Smith on enforcing market contracts

Gianguido Piani (Moscow Times, 30 May 2005, page 8) makes a strong case against some serious problems of electricity supply in Russia. That he drags Adam Smith into his case is unfortunate. As he notes himself, Smith died long “before electricity could make its contribution to the wealth of nations”.

Smith did not exclude roles for government in his “Wealth of Nations” (Book V); roles, I suggest which far exceed the boundaries set for the state by those who have misused his legacy in their portrayal of him as a laissez faire zealot, which he was not. He never used the words laissez faire, nor did he support it as a general policy.

From his “Wealth of Nations” we can deduce how Adam Smith might have considered the situation described by Gianguido Piani that applies to interruptions in electricity through inadequate investment by private owners. For exactly the same reasons that Smith opposed monopolistic pricing and, interestingly, supported laws restricting lenders to only up to an official maximum of 5 per cent interest, he would have approached excess profits and inadequate investment in electricity in the same manner.

He would have favoured a policy of requiring electricity companies to fulfil their contracts with their customers, and being forced to do so by the courts. They enter into contracts to supply customers with electricity and interruptions in supply from inefficiencies in their services and outages caused by sub-optimal investment are breaches of contract. Smith would have favoured enforcement of those contracts by the State, including taxation of their profits and revenue.

Thus, when Piani writes: “As recently as last month in Sweden, power companies were made legally responsible for increasingly frequent service disruptions to force them to invest in grid modernization”, he reports a very Smithian stance on these matters.

When Piani also writes: “Adam Smith's often-abused metaphor of the baker and butcher, who benefit society by caring for their own wallets, does just not apply to power systems,” he misapplies his analogy (it does apply to power stations, too!) and he gets Smith’s point wrong.

The “butcher, the brewer and the baker”, like the electricity companies, offer contracts to their customers: “Give us the price we want for our products, and we will supply you with your dinner”. If, like the Russian electricity companies, they take the money and do not supply their products, they commit theft and should be liable for it. If food suppliers or electricity companies promise to supply customers with goods but do not deliver, leaving customers without their dinners and the means to cook them, they likewise commit fraudulent acts and should be liable for them.

Gianguido Piani's article is at MoscowTimes.com (issue 3176)

Almost right, but then he blew it

Mike Rosen presents a daily radio show and write a punchy comment column for Rocky Mountain News, Denver, USA.

Last week he almost wrote a piece that could have been a strong candidate for monthly The Adam Smith Solution prize. Below I give four selections from it. The first two paragraphs are right on the money (as US newspaper columnists put it):

“A market economy is based on incentives. The prospect of financial reward is what motivates most people to work, save and invest. There's nothing particularly ingenious about a system that recognizes this. It's intuitive. In The Wealth of Nations, Adam Smith didn't invent an economic system; he merely observed and analyzed what people do naturally when left to their own devices.”

and

“When you impose penalties and restrict rewards on economic activity - such as by excessive taxation - however noble your motives, there are consequences. You get less work, savings, investment and output. If that weren't the case, we could tax ourselves rich.”

And then he rains on his own parade (a favourite cliché of US news reporters):

“Adam Smith summed it up nicely, more than 200 years ago, when he observed that in a market economy, people pursuing their own prosperity are inadvertently moved as if by an "invisible hand" to promote the interests of society as a whole."

Oh, no he didn’t (a traditional Scottish Pantomime routine)!

Apart from the generalization of the single use of the metaphor ‘invisible hand’ into ‘people pursuing their own prosperity’ (Smith referred in his single use of the metaphor in “Wealth of Nations” to merchants preferring to sell in their home market to selling abroad as an example of the unintended consequences of the merchants’ preference aiding national economic growth), he never used the words ‘as if by’.

Nor did he imply that that every inclination that promoted one’s own prosperity would necessarily ‘promote the interests of society as a whole.’ Individual actions could also have negative consequences for society. For example, the inclination of “merchants and manufacturers” to promote local monopolies for themselves, to raise prices and thereby profits at the expense of other activities of benefit to society.

