Smith challenged the mercantilist orthodoxy of his time, the belief that nations grow rich by hoarding gold and restricting imports. Instead, he argued that prosperity arises from productive labour, specialisation, and voluntary exchange. His famous pin factory illustrated how the division of labour multiplies productivity and wealth. Nearly 250 years later, his observations remain remarkably relevant.
Smith was not advocating an anarchic free-for-all. Contrary to the caricature often presented by critics, he saw a vital role for the state: to uphold justice, enforce contracts, protect property rights, and provide public goods. What he warned against was something different: the concentration of economic privilege and the meddling of governments captured by special interests.
In modern language, Smith was not preaching laissez-faire dogma. He was describing what we would now call regulated capitalism within a framework of liberal democracy.
The empirical record since then is rather difficult to ignore. Countries that broadly follow these principles, secure property rights, open markets, competition, and the rule of law, have become prosperous. Those that suppressed markets and concentrated economic power in the state did not.
The simple arithmetic of economic growth explains why.
As The Economist recently reminded its readers, economic progress begins with the mathematics of compounding. An economy growing at 1 per cent per year will barely double over two generations. One growing at 7 per cent will expand roughly thirtyfold.
The contrast between South Korea and Ghana illustrates the point rather starkly. In 1960, the two countries had roughly similar levels of income per person. Today, South Koreans browse luxury shops and sip cappuccinos in fashionable cafés, while the average Ghanaian survives on roughly four dollars a day.
Many factors may explain this divergence, but one is hard to miss. South Korea gradually embraced export-oriented markets, competition, and industrial entrepreneurship. Ghana, like many developing countries, particularly in Africa at the time, experimented with state planning, protected monopolies, and heavy economic controls.
The outcomes speak for themselves.
This raises uncomfortable questions for the development community. Over the past sixty years, Africa has received vast quantities of aid, advice, and technical assistance from well-intentioned international agencies. Yet for decades, many economies remained trapped in systems that discouraged entrepreneurship, protected state monopolies, and weakened incentives for productive investment.
It would be unfair to blame development agencies alone for this. But it is equally difficult to argue that the international development establishment consistently championed the kind of decentralised market dynamism that Smith described.
Meanwhile, the ideological debate has quietly moved on.
Very few political movements today seriously propose abolishing capitalism. Not even communist parties governing China or Vietnam attempt that experiment anymore. Even far-left political parties in the West have largely abandoned such ambitions. Capitalism, it seems, survives its critics with remarkable resilience.
This does not mean markets solve everything, or that governments are unnecessary. The most successful societies combine markets with strong institutions, economic freedom with the rule of law, and capitalism with democratic accountability.
But one awkward fact remains. Most critics of capitalism also depend on it. Every salary paid in international organisations, every development programme financed by taxpayers, and every pension collected by retired UN staff ultimately originates in wealth created by capitalism. In other words, even capitalism's critics tend to live rather comfortably from the system they distrust.
As Robert Lucas, Nobel Prize Winner in Economics, has observed, "once one begins thinking seriously about economic growth, it becomes hard to think about anything else." Perhaps that is why the debate about capitalism continues. The evidence accumulates faster than the willingness of some people to change their minds.
Smith was not advocating an anarchic free-for-all. Contrary to the caricature often presented by critics, he saw a vital role for the state: to uphold justice, enforce contracts, protect property rights, and provide public goods. What he warned against was something different: the concentration of economic privilege and the meddling of governments captured by special interests.
In modern language, Smith was not preaching laissez-faire dogma. He was describing what we would now call regulated capitalism within a framework of liberal democracy.
The empirical record since then is rather difficult to ignore. Countries that broadly follow these principles, secure property rights, open markets, competition, and the rule of law, have become prosperous. Those that suppressed markets and concentrated economic power in the state did not.
The simple arithmetic of economic growth explains why.
As The Economist recently reminded its readers, economic progress begins with the mathematics of compounding. An economy growing at 1 per cent per year will barely double over two generations. One growing at 7 per cent will expand roughly thirtyfold.
The contrast between South Korea and Ghana illustrates the point rather starkly. In 1960, the two countries had roughly similar levels of income per person. Today, South Koreans browse luxury shops and sip cappuccinos in fashionable cafés, while the average Ghanaian survives on roughly four dollars a day.
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| (graph based on rounded figures, for illustration purposes only) |
Many factors may explain this divergence, but one is hard to miss. South Korea gradually embraced export-oriented markets, competition, and industrial entrepreneurship. Ghana, like many developing countries, particularly in Africa at the time, experimented with state planning, protected monopolies, and heavy economic controls.
The outcomes speak for themselves.
This raises uncomfortable questions for the development community. Over the past sixty years, Africa has received vast quantities of aid, advice, and technical assistance from well-intentioned international agencies. Yet for decades, many economies remained trapped in systems that discouraged entrepreneurship, protected state monopolies, and weakened incentives for productive investment.
