Adam Smith (updated)

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Adam Smith FRSA
Born	16 June [O.S. 5 June] 1723 Kirkcaldy, Fife, Scotland
Died	17 July 1790 (aged 67) Edinburgh, Scotland
Nationality	Scottish
Alma mater	University of Glasgow Balliol College, Oxford
Notable work	The Wealth of Nations The Theory of Moral Sentiments
Region	Western philosophy
School	Classical economics, classical liberalism
Main interests	Political philosophy, ethics, economics
Notable ideas	Classical economics, modern free market, division of labour, the "invisible hand"
Signature

Adam Smith FRSA (16 June [O.S. 5 June] 1723 – 17 July 1790) was a Scottish economist, philosopher and author as well as a moral philosopher, a pioneer of political economy and a key figure during the Scottish Enlightenment. Smith wrote two classic works, The Theory of Moral Sentiments (1759) and An Inquiry into the Nature and Causes of the Wealth of Nations (1776). The latter, often abbreviated as The Wealth of Nations, is considered his magnum opus and the first modern work of economics.

Smith studied social philosophy at the University of Glasgow and at Balliol College, Oxford, where he was one of the first students to benefit from scholarships set up by fellow Scot John Snell. After graduating, he delivered a successful series of public lectures at Edinburgh, leading him to collaborate with David Hume during the Scottish Enlightenment. Smith obtained a professorship at Glasgow, teaching moral philosophy and during this time, wrote and published The Theory of Moral Sentiments. In his later life, he took a tutoring position that allowed him to travel throughout Europe, where he met other intellectual leaders of his day.

Smith laid the foundations of classical free market economic theory. The Wealth of Nations was a precursor to the modern academic discipline of economics. In this and other works, he developed the concept of division of labor and expounded upon how rational self-interest and competition can lead to economic prosperity. Smith was controversial in his own day and his general approach and writing style were often satirized by Tory writers in the moralising tradition of William Hogarth and Jonathan Swift. In 2005, The Wealth of Nations was named among the 100 best Scottish books of all time.

Biography

Early life

Smith was born in Kirkcaldy, in the County of Fife, Scotland. His father, also Adam Smith, was a Scottish Writer to the Signet (senior solicitor), advocate and prosecutor (judge advocate) and also served as comptroller of the customs in Kirkcaldy. In 1720, he married Margaret Douglas, daughter of the landed Robert Douglas of Strathendry, also in Fife. His father died two months after he was born, leaving his mother a widow. The date of Smith's baptism into the Church of Scotland at Kirkcaldy was 5 June 1723 and this has often been treated as if it were also his date of birth, which is unknown. Although few events in Smith's early childhood are known, the Scottish journalist John Rae, Smith's biographer, recorded that Smith was abducted by gypsies at the age of three and released when others went to rescue him. Smith was close to his mother, who probably encouraged him to pursue his scholarly ambitions. He attended the Burgh School of Kirkcaldy—characterized by Rae as "one of the best secondary schools of Scotland at that period"—from 1729 to 1737, he learned Latin, mathematics, history, and writing.

Formal education

Smith entered the University of Glasgow when he was 14 and studied moral philosophy under Francis Hutcheson. Here, Smith developed his passion for liberty, reason, and free speech. In 1740, Smith was the graduate scholar presented to undertake postgraduate studies at Balliol College, Oxford, under the Snell Exhibition.

Smith considered the teaching at Glasgow to be far superior to that at Oxford, which he found intellectually stifling. In Book V, Chapter II of The Wealth of Nations, Smith wrote: "In the University of Oxford, the greater part of the public professors have, for these many years, given up altogether even the pretense of teaching." Smith is also reported to have complained to friends that Oxford officials once discovered him reading a copy of David Hume's A Treatise of Human Nature, and they subsequently confiscated his book and punished him severely for reading it. According to William Robert Scott, "The Oxford of [Smith's] time gave little if any help towards what was to be his lifework." Nevertheless, Smith took the opportunity while at Oxford to teach himself several subjects by reading many books from the shelves of the large Bodleian Library. When Smith was not studying on his own, his time at Oxford was not a happy one, according to his letters. Near the end of his time there, Smith began suffering from shaking fits, probably the symptoms of a nervous breakdown. He left Oxford University in 1746, before his scholarship ended.

In Book V of The Wealth of Nations, Smith comments on the low quality of instruction and the meager intellectual activity at English universities, when compared to their Scottish counterparts. He attributes this both to the rich endowments of the colleges at Oxford and Cambridge, which made the income of professors independent of their ability to attract students, and to the fact that distinguished men of letters could make an even more comfortable living as ministers of the Church of England.

Smith's discontent at Oxford might be in part due to the absence of his beloved teacher in Glasgow, Francis Hutcheson, who was well regarded as one of the most prominent lecturers at the University of Glasgow in his day and earned the approbation of students, colleagues, and even ordinary residents with the fervor and earnestness of his orations (which he sometimes opened to the public). His lectures endeavored not merely to teach philosophy, but also to make his students embody that philosophy in their lives, appropriately acquiring the epithet, the preacher of philosophy. Unlike Smith, Hutcheson was not a system builder; rather, his magnetic personality and method of lecturing so influenced his students and caused the greatest of those to reverentially refer to him as "the never to be forgotten Hutcheson"—a title that Smith in all his correspondence used to describe only two people, his good friend David Hume and influential mentor Francis Hutcheson.

Portrait of Smith's mother, Margaret Douglas

Teaching career

Smith began delivering public lectures in 1748 in Edinburgh, sponsored by the Philosophical Society of Edinburgh under the patronage of Lord Kames. His lecture topics included rhetoric and belles-lettres, and later the subject of "the progress of opulence". On this latter topic, he first expounded his economic philosophy of "the obvious and simple system of natural liberty". While Smith was not adept at public speaking, his lectures met with success.

In 1750, Smith met the philosopher David Hume, who was his senior by more than a decade. In their writings covering history, politics, philosophy, economics, and religion, Smith and Hume shared closer intellectual and personal bonds than with other important figures of the Scottish Enlightenment.

In 1751, Smith earned a professorship at Glasgow University teaching logic courses, and in 1752, he was elected a member of the Philosophical Society of Edinburgh, having been introduced to the society by Lord Kames. When the head of Moral Philosophy in Glasgow died the next year, Smith took over the position. He worked as an academic for the next 13 years, which he characterized as "by far the most useful and therefore by far the happiest and most honorable period [of his life]".

Smith published The Theory of Moral Sentiments in 1759, embodying some of his Glasgow lectures. This work was concerned with how human morality depends on sympathy between agent and spectator, or the individual and other members of society. Smith defined "mutual sympathy" as the basis of moral sentiments. He based his explanation, not on a special "moral sense" as the Third Lord Shaftesbury and Hutcheson had done, nor on utility as Hume did, but on mutual sympathy, a term best captured in modern parlance by the 20th-century concept of empathy, the capacity to recognize feelings that are being experienced by another being.

François Quesnay, one of the leaders of the physiocratic school of thought

Following the publication of The Theory of Moral Sentiments, Smith became so popular that many wealthy students left their schools in other countries to enroll at Glasgow to learn under Smith. After the publication of The Theory of Moral Sentiments, Smith began to give more attention to jurisprudence and economics in his lectures and less to his theories of morals. For example, Smith lectured that the cause of increase in national wealth is labor, rather than the nation's quantity of gold or silver, which is the basis for mercantilism, the economic theory that dominated Western European economic policies at the time.

In 1762, the University of Glasgow conferred on Smith the title of Doctor of Laws (LL.D.). At the end of 1763, he obtained an offer from Charles Townshend—who had been introduced to Smith by David Hume—to tutor his stepson, Henry Scott, the young Duke of Buccleuch. Smith resigned from his professorship in 1764 to take the tutoring position. He subsequently attempted to return the fees he had collected from his students because he had resigned partway through the term, but his students refused.

Tutoring and travels

Smith's tutoring job entailed touring Europe with Scott, during which time he educated Scott on a variety of subjects, such as etiquette and manners. He was paid £300 per year (plus expenses) along with a £300 per year pension; roughly twice his former income as a teacher. Smith first travelled as a tutor to Toulouse, France, where he stayed for a year and a half. According to his own account, he found Toulouse to be somewhat boring, having written to Hume that he "had begun to write a book to pass away the time". After touring the south of France, the group moved to Geneva, where Smith met with the philosopher Voltaire.

