Economic Theories: Adam Smith vs Milton Friedman

The Greatest Economists

Neoliberalism is a political theory where government interference is regulated in free market operation in order to maximize individuals’ liberty. Adam Smith, the founder of modern economics, believed that individuals would work in their self-interest and produce what society requires in terms of goods and services. His book the “Wealth of Nations” discusses how free market economy could run on its own without government interference. He opposed government intervention, labor laws, products restrictions and trade restrictions since he believed that the market could run smoothly without them. In the theory of moral sentiments Adam Smith explained the self-regulation of the market forces.

On the other hand, Milton Friedman, another great economist, specialized in stabilization policy, consumption and monetary theory. During his early career, he believed in Keynes`s theories but he never supported price and wage control. He believed in monetarism, which is a microeconomic policy, and the unemployment rate that the government can regulate at the risk of inflation. He also favored free market economics where there is no government interference. He supported a voluntary army, floating exchange rates, education vouchers and abolition of medical licenses. Both Adam Smith and Milton Friedman supported free trade, economic liberalization and reduction of government expenditure to promote the spirit of entrepreneurship. However, there are differences between the theories of Adam Smith and Milton Friedman. The paper analyzes these theories and the differences between them.

Adam Smith (2017), in his book the Wealth of Nations, states that the division of labor is critical for countries that want to promote entrepreneurship. He believed that the greatest improvement in powers of skill and labor was the division of labor. The latter can be divided into a greater number of parts for those manufacturers that have employed many employees compared to those that have fewer employees (Smith & Bullock, 2017). Therefore, this helps to boost production in an organization. However, Friedman did not talk about the division of labor in his theories. He focused mostly on the free economy where there are no government interventions as the way to promote entrepreneurship.

According to Smith (2017), countries should specialize in what they can produce best in order to increase production. For example, if a country X is better in silk production than a country Z, which is good in coffee production, the country X should focus only on silk production. On the other hand, the country Z should only focus on coffee production. Entrepreneurship is promoted when these countries trade and exchange those things they produce for those they do not produce. The increase in the quantity of production as a result of the division of labor is due to three factors: the saving of time is usually lost by moving from one occupation to another; machines that enable one person to perform a task that was initially done by many people and the level of skills acquired by each worker.

According to Smith (2017), the division of labor leads to specialization. Specialization means that a person focuses on a simple task and makes it the sole employment of his/her life. Therefore, the quality of goods or services that he/she produces improves while the quantity increases. Hence, this promotes entrepreneurship because goods and services available for trading will increase and improve drastically due to specialization.

Second, time-saving is because people focus on one task. There is no time lost because people do not move from one job to another. According to Smith (2017), it is impossible for workers to move quickly from one kind of job to another that is carried on a different station with different tools without wasting time. A lot of time will be wasted in the course of moving to another job. The third thing is the use of machines during production. Specialization results to the application of technology in production. Therefore, the use of technology boosts production, hence, promoting entrepreneurship.

According to Smith (2017), the division of labor improves the technology and also provides workers with the opportunity to brainstorm different ways to make their tasks easier and more efficient. Therefore, this leads to growth of surpluses that can be re-invested or traded. However, there are several factors that limit the division of labor. Among them is the market expansion. A country might be producing surpluses but due to low demand or slow growth of the market for its products, the volume of goods and services demanded remains the same. This results to wastage of resources since the goods and services produced cannot reach the market. As a result, inadequate expansion of market does not promote entrepreneurship. Another factor that limits the division of labor is inadequate capital supply. It means that a country cannot maximize its production capability. According to Smith, there are countries that have the potential of producing certain products and providing them to the market in large quantities but due to inadequate capital they cannot produce their products on a large scale.

In his third book, Smith explains the history of development of economic relations. He begins with an agricultural society, how cities were developed and how they depend on rural areas for food. Once a city is developed it depends on a nation, but the nation also relies on the city as a market for its goods. He explains how the feudal system had been broken down in Europe and then replaced by mercantilism. In the feudal system, wealth belonged to the noble class and the landlords. However, their wealth decreased when the tenants became powerful and started making demands (Smith, 2017). During the feudal system, the law applied differently to different people depending on their social status in the society. After this system had been abandoned, people adopted a system where they were more or less equal under law. However, it took a longer period for capitalism to flourish since people who were prepared to invest did not have confidence that they would get back their capital.

