will weaken the economy. Adam Smith believed that invisible hand is a
natural phenomenon that guides the market through competition for scarce resources.
He believed that human wants are unlimited but human needs are limited, and people
can compete with each other, then existence of competitive is the necessary condition
for free market. With government intervention, people would stop competing, and in
turn it causes that prices increases and quality decreases.
As mentioned above, Adam Smith recognized significant areas where only
government could act effectively, and then identified three specific duties for the
government, and believed all unnecessary interventions must be avoided. For example,
each country must be protect all citizens and society from foreign invasions, and then
the necessary budget is estimated. But it does not mean that government can involve
into the other societies and causes to create a lot of things. This is also the same for the
provision of systems of justice. He confirmed an independent court system and
administration of justice and verdict to control crime and protect the private right and
his property. The aim of the establishment of systems of justice is to reduce the injustice
and protect all citizens from oppression of others.
He suggested that government interventions in providing public goods, such as roads
and public bridges or infrastructure, education of the youth and education to people of

2|P a g e
all ages, health and medical care can be useful for earning a living and also can be
productive. But, it does not mean for government to behave like a firm in order to
maximize its profit. In fact, the father of laissez faire in the economics wanted all classes
of society, even the poorest, to benefit from the free-market system. He believed that
only the social conditions cause to create a little difference in intelligence between the
poor and the rich people, and then supported this kind of people by public taxed
(according to one's ability to pay) and small parents fee. In fact, he made aggressive
arguments for competition and private funding in education. He believed that
government and State can play an important role for managing the public schools, as
many young students have no money for going to the private universities, and it is very
important to know the student's abilities and talents and invest in them as a human and
as a labor force of the society.
As a result, most trouble in the economy arises from the latter function of
government. It is because profit - seeking individuals may not be able to efficiently build
and operate and they become state monopolies. Today, it can see that government could
not work properly, and leaving the management and not ownerships of these works to
the private sector in framework of some contracts like BOT, joint venture and the same
contracts with foreign investments.
Adam Smith referred to laissez - faire and the natural liberty concept which the latter
relates the individual liberty to the positive economic outcomes. He argued that
government interference in the economy will damage the nation's wealth, and then
insisted to the elimination of these interventions as restrictions.
It is pointed out that progressive tax is the only source of revenue for governments
and all public expenditure was to be paid from tax collection on the high - income
households or rich people and their maintenance financed by user - charges of public
facilities for the financing of repairs to roads and bridges and paying for medical care
to the people who suffers from diseases and could not pay the cost of their therapy.
Government must develop the postal service for public use, and provide the other
services, and also it should be run an official mint to guarantee the purity of the coinage.
It is clear that central bank (The Bank of England at that time), should manage
government and introduce necessary regulations in order to stop extra spending by
monetary tools (issues bonds or using liquidity). Now the question is, what did he
consider inappropriate for government intervention, despite of mentioned features for
government services? In fact, the father of economy suggest the appropriate
involvement in the economy for government.

3|P a g e
 Legislators and policymakers who influence them are sensitive to all mistake thoughts
about how societies work (Galileo is a good example in this respect). There were some
notions as the balance of trade required to be positive in favor of exports, so that a
nation could accumulate stocks of gold. Therefore, trading policies of protection against
imports were developed, and supported by tariffs and prohibitions, and then the price
of goods allowed to be higher than importing them, and of course following these kind
of polices destroyed the relations between nations and created many conflicts and wars
between them.
Adam Smith rejected with this kind of government interventions in the economy,
because he wanted to use the mutually advantages trade between nations. In his sense,
each country had its absolute advantage and relative advantage in producing a goods
than the other country, and then they have their specific technology and innovations
which can obtain them with peaceful trading countries. The nations will lost the
opportunities with imposing tariffs or restrictions in their trading with other nations,
and Smith disagreed with the similar interventions by government in this area. He argued
that this kind of interventions in economy and imposing tariff policy on trade is a high
price that tends not to compensate. Of course, there are many political factor that
contribute to an individual or a country becoming rich or poor, and decreasing its share
in the trade, and it needs more scrutiny.
The father of economy explained that government and its high interference in the
economy is a violation of natural liberty, but it introduced for pursuing policies related
to progress of the economy like development of trade, but because of creating many
consequences, it became a big obstacle to the development of free trade, and creating
two poles of rich and poor countries makes it extremely difficult. Adam Smith observed
all bad effects from government interference in the economy and then opposed all of
them, and limited the role of government in the economy.
In summary, Adam Smith expected that government should leave the economy alone
and not involve with the natural liberty of free market and free trade. He was concerned
about the government performance in granting the special privileges to some
manufacturers and merchants in production and trade respectively, and believed that it
made some huge monopolies that will be enemy with free market and at least destroy
the market forces, and create market failure. It is clear that price and wage in monopoly
is greater than its natural rate in free market, and because of existence this gap, the
economy do not work in proper way and the later issues like bribery and corruption and
usury are coming to destroy the economy. The two next sections briefly present