David Hume was a friend and contemporary of Smith's.

 

From Geneva, the party moved to Paris. Here, Smith met Benjamin Franklin, and discovered the Physiocracy school founded by François Quesnay. Physiocrats were opposed to mercantilism, the dominating economic theory of the time, illustrated in their motto Laissez faire et laissez passer, le monde va de lui même! (Let do and let pass, the world goes on by itself!). 

The wealth of France had been virtually depleted by Louis XIV and Louis XV in ruinous wars, and was further exhausted in aiding the American insurgents against the British. The excessive consumption of goods and services deemed to have no economic contribution was considered a source of unproductive labor, with France's agriculture the only economic sector maintaining the wealth of the nation. Given that the English economy of the day yielded an income distribution that stood in contrast to that which existed in France, Smith concluded that "with all its imperfections, [the Physiocratic school] is perhaps the nearest approximation to the truth that has yet been published upon the subject of political economy." The distinction between productive versus unproductive labour—the physiocratic classe steril—was a predominant issue in the development and understanding of what would become classical economic theory.

Later years

In 1766, Henry Scott's younger brother died in Paris, and Smith's tour as a tutor ended shortly thereafter. Smith returned home that year to Kirkcaldy, and he devoted much of the next decade to writing his magnum opus. There, he befriended Henry Moyes, a young blind man who showed precocious aptitude. Smith secured the patronage of David Hume and Thomas Reid in the young man's education. In May 1773, Smith was elected fellow of the Royal Society of London, and was elected a member of the Literary Club in 1775. The Wealth of Nations was published in 1776 and was an instant success, selling out its first edition in only six months.

In 1778, Smith was appointed to a post as commissioner of customs in Scotland and went to live with his mother (who died in 1784) in Panmure House in Edinburgh's Canongate. Five years later, as a member of the Philosophical Society of Edinburgh when it received its royal charter, he automatically became one of the founding members of the Royal Society of Edinburgh. From 1787 to 1789, he occupied the honorary position of Lord Rector of the University of Glasgow.

Death

A commemorative plaque for Smith is located in Smith's home town of Kirkcaldy.

 

Smith died in the northern wing of Panmure House in Edinburgh on 17 July 1790 after a painful illness. His body was buried in the Canongate Kirkyard. On his deathbed, Smith expressed disappointment that he had not achieved more.

Smith's literary executors were two friends from the Scottish academic world: the physicist and chemist Joseph Black and the pioneering geologist James Hutton. Smith left behind many notes and some unpublished material, but gave instructions to destroy anything that was not fit for publication. He mentioned an early unpublished History of Astronomy as probably suitable, and it duly appeared in 1795, along with other material such as Essays on Philosophical Subjects.

Smith's library went by his will to David Douglas, Lord Reston (son of his cousin Colonel Robert Douglas of Strathendry, Fife), who lived with Smith. It was eventually divided between his two surviving children, Cecilia Margaret (Mrs. Cunningham) and David Anne (Mrs. Bannerman). On the death of her husband, the Reverend W. B. Cunningham of Prestonpans in 1878, Mrs. Cunningham sold some of the books. The remainder passed to her son, Professor Robert Oliver Cunningham of Queen's College, Belfast, who presented a part to the library of Queen's College. After his death, the remaining books were sold. On the death of Mrs. Bannerman in 1879, her portion of the library went intact to the New College (of the Free Church) in Edinburgh and the collection was transferred to the University of Edinburgh Main Library in 1972.

Personality and beliefs

Character

James Tassie's enamel paste medallion of Smith provided the model for many engravings and portraits that remain today.

 

Not much is known about Smith's personal views beyond what can be deduced from his published articles. His personal papers were destroyed after his death at his request. He never married, and seems to have maintained a close relationship with his mother, with whom he lived after his return from France and who died six years before him.

Smith was described by several of his contemporaries and biographers as comically absent-minded, with peculiar habits of speech and gait, and a smile of "inexpressible benignity". He was known to talk to himself, a habit that began during his childhood when he would smile in rapt conversation with invisible companions. He also had occasional spells of imaginary illness, and he is reported to have had books and papers placed in tall stacks in his study. According to one story, Smith took Charles Townshend on a tour of a tanning factory, and while discussing free trade, Smith walked into a huge tanning pit from which he needed help to escape. He is also said to have put bread and butter into a teapot, drunk the concoction, and declared it to be the worst cup of tea he ever had. According to another account, Smith distractedly went out walking in his nightgown and ended up 15 miles (24 km) outside of town, before nearby church bells brought him back to reality.

James Boswell, who was a student of Smith's at Glasgow University, and later knew him at the Literary Club, says that Smith thought that speaking about his ideas in conversation might reduce the sale of his books, so his conversation was unimpressive. According to Boswell, he once told Sir Joshua Reynolds, that 'he made it a rule when in company never to talk of what he understood'.

Portrait of Smith by John Kay, 1790

Smith has been alternately described as someone who "had a large nose, bulging eyes, a protruding lower lip, a nervous twitch, and a speech impediment" and one whose "countenance was manly and agreeable." Smith is said to have acknowledged his looks at one point, saying, "I am a beau in nothing but my books." Smith rarely sat for portraits, so almost all depictions of him created during his lifetime were drawn from memory. The best-known portraits of Smith are the profile by James Tassie and two etchings by John Kay. The line engravings produced for the covers of 19th-century reprints of The Wealth of Nations were based largely on Tassie's medallion.

Religious views

Considerable scholarly debate has occurred about the nature of Smith's religious views. Smith's father had shown a strong interest in Christianity and belonged to the moderate wing of the Church of Scotland. The fact that Adam Smith received the Snell Exhibition suggests that he may have gone to Oxford with the intention of pursuing a career in the Church of England.

Anglo-American economist Ronald Coase has challenged the view that Smith was a deist, based on the fact that Smith's writings never explicitly invoke God as an explanation of the harmonies of the natural or the human worlds. According to Coase, though Smith does sometimes refer to the "Great Architect of the Universe", later scholars such as Jacob Viner have "very much exaggerated the extent to which Adam Smith was committed to a belief in a personal God", a belief for which Coase finds little evidence in passages such as the one in the Wealth of Nations in which Smith writes that the curiosity of mankind about the "great phenomena of nature", such as "the generation, the life, growth, and dissolution of plants and animals", has led men to "enquire into their causes", and that "superstition first attempted to satisfy this curiosity, by referring all those wonderful appearances to the immediate agency of the gods. Philosophy afterwards endeavored to account for them, from more familiar causes, or from such as mankind were better acquainted with than the agency of the gods".

Some other authors argue that Smith's social and economic philosophy is inherently theological and that his entire model of social order is logically dependent on the notion of God's action in nature.

Smith was also a close friend of David Hume, who was commonly characterized in his own time as an atheist. The publication in 1777 of Smith's letter to William Strahan, in which he described Hume's courage in the face of death in spite of his irreligiosity, attracted considerable controversy.

Published works

The Theory of Moral Sentiments

In 1759, Smith published his first work, The Theory of Moral Sentiments, sold by co-publishers Andrew Millar of London and Alexander Kincaid of Edinburgh. Smith continued making extensive revisions to the book until his death. Although The Wealth of Nations is widely regarded as Smith's most influential work, Smith himself is believed to have considered The Theory of Moral Sentiments to be a superior work.

In the work, Smith critically examines the moral thinking of his time, and suggests that conscience arises from dynamic and interactive social relationships through which people seek "mutual sympathy of sentiments." His goal in writing the work was to explain the source of mankind's ability to form moral judgement, given that people begin life with no moral sentiments at all. Smith proposes a theory of sympathy, in which the act of observing others and seeing the judgements they form of both others and oneself makes people aware of themselves and how others perceive their behavior. The feedback we receive from perceiving (or imagining) others' judgements creates an incentive to achieve "mutual sympathy of sentiments" with them and leads people to develop habits, and then principles, of behavior, which come to constitute one's conscience.

