Tag Archives: Adam Smith

Adam Smith and the Free Market

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A friend sent this along for comment.

Have Adam Smith and his writings been hijacked by free market economics?

Yes. Smith was deeply suspicious of the business class. When I was teaching, I used to give quotes without attribution for students to comment on, and they regularly treated Smith quotes as being from Marx. Smith knew nothing of capitalism, which barely existed in his day, and would be appalled by the idea of an economy based on a class of workers without property. His insight that people’s selfishness might produce collectively beneficial results (“the invisible hand”) has been taken over by so-called free market economics, and debased into a “greed is good” mantra that is totally antithetical to Smith’s teaching.

Smith complemented The Wealth of Nations with The Theory of Moral Sentiments, which explained that the moral sentiments of trust and compassion were required, among other things, to make a market economy operate at all. This idea has no role in “free market economics,” which imagines that economic actors are soulless egoists. Smith also maintained the first modern version of the labor theory of value, on which the exchange value of a commodity is the labor embodied in it. “Free market” economics rejects this in favor of a subjective theory of value on which price is determined entirely by supply and effective demand, what people with money will pay for it, because labor value is deemed “Marxist,” because Marx developed the most sophisticated version of value theory. A theory without labor value is not Smithian.

The problem here begins with knowing what is meant by “Adam Smith and his writings” and following that what is meant by “free market economics”. And then with making sense of “economic actors are soulless egoists” and “a ‘greed is good’ mantra”. Then beyond all of that, there is this which makes his argument utterly vacuous: “Marx developed the most sophisticated version of value theory” which he rounds us to “a theory without labor value is not Smithian” which means in his hands that only Marxists with their labour theory of value can truly state that they are following in the genuine tradition of Adam Smith.

Adam Smith is best understood via the invisible hand, that an economy is driven by individual decision making through entrepreneurial activity. The quotation is attempting to argue that Karl Marx is the true descendent of Adam Smith. Every aspect of this argument is false, an attempt to appropriate Smith, who advocated free markets, on behalf of Marx, who advocated a centralised tyranny in which markets play no role in directing resources towards their highest valued uses.

The first fair and deliberate exchange in world history

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From The Wealth of Nations:

“Nobody ever saw a dog make a fair and deliberate exchange of one bone for another with another dog. Nobody ever saw one animal by its gestures and natural cries signify to another, this is mine, that yours; I am willing to give this for that….But man has almost constant occasion for the help of his brethren, and it is in vain for him to expect it from their benevolence only. He will be more likely to prevail if he can interest their self-love in his favour, and show them that it is for their own advantage to do for him what he requires of them. Whoever offers to another a bargain of any kind, proposes to do this. Give me that which I want, and you shall have this which you want, is the meaning of every such offer; and it is in this manner that we obtain from one another the far greater part of those good offices which we stand in need of.”

On the other hand, it could be the resurrection of an economy recovering from the grip of a socialist experiment, Venezuela say, in about a year or two from now.

Cartoon via Powerline – The Week in Pictures

Adam Smith and “the man of system”

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From Smith’s Theory of Moral Sentiments (paragraph VI.II.41-42):

The man whose public spirit is prompted altogether by humanity and benevolence, will respect the established powers and privileges even of individuals, and still more those of the great orders and societies, into which the state is divided. Though he should consider some of them as in some measure abusive, he will content himself with moderating, what he often cannot annihilate without great violence. When he cannot conquer the rooted prejudices of the people by reason and persuasion, he will not attempt to subdue them by force; but will religiously observe what, by Cicero, is justly called the divine maxim of Plato, never to use violence to his country no more than to his parents. He will accommodate, as well as he can, his public arrangements to the confirmed habits and prejudices of the people; and will remedy as well as he can, the inconveniencies which may flow from the want of those regulations which the people are averse to submit to. When he cannot establish the right, he will not disdain to ameliorate the wrong; but like Solon, when he cannot establish the best system of laws, he will endeavour to establish the best that the people can bear.

