Adam Smith's Error
How a Scottish philosopher's half-truth became the operating system of the modern world — explained, in part, by a nursery rhyme.
The original (Spanish) version of this article can be found here.
In a joke you have probably heard before, two men who grew up together in East Germany meet again, years later, after the fall of the Berlin Wall:
“Wolfgang,” goes one, “do you realize everything we were told about socialism was a lie?”
“I do, Hans, I do. But that’s not the worst part, you know?” quips the other. “The worst part is that everything we were told about capitalism was true”.
And that’s pretty much what happened. For half a century, the world fought an existential battle between two competing visions of society. But the moment it was over, almost forty years ago, we took the winner's account as read: we assumed that everything we had been told about capitalism—the good and the bad alike—was true.
But what if it wasn’t? What if our understanding of the economy was rooted in a lie as well? No, I don’t mean the kind of lie that Bernie Sanders or Jean-Luc Mélenchon would have in mind —one about injustice and rigged rules. I mean a lie in the way creationism was a lie, or the belief that the Sun orbited the Earth was a lie. What if we were wrong about the fundamental mechanisms that drive human exchange?
Well, that would, for a start, make quite a lot of sense. At 250 years old, the governing principles of economics form the longest-standing foundational model in modern science. They were formulated barely 90 years after Newton’s Principia, long before we understood that heat is energy, not a substance, or that infections are caused by microbes. Our contemporary model of economics predates Darwin’s theory of evolution by almost a century and Einstein’s relativity by 130 years. If anything should be shocking, it is that it has survived unchallenged this long.
On top of that, a fault line running through our understanding of economics would explain a great deal about the malaise now settling over the West. Socialist regimes didn’t fall because they were unjust —unfair and brutal systems can last centuries. They collapsed because they were untrue: because they didn’t work. Reality refused to behave the way the doctrine said it would, and people could no longer live inside that story.
Isn't that precisely what is happening in the West today? Increasingly, we face a reality that does not work the way we were told it would. The virtues we so carefully cultivated—effort, persistence, excellence, sacrifice—have stopped paying out. A person today can be their most disciplined, hardest-working self and still slide below the standing of their parents. Something, clearly, is not working. Confused, many people have surrendered to the idea that we are being scammed—by woke elites, by billionaires, by tech bros, take your pick. But there is a simpler explanation: something in the way we understand the economy—and society, and human nature itself—is simply wrong.
So what would that be?
This is the first of a five-part summer series about a birth defect in our conception of society. A myth that has seeped from economics through culture, morals and politics until it has taken over our private lives and now governs how we raise our children, how we choose a partner, how we measure a life—and our own worth.
Every Tuesday through August, I’ll send out one episode, under these —I hope— irresistible headlines:
1. Adam Smith’s Error
2. On Productivity and Desire
3. The Undesired
4. What Is Wealth?
5. Intuitions for a Knowledge Theory of Value
I get all of this might sound like a huge lot of economics, but it isn’t. This series aims to be so practical it reads almost like a guide. Its goal is to give you the knowledge you need to understand our modern crazy world. If I succeed, you will finish these essays transformed: seeing the world in a different light, making better decisions about your future, perhaps even understanding yourself a little better.
It all begins with a simple question. One that, for all its apparent urgency, we have never quite managed to answer:
What exactly is “wealth”?
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Adam Smith’s Error
So—what is wealth?
It surely is a very hot topic. Newspapers arrive full of stories about it: wealth inequality is rising, wealth concentration has hit an all-time high, the wealthy are wealth’ing and many people think wealth should be redistributed. The stock market rally is not a bubble, it is a wave of “generational wealth” and social media is full of people eager to teach you how to ride it.
Wealth is also a defining feature of our time: in the past 25 years, we’ve been told, it has skirocketed. It has grown faster than at any other time in history until it doubled what it was in 2000.
And yet, what is that wealth made of? What is the actual substance that is growing so rapidly? If we listen to the analysts, two-thirds of it are the buildings where we work and live; real estate. But buildings don’t grow. The world hasn’t built that much either, save from China, in the past 25 years. So how is wealth growing?
It can shrink too. Last week, in a mini-crash, hundreds of billions of dollars of this elusive substance vanished from the South Korean stock market in a few sessions. But vanished to where? Did someone take them? Can wealth simply cease to exist?
Stranger still: if you ask around, almost no one will tell you wealth is a monetary asset. Wealth is health, they will say. Or free time, or love, or peace of mind.