4|P a g e
Mercantilism and the Physiocrats thought about government interventions in the
economy.

Mercantilism

Under this theory, government's role is important in the economy and especially in
foreign trade. Mercantilism suggests that the longest ruling government should advance
trade by playing a protectionist role in the economy, by encouraging exports and
discouraging imports, especially through using of tariffs.
Mercantilism believed that the only measure of a country's wealth is gold, and then
the best way for maximizing the country's gold stock, was to make few imports for
necessary goods and many exports, and then made their trade policies in order to
increase gold and then maximize the income. Mercantilism pursued their goals with
more government intervention in the economy. Mercantilism restricted imports of
manufactured goods via tariffs or quotas, encouraged imports of raw materials,
encouraged exports of manufactured goods via subsidies, encouraged production and
discourage consumption by imposing taxes on imports of final products.
In general, because of scarce resources, mercantilists advocated specific government
programs that would benefit them, and also advocated government intervention, tariffs,
and charters for trading companies, etc. Some countries like Britain followed the same
proper policies to protect their traders, and also in some cases restricted their imports.
But the father of economics disagreed with regulation heavy mercantilist doctrine, and
concerned with the effects of these policies. He explained about improper results of
overweening government intervention in the economy that monopolies is one of them.
It is clear that the wages in monopolies will be greatly above the natural rate in free
market. In his discussion, he referred to the East India Company which was a quasi-
government organization at that time.
Smith pointed out the situations in which government intervention in the economy
was necessary, and outlined the cases where government intervention in trade is useful.
He agreed with some of them, but not the cases where governments could abuse from
their power for getting wealth. Therefore, he made it clear that governments can help a
part in making markets to behave in proper way. But, the question is how much it would
play? Today, it can be seen the role of mercantilism thought in the trade policies for
some developed countries. For example in 2012, President Barack Obama made a goal
for doubling of American exports over the next five years. But, the problem is that it
does not increase the demand.

5|P a g e
 In summary, Adam Smith disagreed with wars and criticized it because creating a
large public dept. He saw that mercantilists encourages wars and give money at high
interest rate or usury to the government, and it causes a huge public debt that in turn
create many issues in the economy, and Smith viewed wars a source for wasting the
money and producing a huge public debt cause to divert money away from investment
and then reduce the economic growth. Because of this, Smith attacked on mercantilism's
policy that their goal was to increase exports to its colonies and other societies, and limit
imports from them, and stated that continuing this policy will end the free trade between
countries. He disagreed with the mercantilist nations about the definitions of wealth.
The mercantilist believed that gold and silver is the only source for increasing wealth,
and tried to increase their export and restricted their imports to obtain a surplus trade
and more gold and more power for their government and this is conflict with the
economics thought. Smith did not believed that gold is the nation wealth, because he
saw that many workers live in a bad situation with low wage, and they could not buy the
necessary things. They had bad nutrition's with bad healthy and full stress. Then he
stated that consumable goods is the nation's wealth. When the people could buy
anything, it shows that the people of this country live in welfare and this society will be
rich, and then disagreed with mercantilist trade practices and increasing government
involvement in the economy and trade. Smith believed that above trade practices will
slow production and international trade. In his sense, mercantilist was self-defeating
caused from the monopolizing nature of some merchants and manufacturers, and all
this caused by more interventions for government which must be stop. The father of
economy advised that let the free market operate without extra intervention of
government.