This common error cost Mike his otherwise winning chance for the monthly prize. However, he did end with a paragraph that complements the other two quoted above:

“They do this by creating wealth - for themselves and, in the process, for others. Any society that becomes obsessed with restricting the accumulation of personal wealth will destroy initiative and creativity. The way the world works, if you want the poor to get richer, you have to make it possible for others to get richer, too.”

So well done, Mike, but keep working on what Adam Smith actually said, not what is endlessly repeated in US Economics 101.

Mike column can be read at:
www.rockymountainnews.com/drm/news_columnists/article/0,1279,DRMV_86_3809614,00.html/

Smith's True Legacy

“Business cannot thrive in an island of wealth in a sea of poverty”
The Financial Express, Bombay, India 23 May 2005-05-23
Shailender Chaudhary

In which Chaudhary claims that Adam Smith advocated ‘laissez faire’ and the ‘invisible hand’.

My response:

Adam Smith did not advocate leaving "merchants and manufacturers" to do whatever they wanted. He never supported nor mentioned laissez faire.

"Wealth of Nations" is a polemic against leaving them alone to monopolise and act against the public interest.

His legacy was turned on its head as an alibi in the 19th-20th century by spokemen for mill and mine owners, especially in America.

Firms, no matter how mighty, are not above the law and should never be treated as such. Freedom within the law, subject to the restraints of justice and good behaviour, is Smith's true legacy.

Oh no he didn't say that

Letter to Mr Tierney, OP ED columnist for the New York Times, in response to his interesting article drawing conclusions about some themes in the new Star Wars film, which he relates to Adam Smith's alleged philosophy. My letter is a response to his representation of Adam Smith and not to the merits of the film.

Dear Mr Tierney

You have misunderstood Adam Smith and have not quite understood altruism as it was/is practised by humans (and other primates).

Altruism was/is conditional in practice. Members of a small clan do not practice unconditional altruism. It is reciprocated, or it does not happen for long. Free riders are punished, starting with avoidance and leading all the way to exclusion from the clan. If this was not so, a clan with non-altruists among them would quickly disintegrate ("if you do not work, neither shall you eat"). Only the young and the sick receive assistance without reciprocation and , then, only while the clan as surplus food to go round all.

Punishment of non-reciprocating members is mandatory. It can be seen in modern chimpanzee groups - individual chimps groom other chimps that groom them and do not groom chimps that have not reciprocated earlier (unless compelled by the Alpha males). Modern humans are no different, as a moment's introspection will testify (people outside the family who do not return proportionate favours when you need them are avoided - the gift/favour exchange cycle terminates).

Adam Smith did not advocate selfishness as a principle of human interaction. He regarded 'self love' as insufficient. The dependence of modern humans on each other is now total. Millions of anonymous people work to bring you and the rest of us everything we depend upon to live on. He showed this on a smaller scale in his description of the division of labour in Book I of " Wealth of Nations" (chapter 2) in respect of the common labourer's rough coat. The dependence on the efforts of anonymous strangers characterises society, more so today than ever, because our 'needs' have expanded exponentially.

Nobody in a lifetime could possibly know everybody needed to provide them with the food, clothing, shelter, consumer goods and the extras that they need to have anything resembling an acceptable living. Hence, relying on the altruistic exchanges in a family group would soon reduce your living standards to poverty levels. It was this that Adam Smith drew attention to. His conclusion was not that the alternative was selfishness (a complete misreading of "Moral Sentiments" and "Wealth of Nations", a not uncommon feature of what has happened to Smith's intellectual legacy). Reciprocal exchanges developed in what he called markets to generalise the needs of societies consistingf of many clans, families and strangers (the majority).