Wealth is everywhere. It is a cornerstone of the modern world. We fight over its distribution, we organize our lives around acquiring it, and yet for all we talk about it, we cannot capture precisely what it is.
That was not always the case. For most of history, all the way to the end of the eighteenth century, it was perfectly clear. Wealth was the gold and silver sitting in government vaults. It made sense. Industry as we know it did not yet exist; stocks of grain perished very quickly; housing was informal—whole stretches of every city rose wherever people could raise a wall—and while farmland held value, it was only as much as could be squeezed from the peasants who worked it. Precious metal was the one form of value that lasted, remained stable, and could be counted, hoarded and moved around.
Conveniently, the path to getting richer was just as clear: one just had to get more gold and silver. But there is only so much of it in the world. Wealth, it followed, was a zero-sum game: for one person, or one country to have more, another had to end up with less.
From that idea, around the sixteenth century, grew a political system we now call mercantilism. If the world’s wealth was a fixed pile of stuff, the only rational policy was to capture a bigger share. To become richer, governments choked trade, banned exports of gold and silver, slapped on tariffs, and built empires whose purpose was to strip other territories of their resources. The result was a world of state-sponsored piracy—one in which stealing was not a failure of the system but its most sensible business model.
Adam Smith believed that was all wrong. And that it was, in fact, making everyone poorer. In 1776, writing in a quiet Scottish fishing village fifty miles north of Edinburgh, he set out to overturn the conventional wisdom.
He began with this:
THE ANNUAL LABOUR of every nation is the fund which originally supplies it with all the necessaries and conveniencies of life which it annually consumes, and which consist always either in the immediate produce of that labour, or in what is purchased with that produce from other nations.
Wealth, Smith claimed, was not a stock but a flow: a country’s capacity to produce. The richest nations were not the ones sitting on the largest chests of gold, but the ones that put the most people to work. Society, in his view, should be something like a massive factory in which each person contributed their effort to create, together, something of value. The wealth of nations, as the title had it, was a matter of how many hands a country could set to productive work, and how intelligently.
This new system had a weakness. If people were to be a tiny cog in an assembly line, producing thousands of units of the same product, they would not be able to make everything else they needed to live. The old ways of self-suffiency had to give way to a more sophisticated way of organizing society itself. The market was the mechanism that would let each person exchange the product of their own labor for everyone else’s, and so obtain, as Smith put it, all the necessities of life.
This is how, famously, in this vision, all incentives aligned: individual self-interest led to collective wealth because producing more made the whole mechanism grow. In turn, contributing to the economic engine was not just a matter of personal choice, it was a social imperative. One that people were expected to fulfill in one of two very specific ways: either by providing labour or capital.
His doctrine, a common grammar of effort and reward, turned out to be the greatest coordination technology ever invented: a story so simple that it could align strangers across cultures, languages and time zones. Under capitalism, a person in Shenzhen, another in Rotterdam and a third in São Paulo could collaborate on the same enteprise without sharing a religion, a goal or a government—without even knowing of each other's existence. No empire, no church, no ideology ever got so many human beings pulling in the same direction. A single fact captures the scale of its achievements: in the age of capitalism, human life expectancy has more than doubled—and in some countries tripled.
Smith’s model of society proved so successful, so pervasive, so beautifully lined up with the liberal ideas of human worth and the development of the early industries and cities, that it has continued to organize our lives for 250 years. Still today, countries organize themselves around maximizing their productive capacity. Industrial policy remains one of the most consequential fields of government, and when a country underperforms against some standard, we rush to diagnose flaws in its productive system: its companies are too small, or its capital is badly allocated. Top economists regularly meet top politicians in luxury hotels, everyone in suits, to rank countries along the lines how productive they are. The panic around the possibility of AI replacing hundreds of millions of jobs stems out of the same belief: that workers main role in the economy is to produce things. If AI can also produce stuff, then it can replace them.
In the political arena, the topic is getting so scorchingly hot that political parties —like Trump’s, or Merz’s in Germany— barely speak about anything else. Just in the past few months, several skirmishes have broken out among prominent economists online. In one, the argument was that Europe is falling behind in the international order because it can no longer keep its head down and produce more. Europoors are lazy creatures, critics claim. In another, a chorus of notable authors have declared themselves worried that China is about to deliver a second “shock”, having learned to make more things, better, than its complacent Western counterparts.
Throughout this entery time, economic theory has kept labor and capital at its core, the same way physics has energy and gravity, or biology has genes and natural selection. We call the resulting measure productivity and treat it as an obscure technical statistic, but consider what the concept really means: if what we can produce is our wealth, then productivity is not a measure of wealth. It is wealth itself.