According to Smith (2017), growth of cities across Europe was a result of improved economies. City dwellers represented forces of trade and industries. Industrialists and merchants were the ones who contributed to economic growth and progress. On the other hand, the landed nobles were the ones responsible for political stability of a nation. Unlike Friedman, Smith criticized the mercantilism theory because he believed that people who participated in agriculture would also benefit as the city dwellers from the trade. His argument here was that people regardless of their social status can prosper provided they are industrious. He also agrees that the development of cities should lead to political stability, freedom and equality.

In his fourth book, Smith criticized the economic policies and theories that preceded his work. He argued that some policies were not good for development and wealth of a nation. He started by criticizing the idea that the economic wealth of a nation can be measured by the amount of silver and gold that it possesses. The confusion about his argument is that money is used for trading hence it is used to buy commodities and labor which are instrument of wealth of a nation. The relationship between money and wealth resulted in the prohibition of the exportation of silver and gold by governments. However, those countries that specialize in trade do not see negative effects of exporting silver and gold. They view it as an opportunity to increase their wealth when they re-export goods of better quality at a higher price.

Smith, unlike Friedman, fully disagrees with the idea of government intervention. He criticized some governmental practices such as the idea of protectionist tariffs which encouraged the development of home industries. He believed that international trade has two advantages which are: the trade helps in selling surplus products of a country that is not demanded at home and bring back products that are demanded at home. Second, the trade gives value to surplus local products that did not have value locally. Therefore, international trade widens the home market, and the introduction of new goods results in perfection of the division of labor.

Smith also argued that the restriction on imports of those commodities that are produced locally created monopoly at the local market. Therefore, this benefits the producers of these products. Nevertheless, the benefits of such monopoly to the society and the market are doubtful. According to Smith’s argument regarding the monopoly power, people only think of the benefits that they will get from their investments. He goes on and explains how people who have invested locally in different industries are willing to produce high-quality products and provide them to the market. He states that if foreign products can be bought at a cheaper price than local products then prohibition on the importation of these products is harmful.

Adam Smith also criticizes high tariffs charged by countries on imports. He argued that those tariffs only make goods expensive to local consumers. The imposed tariffs affect only an industrial and small merchant class of people. However, the tariffs can be beneficial if imposed for certain duration and when a country wants to protect a type of production that employs many people.

On the other hand, Milton Friedman in his book “Capitalism and Freedom” he saw the danger of concentrating power. Friedman advocated for the limit of the control of a government over social, economic and political lives. Whether it is in any sector of the economy, he wanted the decision-making process to be focused on individuals rather than government. According to him, those people who control power today, and the ones who made those decisions, may not control the power tomorrow. He argues that the decisions that they made today might be considered good but may be also regarded as harmful in future.

Friedman saw the connection between economics and politics. He said the two exist side by side such as a society that is economically socialist cannot be politically democratic. He said that in the economic system, capitalism will promote freedom either indirectly or directly. However, the market freedom promotes broader political freedom. It is the capital institution that has made us enjoy the economic freedoms that we are enjoying. Unlike Smith, who sees some of the benefits of trade restrictions, Friedman viewed them as burdensome, harmful to the society and also dangerous to the government. He said individuals have power to decide what they want to do. Therefore, the freedom that people have to engage in economic activities should be personal freedom. However, economic freedom determines the power of a government; hence it has a direct relationship with political freedom.

Friedman disagrees with the notion that free-trade economies are not stable. According to Friedman, free-enterprise economies have led to economic growth and full employment. He accuses the governments of coming up with excuses in order to increase their intervention. He argued that the great depression was due to poor governance where the government imposed tough policies such as regulations, restrictions, and high taxes. However, he said that the role of the government should offer a stable monetary framework through fiscal and monetary policies.

He said that it was important for power to be dispersed. According to the author, it is dangerous for the power to be concentrated as it negatively influences the government in the process of regulating the monetary policy. According to Friedman (1982), it is difficult to have an institutional framework that will balance the two. He said that during the period between the Civil War and 1913, the world economy was stable compared to the period between 1913 and the time he wrote his book. However, he agrees that the world wars and globalization might have contributed to an unstable economy but he emphasizes that the Federal Reserve policies were the major contributor to a turbulent economy.