Some scholars have perceived a conflict between The Theory of Moral Sentiments and The Wealth of Nations; the former emphasizes sympathy for others, while the latter focuses on the role of self-interest. In recent years, however, some scholars of Smith's work have argued that no contradiction exists. They claim that in The Theory of Moral Sentiments, Smith develops a theory of psychology in which individuals seek the approval of the "impartial spectator" as a result of a natural desire to have outside observers sympathize with their sentiments. Rather than viewing The Theory of Moral Sentiments and The Wealth of Nations as presenting incompatible views of human nature, some Smith scholars regard the works as emphasizing different aspects of human nature that vary depending on the situation. Otteson argues that both books are Newtonian in their methodology and deploy a similar "market model" for explaining the creation and development of large-scale human social orders, including morality, economics, as well as language. Ekelund and Hebert offer a differing view, observing that self-interest is present in both works and that "in the former, sympathy is the moral faculty that holds self-interest in check, whereas in the latter, competition is the economic faculty that restrains self-interest."

The Wealth of Nations

Disagreement exists between classical and neoclassical economists about the central message of Smith's most influential work: An Inquiry into the Nature and Causes of the Wealth of Nations (1776). Neoclassical economists emphasize Smith's invisible hand, a concept mentioned in the middle of his work – Book IV, Chapter II – and classical economists believe that Smith stated his programme for promoting the "wealth of nations" in the first sentences, which attributes the growth of wealth and prosperity to the division of labor. 

Smith used the term "the invisible hand" in "History of Astronomy" referring to "the invisible hand of Jupiter", and once in each of his The Theory of Moral Sentiments (1759) and The Wealth of Nations (1776). This last statement about "an invisible hand" has been interpreted in numerous ways. 

Later building on the site where Smith wrote The Wealth of Nations

As every individual, therefore, endeavours as much as he can both to employ his capital in the support of domestic industry, and so to direct that industry that its produce may be of the greatest value; every individual necessarily labours to render the annual revenue of the society as great as he can. He 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 an affectation, indeed, not very common among merchants, and very few words need be employed in dissuading them from it.

Those who regard that statement as Smith's central message also quote frequently Smith's dictum:

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.

The first page of The Wealth of Nations, 1776 London edition

 

Smith's statement about the benefits of "an invisible hand" may be meant to answer Mandeville's contention that "Private Vices ... may be turned into Public Benefits". It shows Smith's belief that when an individual pursues his self-interest under conditions of justice, he unintentionally promotes the good of society. Self-interested competition in the free market, he argued, would tend to benefit society as a whole by keeping prices low, while still building in an incentive for a wide variety of goods and services. Nevertheless, he was wary of businessmen and warned of their "conspiracy against the public or in some other contrivance to raise prices". Again and again, Smith warned of the collusive nature of business interests, which may form cabals or monopolies, fixing the highest price "which can be squeezed out of the buyers". Smith also warned that a business-dominated political system would allow a conspiracy of businesses and industry against consumers, with the former scheming to influence politics and legislation. Smith states that the interest of manufacturers and merchants "in any particular branch of trade or manufactures, is always in some respects different from, and even opposite to, that of the public ... The proposal of any new law or regulation of commerce which comes from this order, ought always to be listened to with great precaution, and ought never be adopted till after having been long and carefully examined, not only with the most scrupulous, but with the most suspicious attention." Thus Smith's chief worry seems to be when business is given special protections or privileges from government; by contrast, in the absence of such special political favors, he believed that business activities were generally beneficial to the whole society:

It is the great multiplication of the production of all the different arts, in consequence of the division of labour, which occasions, in a well-governed society, that universal opulence which extends itself to the lowest ranks of the people. Every workman has a great quantity of his own work to dispose of beyond what he himself has occasion for; and every other workman being exactly in the same situation, he is enabled to exchange a great quantity of his own goods for a great quantity, or, what comes to the same thing, for the price of a great quantity of theirs. He supplies them abundantly with what they have occasion for, and they accommodate him as amply with what he has occasion for, and a general plenty diffuses itself through all the different ranks of society. (The Wealth of Nations, I.i.10)

The neoclassical interest in Smith's statement about "an invisible hand" originates in the possibility of seeing it as a precursor of neoclassical economics and its concept of general equilibrium – Samuelson's "Economics" refers six times to Smith's "invisible hand". To emphasize this connection, Samuelson quotes Smith's "invisible hand" statement substituting "general interest" for "public interest". Samuelson concludes: "Smith was unable to prove the essence of his invisible-hand doctrine. Indeed, until the 1940s, no one knew how to prove, even to state properly, the kernel of truth in this proposition about perfectly competitive market." 

1922 printing of An Inquiry into the Nature and Causes of the Wealth of Nations

 

Very differently, classical economists see in Smith's first sentences his program to promote "The Wealth of Nations". Using the physiocratical concept of the economy as a circular process, to secure growth the inputs of Period 2 must exceed the inputs of Period 1. Therefore, those outputs of Period 1 which are not used or usable as inputs of Period 2 are regarded as unproductive labor, as they do not contribute to growth. This is what Smith had heard in France from, among others, François Quesnay, whose ideas Smith was so impressed by that he might have dedicated The Wealth of Nations to him had he not died beforehand. To this French insight that unproductive labor should be reduced to use labour more productively, Smith added his own proposal, that productive labor should be made even more productive by deepening the division of labor. Smith argued that deepening the division of labour under competition leads to greater productivity, which leads to lower prices and thus an increasing standard of living—"general plenty" and "universal opulence"—for all. Extended markets and increased production lead to the continuous reorganization of production and the invention of new ways of producing, which in turn lead to further increased production, lower prices, and improved standards of living. Smith's central message is, therefore, that under dynamic competition, a growth machine secures "The Wealth of Nations". Smith's argument predicted Britain's evolution as the workshop of the world, underselling and outproducing all its competitors. The opening sentences of the "Wealth of Nations" summarize this policy:

The annual labour of every nation is the fund which originally supplies it with all the necessaries and conveniences of life which it annually consumes ... . [T]his produce ... bears a greater or smaller proportion to the number of those who are to consume it ... .[B]ut this proportion must in every nation be regulated by two different circumstances;

• first, by the skill, dexterity, and judgment with which its labour is generally applied; and,
• secondly, by the proportion between the number of those who are employed in useful labour, and that of those who are not so employed [emphasis added].

However, Smith added that the "abundance or scantiness of this supply too seems to depend more upon the former of those two circumstances than upon the latter."

Criticism and dissent

Alfred Marshall criticized Smith's definition of the economy on several points. He argued that man should be equally important as money, services are as important as goods, and that there must be an emphasis on human welfare, instead of just wealth. The "invisible hand" only works well when both production and consumption operates in free markets, with small ("atomistic") producers and consumers allowing supply and demand to fluctuate and equilibrate. In conditions of monopoly and oligopoly, the "invisible hand" fails. Nobel Prize-winning economist Joseph E. Stiglitz says, on the topic of one of Smith's better-known ideas: "the reason that the invisible hand often seems invisible is that it is often not there."

Other works

Smith's burial place in Canongate Kirkyard

Shortly before his death, Smith had nearly all his manuscripts destroyed. In his last years, he seemed to have been planning two major treatises, one on the theory and history of law and one on the sciences and arts. The posthumously published Essays on Philosophical Subjects, a history of astronomy down to Smith's own era, plus some thoughts on ancient physics and metaphysics, probably contain parts of what would have been the latter treatise. Lectures on Jurisprudence were notes taken from Smith's early lectures, plus an early draft of The Wealth of Nations, published as part of the 1976 Glasgow Edition of the works and correspondence of Smith. Other works, including some published posthumously, include Lectures on Justice, Police, Revenue, and Arms (1763) (first published in 1896); and Essays on Philosophical Subjects (1795).

Legacy

In economics and moral philosophy

The Wealth of Nations was a precursor to the modern academic discipline of economics. In this and other works, Smith expounded how rational self-interest and competition can lead to economic prosperity. Smith was controversial in his own day and his general approach and writing style were often satirised by Tory writers in the moralizing tradition of Hogarth and Swift, as a discussion at the University of Winchester suggests. In 2005, The Wealth of Nations was named among the 100 Best Scottish Books of all time.

In light of the arguments put forward by Smith and other economic theorists in Britain, academic belief in mercantilism began to decline in Britain in the late 18th century. During the Industrial Revolution, Britain embraced free trade and Smith's laissez-faire economics, and via the British Empire, used its power to spread a broadly liberal economic model around the world, characterized by open markets, and relatively barrier-free domestic and international trade.

