Does Adam Smith's theory really imply today's inequality?

What was the ideal economic system for Adam Smith? His writings disapprove of high profits and advocate regulation, a minimum wage and well-designed taxes.

Some of the most recurrent subjects for public debate are wages, profits, taxes and inequality. What’s more, perhaps because of the recent series of economic crises, ideas about policies in these areas that were once marginal are now increasingly mainstream.

Raising the minimum wage is no longer assumed to have the distorting effects on the labour market that it was assumed to. High profits are coming to be seen as symptoms of economic pathology, not a robust business model. Demands for redistributive taxation have found new defenders (though more pragmatic perspectives propose a new trade-off between fairness and efficiency). And inequality has prevailed as an overriding concern among developed economies as much as developing economies.

These positions were in fact central tenets in the thinking of the original market theorist, Adam Smith. Readers long confused the points in The Wealth of Nations that explained how society originally emerged or how it currently operated with the economy that Smith was prescribing. To reconstruct what the ideal economic system was for Smith, one needs instead to assemble all the economic prescriptions he proposed.

Smith thought that high profits were a symptom of serious market disequilibrium: they were ‘always highest in the countries which are going fastest to ruin.’ This is because ‘the rate of profit does not, like rent and wages, rise with the prosperity, and fall with the declension of the society.’ The current record-breaking corporate profits would not have surprised him.

Accordingly, Smith believed wages should be sufficient to provide the ‘necessaries’, defined as middle-class comforts. This was a call for a generous minimum wage, which he expected to occur naturally, following economic growth. It’s only low wages that resulted from concerted action – either government intervention, as when the ‘sophistry’ of merchants and manufacturers manipulated legislatures to pass favourable laws; or when employers used their bargaining advantage to coerce workers. Unsurprisingly, Karl Marx was an admirer of this view.

Smith also praised the British tax system. It featured per capita taxes that were twice as high as those imposed on the French, yet the ‘people of France… are much more oppressed by taxes than the people of Great Britain.’ Why? Because French taxes fell disproportionately on the poor. ‘The inequality of the worst kind’ was when taxes must ‘fall much heavier upon the poor than upon the rich.’ The reasons were not moral. Bad taxes were simply bad economics.

Smith also thought regulation in favour of the worker was ‘always just and equitable,’ that inheritances should be partitioned, even royal land should be redistributed. Once all these building blocks are assembled, it is hard to see how steep inequality could even arise.