The man of system, on the contrary, is apt to be very wise in his own conceit; and is often so enamoured with the supposed beauty of his own ideal plan of government, that he cannot suffer the smallest deviation from any part of it. He goes on to establish it completely and in all its parts, without any regard either to the great interests, or to the strong prejudices which may oppose it. He seems to imagine that he can arrange the different members of a great society with as much ease as the hand arranges the different pieces upon a chess-board. He does not consider that the pieces upon the chess-board have no other principle of motion besides that which the hand impresses upon them; but that, in the great chess-board of human society, every single piece has a principle of motion of its own, altogether different from that which the legislature might chuse to impress upon it. If those two principles coincide and act in the same direction, the game of human society will go on easily and harmoniously, and is very likely to be happy and successful. If they are opposite or different, the game will go on miserably, and the society must be at all times in the highest degree of disorder.

They have all the answers to questions that are not being asked. Smith could see the gulag even before he had seen Robespierre.

When Adam Smith wrote on “the wealth of nations” what did he mean by “wealth”?

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This was the initial query sent to the Societies for the History of Economic Thought discussion thread on June 16.

Dear colleagues,
I’m trying to trace the source of translating “economics” as “the science of wealth” (and sometimes “the science of the wealth of nations”) in late nineteenth-century Ottoman-Turkish. Ottoman economists most probably rendered it from French (“la science de la richesse”), from popular sources preceding the 1860s. I could find expressions like “l’économie politique est la science de la richesse” in many economic texts from the era, but I’m trying to understand how common it was to use “la science de la richesse” instead of or interchangeably with “l’économie politique” referring to the discipline itself.

What has followed has been a brief discourse that amounts to the statement from one of the French correspondents that “it is very easy to show that ‘science de la richesse‘ was a synonym of political economy in the first half of 19th century, not from ‘popular sources’ but just to explain the title of books.” I have therefore sent my own brief contribution along, because I do think that words make a very great deal of difference in how we think and what we are able to understand.

It has seemed to me for a while that the title, The Wealth of Nations, is an eighteenth century use of words and is somewhat misleading as to the point that Smith was making. I have tried to find a modern phrase that would capture what he meant, and the closest I have been able to come to is: The Prosperity of Nations. “Wealth” has a kind of treasure chest notion to it (which it may not have had back then), and the word “wealthy” is tied to personal riches, which is not at all, I think, what Smith was trying to get at. So when I read that the French for “wealth” is “richesse“, or that my google translator turns “The Wealth of Nations” into “la richesse des nations“, I really do therefore wonder how much has been lost in translation. Because when I translate the English word “riches” into French, it gives me “richesse” once again. The alternative French to English of “richesse” are “wealth”, “richness”, “riches”, “rich” and “affluent”. And for the French word “riche” we get these English translations: “rich”, “wealthy”, “affluent”, “opulent”, “splendid” and “luxurious”. Each of them seem totally inadequate to making sense of what Smith had in mind or what the book is about. This seems to me more than just a curiosity.

Adam Smith on Say’s Law

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The actual mechanism of exchange that is often mistaken for Say’s Law is the statement that demand is constituted by supply. Purchases are made with the money one has received from producing and selling. How odd that I had never noticed this in Adam Smith before where he writes exactly that. This is from the Introduction to Book II, “On the Nature, Accumulation, and Employment of Stock”:

When the division of labour has once been thoroughly introduced, the produce of a man’s own labour can supply but a very small part of his occasional wants. The far greater part of them are supplied by the produce of other men’s labour, which he purchases with the produce, or, what is the same thing, with the price of the produce of his own. But this purchase cannot be made till such time as the produce of his own labour has not only been completed, but sold.

Ah those two words, “but sold”. It’s not enough to produce something. Whatever one has produced must be then be converted into money before one can then buy something else: C-M-C’.