George Stigler attributes to Smith "the most important substantive proposition in all of economics". It is that, under competition, owners of resources (for example labor, land, and capital) will use them most profitably, resulting in an equal rate of return in equilibrium for all uses, adjusted for apparent differences arising from such factors as training, trust, hardship, and unemployment.

Paul Samuelson finds in Smith's pluralist use of supply and demand as applied to wages, rents, and profit a valid and valuable anticipation of the general equilibrium modelling of Walras a century later. Smith's allowance for wage increases in the short and intermediate term from capital accumulation and invention contrasted with Malthus, Ricardo, and Karl Marx in their propounding a rigid subsistence–wage theory of labor supply.

Joseph Schumpeter criticized Smith for a lack of technical rigor, yet he argued that this enabled Smith's writings to appeal to wider audiences: "His very limitation made for success. Had he been more brilliant, he would not have been taken so seriously. Had he dug more deeply, had he unearthed more recondite truth, had he used more difficult and ingenious methods, he would not have been understood. But he had no such ambitions; in fact he disliked whatever went beyond plain common sense. He never moved above the heads of even the dullest readers. He led them on gently, encouraging them by trivialities and homely observations, making them feel comfortable all along."

Classical economists presented competing theories of those of Smith, termed the "labour theory of value". Later Marxian economics descending from classical economics also use Smith's labor theories, in part. The first volume of Karl Marx's major work, Das Kapital, was published in German in 1867. In it, Marx focused on the labor theory of value and what he considered to be the exploitation of labor by capital. The labor theory of value held that the value of a thing was determined by the labor that went into its production. This contrasts with the modern contention of neoclassical economics, that the value of a thing is determined by what one is willing to give up to obtain the thing. 

The Adam Smith Theatre in Kirkcaldy

 

The body of theory later termed "neoclassical economics" or "marginalism" formed from about 1870 to 1910. The term "economics" was popularised by such neoclassical economists as Alfred Marshall as a concise synonym for "economic science" and a substitute for the earlier, broader term "political economy" used by Smith. This corresponded to the influence on the subject of mathematical methods used in the natural sciences. Neoclassical economics systematized supply and demand as joint determinants of price and quantity in market equilibrium, affecting both the allocation of output and the distribution of income. It dispensed with the labor theory of value of which Smith was most famously identified with in classical economics, in favor of a marginal utility theory of value on the demand side and a more general theory of costs on the supply side.

The bicentennial anniversary of the publication of The Wealth of Nations was celebrated in 1976, resulting in increased interest for The Theory of Moral Sentiments and his other works throughout academia. After 1976, Smith was more likely to be represented as the author of both The Wealth of Nations and The Theory of Moral Sentiments, and thereby as the founder of a moral philosophy and the science of economics. His Homo economicus or "economic man" was also more often represented as a moral person. Additionally, economists David Levy and Sandra Peart in "The Secret History of the Dismal Science" point to his opposition to hierarchy and beliefs in inequality, including racial inequality, and provide additional support for those who point to Smith's opposition to slavery, colonialism, and empire. They show the caricatures of Smith drawn by the opponents of views on hierarchy and inequality in this online article. Emphasized also are Smith's statements of the need for high wages for the poor, and the efforts to keep wages low. In The "Vanity of the Philosopher: From Equality to Hierarchy in Postclassical Economics", Peart and Levy also cite Smith's view that a common street porter was not intellectually inferior to a philosopher, and point to the need for greater appreciation of the public views in discussions of science and other subjects now considered to be technical. They also cite Smith's opposition to the often expressed view that science is superior to common sense.

Smith also explained the relationship between growth of private property and civil government:

Men may live together in society with some tolerable degree of security, though there is no civil magistrate to protect them from the injustice of those passions. But avarice and ambition in the rich, in the poor the hatred of labour and the love of present ease and enjoyment, are the passions which prompt to invade property, passions much more steady in their operation, and much more universal in their influence. Wherever there is great property there is great inequality. For one very rich man there must be at least five hundred poor, and the affluence of the few supposes the indigence of the many. The affluence of the rich excites the indignation of the poor, who are often both driven by want, and prompted by envy, to invade his possessions. It is only under the shelter of the civil magistrate that the owner of that valuable property, which is acquired by the labour of many years, or perhaps of many successive generations, can sleep a single night in security. He is at all times surrounded by unknown enemies, whom, though he never provoked, he can never appease, and from whose injustice he can be protected only by the powerful arm of the civil magistrate continually held up to chastise it. The acquisition of valuable and extensive property, therefore, necessarily requires the establishment of civil government. Where there is no property, or at least none that exceeds the value of two or three days' labour, civil government is not so necessary. Civil government supposes a certain subordination. But as the necessity of civil government gradually grows up with the acquisition of valuable property, so the principal causes which naturally introduce subordination gradually grow up with the growth of that valuable property. (...) Men of inferior wealth combine to defend those of superior wealth in the possession of their property, in order that men of superior wealth may combine to defend them in the possession of theirs. All the inferior shepherds and herdsmen feel that the security of their own herds and flocks depends upon the security of those of the great shepherd or herdsman; that the maintenance of their lesser authority depends upon that of his greater authority, and that upon their subordination to him depends his power of keeping their inferiors in subordination to them. They constitute a sort of little nobility, who feel themselves interested to defend the property and to support the authority of their own little sovereign in order that he may be able to defend their property and to support their authority. Civil government, so far as it is instituted for the security of property, is in reality instituted for the defence of the rich against the poor, or of those who have some property against those who have none at all. (Source: The Wealth of Nations, Book 5, Chapter 1, Part 2)

In British Imperial debates

Smith's chapter on colonies, in turn, would help shape British imperial debates from the mid-19th century onward. The Wealth of Nations would become an ambiguous text regarding the imperial question. In his chapter on colonies, Smith pondered how to solve the crisis developing across the Atlantic among the empire's 13 American colonies. He offered two different proposals for easing tensions. The first proposal called for giving the colonies their independence, and by thus parting on a friendly basis, Britain would be able to develop and maintain a free-trade relationship with them, and possibly even an informal military alliance. Smith's second proposal called for a theoretical imperial federation that would bring the colonies and the metropole closer together through an imperial parliamentary system and imperial free trade.

Smith's most prominent disciple in 19th-century Britain, peace advocate Richard Cobden, preferred the first proposal. Cobden would lead the Anti-Corn Law League in overturning the Corn Laws in 1846, shifting Britain to a policy of free trade and empire "on the cheap" for decades to come. This hands-off approach toward the British Empire would become known as Cobdenism or the Manchester School. By the turn of the century, however, advocates of Smith's second proposal such as Joseph Shield Nicholson would become ever more vocal in opposing Cobdenism, calling instead for imperial federation. As Marc-William Palen notes: "On the one hand, Adam Smith’s late nineteenth and early twentieth-century Cobdenite adherents used his theories to argue for gradual imperial devolution and empire ‘on the cheap’. On the other, various proponents of imperial federation throughout the British World sought to use Smith’s theories to overturn the predominant Cobdenite hands-off imperial approach and instead, with a firm grip, bring the empire closer than ever before." Smith's ideas thus played an important part in subsequent debates over the British Empire.

Portraits, monuments, and banknotes

A statue of Smith in Edinburgh's High Street, erected through private donations organized by the Adam Smith Institute

 

Smith has been commemorated in the UK on banknotes printed by two different banks; his portrait has appeared since 1981 on the £50 notes issued by the Clydesdale Bank in Scotland, and in March 2007 Smith's image also appeared on the new series of £20 notes issued by the Bank of England, making him the first Scotsman to feature on an English banknote.

