Adam Smith’s Economic-Development Formula

S E E D E D   C O N T E N T

A dam Smith’s  investigation into what we now call “economic development” in his landmark book  An Inquiry Into the Nature and Causes of the Wealth of Nations  was first published 248 years ago today. It’s a good time to note how many economic-development challenges facing America’s states and cities today are from having lost sight of the fundamental truths that Smith identified back in 1776.

We know the book as Wealth of Nations , but that shorthand loses sight of the most important question. It was the “nature and causes” of national wealth that interested Smith, not the wealth itself. He wanted to know what makes some places wealthy, while others stay poor. Smith spent decades learning about real-world examples of wealthy places and poor places and tried to identify factors that caused each. He was fascinated how two places with roughly equal access to resources and raw materials could end up in wildly different states of prosperity or poverty.

He wouldn’t publish his full, two-volume opus until 1776,  but as early as 1755 , Smith had gotten to the point where he could share this insight with a lecture audience:

Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism, but peace, easy taxes, and a tolerable administration of justice; all the rest being brought about by the natural course of things.

That’s as simple an explanation of the power of free markets and free people as you’re ever likely to find, and it’s just as valid today as it was then. It has played out around the world in case studies such as East versus West Germany, North versus South Korea, and the People’s Republic of China versus Taiwan or pre-reunification Hong Kong, where peoples divided by artificial borders ended up amidst poverty or prosperity depending on how tightly their government clung to economic control.

Smith didn’t need to wait until Karl Marx’s dumber ideas were tested to destruction. More than 160 years before the Bolshevik Revolution, he understood the inevitable result of government central planning:

All governments which thwart this natural course, which force things into another channel, or which endeavour to arrest the progress of society at a particular point, are unnatural, and to support themselves are obliged to be oppressive and tyrannical.

While we tend to associate central planning with socialist governments, the examples Smith was working from that led him to this conclusion were practicing something far closer to what we’d today consider “industrial policy” or even “economic development.”

Perhaps the most famous example of this kind of economic model in Smith’s era was France under Jean-Baptiste Colbert, the finance minister under King Louis XIV. Colbert attempted to centrally manage France into a manufacturing, export-driven superpower through what we’d today call tariffs, tax abatements, industrial policy, and invasive regulations.

This “Colbertism” seemed to work for a while, especially from the king’s point of view, but ultimately failed, paving the way for the more free-market and entrepreneurial United Kingdom to overtake France as the economic superpower of Europe, and eventually the world. Its long-term costs also contributed to economic and societal dysfunction that culminated in the French Revolution a century later.

Despite all of the evidence of history and having had the answers in front of us for two and a half centuries, modern American economic policy is leaning closer to the seductive promises of Colbert-style central planning and further from Adam Smith’s time-tested free-market truths. Colbert’s failed plans to centrally manage economic growth and artificially create a manufacturing economy echo loudly today in federal industrial policies such as the CHIPS Act and the so-called Inflation Reduction Act, which used subsidies to supplant Smith’s “natural course of things.”

It’s not just federal policy, either. This focus on the grand sweep of global history and national policy can keep us from recognizing that while Smith was talking about nations, his prescription of “peace, easy taxes, and a tolerable administration of justice” is just as valid when applied to the wealth of America’s cities and states; although, in writing  Wealth of Cities  or  Wealth of States  Smith might have rephrased it as “public safety, easy taxes, and a tolerable regulatory environment.” Places that are safe, where taxation is moderate, and where the government’s interference is limited to reasonable concerns over public health and safety are far more likely to become prosperous than those where crime is rampant, where taxes are high, or where the simplest things require navigating mazes of red tape.

Some places, such as San Francisco, get all three factors wrong. But as anyone who has tried to open a business, build a home, hire an employee, or sell a product anywhere in America today could testify, even the most permissive of America’s states or cities could stand to relearn the lessons that Adam Smith shared so long ago. Fees, fines, regulations, paperwork, permits, penalties, codes, inspections, variances, assessments, and all the other mechanisms of the “administration of justice” constantly test Americans’ limits of tolerance.

At every level of the American economy, we’re a long way from Smith’s prosperity-creating “natural order of things” — and it shows.