Look again at his advice not to rely on benevolence when you want to secure your dinner from the "Butcher, the Brewer and the Baker" ("Wealth of Nations"). He advises you to seek to appeal to their 'self interest', not your own! You do this by persuading them to conclude a "bargain" - "give me what I want and I will give you what you want". This is the conditional proposition. Markets enable billions to conduct their reciprocal exchanges peacefully and harmoniously. You think you work for the New York Times for your own self-interest? Not so. You work to serve the interests of others by receiving the means (wages) to supply the multitude of others whose output you wish/need to consume. They do likewise for you.

Indeed, Adam Smith's message is the exact opposite of the way you portray it. You serve your own interests best by serving the interests of others. If you withdraw from society your living standards would soon collapse with the same certainty as your ancestors would have experienced had they withdrawn from collaborating and reciprocating with their fellow clan members. If they had done so early enough in their lives, before they had lived long enough to breed, the unbroken chain of life from them to you would have terminated.

I discuss this central theme of Adam Smith's philosophy and economics in my book, "Adam Smith's Lost Legacy" (Palgrave Macmillan, March 2005).

Only in America: Idiocy of the Month!

America is famous for the widespread notion that Adam Smith proclaimed the “invisible hand” as the driving force of capitalism. At Lost Legacy we try to combat this distortion of his views – he never knew capitalism nor did he invoke the invisible hand metaphor into a maxim for markets.

However, there is no end to the extremes in everything that America cannot visit. Denise Cray, of SingleSkaters.com (!) has managed to link the experience of a young woman in a failed relationship arranged by a dating agency to Adam Smith’s “Wealth of Nations” and the invisible hand!

I know it is nuts but it shows how far we have to go to rescue Adam Smith’s Lost Legacy from those who have purloined it. Take a look at what Denise writes (http://www.singleskaters.com/):

“Case in point, an excerpt from an unforgettable true story we received on 09/01/2004. “I subscribed to eharmony.com in September of 2003. I was, like many other men and women, looking for a suitable spouse. Less than a year ago I met and married a man in Texas through [a US dating agency] and proceeded to 'fall in love for all the right reasons' which I just wanted a good husband. He has damaged my home, and severely jeopardized my financial stability, which was my inheritance as I have been left flat with nothing. I have not heard from him in over a month and I do not know where he is. I am also humiliated.”

Adam Smith (writes Denise) would have agreed that passion is the invisible hand. Adam Smith’s historical quote “he (man) intends only his own gain, and he is in this, as in other cases, led by an invisible hand to promote an end which was no part of his intentions”. No scientific method can take the credit for building successful relationships.”

No, I did not make it up.

A Debate Continues

I am in debate with Intellectual Conservative, a think tank blog in the USA. To follow the exchanges see: www.intellectualconservative.com and look up 'Articles'. Below is the latest response from Lost Legacy:

Capitalism and Judeo-Christian Religion
Gavin Kennedy

Thomas Brewton's reply to my comments on his original article is wellstated and I thank him for his courtesy in engaging in polite debate. Perhaps he, and Intellectual Conservative, will indulge me again tomy responding briefly.

Thomas Brewton linked the 'invisible hand' in a capitalist market to the alleged self restraints of 'our Judeo-Christian heritage'. I make two points:

1) while it is commonplace nowadays to see the 'invisible hand' as representative of market economies, this is not how Adam Smith saw the relationship. He only mentioned the invisible hand once in"Wealth of Nations" and he did not pack into the metaphor what 19th and 20th century economists added. I was trying to correct this all too prevalent interpretation because it smuggles into Smith's meaning many implications with which he disagreed;


2) Smith's own moral philosophy of the "impartial spectator" and the learning of the appropriate conduct that produces harmonious relations in human societies (presented in his Theory of Moral Sentiments", 1759) did not rest on a Judeo-Christian heritage.

