Economics

Study Notes

Adam Smith, Karl Marx and Friedrich Hayek on Economic Systems

Level:
AS, A Level, IB
Board:
AQA, Edexcel, OCR, IB, Eduqas, WJEC

Here is a handy summary of the thinking of Adam Smith, Karl Marx and Friedrich Hayek on Economic Systems.

Adam Smith on economic systems

In his 1776 book ‘Wealth of Nations’, Adam Smith (amongst many other things!) wrote about the ‘invisible hand’ of resource allocation, and the role of ‘self-interest’, in an early reference to free-market economies. The key quotes from Wealth of Nations on this topic are:

“[Every individual] generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest, he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good.”

“It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages.”

At the same time, however, Adam Smith warned that we should be wary of businesses that become too large (i.e. monopolies) because of their tendency to raise prices. He recognised that the government should keep an eye on their activities, but believed it was dangerous for large businesses to influence politics and legislation.

Smith also recognised that in a free market economy, some people would be rich ‘property owners’ i.e. owners of the factors of production, and there would be far fewer of these people than labourers. He said that one important role of government in this type of economic system would be to maintain law and order, because the many poor would want to take over the property of the rich.

Other roles for the government, identified by Smith, include the issuing of patents and copyright (to protect invention), providing national defence, regulating the banking sector, building infrastructure, and public goods.

Smith is now regarded as the founder of free market (or laissez-faire) economics, despite recognising the need for some government intervention.

The Invisible Hand - 60 Second Adventures in Economics

Karl Marx and economic systems

Marx developed many of Adam Smith’s ideas on capitalism / free-market economics, but mostly considered the negative consequences.

He agreed that free markets would lead to large increases in productivity and output, but also thought that the impact on labourers would be terrible.

Marx believed that the drive for profit by business owners in the capitalist system would push worker wages to ‘subsistence’ levels and that they would be exploited. He said that, ultimately, exploited workers would work together and overthrow capitalism in a revolution. Capitalism would be replaced by socialism.

In this system, production would be coordinated centrally, and distribution of the goods made would be “to each according to his contribution”. Beyond this, though, Max gave little indication of how he thought a centrally planned command economy would operate in practice.

Friedrich Hayek and economic systems

Hayek is probably the best-known member of what is known as the Austrian School of economics, in which there is a strong belief in the role and importance of the individual in the economy, rather than any collective group or government.

During the 1930s, he engaged in lively debate with the economist Keynes – Keynes supported significant government intervention in the economy to stimulate growth whereas Hayek did not.

Whereas Adam Smith saw a role for government intervention in money markets and financial markets, Hayek disagreed, arguing that intervention in money markets was one of the main causes of economic instability (the pattern of booms and recessions).

In other words, Hayek saw less of a role for governments in an economy than even Smith. For Hayek, the only possible role for a government was to maintain law and order. Later in life, he did suggest that the state could provide a small ‘safety net’ for those who found themselves unable to work.

Hayek also argued strongly against command economies, noting that a small group of individuals would be entirely responsible for determining the allocation and distribution of resources; in his view, it would be completely impossible for them to ever have enough information to do this properly to meet people’s needs.

Hayek believed that markets alone would have the information needed to make these decisions, because markets coordinate the views and information held by everyone, in a ‘spontaneous’ way.

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