Smith also goes further in that same intro by discussing the role of the entrepreneur in finding value adding forms of work for employees who could not do so on their own. This is where Keynesian economics breaks down in the belief that a community can spend its money before it is earned. Perhaps an individual can, but not everyone together. In the passage below, the stock held by the employer would today basically consist of those lines of credit that allow employers to pay their workers before the goods they are producing find buyers. That stock must exist if individuals are to receive the goods they then purchase with their wages:

As the accumulation of stock is previously necessary for carrying on this great improvement in the productive powers of labour, so that accumulation naturally leads to this improvement. The person who employs his stock in maintaining labour, necessarily wishes to employ it in such a manner as to produce as great a quantity of work as possible. He endeavours, therefore, both to make among his workmen the most proper distribution of employment, and to furnish them with the best machines which he can either invent or afford to purchase. His abilities in both these respects are generally in proportion to the extent of his stock, or to the number of people whom it can employ. The quantity of industry, therefore, not only increases in every country with the increase of the stock which employs it, but, in consequence of that increase, the same quantity of industry produces a much greater quantity of work.

How much does any of this penetrate the conscious awareness of an economist today?

Economic sinners

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I am in the middle of so many projects in which the modern version of economic theory is at the centre, that I find my thoughts overflowing into these blogs. A blog is not, however, supposed to be anything other than an overview shared among like-minded people. Comments on my post on the sins of economics are reasonable and temperate, but still fill me with some dismay which has me led me to go over some of that ground again. The sense of inevitability for the Industrial Revolution in the midst of the pastoral settings of eighteenth century England is not one I share. What did happen is not necessarily what had to happen. As Tel, no doubt intending to be ironic, points out:

I dunno, it’s probably more important that Isaac Newton invented gravity… I mean, without gravity you could slip easily, lose your footing and fly off into space. Sorry, but Newton is much more important in the scheme of human progress.

As it happens, Newton’s three laws did not change all that much about anything, but it did change the climate of thought. Certain ideas matter. It was not Adam Smith by himself and on his own, although he did have a fair share to do with it. The period 1770 through to about 1830 was the only period in history when being anti-establishment meant being pro-market. It was in that relatively brief span of time that the market economy was allowed to come into the foreground in the teeth of opposition from the landed aristocracy to the Luddite opponents of new technologies. Economic theory has been trying to backtrack ever since, whether the Marxist variety or the Keynesian variety and now even the mainstream. With Green policies so insidious, where to from here is not all that obvious, although I think that with the market genie out of the bottle, it remains almost impossible to stop. But Schumpeter in 1942 was already predicting that capitalism’s success would be its downfall.

Ray has then added:

I trust we are not ascribing the growth experienced during the Industrial Revolution to Adam Smith. It was not until after the repeal of the Corn Laws and Navigation Acts in 1846 and 1849 respectively, more than seventy years after The Wealth of Nations was first published, that the teachings of Smith and Ricardo, began to dominate policy matters. Until then, the Mercantilists ran public policy, very much the antithesis of everything Smith taught us.

A climate of opinion is essential for any system to take hold. If opinion didn’t matter, if the structure of beliefs made no difference, then elect socialists and get on with spreading equity instead of wealth. These things matter now and they certainly mattered 1770-1830.

And this was brought up from the Zero Hedge list, which is supposedly an example of seeking greater market regulation:

The benefits of free trade outweigh the costs of a country losing its manufacturing sector as a result; the fact that domestic companies have to comply with much stricter and costlier regulations than their foreign competitors is of no consequence.

If you don’t think domestic regulation affects an economy’s ability to produce, just have a look at the mining industry before and after Labor. Try adding in a measure of carbon pricing and see how the aluminium industry prospers. The phrase “internationally competitive” has a meaning. This may not be phrased to your liking, but it makes a point worth thinking about.

So let me finish with this quote from Rich:

A seed takes time to grow to a tree that bares fruit, and in that time it needs its protectors and proselytisers.

If economics in 1776 was like economics today, how likely would the Industrial Revolution have been then?

Invaders from planet stupid

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A very interesting post by Steve Hayward at Powerline with the title, First they came for the Sociologists. But in spite of its title, the post is mostly about economics.

The one field in the social sciences where there is the least presence of post-modern oppression-“privilege” types is Economics, which prompts me to propose the theorem that the presence of politically correct nonsense in an academic department is inversely proportional to the emphasis placed on rigorous regression modeling in the discipline (or knowledge of ancient languages).