Statue of Smith built in 1867–1870 at the old headquarters of the University of London, 6 Burlington Gardens

 

A large-scale memorial of Smith by Alexander Stoddart was unveiled on 4 July 2008 in Edinburgh. It is a 10-foot (3.0 m)-tall bronze sculpture and it stands above the Royal Mile outside St Giles' Cathedral in Parliament Square, near the Mercat cross. 20th-century sculptor Jim Sanborn (best known for the Kryptos sculpture at the United States Central Intelligence Agency) has created multiple pieces which feature Smith's work. At Central Connecticut State University is Circulating Capital, a tall cylinder which features an extract from The Wealth of Nations on the lower half, and on the upper half, some of the same text, but represented in binary code. At the University of North Carolina at Charlotte, outside the Belk College of Business Administration, is Adam Smith's Spinning Top. Another Smith sculpture is at Cleveland State University. He also appears as the narrator in the 2013 play The Low Road, centered on a proponent on laissez-faire economics in the late 18th century, but dealing obliquely with the financial crisis of 2007–2008 and the recession which followed; in the premiere production, he was portrayed by Bill Paterson.

A bust of Smith is in the Hall of Heroes of the National Wallace Monument in Stirling.

Residence

Adam Smith resided at Panmure House from 1778 to 1790. This residence has now been purchased by the Edinburgh Business School at Heriot Watt University and fundraising has begun to restore it. Part of the Northern end of the original building appears to have been demolished in the 19th century to make way for an iron foundry.

As a symbol of free-market economics

Adam Smith's Spinning Top, sculpture by Jim Sanborn at Cleveland State University

 

Smith has been celebrated by advocates of free-market policies as the founder of free-market economics, a view reflected in the naming of bodies such as the Adam Smith Institute in London, the Adam Smith Society and the Australian Adam Smith Club, and in terms such as the Adam Smith necktie.

Alan Greenspan argues that, while Smith did not coin the term laissez-faire, "it was left to Adam Smith to identify the more-general set of principles that brought conceptual clarity to the seeming chaos of market transactions". Greenspan continues that The Wealth of Nations was "one of the great achievements in human intellectual history". P.J. O'Rourke describes Smith as the "founder of free market economics".

Other writers have argued that Smith's support for laissez-faire (which in French means leave alone) has been overstated. Herbert Stein wrote that the people who "wear an Adam Smith necktie" do it to "make a statement of their devotion to the idea of free markets and limited government", and that this misrepresents Smith's ideas. Stein writes that Smith "was not pure or doctrinaire about this idea. He viewed government intervention in the market with great skepticism...yet he was prepared to accept or propose qualifications to that policy in the specific cases where he judged that their net effect would be beneficial and would not undermine the basically free character of the system. He did not wear the Adam Smith necktie." In Stein's reading, The Wealth of Nations could justify the Food and Drug Administration, the Consumer Product Safety Commission, mandatory employer health benefits, environmentalism, and "discriminatory taxation to deter improper or luxurious behavior".

Similarly, Vivienne Brown stated in The Economic Journal that in the 20th-century United States, Reaganomics supporters, the Wall Street Journal, and other similar sources have spread among the general public a partial and misleading vision of Smith, portraying him as an "extreme dogmatic defender of laissez-faire capitalism and supply-side economics". In fact, The Wealth of Nations includes the following statement on the payment of taxes:

The subjects of every state ought to contribute towards the support of the government, as nearly as possible, in proportion to their respective abilities; that is, in proportion to the revenue which they respectively enjoy under the protection of the state.

Some commentators have argued that Smith's works show support for a progressive, not flat, income tax and that he specifically named taxes that he thought should be required by the state, among them luxury-goods taxes and tax on rent. Yet Smith argued for the "impossibility of taxing the people, in proportion to their economic revenue, by any capitation" (The Wealth of Nations, V.ii.k.1). Smith argued that taxes should principally go toward protecting "justice" and "certain publick institutions" that were necessary for the benefit of all of society, but that could not be provided by private enterprise (The Wealth of Nations, IV.ix.51). 

Additionally, Smith outlined the proper expenses of the government in The Wealth of Nations, Book V, Ch. I. Included in his requirements of a government is to enforce contracts and provide justice system, grant patents and copy rights, provide public goods such as infrastructure, provide national defence, and regulate banking. The role of the government was to provide goods "of such a nature that the profit could never repay the expense to any individual" such as roads, bridges, canals, and harbours. He also encouraged invention and new ideas through his patent enforcement and support of infant industry monopolies. He supported partial public subsidies for elementary education, and he believed that competition among religious institutions would provide general benefit to the society. In such cases, however, Smith argued for local rather than centralized control: "Even those publick works which are of such a nature that they cannot afford any revenue for maintaining themselves ... are always better maintained by a local or provincial revenue, under the management of a local and provincial administration, than by the general revenue of the state" (Wealth of Nations, V.i.d.18). Finally, he outlined how the government should support the dignity of the monarch or chief magistrate, such that they are equal or above the public in fashion. He even states that monarchs should be provided for in a greater fashion than magistrates of a republic because "we naturally expect more splendor in the court of a king than in the mansion-house of a doge". In addition, he allowed that in some specific circumstances, retaliatory tariffs may be beneficial:

The recovery of a great foreign market will generally more than compensate the transitory inconvenience of paying dearer during a short time for some sorts of goods.

However, he added that in general, a retaliatory tariff "seems a bad method of compensating the injury done to certain classes of our people, to do another injury ourselves, not only to those classes, but to almost all the other classes of them" (The Wealth of Nations, IV.ii.39).

Economic historians such as Jacob Viner regard Smith as a strong advocate of free markets and limited government (what Smith called "natural liberty"), but not as a dogmatic supporter of laissez-faire.

Economist Daniel Klein believes using the term "free-market economics" or "free-market economist" to identify the ideas of Smith is too general and slightly misleading. Klein offers six characteristics central to the identity of Smith's economic thought and argues that a new name is needed to give a more accurate depiction of the "Smithian" identity. Economist David Ricardo set straight some of the misunderstandings about Smith's thoughts on free market. Most people still fall victim to the thinking that Smith was a free-market economist without exception, though he was not. Ricardo pointed out that Smith was in support of helping infant industries. Smith believed that the government should subsidise newly formed industry, but he did fear that when the infant industry grew into adulthood, it would be unwilling to surrender the government help. Smith also supported tariffs on imported goods to counteract an internal tax on the same good. Smith also fell to pressure in supporting some tariffs in support for national defense.

Some have also claimed, Emma Rothschild among them, that Smith would have supported a minimum wage, although no direct textual evidence supports the claim. Indeed, Smith wrote:

The price of labour, it must be observed, cannot be ascertained very accurately anywhere, different prices being often paid at the same place and for the same sort of labour, not only according to the different abilities of the workmen, but according to the easiness or hardness of the masters. Where wages are not regulated by law, all that we can pretend to determine is what are the most usual; and experience seems to show that law can never regulate them properly, though it has often pretended to do so. (The Wealth of Nations, Book 1, Chapter 8)

However, Smith also noted, to the contrary, the existence of an imbalanced, inequality of bargaining power:

A landlord, a farmer, a master manufacturer, a merchant, though they did not employ a single workman, could generally live a year or two upon the stocks which they have already acquired. Many workmen could not subsist a week, few could subsist a month, and scarce any a year without employment. In the long run, the workman may be as necessary to his master as his master is to him, but the necessity is not so immediate.

Public good

From Wikipedia, the free encyclopedia

In economics, a public good is a good that is both non-excludable and non-rivalrous in that individuals cannot be effectively excluded from use and where use by one individual does not reduce availability to others. This is in contrast to a common good which is non-excludable but is rivalrous to a certain degree. 

Public goods include knowledge, official statistics, national security, common language(s), flood control systems, lighthouses, and street lighting. Public goods that are available everywhere are sometimes referred to as global public goods. There is an important conceptual difference between the sense of "a" public good, or public "goods" in economics, and the more generalized idea of "the public good" (or common good, or public interest), "a shorthand signal for shared benefit at a societal level".

Many public goods may at times be subject to excessive use resulting in negative externalities affecting all users; for example air pollution and traffic congestion. Public goods problems are often closely related to the "free-rider" problem, in which people not paying for the good may continue to access it. Thus, the good may be under-produced, overused or degraded. Public goods may also become subject to restrictions on access and may then be considered to be club goods or private goods; exclusion mechanisms include copyright, patents, congestion pricing, and pay television.

There is a good deal of debate and literature on how to measure the significance of public goods problems in an economy, and to identify the best remedies.

In a non-economic sense, the term is often used to describe something that is useful for the public generally, such as education and infrastructure, although these are not "public goods" in the economic sense.