It would be unfair to blame development agencies alone for this. But it is equally difficult to argue that the international development establishment consistently championed the kind of decentralised market dynamism that Smith described.
Meanwhile, the ideological debate has quietly moved on.
Very few political movements today seriously propose abolishing capitalism. Not even communist parties governing China or Vietnam attempt that experiment anymore. Even far-left political parties in the West have largely abandoned such ambitions. Capitalism, it seems, survives its critics with remarkable resilience.
This does not mean markets solve everything, or that governments are unnecessary. The most successful societies combine markets with strong institutions, economic freedom with the rule of law, and capitalism with democratic accountability.
But one awkward fact remains. Most critics of capitalism also depend on it. Every salary paid in international organisations, every development programme financed by taxpayers, and every pension collected by retired UN staff ultimately originates in wealth created by capitalism. In other words, even capitalism's critics tend to live rather comfortably from the system they distrust.
As Robert Lucas, Nobel Prize Winner in Economics, has observed, "once one begins thinking seriously about economic growth, it becomes hard to think about anything else." Perhaps that is why the debate about capitalism continues. The evidence accumulates faster than the willingness of some people to change their minds.
What makes this essay both interesting and slightly uncomfortable is how obvious the central point appears in retrospect.
ReplyDeleteAt the 250th anniversary of Adam Smith’s An Inquiry into the Nature and Causes of the Wealth of Nations, the mechanism he described still seems oddly underappreciated in parts of the development world: the arithmetic of compounding economic growth.
The mathematics is not complicated. An economy growing at 1% annually barely doubles over two generations. One growing at 7% expands roughly thirtyfold. Once that logic is internalised, the divergence between countries such as South Korea and Ghana becomes far less mysterious.
What is striking is not that Smith understood this in 1776, but that institutions devoted to development often seemed slow to place economic growth at the centre of their thinking.
Even in leading social-science institutions such as the London School of Economics and Political Science, which has trained a large share of development professionals, the arithmetic of growth was not always treated as the decisive variable it clearly is.
During many years working with UNICEF, I struggle to recall a single senior discussion in which sustained economic growth was treated as the central determinant of long-term human welfare. Yet without growth, the resources required for education, health systems, infrastructure and social protection simply do not materialise.
It is striking that at the London School of Economics, wealth creation was gradually treated as a lesser concern than its redistribution. LSE, and academia at large, has skewed leftward over many decades is not a feeling; it is reflected in the shift of curriculum. As the 20th century progressed, the classical liberal economic tradition, represented by Ricardo and Stuart Mill, which once defined the LSE, was gradually sidelined by a focus on social engineering. LSE moved from asking "How do we create an environment where a billion people can trade their way out of poverty?" to asking "How can bureaucracies manage the symptoms of poverty?" This created a generation of development professionals who viewed the state as the primary actor and the market as a chaotic force that needed taming. The tragedy of the UNICEF mindset you mentioned is that it mistakes outcomes for engines. Health and Education are the dividends of a productive economy. Economic freedom is what pays those dividends. Institutions focused on social protection in countries that had not yet produced anything to protect. The reason this conversation feels uncomfortable is that it suggests much of the aid industry has been counterproductive. If you ignore Adam Smith’s lessons on property rights and competition, aid and technical assistance just become a way to subsidise inefficient state monopolies. The LSE and its peers didn't just "play down" growth; they treated the very mechanics of capitalism, competition, profit, and creative destruction with a high degree of academic suspicion.
DeleteThomas, the claim that the LSE (and academia more broadly) has drifted from classical liberal economics toward more interventionist models of development certainly has some merit. But your account arguably simplifies a more complex intellectual evolution.
DeleteMany development economists influenced by those shifts still debate the role of markets, institutions and incentives. Within academia, there remain strong voices arguing for market-based approaches alongside critiques of bureaucratic development models.
Your critique of aid and social protection reflects an important ideological current, but it may understate the diversity of views that still exist within the field.
There may well still be debates within academia over development models; however, the one favouring redistribution has won hands down for decades.
DeleteI should have added that I am not against aid and social protection per se. However, I have for decades had problems with the way aid was practised and social protection systems were designed.
DeleteIn terms of semantics neither capitalism nor communism are attractive to me; however, the term 'free enterprise' seems a better word.
ReplyDeleteIn history the laissez-faire form of capitalism as practiced by the East India Company certainly gave it a bad name; and, that may be one reason development theorists shied away from it.
Governments must provide regulation, security and strive to prevent oppression (i.e. allow freedom to compete and operate natural monopolies as public utilities).
As to Ghana, they got off to a bad start at independence when Kwame Nkrumah said: "Seek ye first the kingdom of politics and all things shall be added onto you."