I personally think modern economics is well to the left as an academic subject. The veneer of bourgeois respectability is important to economists if their economics message is to influence the political class. Mainstream economics is no longer about the need for free markets, but the importance of controlling free markets. It may be disciplined by various sets of data, but economic theory is no longer Adam Smith. It is, instead, the nearest thing to Marxism that still retains that overlay of markets, best represented by Keynesian theory. Keynes disarmed the Marxists of his time by siding with them over Say’s Law, which had perennially been the province of the economics far left and central to their critique of capitalism.

I have half a chapter on this in my Free Market Economics, beginning with the notion of “perfect competition”. “Perfect” implies that this is the ideal, and is contrasted with “imperfect” competition. Perfect markets cannot exist, given its definition (e.g. perfect knowledge). All other markets are imperfect, which leaves much room for intervention at every turn.

But even with my continuous criticism of mainstream theory, I believe there is only one economics. The “political economy” department at Sydney is merely a cop out. Whatever sociological version of economics that might be taught, unless they also do supply and demand and marginal analysis along with the full panoply of mainstream theory, it is useless, other than as a leftist critique of markets. This is a quote from Greg Mankiw who was on the other end of these barbarian invaders:

Those who attended either of the sessions I was involved with at the ASSA meeting know that the audience included some hecklers. During the first session, I was the target. During the second, Larry Summers was. (At one point, the moderator Bob Hall threatened to call security.) Here is a Washington Post article about the hecklers.

After the first session was over, one of the hecklers came up to me and asked, “How much money have the Koch brothers paid you?” My answer, of course, was “not a penny.”

I don’t find it odd that people disagree with me. I am always open to the possibility that I am wrong about lots of things, and I much enjoy talking with students and colleagues who have views different from mine. But I do find it odd that people who disagree with me are sometimes quick to question my sincerity. If I am wrong, it is sincere wrong-headedness, not the result of being on some plutocrat’s payroll, as some on the left want to believe.

The hecklers probably limit their own effectiveness by questioning the motives of those who disagree with them. I have found that to convince other people, it is usually best not to assume your own moral superiority but rather to talk with them as equals who just happen to have a different point of view.

Personally I think Greg was too mild in his criticism of these know-nothings. I disagree about a lot, but I am never in doubt that the economists I deal with know a lot more about economies than their non-economist critics, a lot lot more and within a proper contextual setting. The true worry is how sympathetic the Washington Post article is to these invaders from the planet stupid.

Free Market Economics 2nd ed

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fme2 cover_Page_1

When I wrote the first edition of my Free Market Economics in 2009, I thought of it even then as the best introduction to economic theory anywhere. It combined five features that were unique to this book: an uncompromising anti-Keynesian core, a microeconomics that rejected the notion of an equilibrium, a focus on the role of the entrepreneur, a discussion of the classical theory of the cycle and the installation of uncertainty as the crucial element in any serious discussion of how an economy runs.

I also had no idea how much more I wanted to say until I came to write the second edition which to my eyes has transcended the first, having been fashioned out of what I learned by teaching the first edition for five years while watching how economic events unfolded following the stimulus. You may only have the author’s word for it here, but there is no book like it. If you want to understand how an economy works based on the English tradition in economic theorising that goes from Adam Smith to John Stuart Mill, there is literally only a single place you can go. The book reverses two “revolutions” in economics, not just the Keynesian of the 1930s, but the marginalist revolution of the 1870s as well. It is a companion volume to David Simpson’s wonderful The Rediscovery of Classical Economics, also co-published by the IEA. Reading the two will provide you with an understanding of just what is wrong with economic theory today. That traditional policy based on standard economic theory is ruining our economies is beyond any doubt, but the reason why that is so will nevertheless remain incomprehensible to anyone who continues to believe that aggregate demand is a valid concept in trying to make sense of economic events or that equilibrium has much if anything to do with how an economy works.