Terminology, and types of goods

Paul A. Samuelson is usually credited as the first economist to develop the theory of public goods. In his classic 1954 paper The Pure Theory of Public Expenditure, he defined a public good, or as he called it in the paper a "collective consumption good", as follows:

[goods] which all enjoy in common in the sense that each individual's consumption of such a good leads to no subtractions from any other individual's consumption of that good...

This is the property that has become known as non-rivalry. A pure public good exhibits a second property called non-excludability: that is, it is impossible to exclude any individuals from consuming the good. 

However, many goods may satisfy the two public good conditions (non-rivalry and non-excludability) only to a certain extent or only some of the time. These goods are known as impure public goods.

The opposite of a public good is a private good, which does not possess these properties. A loaf of bread, for example, is a private good; its owner can exclude others from using it, and once it has been consumed, it cannot be used again.

A good that is rivalrous but non-excludable is sometimes called a common-pool resource. Such goods raise similar issues to public goods: the mirror to the public goods problem for this case is the 'tragedy of the commons'. For example, it is so difficult to enforce restrictions on deep-sea fishing that the world's fish stocks can be seen as a non-excludable resource, but one which is finite and diminishing.

Definition matrix

	Excludable	Non-excludable
Rivalrous	Private goods food, clothing, cars, parking spaces	Common-pool resources fish stocks, timber, coal
Non-rivalrous	Club goods cinemas, private parks, satellite television	Public goods free-to-air television, air, national defense

Elinor Ostrom proposed additional modifications to the classification of goods to identify fundamental differences that affect the incentives facing individuals (1) Replacing the term "rivalry of consumption" with "subtractability of use". (2) Conceptualizing subtractability of use and excludability to vary from low to high rather than characterizing them as either present or absent. (3) Overtly adding a very important fourth type of good—common-pool resources—that shares the attribute of subtractability with private goods and difficulty of exclusion with public goods. Forests, water systems, fisheries, and the global atmosphere are all common-pool resources of immense importance for the survival of humans on this earth. (4) Changing the name of a "club" good to a "toll" good since many goods that share these characteristics are provided by small scale public as well as private associations.

Challenges in identifying public goods

The definition of non-excludability states that it is impossible to exclude individuals from consumption. Technology now allows radio or TV broadcasts to be encrypted such that persons without a special decoder are excluded from the broadcast. Many forms of information goods have characteristics of public goods. For example, a poem can be read by many people without reducing the consumption of that good by others; in this sense, it is non-rivalrous. Similarly, the information in most patents can be used by any party without reducing consumption of that good by others. Official statistics provide a clear example of information goods that are public goods, since they are created to be non-excludable. Creative works may be excludable in some circumstances, however: the individual who wrote the poem may decline to share it with others by not publishing it. Copyrights and patents both encourage the creation of such non-rival goods by providing temporary monopolies, or, in the terminology of public goods, providing a legal mechanism to enforce excludability for a limited period of time. For public goods, the "lost revenue" of the producer of the good is not part of the definition: a public good is a good whose consumption does not reduce any other's consumption of that good.

Debate has been generated among economists whether such a category of "public goods" exists. Steven Shavell has suggested the following:

...when professional economists talk about public goods they do not mean that there are a general category of goods that share the same economic characteristics, manifest the same dysfunctions, and that may thus benefit from pretty similar corrective solutions...there is merely an infinite series of particular problems (some of overproduction, some of underproduction, and so on), each with a particular solution that cannot be deduced from the theory, but that instead would depend on local empirical factors.

Common confusion is that public goods are goods provided by the public sector. Although it is often the case that government is involved in producing public goods, this is not necessarily the case. Public goods may be naturally available. They may be produced by private individuals and firms, by non-state collective action, or they may not be produced at all.

The theoretical concept of public goods does not distinguish with regard to the geographical region in which a good may be produced or consumed. However, some theorists such as Inge Kaul use the term "global public good" for public goods which is non-rival and non-excludable throughout the whole world, as opposed to a public good which exists in just one national area. Knowledge has been held to be an example of a global public good, but also as a commons, the knowledge commons.

Aggregate demand (ΣMB) is the sum of individual demands (MBi)

 

Graphically, non-rivalry means that if each of several individuals has a demand curve for a public good, then the individual demand curves are summed vertically to get the aggregate demand curve for the public good. This is in contrast to the procedure for deriving the aggregate demand for a private good, where individual demands are summed horizontally.

Social goods

Social goods are defined as public goods that could be delivered as private goods, but are usually delivered by the government for various reasons, including social policy, and funded via public funds like taxes. Note that some writers have used the term "public good" to refer only to non-excludable "pure public goods" and refer to excludable public goods as "club goods".

Examples

Common examples of public goods include: defense, public fireworks, lighthouses, clean air and other environmental goods, and information goods, such as official statistics, software development, authorship, and invention. Some goods, like orphan drugs, require special governmental incentives to be produced, but cannot be classified as public goods since they do not fulfill the above requirements (non-excludable and non-rivalrous.) Law enforcement, streets, libraries, museums, and education are commonly misclassified as public goods, but they are technically classified in economic terms as quasi-public goods because excludability is possible, but they do still fit some of the characteristics of public goods.

The provision of a lighthouse is a standard example of a public good, since it is difficult to exclude ships from using its services. No ship's use detracts from that of others, but since most of the benefit of a lighthouse accrues to ships using particular ports, lighthouse maintenance can be profitably bundled with port fees (Ronald Coase, The Lighthouse in Economics 1974). This has been sufficient to fund actual lighthouses. 

Technological progress can create new public goods. The most simple examples are street lights, which are relatively recent inventions (by historical standards). One person's enjoyment of them does not detract from other persons' enjoyment, and it currently would be prohibitively expensive to charge individuals separately for the amount of light they presumably use. Official statistics are another example. The government's ability to collect, process and provide high-quality information to guide decision-making at all levels has been strongly advanced by technological progress. On the other hand, a public good's status may change over time. Technological progress can significantly impact excludability of traditional public goods: encryption allows broadcasters to sell individual access to their programming. The costs for electronic road pricing have fallen dramatically, paving the way for detailed billing based on actual use. 

Some question whether defense is a public good. Murray Rothbard argues:

'national defense' is surely not an absolute good with only one unit of supply. It consists of specific resources committed in certain definite and concrete ways—and these resources are necessarily scarce. A ring of defense bases around New York, for example, cuts down the amount possibly available around San Francisco.

Jeffrey Rogers Hummel and Don Lavoie note,

Americans in Alaska and Hawaii could very easily be excluded from the U.S. government's defense perimeter, and doing so might enhance the military value of at least conventional U.S. forces to Americans in the other forty-eight states. But, in general, an additional ICBM in the U.S. arsenal can simultaneously protect everyone within the country without diminishing its services.

Public goods are not restricted to human beings. It is one aspect of the study of cooperation in biology.

Free rider problem

Public goods provide a very important example of market failure, in which market-like behavior of individual gain-seeking does not produce efficient results. The production of public goods results in positive externalities which are not remunerated. If private organizations do not reap all the benefits of a public good which they have produced, their incentives to produce it voluntarily might be insufficient. Consumers can take advantage of public goods without contributing sufficiently to their creation. This is called the free rider problem, or occasionally, the "easy rider problem" (because consumers' contributions will be small but non-zero). If too many consumers decide to "free-ride", private costs exceed private benefits and the incentive to provide the good or service through the market disappears. The market thus fails to provide a good or service for which there is a need.

The free rider problem depends on a conception of the human being as homo economicus: purely rational and also purely selfish—extremely individualistic, considering only those benefits and costs that directly affect him or her. Public goods give such a person an incentive to be a free rider.

For example, consider national defense, a standard example of a pure public good. Suppose homo economicus thinks about exerting some extra effort to defend the nation. The benefits to the individual of this effort would be very low, since the benefits would be distributed among all of the millions of other people in the country. There is also a very high possibility that he or she could get injured or killed during the course of his or her military service.

On the other hand, the free rider knows that he or she cannot be excluded from the benefits of national defense, regardless of whether he or she contributes to it. There is also no way that these benefits can be split up and distributed as individual parcels to people. The free rider would not voluntarily exert any extra effort, unless there is some inherent pleasure or material reward for doing so (for example, money paid by the government, as with an all-volunteer army or mercenaries). The free-riding problem is even more complicated than it was thought to be until recently. Any time non-excludability results in failure to pay the true marginal value (often called the "demand revelation problem"), it will also result in failure to generate proper income levels, since households will not give up valuable leisure if they cannot individually increment a good. This implies that, for public goods without strong special interest support, under-provision is likely since benefit-cost analyses are being conducted at the wrong income levels, and all of the ungenerated income would have been spent on the public good, apart from general equilibrium considerations.