Indeed Smith's rejection of "benevolence" as the guiding principle for expecting the necessary assistance from multitudes of anonymous strangers, who contribute to the living standards of even the"poorest common labourers" of 18th century Britain, was directly contrary to the Christian theology of the time (see "Moral Sentiments", Book VII, section ii, Chapter 3). Smith considered benevolence, the 'supreme virtue of the Deity', to be beyond human replication, and wrote instead in favour of "truck, barter and exchange", i.e., ordinary bargaining as the means to achieving our"dinner" from the "butcher, the brewer and the baker" ("Wealth of Nations", Book I, chapter 2).

In sum, Smith's argued that to serve our own interests best we should serve the interests of others.

It was in the exchange economy of the growing markets and the division of labour, re-appearing in 16th to 18th century Britain andwestern Europe, a thousand years after the Fall of Rome, that Smith saw an opulent future for all 'ranks' of society, including the common labourers (whom he compared favourably in living standards to the richest North American or African 'prince', rulers of a 1,000"naked savages"). His vision had nothing to do with our Judeo-Christian heritage, or any other religion, Muslim, Hindu or Chinese, etc. My point was simply to draw this to Thomas Brewton's attention by critiquing his compulsive melding of the two together. No religion has a monopoly on moral conduct, though they all claim to have such.

Adam Smith's philosophy of human sentiments and moral conduct can be fitted into a Judeo-Christian moral framework; it can also be fitted into any other religion, or none. This does not make any religion right or wrong and I mean no disrespect to people of any religion. It simply states that for smithian markets to function well, the Judeo-Christian heritage is neither necessary nor sufficient.

My point in critiqueing those who suggest differently, is that we need secular democracies, operating under freedom from dominant religious norms (a sure recipe for tyranny, as the Founding Fathers recognised), wedded to smithian markets and the smithian ethic that we serve our interests best by serving the interests of others.

Gavin Kennedy (Prof)

Author of "Adam Smith's Lost Legacy", Palgrave Macmillan, 2005 (www.lostlegacy.co.uk)

"The Adam Smith Solution Prize" for May 2005!

There are occasional glimpses of welcome news on The Adam Smith Solution – no, not the original 'Das Adam Smith Problem', emanating from a few 19th century German academics.

I refer to the modern, serious 'Das Adam Smith Problem' that portrays his contribution to political economy as steeped in laissez faire, minute roles for the State, a capitalism ‘red in tooth and claw’, and the separation of economics from morality and the normal decencies of human conduct.

None of these associations were part of Adam Smith’s Legacy.

Scanning daily the world’s press can be exasperating for those trying to recover Smith legacy. The field is crowded with those spreading the false image of what Adam Smith wrote about. Hence, to come across an item that is spot on the truth is truly a happy occasion.

Ganesh S. Krishnan, from Minnesota, USA, wrote on Monday May 16 a Letter to the Editor of The Indian Express, Bombay, India (http:/www.indianexpress.com.print.php?content_id=70413). He spoke of a six-hour video programme, “Commanding Heights – The Battle for the World Economy” that extolled the virtues of free markets and free trade and added:

“But we need to bear in mind, lest we get bowled over by free trade, that Adam Smith’s The Wealth of Nations (1776) was a polemic against monopolist tendencies. He favoured open competition, not the absence of restraints on the free market.”

Could Ganesh S. Krishnan be clearer? He is 100 per cent right. If only the majority of those who profess to speak on Smith’s behalf were as familiar with Smith’s legacy, half the Das Adam Smith Problem would be solved (the other half requires Professors of Economics in the world’s universities to stop teaching their students nonsense about Smith, thus spreading the contagion into the next generations).

I have started a monthly prize today: “The Adam Smith Solution Prize” for clearly demonstrating an understanding “Wealth of Nations” or “Moral Sentiments”.

This Month’s Adam Smith’s Lost legacy “The Adam Smith Solution Prize” is awarded to Ganesh S. Krishnan of Minnesota.

[Should you have nominations for the monthly prize, send them to http://www.lostlegacy.co.uk/ ]

Yes, but Don't Spoil the Message!