My Free Market text was written in a kind of white heat over twelve weeks as the text for the course I was giving during the first months of the worldwide introduction of stimulus packages pretty well everywhere. The absolute dead certainty I had was that public sector spending whose only aim was to create jobs would end in disaster, as it most assuredly has. Our economies are sinking under the weight of massive levels of unproductive public spending and debt levels that continuously subvert every attempt to wind them back. Yet you cannot go to any standard economics text even for an inkling of why that is.

To understand any of this you must first understand Say’s Law. Say’s Law was the bedrock principle of economic theory from the earliest years of the nineteenth century until swept away in a fit of distraction by the publication of Keynes’s General Theory in 1936. It is founded on recognising that only value adding production can create economic growth and add to the number of jobs. The most central chapter in the book is the chapter on Value Added, a chapter found in no other text that I know of. Yet without understanding value added, understanding that every form of production not just creates more goods and services but also at the same time uses up existing goods and services during the production process, it is impossible to think about public spending and economic policy correctly. Only if what is produced has greater value than the resources used up can an economy grow. Government spending seldom creates value. The stimulus was therefore doomed to fail as is so much of the policy matrix found today.

The strangest part about the book, however, was for me to discover my own beliefs on the nature of economic theory. There is not a chapter in it that would fit into a standard economics text. All of it takes you back to an earlier time and a different theoretical matrix. Space is too short to tell you much more but let me draw you to the cover which shows a water mill on a plaque made of clay. This is because the two most important influences on my own way of thinking have been two of the greatest economists England has ever produced, John Stuart Mill and Henry Clay.

I can do no more than encourage you to read this book. It is a defence of the market economy published at a time when there may never been a greater need for such a defence.

Is this the dumbest book on economics ever written?

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There will have to be a wall of shame for economists who endorsed Keynesian solutions back in 2009 who will need to have their beliefs brought back to haunt them. Picked up in a secondhand bookshop a particularly pathetic version of what had been quite common back in those heady days of the stimulus, this being a book titled, Animal Spirits, written by two Nobel Prize winners, George Akerlof and Robert Shiller. If these types were ever capable of shame they would be buying up every copy in print and have them consigned to the flames. Instead and no doubt, they continue in the delusion that we have been saved from far worse by the timely actions taken to stimulate demand.

Mind you, I had been just as certain that the entire attempt to diminish the impact of the recession and return us to reasonable rates of growth would turn out the disaster it has been. But for myself, I can now run the told-you-so as much and as far as I like. There is not a shred of evidence, outside their own nonsense-Keynesian models, that the stimulus did anything but harm. But since they are incapable of even having a glimmer of a notion that the economic models they have devoted their lives to understanding are about as useful as the theory of phlogiston was in physics, they just carry on. It is only we critics who go back to those books and try to remind others that Keynesian economic policy has been an unmitigated disaster. So far are we now from a robust recovery, a ten year pause will turn out to be the best we can hope for. This is from the Preface, and recall that this is from 2009 just as the stimulus programs were getting under way:

“A repeat of the Great Depression is now a possibility because economists, the government and the general public have in recent years grown complacent. They have forgotten the lessons of the 1930s. In those hard times we learned how the economy really works. . . .

“In the middle of the Great Depression John Maynard Keynes published The General Theory of Employment, Interest and Money. In this 1936 masterwork, Keynes described how creditworthy governments like those of the United States and Great Britain could borrow and spend, and thus put the unemployed back to work.”

That was 2009. Is the world in 2014 the one they expected, the outcome they foresaw? I suspect not. Yet there is hardly another ripple of any other kind they could blame the deeply depressed nature of the American economy on other than the policies of the past five years. The one certainty is that no one is any longer telling us now about the great “masterwork” written by Keynes.

Almost as nonsensical is the potted history of economic thought they provide. Can they actually be as ignorant of pre-Keynesian economic thought as they suggest by these words:

“According to traditional economics, free market capitalism will be essentially perfect and stable. There is little, if any, need for government interference. On the contrary, the only risk of major depression today, or in the future, comes from government intervention.