In the case of information goods, an inventor of a new product may benefit all of society, but hardly anyone is willing to pay for the invention if they can benefit from it for free. In the case of an information good, however, because of its characteristics of non-excludability and also because of almost zero reproduction costs, commoditization is difficult and not always efficient even from a neoclassical economic point of view.

Economic and political solutions

Assurance contracts

An assurance contract is a contract in which participants make a binding pledge to contribute to building a public good, contingent on a quorum of a predetermined size being reached. Otherwise the good is not provided and any monetary contributions are refunded. 

A dominant assurance contract is a variation in which an entrepreneur creates the contract and refunds the initial pledge plus an additional sum of money if the quorum is not reached. (The entrepreneur profits by collecting a fee if the quorum is reached and the good is provided.) In game-theoretic terms this makes pledging to build the public good a dominant strategy: the best move is to pledge to the contract regardless of the actions of others. 

Coasian solution

A Coasian solution, named for the economist Ronald Coase, proposes that potential beneficiaries of a public good can negotiate to pool their resources and create it, based on each party's self-interested willingness to pay. His treatise, "The Problem of Social Cost" (1960), argued that if the transaction costs between potential beneficiaries of a public good are low—that it is easy for potential beneficiaries to find each other and organize a pooling their resources based upon the good's value to each of them—that public goods could be produced without government action.

Much later, Coase himself wrote that while what had become known as the Coase Theorem had explored the implications of zero transaction costs, he had actually intended to use this construct as a stepping-stone to understand the real world of positive transaction costs, corporations, legal systems and government actions:

I examined what would happen in a world in which transaction costs were assumed to be zero. My aim in doing so was not to describe what life would be like in such a world but to provide a simple setting in which to develop the analysis and, what was even more important, to make clear the fundamental role which transaction costs do, and should, play in the fashioning of the institutions which make up the economic system.

Coase also wrote:

The world of zero transaction costs has often been described as a Coasian world. Nothing could be further from the truth. It is the world of modern economic theory, one which I was hoping to persuade economists to leave. What I did in "The Problem of Social Cost" was simply to shed light on some of its properties. I argued in such a world the allocation of resources would be independent of the legal position, a result which Stigler dubbed the "Coase theorem".

Thus, while Coase himself appears to have considered the "Coase theorem" and Coasian solutions as simplified constructs to ultimately consider the real 20th-century world of governments and laws and corporations, these concepts have become attached to a world where transaction costs were much lower, and government intervention would unquestionably be less necessary. 

A minor alternative, especially for information goods, is for the producer to refuse to release a good to the public until payment to cover costs is met. Author Stephen King, for instance, authored chapters of a new novel downloadable for free on his website while stating that he would not release subsequent chapters unless a certain amount of money was raised. Sometimes dubbed holding for ransom, this method of public goods production is a modern application of the street performer protocol for public goods production. Unlike assurance contracts, its success relies largely on social norms to ensure (to some extent) that the threshold is reached and partial contributions are not wasted. 

One of the purest Coasian solutions today is the new phenomenon of Internet crowdfunding. Here rules are enforced by computer algorithms and legal contracts as well as social pressure. For example, on the Kickstarter site, each funder authorizes a credit card purchase to buy a new product or receive other promised benefits, but no money changes hands until the funding goal is met. Because automation and the Internet so reduce the transaction costs for pooling resources, project goals of only a few hundred dollars are frequently crowdfunded, far below the costs of soliciting traditional investors.

Government provision

If voluntary provision of public goods will not work, then the solution is making their provision involuntary. This saves each of us from our own tendency to be a free rider, while also assuring us that no one else will be allowed to free ride. One frequently proposed solution to the problem is for governments or states to impose taxation to fund the production of public goods. This does not actually solve the theoretical problem because good government is itself a public good. Thus it is difficult to ensure the government has an incentive to provide the optimum amount even if it were possible for the government to determine precisely what amount would be optimum. These issues are studied by public choice theory and public finance. 

Sometimes the government provides public goods using "unfunded mandates". An example is the requirement that every car be fit with a catalytic converter. This may be executed in the private sector, but the end result is predetermined by the state: the individually involuntary provision of the public good clean air. Unfunded mandates have also been imposed by the U.S. federal government on the state and local governments, as with the Americans with Disabilities Act, for example.

Regardless, some argue that the role of the government is to provide vital goods to all individuals, some of which they cannot obtain privately. In order to ensure that government services are properly funded taxes are imposed. Although enforced taxes deter the free-rider problem, many contend that some goods should be excluded and provided privately. However, this is not possible with all goods such as pure public goods that are inseparable and inclusive, thus arguably requiring "provision by public means".

Subsidies and joint products

A government may subsidize production of a public good in the private sector. Unlike government provision, subsidies may result in some form of a competitive market. The potential for cronyism (for example, an alliance between political insiders and the businesses receiving subsidies) can be limited with secret bidding for the subsidies or application of the subsidies following clear general principles. Depending on the nature of a public good and a related subsidy, principal–agent problems can arise between the citizens and the government or between the government and the subsidized producers; this effect and counter-measures taken to address it can diminish the benefits of the subsidy.

Subsidies can also be used in areas with a potential for non-individualism: For instance, a state may subsidize devices to reduce air pollution and appeal to citizens to cover the remaining costs.

Similarly, a joint-product model analyzes the collaborative effect of joining a private good to a public good. For example, a tax deduction (private good) can be tied to a donation to a charity (public good). It can be shown that the provision of the public good increases when tied to the private good, as long as the private good is provided by a monopoly (otherwise the private good would be provided by competitors without the link to the public good).

Privileged group

The study of collective action shows that public goods are still produced when one individual benefits more from the public good than it costs him to produce it; examples include benefits from individual use, intrinsic motivation to produce, and business models based on selling complement goods. A group that contains such individuals is called a privileged group. A historical example could be a downtown entrepreneur who erects a street light in front of his shop to attract customers; even though there are positive external benefits to neighboring nonpaying businesses, the added customers to the paying shop provide enough revenue to cover the costs of the street light.

The existence of privileged groups may not be a complete solution to the free rider problem, however, as underproduction of the public good may still result. The street light builder, for instance, would not consider the added benefit to neighboring businesses when determining whether to erect his street light, making it possible that the street light isn't built when the cost of building is too high for the single entrepreneur even when the total benefit to all the businesses combined exceeds the cost.

An example of the privileged group solution could be the Linux community, assuming that users derive more benefit from contributing than it costs them to do it. For more discussion on this topic see also Coase's Penguin. 

Another example is those musicians and writers who create music and writings for their own personal enjoyment, and publish because they enjoy having an audience. Financial incentives are not necessary to ensure the creation of these public goods. Whether this creates the correct production level of writings and music is an open question.

Merging free riders

Another method of overcoming the free rider problem is to simply eliminate the profit incentive for free riding by buying out all the potential free riders. A property developer that owned an entire city street, for instance, would not need to worry about free riders when erecting street lights since he owns every business that could benefit from the street light without paying. Implicitly, then, the property developer would erect street lights until the marginal social benefit met the marginal social cost. In this case, they are equivalent to the private marginal benefits and costs.

While the purchase of all potential free riders may solve the problem of underproduction due to free riders in smaller markets, it may simultaneously introduce the problem of underproduction due to monopoly. Additionally, some markets are simply too large to make a buyout of all beneficiaries feasible—this is particularly visible with public goods that affect everyone in a country.

Introducing an exclusion mechanism (club goods)

Another solution, which has evolved for information goods, is to introduce exclusion mechanisms which turn public goods into club goods. One well-known example is copyright and patent laws. These laws, which in the 20th century came to be called intellectual property laws, attempt to remove the natural non-excludability by prohibiting reproduction of the good. Although they can address the free rider problem, the downside of these laws is that they imply private monopoly power and thus are not Pareto-optimal. 