According to Friedman, there are more negative effects of concentrating power in a central authority apart from the risk of personal freedom. He did not see any benefits of government intervention in decision-making. He provided several examples such as trade restrictions and price support that protect domestic industries, and jobs will increase prices for consumer goods and taxes. Trade restrictions will also strain the relationship that a country has with others. Licensing of doctors and other medical workers is aimed at improving consumers` safety. However, this may reduce the number of practicing medical experts in the market. Therefore, the medical care prices will increase while those who cannot afford it will be encouraged to look for the back door services. Another example provided by him is the minimum wage that raises the price that employers are willing to offer for a certain job. Minimum wage creates fewer jobs in the market hence the rate of unemployment increases. High rate of unemployment destabilizes nations’ economic power.

Economic thought presented in Murray Rothbard`s books was not so different before Adam Smith. During the first half of the 17th century, royal absolutism was adapted in Europe. In this economic status, the king was supposed to rule through hierarchical bureaucracy. Therefore, there was a kind of alliance that helped the king to rule. For instance, there were feudal or post-feudal merchants, who were assisting the king in making decision and ruling the nation. The system was called mercantilism and it lasted from the 16th to the 18th centuries. Many historians refer to this period as a system of state building. During this time, countries were promoting entrepreneurship by restricting imports while offering subsidies on exports. The objective was to protect local industries. The system was characterized by heavy government expenditure, war, imperialism, high inflation just to mention a few. The state was supposed to maintain a powerful group in the economy, the members of which were given some privileges, for example, exclusive right to sell their products in a particular area therefore they were like monopoly in those regions. The rights were also given to the group of traders that were assisting the king in tax collection. Therefore, they ended up acquiring the status of monopoly in the region.

The prominent aspects of mercantilist policy – subsidizing exports and import restrictions – were parcel of the system of monopoly privilege. Domestic merchants benefited from import restrictions and also export subsidies. During this period, most countries were taking part in trade in order to improve their wealth. Unlike the periods of Adam Smith and Milton Friedman, there was no money and gold and silver were used for trade. Most countries did not know how to reduce inflation. For instance, Spain, once considered as an economic giant, was able to get gold and silver from its colonies and to use it for trading with other countries in Europe. In the short run, it became an economic powerhouse. However, in the long run, it suffered from inflation due to the influx of products in the country.

During the Murray period, there was no the division of labor. Therefore, there was no specialization. The invention of new products, new technologies, and new methods of handling products was discouraged (Rothbard, 2006). For example, an introduction of the loom used for production of luxury items and silk stocking was outlawed. The hand knitters did not want competition from this machine. During the Murray period, many countries experienced industrial growth. As a result, the quantity of products produced increased, thus, promoting trade.

Unlike the periods of Friedman and Smith, when industrialization was viewed to have great benefits to a country, some countries like France were discouraging it. For example, France imposed the maximum wage that discouraged workers to enter into the industry sector. The objective was to make workers keep doing farm work. Apprenticeship requirements also limit the labor mobility (Rothbard, 2006). For example, masters were only required to have a maximum of two apprentices. Therefore, this prevented the growth of craft industries since there was inadequate labor for the production. The market price of products was also determined by the government. Salt producers were supposed to sell salt only to government stores at a fixed price. The government would later force people to buy the salt at inflated prices in order to make money to run the country.

To sum up, Adam Smith and Friedman have different theories supporting entrepreneurship. Adam Smith focused mostly on job specialization, meaning that people were supposed to focus on what they can produce best. Specialization led to innovation where machines were used in the production. Therefore, in the end the quality of the goods and services produced improved and increased respectively. Smith explained the need of a country to specialize in what it can produce better than other countries in order to boost its trade. For instance, a country that is good in manufacturing should focus on producing manufactured goods while the countries with favorable climate and soil should focus on agriculture. The surplus that they have will be used for trading in order to acquire what they do not produce. Unlike Smith, Friedman agreed with some government intervention policies such as fiscal policy that enables to fight inflation in a country.

On the other hand, Smith supported the system where government policies are not imposed in a country. He believed those policies to be harmful to the economy because they only make the cost of goods and services increase. According to him, some policies imposed by a government such as an import restriction can result in the development of monopoly power in a state.

On the other hand, during the Murray’s period there was no specialization and use of machines was discouraged. Kings were assisted by different members of communities such as merchants in making critical economic decisions. In the return, they got favors from the king. Most merchants that assisted the king were allocated regions where they were supposed to sell their products without competition from other traders.