Exceptions to Liberty in Adam Smith’s Works

As far as these duties go, Smith sounds pretty laissez-​faire, although how we define public works could open the door to many different kinds of government intervention.

But the real difficulty in holding Smith up as an ardent defender of free markets and a staunch opponent of government intervention comes from the many additional exceptions to liberty sprinkled throughout his works. What are Smith’s famous exceptions to the “natural system of perfect liberty?” The list is indeed long if you scour his 1500 pages of published work and count any deviation, however minor or qualified. But for our purposes I will discuss a few of the most popular, in the areas of banking (and money lending) and education.

Smith plainly supported three restrictions of liberty in banking and money lending. First, he supported a ban on the issuance of small-​denomination banknotes. He reasoned that conmen could defraud the poor because they are less informed about, and less likely to check the legitimacy of, small-​denomination banknotes. The further problem he claims to avoid by this prohibition is a general deterioration of confidence of banknotes. Since banknotes greatly facilitated commerce, losing their respectability would harm the economy. Smith also expressed the concern that with small-​denomination notes, more gold and silver currency would be collected into bank vaults, thereby making society more prone to an invading force seeking to seize the treasure held in the bank vaults.

A second related restriction on banking was the ban on option-​clause banknotes. At one point in Scottish history, banks issued bank notes that gave the bank the option of postponing redemption of the banknote for currency (usually gold or silver) for a certain period of time. The option-​clause was useful for the banks because it prevented panic-​driven bank-​runs. In return for the postponement, the bearer of the banknote would receive a high rate of interest on the banknote until he could redeem it.

Smith’s third banking restriction was supporting bans on usury. Smith’s story of why interest rates should be capped bears some likeness to idea in Joseph Stiglitz and Andrew Weiss’s model of credit rationing. The idea, in a nutshell, is that higher interest rates will deter less risky borrowers with projects of modest return and attract more risky borrowers with projects of possibly higher returns. Of course, one might question the information assumptions underlying the story. But, more importantly, the Stiglitz and Weiss model does not justify the government imposition of caps on interest rates; it simply offers an explanation for why private lenders might refrain from lending at higher rates, and in that sense “ration” credit.

Smith defends all of these legal restrictions on public welfare grounds. Personally, I disagree with Smith’s advocacy of these restrictions primarily because I find his arguments about their benefits to be weak. Lawrence H. White, for example, has documented how the use of the option-​clause banknotes seemed to work very well in preventing bank runs and in satisfying customer demands for banknotes. Jeremy Bentham, in a ringing critique of Smith’s position on usury, argues that no one is in a better position than the bankers in determining who should receive loans. Furthermore, it is primarily through the risks and inventiveness of speculators and projectors that society advances. Smith may have defended these restrictions because they were all part of the status quo, rather than because he found his arguments really compelling.

Smith also deviates from a system of perfect liberty in the realm of education. Although, his views on education are long, ambiguous, and even slightly contradictory, his criticism of the stultifying effects of the division of labor is not:

Smith talks about education as a way to ameliorate the worst effects of the division of labor. He suggests that all children can be taught to “read, write, and account” at relatively little expense. He recommends that every parish should have its own school subsidized through taxes. His expansive language about universal literacy, and his advocacy of government funding, has led many Left Smithians to think that he would advocate compulsory schooling, full state-​funding of schooling, and a large infrastructure of state-​produced schooling.

But Smith is careful in his language and qualifies this exception-​-​even to the point of partially repudiating it. Smith emphasizes that any government funding should come from local taxation, not national revenues, because there is greater accountability and better moral judgment. No justification for a Department or Ministry of Education can be found here. Smith also says that even the poor should pay fees to send their children to school. Not only that, he suggests that the pay of the teachers should in “principal” part come from the voluntary payments of the customers, because teachers need to be held accountable for the teaching they deliver. Finally, Smith summarized his discussion of education by saying:

If education can be delivered privately with equal propriety and some advantage, why did he mention the local-​tax subsidy earlier?

An important evidence of Smith’s presumption of liberty in these cases is his hedging. He is careful to qualify his exceptions, sometimes in great detail. In the matter of small-​denomination notes, Smith explicitly acknowledges that the exception violates liberty. But he claims the benefits are so great that the exception is warranted. Still, one gets the sense that Smith may not have been very comfortable with some of his exceptions, such as with public funding of education.

Smith was sometimes cautious in proposing changes to the status quo. He sometimes seems to be bargaining, trying to persuade people by degrees rather than simply battering them into submission. Dupont de Nemours explains in a letter to Smith how he dampened his laissez-​faire views because he was afraid that “assaulting” people’s eyes “with a bright light” of liberty “would reconstitute their blindness.” Smith likely held a similar sentiment. He wanted to encourage people to learn from his ideas, not reject them outright because of their extremity.