The idea that individual behaviour is the source of common prosperity has seeped so deep into our culture that we now raise our children by its logic—educating them in effort and hard work as the reliable route to a good life—and hold ourselves accountable to the same philosophy, making decisions by its lights at every step, from the parliament to the kitchen table. We judge ourselves on a scale of “being productive”; personal productivity is today a top-selling genre of nonfiction; we feel guilty on the days we produce nothing and we grant or deny help—to the unemployed, to the poor, to entire countries—according to whether we judge that they have worked hard enough to deserve it.
Productivity has become the currency of the social contract: the one accepted way of demonstrating commitment and virtue. Which is precisely why it matters whether the theory behind it is true.
It is not.
Let me explain it in the easiest, silliest, most entertaining way I have been able to muster.
When Five Little Fingers Fry an Egg
In the Spanish version of the nursery rhyme “This Little Piggy”, five little fingers are about to fry an egg. An adult gently squeezes each of the child’s fingers in a sequence to tell this story:
This little finger bought an egg,
This little finger fried it,
This little finger salted it,
This little finger stirred it,
And this chubby little thumb... ate it all up!
Here we have a hand, like a country, that produces stuff: fried eggs. Four fingers produce; the fifth, as we’ll see, only eats.
The total output of the hand is one egg. What’s the productivity of each of the fingers? That would be one egg divided by four fingers. If the hand were a country and each finger a worker, its productivity would be ¼ of a fried egg per worker.
Now let’s imagine we give the index finger a miracle technology that allows it to do everything by itself: buy the egg, fry it, salt it, and stir it. We no longer need four fingers to produce, just one.
That one finger’s productivity is now four times higher. But what happens to the productivity of the whole hand—what we call the “aggregate productivity” of the country—thanks to this new technology? Does it go up? Does it go down? Nope. Same as before. The output is still one egg per four fingers, or ¼ of an egg per finger. The sum of all the fingers’ productivity is exactly what it was — it’s just distributed differently.
The problem is that some fingers are now left with nothing to do, and off they go to the little fingers’ unemployment line. When one finger multiplies its productivity fourfold, it pushes the others out of the productive system altogether—reducing their productivity to zero.
When any technology—AI, the Internet, the personal computer or any other—manages to increase the output of some workers and some companies within a given economy at the expense of others, the result is not growth in the economy’s aggregate productivity. The result is that some workers end up better off, and others much worse off.
Economists call this phenomenon “technological displacement,” and it is what has happened with digital technologies over the past 25 years or so. Some workers—such as those in tech companies—have seen their productivity boom, while other sectors were hollowed out.
Ah—you can almost hear the politicians object—but then what we need is to get every finger the same technology, so that instead of one egg we can fry four! Let every little finger buy, fry, salt, and stir its own egg, and that way there’ll be many more eggs, and we’ll all be much more productive!
Right?
Sure, fine, but who’s going to eat all those eggs? We only have one chubby thumb.
The thumb is the consumer.
No matter how many eggs the producers fry, if they don’t have more consumers to sell them to, only two outcomes are possible: either the price of fried eggs drops, and the chubby thumb eats four eggs for the price of one, or the remaining eggs get thrown away because there’s no consumer to be found for them.
And this, dear friends—this silly story, this thing you can explain on the fingers of one hand—reveals the lie we have been telling ourselves for 250 years:
We’ve convinced ourselves that what makes countries richer is increasing productivity: frying more eggs. But frying more eggs, if there’s no one to buy them, cannot make us richer. It can lift our standard of living, sure. And it can benefit everyone through lower prices, absolutely. But it will not improve our standing relative to everyone else.
The consequence is what we can observe in the West today: when a technology pumps up the productivity of one sector of the economy without extending its customer base, many workers are displaced into less “productive” jobs. Income concentrates, wealth concentrates, inequality rises.
So how did productivity grow, all those years? How did capitalism actually work?
Contrary to what we have been told, what made (some) countries richer over the past 250 years was not the growth of their capacity to produce, but the growth of their consumption.
The Great Conquest of Customers
Since the Industrial Revolution, in the West, we’ve been playing a game. Every technological leap has multiplied our ability to fry eggs much faster than our capacity to eat them. And the solutions we’ve kept inventing to escape the trap are, told in order, the economic history of the last 250 years.