“This line of reasoning goes back to Adam Smith.” (p. 2)

The notion that Adam Smith, or any other economist of the classical tradition, expected a ripple-free economy with no depressions and that no government interference was ever necessary is so lacking in historical accuracy that I would barely accept such ignorance from a first year student. That they could believe and commit to print such obviously untrue statements – obvious, that is, to anyone who has taken the trouble to learn even the rudiments of the classical theory of the cycle or what Adam Smith had actually written – is a disgrace.

But if I have to choose the least sensible statement they made in this startling superficial and inane book, it is their attribution of the cause of the Global Financial Crisis to an excess of saving, the precise issue raised by Keynes:

“In the short run, an exogenous increase in the demand for desired saving rate of just a couple of percentage points may be enough to tip the economy into recession, as indeed seems to be happening in the current financial crisis.” (p. 116)

The entire financial world held its breath as the banking system teetered on the edge of collapse, with every lender profoundly unsure of the safety of lending to others, and this is reduced to decisions to save. It is embarrassing to have to read such thoughts from two of the most respected economists in the world. This is more of the Keynes the master, but though no one any longer would write any such thing given how events have turned out, it makes one despair whether economic theory can ever again provide serious guidance to those who make economic policy. It is a frightening book lacking even the rudiments of depth or common sense.

A bit of a rant and tirade of my own

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From the most recent of Captain Capitalism’s rantings and tirades of a frustrated economist:

As I’ve aged and become more experienced, I start to realize just how much of a fraudulent study economics is. Not because economics isn’t important. Not because there isn’t some serious important issues that economics addresses. It’s not even that the secret to riches for all does lay within economics (it does and it is what ultimately drives my eternal passion for economics). But rather how the field’s self-proclaimed experts have turned it into nothing more than self-serving political bunk. It is no longer simply about the “efficient allocation of resources” or “maximizing the wealth of people” but rather idiotic concepts like the Phillips Curve, running advanced (and ultimately flawed) economic models, fretting about things like the liquidity trap, drawing idiotic foursquare games for “prisoner theory,” and the hundreds of other temporary and fleeting relationships that have been observed in the past 60 years that the economist academians trump out and treat it as if it were a real science when in reality it is a constantly changing art as it is human psychology that underpins it all.

The unfortunate fact is that economics has gone from amongst the social sciences to join the non-science of socialist religious observance. So if I may continue to quote:

If you truly want to understand (or disprove some things about) economics, I argue going backwards. I argue going outside the study. I argue applying some basic, simple logic and factual testing to see if this increasingly complex “field” even makes sense anymore or is merely a circle jerk for wanna-be mathematicians just like religion is for most clergymen.

For example, a simple question I have, is WWII the only data point the Keynesianism can point to in history where it worked? And if so, why the hell did we base the entire western world’s governance and economic policies on something so ill-tested?

Another, precisely whose brilliant idea was it that government should intervene period? Who precisely died and made you economic king giving you authority to “provide incentives” or “boost demand curves?” Since when was it the government’s and politician’s responsibility to MANAGE people? (I’ll tell you who. One sick, power-hungry, totalitarian, that’s who).

And though I am certainly very political, shouldn’t we be concerned when the likes of Krugman call Republicans racist or we start claiming that 100% purely politically moves such as “diversity” have some kind of inherent value? i.e. – why is politics allowed to enter, let alone corrupt economists and their views?

I could go on, but these simple questions are identical to the basic, logical questions we need to ask (but aren’t allowed to) of religion.

Economics once really was useful and enlightening but you’d have to go back to its golden age, from Adam Smith to John Stuart Mill. Since the mathematicians took over sometimes around the 1870s, and economics became social-physics, it has been generally downhill. I read journals now as part of my penance, but it is mostly non-answers to unimportant questions. Meanwhile, not only do politicians invent whatever economic theory they need to suit their wishes, so too do their economic advisors. Economics was once a discipline. You obeyed its rules or your economy would unravel. There is only just that last small bit of Adam Smith-John Stuart Mill left to keep our economies from completely crashing, but even that small bit is eroding fast. Economics has for the most part gone back to being Mercantilist trash.