Adam Smith and Free Market Capitalism
Main idea
The spread of industrialization resulted in the rejection of older economic systems like mercantilism and new economic ideas like capitalism from thinkers like Adam Smith.
Adam Smith (1723-1790) was an economic theorist in the 18th century and is considered the father of modern capitalism. Throughout the 19th and 20th centuries, increasing numbers of economic elites began to accept his ideas, resulting in the slow replacement of mercantilism with free market capitalism as the primary economic system in many industrialized nations.
Adam Smith
Nationality: Scottish (British)
Lived: 1723 to 1790 during the early Industrial Revolution
Wrote: The Wealth of Nations–which described what Smith thought made nations successful
Central beliefs: Limit the role of government in economic transactions
Long-term impact: Shifted industrial powers away from mercantilism and toward freer trade
Adam Smith's ideas
In his book The Wealth of Nations, published in 1776, Smith explained what he believed led nations to economic prosperity. He argued the following.
- The wealth of a nation is the total value of everything it produces –agriculture, manufacturing, and services—not how much silver and gold it has.
- Economies function best when competition among buyers and sellers sets prices.
- Government should limit its roles in regulating commerce and trade.
- Self-interest and competition create economic growth.
The role of the government in the economy: Smith believed the government had a crucial but limited role in the economy.
- A nation’s military defenses
- The promotion of education
- The building of infrastructure
- Laws to prevent anti-competitive business behavior, such as monopolies
He also believed that government regulations and economic interventions to reduce poverty are acceptable. He wrote that
- Set the prices of goods
- Grant monopolies to people and companies
- Place unnecessary import tariffs (taxes) on goods
Mercantilism limited economic growth: Adam Smith believed that mercantilism restricted economic growth. He argued that wealth was not just precious metals like silver and gold in limited quantities. Wealth, according to Smith, was the value of all the production and services provided in an economy. Therefore, to increase wealth and make any society more prosperous, you must increase production and the number of services bought and sold. Smith believed mercantilist price control and limits on free trade decreased buying and selling because it kept prices high.
Mercantilist economics | Adam Smith’s economics |
|---|---|
Wealth is gold and silver | Wealth is the production of agriculture, goods, and services |
The world’s wealth is limited | The world has unlimited potential to create wealth |
Limit imports and maximize exports | Trade restrictions on imports and exports make goods more expensive and hurt nations’ economies |
Use import tariffs (taxes) to raise the prices of foreign products to make locally produced goods cheaper | Closed-loop trading between colonies and mother country |
Closed-loop trading between colonies and mother country | Fewer trade restrictions among nations |
The Globalization of Business
Main idea
Industrial capitalism led to increased numbers of international companies. New financial practices supported the growth of trade and commerce.
Industrialization and European imperialism in Africa and Asia in the late 19th century resulted in an increasing number of companies with business operations spread across multiple countries and continents. New financial and business practices aided the expansion and success of these companies.
Transnational business
Businesses with operations that cross borders have existed for thousands of years. However, modern international corporations did not start until the 17th century. Some of the earliest were the European exploration and trade companies of the 17th century. While those companies are gone, several global companies that started in the 19th century are still around and are some of the world’s most recognizable brands.
Unilever is one of the world’s largest companies. In 2020, they employed nearly 150,000 people and sold over 50 billion dollars in products. Unilever brands can be found worldwide and include well-known brands like Ax, Bryers, Hellmann’s, Lipton, Pure Leaf, Klondike, and Q-tips.
Unilever began as two separate companies—Lever and Company and Margarine Unie. Lever was founded in 1885 in England and created the first branded soap, Sunlight. Uni was founded in 1927 in the Netherlands. Their primary product was the butter substitute margarine.
By the early 1900s, Lever and Company exported their products globally. The company had factories in South Africa, Europe, Canada, Australia, and the United States. As their business expanded, ensuring access to raw materials was vital to growth. In 1906, the company opened a palm plantation in the Solomon Islands to supply palm oil fats for their products.
Scottish banker Thomas Sutherland started the Hong Kong and Shanghai Banking Corporation (HSBC) in 1865 to provide banking services and loans to merchants trading across Asia. Today the company has over 34 million customers in 66 countries.
Initially, the company focused on financing Asian exports of the following:
Tea and silk from China
Cotton and jute from India
Sugar from the Philippines
Rice and silk from Vietnam
Within ten years of its founding, HSBC was present in seven countries across Asia, Europe, and North America. In Asia, they had offices in Yokohama in Japan, Ho Chi Minh City in Vietnam, Manila in the Philippines, and Kolkata in India.
New financial practices
New banking and financial practices were developed, making starting and expanding businesses easier.
Stock markets
Stock markets are where individuals buy and sell shares (portions) of companies. Companies sell their stock shares on stock markets to raise money to operate or expand their business. Companies distribute profits among its shareholder.
The first stock markets: The earliest stock markets sold shares of European trading companies in the 17th century to raise money for trading missions in Asia. The Dutch and British East India Companies were a few of the first successful joint-stock companies that traded on early stock markets.
- The first stock market was the Amsterdam stock exchange, which opened in 1602.
- The American stock exchange opened on Wall Street in 1772.
- The first stock exchange opened in London in 1773.
Stock markets financed the industrial revolution: Industrial factories and the building of infrastructure equipment like steamboats and railways required large amounts of investment. New industrial companies used stock markets to finance their growth.
Limited Liability Corporations
Limited liability companies (LLCs) started in Germany in 1892. LLCs make starting and running a business potentially more profitable and less financially risky to the business owner. This business structure was used by privately owned businesses, not publicly owned companies listed on stock exchanges.
LLCs protect owners from personal lawsuits related to the business.
LLCs decrease the amount of taxation owners pay on business profits. Before LLCs, companies paid taxes on their profit. The after-tax profit that went to the owner was taxed again as personal income. But with an LLC, profits are only taxed once as the owner’s income.
LLCs protect business owners from financial responsibility for business debts if the company fails and goes bankrupt.
The Rise of Consumer Capitalism
Main idea
Industrial capitalism lowered the price of consumer goods over time and created an economy driven by consumer spending in industrialized nations.
Industrialization led to the start of an economy built on the mass consumption of goods and services. Consumer culture began in the upper classes in industrialized societies in the mid to late 19th century before slowly growing to provide products to the growing middle and working classes.
Shopping as social status: The stores where people shopped began to determine their social status. Shops in high-end urban areas sold expensive fabrics, furniture, clothes, art, and home goods. Customers who could afford these products were industrialists, factory and business owners, factory and business managers, doctors, and lawyers.
Mass-market products: Companies like Unilever produced the first industrial products that larger numbers of people could afford. Many of these products were marketed as ways to keep your home and family clean—an appealing concept among the lower classes, especially those working in factories or jobs supplying factory materials.
- Sunlight soap: Unilever produced Sunlight soap, initially a few pennies a bar. Sunlight Soap marketed itself as “pure” and “unadulterated” by chemicals, which appealed to urban industrial residents living and working in environments polluted by industrial pollution and waste. Because the product was small, it was easy to sell in small roadside stands where most in the lower classes shopped.