The first solution was to go out looking for other people’s chubby thumbs. When the workshops of Manchester produced more cloth than England could wear, the surplus was sold to the rest of the planet — at gunpoint, if necessary. Nineteenth-century imperialism was, among other things, a search for hungry stomachs: new markets for an output that was growing faster than its consumers. As Rosa Luxemburg wisely put it, capitalism needed an “outside” to sell what its own population couldn’t buy.
The second solution was to fatten up the local fingers, or what we called “consumer capitalism”. In the 1930s, Henry Ford turn this idea into a meme: the workers themselves should be able to buy the cars they were building. Said in the language of economists, domestic demand should be the driver of consumption.
Riding on that idea, Keynes & co. argued that it was demand that drove supply, not the other way around. If we wanted everyone to be a chubby finger, governments should make sure demand was strong enough to give everyone a job. The postwar consensus — with its rising wages, the creation of the middle classes, and the welfare states — was this idea put to work at a civilizational scale: turning producer fingers into consumer fingers.
The next 50 years or so were an experiment in manufacturing consumers. The Marshall Plan, if we look at it in this light, was exactly that: lending Europe the money with which to buy American eggs. The loans that wealthy countries extended to third-world countries at the end of the century were part of the same scheme: vendor financing.
If we look at it from a distance, we can see two clear components here. On the one hand, the new consumers at every phase would be making of value they could sell back to the producers, such as raw materials or low-tech goods. On the other, they would borrow to pay for the output of richer, industrial countries. In effect, what capitalism did for 250 years was find more and more people willing to become capitalists themselves, and therefore happy to take on debt to finance their own development.
By the late twentieth century, there wasn't much left to sell to consumers. Homes in the first world were already full of appliances; a string of debt crises in the developing countries had made lenders think twice before extending credit there again; and wages had stopped growing. The third and last solution was to lend the local fingers money so they could keep buying eggs.
Since the eighties, countries have increasingly relied on debt —mortgages, credit cards, consumer loans, and a swelling pile of public commitments— to fill the gap left by stagnated wages and poor quality jobs. The chubby little thumb has kept on eating — it just can't pay for the eggs anymore.
That last solution burst into flames in 2008. And yet, we still haven’t found another. Meanwhile, many more countries have joined the productive side of the equation, flooding the markets with fried eggs. The global debate about productivity actually hides another one: a dispute over which fingers get to fry eggs (and be paid for it) and which are left to borrow to eat them. All the trade tensions of the last decade, from tariffs to currency wars, are squabbles over who fries and who eats. In many ways, we are going back to that world who thought gold and silver were the only forms of wealth and for one country to be richer another had to be made poorer.
This is why AI, even if it fullfils its wildest promises, wont increase ‘productitivy’. It promises to multiply egg-frying fingers precisely when there’s no new continent left to sell to, wages have been flat for decades, the debt card has already been played, and the consumer of last resort is showing signs of indigestion. A technology that makes production cheaper and, by its own promoters’ account, dispenses with the producers, attacks both sides of the equation at once: it fries more eggs and lays off the people who used to buy them.
And before we wrap up, notice this: The same equation runs through your own life. We were all raised on the producer's creed: work hard, master your craft, be excellent, and the results will come. But look around — look at your office, your industry, your feed. The most productive person you know is almost never the most successful. The best engineer is rarely the CTO; the best writer is rarely the best-selling one; the most dedicated employee is rarely the one promoted. The ones who rise are the ones who found someone to buy what they do: the ones with the manager's ear, the audience, the network or the clients. In other words: the ones who sell. We call this unfairness, and rage at the failure of meritocracy. But in this light this is not a failure at all: it is the system working exactly as it's built. Merit is a theory of production, and production was never the binding constraint. Your effort, like the fingers' eggs, is worth nothing until somebody wants it. The disciplined, hard-working person sliding below their parents' standing is not being cheated out of the rules — they are playing by rules that were never the real ones. They perfected their frying while others were out there finding thumbs.
So this was Adam Smith's error. Wealth, he said, is what a nation can produce. For 1776, the diagnosis might have been right, but only because his world was full of chubby thumbs and there were barely any producing fingers. Anything produced at less cost found a mouth waiting for it. What Smith could not imagine was a world where the machine worked so well that there would no longer be enough people to want its products —and pay for them. He mistook the bottleneck of his century for a law of nature. Everything we call an economic crisis today is, one way or another, the bill for that oversight.
What we should have been asking all along is not how societies produce, but why they consume — what makes human beings want things at all. Why do we exchange. What constitutes value. Or, in other words:
What is wealth?
That will be, again, next Tuesday's question.
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Photo by K. Mitch Hodge on Unsplash