The Physiocrats

The Physiocrats argued, that government leave the economy alone and allow individuals
within the economy to do as they please in attempting to realize their own selfish
interests. They called laissez faire, or let people do, to their doctrine.
The Physiocrats stated that the only source of a nation's wealth was derived from
agriculture, and their thought were in opposite direction of the mercantilist. They
believed to self - interest and competition for improving the economy. In their sense,
government plays like a parasite in the free market, because it might pass a law that
makes it difficult for market forces. They argued for removing of all restrictions on
internal trade and labor migration, and also discussed for the removal of state-

6|P a g e
sponsored monopolies and trading privileges, etc. They believed that if there is any tax,
it should impose on landed property. As they believed that the only agriculture sector
can add the net product, then any taxes levied throughout the economy will fall upon
the net product, and then it is more efficient to go to the root and tax land rents directly.
Adam Smith agreed with the Physiocrats about the limited role of government in the
economy in some special area.

Keynesian Economics

The Great Depression proved the importance of government interventions in the

economy, and the Keynesian theory explained why the government is needed to control
the economy when crisis occurred. In the crisis period, when inefficient performance of
the private sector raised, public sector needs to take proper decisions in the context of
monetary and fiscal policies for transition and establishment of stability in the economic
growth. The Keynesian theory proved to be effective through fiscal policies. Government
spending and tax are the tools for fiscal policy and affect the economic variables through
multiplier effect. The difference between Adam Smith approach and Keynesian
approach, is the fact instead of waiting for the economy to transit of a crisis period, the
government interventions to alleviate the economy and help to economy back to
recovery and do not permit that the crisis became worst. But, the question is again how
much the state would play in the economy? Because it is not correct to give the control
of economy to the government and make it an omnipotence.
In summary, Keynes supported government intervention during the crisis period. He
explained that economics are unstable because of many internal and external factors
that happened and it is impossible to establish full employment without having
government intervention in the economy, and in fact, it is an ideal function for
government to bridge the gap between economy's potential and its difference with actual
output during times of economic turmoil.

Market Failure

A market failure occurs when the Adam Smith's invisible hand could not lead the
economy and individual decisions do not lead to desirable results. Now, this question is
coming, is there any acceptable reason for government intervention to improve the
outcomes caused by market failure. Of course it does mean that increase the ideal
functions of government, or modify the method of interference in the economy for
government. It seems that the political of implementing the solution cause to create

7|P a g e
 further issues and then it does not advised to have more government intervention. It
seems that governments fails too in when it has more intervention in the economy in
order to improve the market failure. As the logic of the market is profit and government
do not have more information, and also do not have an incentive to solve the problem.
More intervention in the markets complicate the situation that need to more
interventions, and then became government failure in the economy. Smith believed that
market forces solve the problem at least and then economy will reach to its equilibrium
state.

Conclusions

The aim of this paper is to pay in a short to the government interventions in the economy
base on Adam Smith thought and the others. The father of economics has considered
three major and efficient role for government, national defense, administration of
justice, and the provision of public goods. He disagreed with all disturbing factors that
destroyed the equilibrium in free market. In economics, the equilibrium is a state where
supply and demand are equaled in there, and it happened when a market price is
established by competition and without existence of monopolies. When government
intervenes too much in free market, then people expect to see many monopolies in the
economy which perform in a shadow economy. Adam smith disagreed with excessive
government interventions in the economy, but at the same time consider three special
function for government, which could be effective in its place. But, these functions will
cause a big involvement in the economy for government to solve the global crisis.

Reference

Adam Smith. 1776. “The Wealth of Nations”.

8|P a g e

View publication stats