For example, in the United States, the patent rights given to pharmaceutical companies encourage them to charge high prices (above marginal cost) and to advertise to convince patients to persuade their doctors to prescribe the drugs. Likewise, copyright provides an incentive for a publisher to act like The Dog in the Manger, taking older works out of print so as not to cannibalize revenue from the publisher's own new works.

The laws also end up encouraging patent and copyright owners to sue even mild imitators in court and to lobby for the extension of the term of the exclusive rights in a form of rent seeking.

These problems with the club-good mechanism arise because the underlying marginal cost of giving the good to more people is low or zero, but, because of the limits of price discrimination those who are unwilling or unable to pay a profit-maximizing price do not gain access to the good.

If the costs of the exclusion mechanism are not higher than the gain from the collaboration, club goods can emerge naturally. James M. Buchanan showed in his seminal paper that clubs can be an efficient alternative to government interventions.

On the other hand, the inefficiencies and inequities of club goods exclusions sometimes cause potentially excludable club goods to be treated as public goods, and their production financed by some other mechanism. Examples of such "natural" club goods include natural monopolies with very high fixed costs, private golf courses, cinemas, cable television and social clubs. This explains why many such goods are often provided or subsidized by governments, co-operatives or volunteer associations, rather than being left to be supplied by profit-minded entrepreneurs. These goods are often known as social goods.

Joseph Schumpeter claimed that the "excess profits", or profits over normal profit, generated by the copyright or patent monopoly will attract competitors that will make technological innovations and thereby end the monopoly. This is a continual process referred to as "Schumpeterian creative destruction", and its applicability to different types of public goods is a source of some controversy. The supporters of the theory point to the case of Microsoft, for example, which has been increasing its prices (or lowering its products' quality), predicting that these practices will make increased market shares for Linux and Apple largely inevitable.

A nation can be seen as a club whose members are its citizens. Government would then be the manager of this club. This is further studied in the Theory of the State.

Altruistic solutions

Social norms

When enough people do not think like free-riders, the private and voluntary provision of public goods may be successful. For example, a free rider might come to a public park to enjoy its beauty, yet discard litter that makes it less enjoyable for others. Other public-spirited individuals don't do this and might even pick up existing litter. Reasons for the act could be that the person derives pleasure from helping their community, feels ashamed if their neighbors or friends saw them, or could be emotionally attached to the public good. People unconsciously adapt their behavior to that of their peers; this is conformity. Even people who engaged in free-riding by littering elsewhere are less likely to if they see others hold on to their trash.

Social norms can be observed wherever people interact, not only in physical spaces but in virtual communities on the Internet. For example, if a disabled person boards a crowded bus, everyone expects that some able-bodied person will volunteer their seat. The same social norm, although executed in a different environment, can also be applied to the Internet. If a user enters a discussion in a chat room and continues to use all capital letters or to make personal attacks ("flames") when addressing other users, the culprit may realize he or she has been blocked by other participants. As in real life, users learning to adapt to the social norms of cyberspace communities provide a public good—here, not suffering disruptive online behavior—for all the participants.

Social sanctions (punishment)

Experimental literature suggests that free riding can be overcome without any state intervention. Peer-to-peer punishment, that is, members sanction those members that do not contribute to the public good at a cost, is sufficient to establish and maintain cooperation. Such punishment is often considered altruistic, because it comes at a cost to the punisher, however, the exact nature remains to be explored. Whether costly punishment can explain cooperation is disputed. Recent research finds that costly punishment is less effective in real world environments. For example, punishment works relatively badly under imperfect information, where people cannot observe the behavior of other perfectly.

Voluntary organizations

Organizations such as the Red Cross, public radio and television or a volunteer fire department provide public goods to the majority at the expense of a minority who voluntarily participate or contribute funds. Contributions to online collaborative media like Wikipedia and other wiki projects, and free software projects such as Linux are another example of relatively few contributors providing a public good (information) freely to all readers or software users. 

Proposed explanations for altruistic behavior include biological altruism and reciprocal altruism. For example, voluntary groups such as labor unions and charities often have a federated structure, probably in part because voluntary collaboration emerges more readily in smaller social groups than in large ones (e.g., see Dunbar's number). 

While both biological and reciprocal altruism are observed in other animals, our species' complex social behaviors take these raw materials much farther. Philanthropy by wealthy individuals—some, such as Andrew Carnegie giving away their entire vast fortunes—have historically provided a multitude of public goods for others. One major impact was the Rockefeller Foundation's development of the "Green Revolution" hybrid grains that probably saved many millions of people from starvation in the 1970s. Christian missionaries, who typically spend large parts of their lives in remote, often dangerous places, have had disproportionate impact compared with their numbers worldwide for centuries. Communist revolutionaries in the 20th century had similar dedication and outsized impacts. International relief organizations such as Doctors Without Borders, Save the Children and Amnesty International have benefited millions, while also occasionally costing workers their lives. For better and for worse, humans can conceive of, and sacrifice for, an almost infinite variety of causes in addition to their biological kin.

Religions and ideologies

"The noblest motive is the public good." Thomas Jefferson Building, Library of Congress.

 

Voluntary altruistic organizations often motivate their members by encouraging deep-seated personal beliefs, whether religious or other (such as social justice or environmentalism) that are taken "on faith" more than proved by rational argument. When individuals resist temptations to free riding (e.g., stealing) because they hold these beliefs (or because they fear the disapproval of others who do), they provide others with public goods that might be difficult or impossible to "produce" by administrative coercion alone. 

One proposed explanation for the ubiquity of religious belief in human societies is multi-level selection: altruists often lose out within groups, but groups with more altruists win. A group whose members believe a "practical reality" that motivates altruistic behavior may out-compete other groups whose members' perception of "factual reality" causes them to behave selfishly. A classic example is a soldier's willingness to fight for his tribe or country. Another example given in evolutionary biologist David Sloan Wilson's Darwin's Cathedral is the early Christian church under the late Roman Empire; because Roman society was highly individualistic, during frequent epidemics many of the sick died not of the diseases per se but for lack of basic nursing. Christians, who believed in an afterlife, were willing to nurse the sick despite the risks. Although the death rate among the nurses was high, the average Christian had a much better chance of surviving an epidemic than other Romans did, and the community prospered.

Religious and non-religious traditions and ideologies (such as nationalism and patriotism) are in full view when a society is in crisis and public goods such as defense are most needed. Wartime leaders invoke their God's protection and claim that their society's most hallowed traditions are at stake. For example, according to President Abraham Lincoln's Gettysburg Address during the American Civil War, the Union was fighting so "that government of the people, by the people, for the people, shall not perish from the earth". Such voluntary, if exaggerated, exhortations complement forcible measures—taxation and conscription—to motivate people to make sacrifices for their cause.

Efficient production levels of public goods

The Pareto optimum provision of a public good in a society is where the combined sum of the marginal rate of substitution between private goods and a given public good of all individuals is equal to the marginal rate of transformation. This contrasts to the Pareto optimality condition of private goods, in which each consumers' marginal rate of substitution is equal; as is the societies marginal rate of transformation.

An example is a community of just two consumers and the government is considering whether or not to build a public park. One person is prepared to pay up to $200 for its use, while the other is willing to pay up to $100. The total value to the two individuals of having the park is $300. If it can be produced for $225, there is a $75 gain on its production since it provides services that the community values at $300 at a cost of only $225.

Regardless of the method of providing public goods, the efficient level of such provision is still being subjected to economic analysis. For instance, the Samuelson condition calculates the efficient level of public goods production to be where the ratio of the marginal social cost of public and private goods production equals the ratio of the marginal social benefit of public and private goods production.

Ownership

An important question regarding public goods is whether they should be owned by the public or the private sector. Economic theorists such as Hart (1995) argue that ownership matters for investment incentives when contracts are incomplete. The incomplete contracting paradigm has been applied to public goods by Besley and Ghatak (2001). They consider the government and a non-governmental organization (NGO) who can both make investments to provide a public good. Besley and Ghatak show that the party who has a larger valuation for the public good should be the owner, regardless of whether the government or the NGO has a better investment technology. This result contrasts with the case of private goods studied by Hart (1995), where the party with the better investment technology should be the owner. However, more recently it has been shown that the investment technology matters also in the public-good case when a party is indispensable or when there are bargaining frictions between the government and the NGO.