This was the gospel of 'state capture'; and, subsequently, the looting/milking of the state resources. Unfortunately other Africa politicians adopted Nkrumah's motto.
I never worked in Korea; however, those who did, have mentioned to me the exceptionally strong desire of Koreans to learn and to work hard to improve.
What one might consider and label as corruption is, in too many countries, just considered as an overhead, a tax or even the oil in the engine of business.
Among UN staff there were many from former colonial powers who seemed to feel guilty about their county's past; and, bent over to apologetically appease the local authorities.
In some cases, this resulted in not being willing to call things by the right name.
UNDP missed the boat early on when they tried to adopt each and every country's priorities, as set forth by local planning commission, as UNDP's priorities.
If followed too slavishly, this would deprive a UN agency of its own priorities regardless of it own reason to exist. In contrast, UNICEF stands out in its ability to assist both sides even in civil wars.
Furthermore, most central planning has been 'top-down'; and, the underlying assumptions have very often proved to be erroneous.
John, I broadly agree with much of what you say. The term “free enterprise” does capture what Adam Smith had in mind more accurately than the caricature often associated with the word “capitalism.” Smith himself was not defending the kind of mercantile monopolies represented by the East India Company. In fact, he criticised them fiercely.
DeleteYour point about Nkrumah is also important. The early post-independence belief that political power alone could deliver prosperity led many countries toward state control rather than institutional development. South Korea chose a different path, and the divergence in outcomes has been remarkable.
I also recognise your point about corruption becoming normalised as a kind of “operating cost” in some systems. That, too, is ultimately an institutional problem. Without the rule of law and competition, the incentives drift in that direction.
The Soviet Union gave Nkrumah Lenin's Peace Prize. They must have considered him a good communist.
ReplyDeleteWhat is striking in this discussion is how little the most distressing facts are allowed to disturb the development industry’s self‑confidence. After sixty years of massive aid flows, the uncomfortable truth is that the African countries receiving the most assistance are further behind the rest of the world than they were at independence. In several cases, they are worse off than they were under colonial administration.
ReplyDeleteIt is not mysterious - aid cannot substitute for the institutional foundations of prosperity: property rights, rule of law, open markets, and accountable government. Where these are absent, aid entrenches the very systems that hold countries back. It props up political elites, subsidises inefficient state structures, and reduces the pressure for reform.
This is not an argument for abandoning Africa. It is an argument for abandoning the comforting illusion that external money can compensate for weak institutions or misguided economic policies. The countries that have risen, South Korea, Singapore, and Mauritius, did so not because outsiders rescued them, but because they built systems that rewarded work, investment, and enterprise.
The development industry needs to rethink not only its methods, but its assumptions. At some point, the absence of progress must become a verdict in itself.
Oh my!
ReplyDeleteWhere did the 'rate of interest' come from? God?
Did capital exist before it could be owned?
Before you defined a system that could name it?
Did commodities just grow on trees?
What happened to tribalism and feudalism?
Not to mention minor systems such as socialism and pastoralism?
Times Change... All things must pass.
Try walking along Broadway in your Natural State these days!
Mahesh, you are right to remind us that economic life did not begin with interest rates, capital markets, or even clearly defined property rights. Human societies have taken many forms, including tribal, feudal, and pastoral, each with its own logic and constraints. That is precisely the point.
DeleteWhat Adam Smith did was not to claim that capital “fell from the sky,” but to observe that once individuals are allowed to exchange, specialise, and retain the fruits of their effort, certain patterns emerge with remarkable consistency. Surpluses appear. Those surpluses are saved or reinvested. Over time, what we call “capital” takes shape, not by decree, but as a consequence of human behaviour under conditions of relative freedom.
Interest rates are not acts of God, but neither are they arbitrary inventions. They reflect time preference, risk, and the opportunity cost of using resources in one way rather than another. These are not ideological constructs; they arise where people make choices.
You are also right that commodities do not “grow on trees”. They are produced. And production, beyond the most basic subsistence level, depends on organisation, incentives, and increasingly, capital accumulation.
The historical systems you mention, feudalism, tribalism, and so on, were not alternatives that delivered sustained, broad-based prosperity. They were, in most cases, systems of hierarchy and constraint, where economic life was bound by status and coercion.
What distinguishes what we now call capitalism, or as we seem to prefer, “free enterprise”, is not that it was invented at a particular moment, but that it gradually removed those constraints. It allowed strangers to trade, individuals to invest, and ideas to scale.
"Arithmetic” matters. Once reinvestment and compounding take hold, the difference between systems becomes dramatic over time.
So yes, times change, and systems evolve. But not all systems are equal in their ability to generate sustained improvements in living standards.
The question is not if capitalism had a beginning in history. The question is whether any alternative system has yet demonstrated a comparable capacity to lift large populations out of poverty over the long run.
So far, the empirical record is rather one-sided.