Hail to the Robber Baron?By Yoshi Tsurumi

Yoshi Tsurumi is a professor of international business at Baruch College, City University of New York. He earned his Doctor of Business Administration from Harvard in 1968, and he taught at Harvard Business School from 1972 to 1976.

Originally published on Wednesday, April 06, 2005 in the Opinion section of The Harvard Crimson (which is the daily newspaper of Harvard University).

Two extracts:

“Thirty years ago, President Bush was my student at Harvard Business School. In my class, he called former president Franklin D. Roosevelt, Class of 1904, a ‘socialist’ and spoke against Social Security, unemployment insurance, the Securities and Exchange Commission, and other New Deal innovations. He refused to understand that capitalism becomes corrupt without democratic civic values and ethical restraints.”

and

“To justify the robber baron culture, America’s business educators and economists falsely cite their demigod of laissez-faire market economics, Adam Smith. Little do they know that Adam Smith in fact scathingly castigated Bush’s type of government: business collusion and unfair taxes, Wal-Mart’s exploitations of labor and communities, and robber barons’ hubris. Nowhere in his 900-page book, The Wealth of Nations, does Smith even imply that those who knowingly harm others and society in their pursuit of personal greed also benefit their society. He rejects the notion that a corporation exists to make money without ethical constraints.”
Comments:

The article by Professor Tsurumi is intemperate and unlikely to be persuasive except for readers who dislike Republican Party policies. That is a pity because it makes one or two good points with which I concur, but many more with which I do not.

Unfortunately, supporters of the thesis that Adam Smith’s Lost Legacy has been purloined into service for policies with which he would have been most unlikely to support or be sympathetic with, cannot always choose their allies!

Apart from the ethical question of quoting the alleged remarks of a student years after he graduated, I am not sure that the student (George W. Bush) should be castigated for ‘refusing to understand’ a statement by his Professor about capitalism One can ‘fail’ to understand something, but to ‘refuse to understand’ does not strike me as a crime or a sin. It sounds more like the accuser would prefer to make it both (you have to understand something to refuse to understand it). More than one professor has been as wrong as his or her students on some issues of policy – in my student days all the professors were ‘Keynesians’ (I remember only one lowly lecturer who was a ‘monetarist’).

I should make it clear that I agree with Professor Tsurumi that ‘capitalism becomes corrupt without democratic civic values and ethical constraints’. But I do so voluntarily and without the compulsion implied in Professor Tsurumi’s allegation against his former student and now President of the United States.

However, the second paragraph quoted seems to me to be an accurate appraisal of the state of modern economics. Elsewhere in the article, Professor Tsurumi writes:

“American economics study has increasingly become a pseudoscience of mathematical formula manipulation that is devoid of humanity”

which is a sentiment with which I entirely agree.


My source for Professor Tsurumi’s article is: Kamran Mofid’s interesting web site: www.commongood.info or k.mofid@btopenworld.com

Connected - tenuously!

En route for a Few Days

Following my promise to announce when I might be 'away for some time', I will be travelling to France on Tuesday 10 May for a stay at our French home for about five months, with a couple of forays back to Edinburgh on business.

It may take a couple of days before I reconnect to Wanadoo, via a telephone line, not broadband.

Apologies in advance. Emails to the usual addresses will get through.

A 'Mix of Karl Marx and Tyranny'

From FrontPagemagazine.com

Robert Scheer, an American columnist, reflecting that April 30 marked the 30th anniversary of the fall of Saigon, claimed America has profited from normalized trade with Vietnam, benefiting from that nation’s cheap labor as we became Vietnam’s chief export market. He claims the modern Vietnamese economy, which he describes as “a mix of Karl Marx and Adam Smith,” provides “renewed proof of the viability of Marx's labor theory of value.”

For a leftwing ideologue, Scheer’s analysis is a complete muddle. How the ‘modern’ (by which he means ‘current’) Vietnamese economy ‘provides “renewed proof of the viability of Marx's labor theory of value” is a complete mystery. Every other countryb where it has been applied has experienced low living standards, economic decline and tyranny.

Vietnam is a state dominated old style Stalinist economy with some sectors and industries open to some carefully controlled western capitalist corporations and many small Vietnamese private entrepreneurs, with the bulk of the economy under the direct political control of the State and subject to its thoroughly discredited failed economic model.

The relevance of ‘Marx’s labor theory of value’ – now an embarrassment even to Marxists – is obscured by the rhetorical excesses of snappy sound bites like a ‘mix of Karl Marx and Adam Smith’. Wages are low in Vietnam because the country is impoverished, a result of a civil war that created a communist state, after a long struggle against French and US interventions, that continued to hold back economic growth through rejecting market solutions

Once the Soviet Union collapsed and left Vietnam to its own subsidyless devices, it only averted its own collapse by relaxing some, but by no means all, of the regulations and policies of a Marxist inspired dominant State.

Vietnam is not ‘viable’ because of ‘the labour theory of value’; it is propped up by low wages combined with imported technology. One hopes that the market sector will continue to grow, which will raise living standards and the real wages the people could earn from expanding employment in it.

If the ideologues of Marx’s ‘labour theory of value’ continue to manage the inefficient and dominant State sector there will be not much scope for the spread of opulence.

The original articles are at: http://www.frontpagemag.com/Articles/ReadArticle.asp?ID=17950
http://www.latimes.com/news/opinion/commentary/la-oe-scheer3may03,0,2555153.column?coll=la-news-comment-opinions

Apologies for the Unannounced Interlude

Apologies. I was in Bucharest, Roumania from 3 - 8 May attending two seminars of negotiation. I had expected to be connectable to the Internet but due to technical difficulties I was unavoidably out of touch until my daughter arrived and connected me in minutes!

Next time I depart in such circumstances I will announce it in advance, just in case I am not being visited by someone more technically proficient than I am.

Nonsense from Arkansas

Kicking the dog
Arkansas Democrat-Gazette - Little Rock, AR, USA:

... “As first noted by Adam Smith, the great paradox of capitalism is that societal welfare is enhanced by the advancement of private self-interest. ...”

Yet another piece of nonsense about Adam Smith, repeating the mandatory confusion about a single point Smith’s made in “Wealth of Nations” and turning it into a cardinal maxim of his political economy, which it never was.

Smith neither wrote about capitalism nor its paradoxes. He was dead long before ‘capitalism’ became a word (1854) or a phenomenon.

Smith wrote about the significance of commerce in a predominantly agricultural society in mid-18th century Britain. His political economy was integrated into his moral philosophy and both were supported by his views on Justice and the Rule of Law. People who had not read his Works carefully hijacked these views and they ascribed to Smith views, which he never held.

He wrote about the power of markets to raise productivity and create economic growth.
During one such discussion he referred to how in some circumstances, but not all, people could believe they were attending to their private interest (in this specific case they preferred to invest in home production and not in exports, in consequence of which, unintentionally, they boosted home economic growth rather than inhibit it). This was his only reference in “Wealth of Nations” to the ‘invisible hand’ (Book IV.ii.9: page 456). It has been turned into a general ‘law’ of economics in US schools and has become an alibi of those who assert that capitalist corporations must be given total freedom to pursue their private interests because it promotes public interests (and ‘Smith said so’!).

Yet, Smith spent several chapters on ‘Wealth of Nations’ critiquing expressions of the private interests of ‘merchants and manufacturers’, who were the small time ‘corporations of the 18th century, not the major capitalist firms of the 21st. Left alone to do what they will, companies express their private interests by forming monopolies, lobbying for selective tariffs and other restrictive practices, to reduce competition and raise prices through forming monopolies and cartels. The so-called ‘invisible hand’ could promote private interests (and often did) that worsened the public interest, reduced productivity, lowered economic growth and restricted liberty.

As in so many aspects of human society, private interest could work for or against the public interest. It all depends. Smith was no apologist for capitalism or for any expression of private interest.