At Last some good sense on China and International Trade!

Contrary to the distant paranoia from protectionists, closet and open, we get some good sense from Ben Stein, a lawyer, an actor and an economist, in today's New York Times. How refreshing to read Adam Smith's point about no country being harmed by the prosperity of a trading partner or (in today's global economy) a neighbour.

In Smith's day the paranoia was directed at France. He was scathing about the sillyness of such a proposition. We should be too with the modern version about China. Stein's article gives loads of facts about the relative size of the Chinese and the US economies. There is no contest between them. The so-called problems are minor. The fact the protectionist nonsense almost triumphed on the tiny case of CAFTA - its annual trade a mere fraction of China's - is a warning to the complacent. If you allow them, the protectionists will spiral the world into recession in pursuit of mere fractions of disputed trade gains and losses, which overall will be remedied by much greater gains once the economies make the necessary adjustments.

Read Ben's article in the New York Times (not a paper with which I always agree). Google NYT and go to today's paper 31 July, in the Business Section.


"Don’t Worry About China. Learn from it.
NYT 31 July 2005
Ben Stein (lawyer, actor, economist)

If we used the more conservative, non-C.I.A. estimates of where Chinese per capita G.D.P. is now, in 25 years it would be about $17,500- and this assumes the continuation of China's recent sizzling growth rates. That would put China's per capita income in 2030 at roughly one-sixth of our level.

In other words, it will be a long time before Chinese per capita G.D.P. matches ours. And for that to happen, it will take a previously unheard-of growth rate for an unheard-of length of time. This is a big series of ifs, especially for a country with a rapidly aging labor force and an inherent contradiction between dictatorship and free markets.

But suppose that it does happen. Suppose that China becomes a larger economic power than the United States. Suppose, in our great-great-grandchildren's day, that the average Chinese citizen is about as rich as the average American. How would it hurt us? Why would we be worse off? If the Chinese were richer, they could buy more from us and employ more of our workers. They could buy more of our stocks. They could tour our beautiful nation more.

The fact that our neighbors are worse off does not make us richer, and the fact that they are better off does not make us poorer.

But another factor is even more important: personal responsibility. Americans who want to make sure they stay well off accomplish nothing by worrying about China. But we can certainly learn something from China. Individuals and nations become rich by investing in human capital - getting a good education, learning good work habits, saving and investing prudently and living healthy lives. Any young Americans who want to keep up with the Chinese can get a good education, work hard, save as much as possible, invest prudently - and they will be just fine now, in 25 years and in 50 years. " (Copyright The New York Times)

Protectionist Extreme Paranoia Department

Brad delong's Blog is probably the best from an economist regularly poring out lively and striking pieces. I don't agree with everything he writes, but the following item taken from http://delong.typepad.com is too precious to miss.

It comes from a Washington DC source and purports to be from what I can only describe as 'nutters'. It is in line with a wide range of distant drumbeats trying to march towards US protectionism; against the Chinese on this occasion.

"AFF's Brainwash :: Gene Healy :: China's Earthquake Weapon: Did anyone catch this line in Max Boot's recent "yellow peril" op-ed, warning that China may be looking into "creating man-made earthquakes" as a way of fighting an asymmetric war against the United States? Meanwhile, neocon national security maven Frank Gaffney warns of a Chinese Pearl Harbor attack on the US via electromagnetic pulse (EMP) weapon. It occurs to me, as it has before, that a capacity for embarassment is a severe liability for a D.C. wonk, especially when it comes to foreign policy. Having recently crapped the bed on the Iraq issue, one would think that Boot, Gaffney, Woolsey, Kristol, et al. would have the decency to maintain a studied silence on national security issues for a time. Or, failing that, to proceed soberly, cautiously into the discussion--rather than spinning doomsday-weapon scenarios drawn from a 1930's Buck Rogers filmreel. But D.C. is a town where you can't get laughed off the stage. Why bother to be careful and judicious?"

For the record, no country need fear a neighbour's prosperity (and in the global trading age, we are enighbours of everybody in it). Adam Smith understood this truth; some politicos do not - and they are more scary than their fantasies.

Bentham and Smith

In JoongAng Daily, Korea: “Society's watchmen should be watched” by Lee Sang-il

In this interesting piece on the cctv society, Le Sang-il takes up the case of the need to watch the watchers. He does not challenge the value of cctv cameras catching suspects associated with terrorist acts, but raises the usual qualms that a tyrannical government might use them for nefarious purposes.

Most democrats would share those concerns to some degree. However, democrats living in democratic societies would soon recognize the difference between democracy and its alternatives and we have a very long way to go before liberty is threatened in the UK.

Lee Sang-il writes:

‘Just as Adam Smith had discovered the "invisible hand" of the free market, Mr. Bentham designed the "invisible eye."’

If Lee Sang-il reads what Adam Smith actually wrote, he would find that on the only three occasions that he used the invisible hand metaphor, he was not referring to markets at all, free or otherwise. That is a myth created by modern economists misapplying the metaphor in a way Smith had not intended. Given that Smith was actually writing about the ‘unintentional consequences’ of human motivations, not directly about markets (Smith’s first reference was to pagan superstition; his second was to the greed of Feudal Lords; and the third was to the preference of ‘merchants and manufacturers’ for preferring local over foreign trade), perhaps he has become a victim of his own metaphor.

Incidentally, the originator of the assertion of the ‘happiness of the greatest number’ was not Jeremy Bentham (he certainly popularised it), but Professor Francis Hutcheson who was Adam Smith’s mentor at the University of Glasgow (1737-40) and a distinguished philosopher in his own right.

Another Front Opens for Protectionism?

From today's US Tokyo Embassy Press Release: a few extracts:

China No Threat to United States in Africa, U.S. Official Says

By Jim Fisher-ThompsonWashington File Staff Writer

Washington - Despite perceived rivalries, the United States and China are cooperating at a number of levels to end conflict and advance development in resource-rich Africa, a top U.S. State Department official told Congress July 28.

Principal Deputy Assistant Secretary of State for African Affairs Michael Ranneberger told the House Africa Subcommittee that "as a natural result of its [economic] growth, China is increasingly involved in the global marketplace, seeking new markets for its goods and reliable sources of energy." Both goals are "reflected in China's increased engagement across sub-Saharan Africa," he said.

Ranneberger said, it is important to note that "in many respects China's engagement is essentially classic Adam Smith [author of The Wealth of Nations, which launched the economic doctrine of free enterprise], value-free capitalism in action. It's worth noting, too, that while we refer to 'China,' Chinese engagement also involves a wide range of private enterprises, semiprivate businesses, and local government entities that engage in trade not directly linked to official Chinese government policy."

He said, "There are of course times when our interests and China's will need to be the subject of dialogue," especially about its growing military support to the repressive regime of President Robert Mugabe of Zimbabwe. "Certainly, the [Bush] administration will continue to work hard to address common challenges - regional and global, economic and political - with China. And in those areas where we have differences, we strive to handle these issues in a candid and open dialogue," Ranneberger said.

Comment:

From the questions it is clear that Congress men and women are raising vague concerns of a different nature to the overtly protectionist concerns of allowing a country open access to the US markets where it may take a large slice of US domestic activity.

Concerns raised about China competing with US traders in Africa are about a country competing with US interests in third countries. What exactly the US (or any other country in the same position) can do directly about foreign competition in third countries is not clear, other than mistakenly retaliate against the foreign competition being successful in the US. That is the danger behind such concerns.

International trade is about trade with and among many foreign countries. As long as it is one-way trade (the home country with foreign countries), the protectionist clamour is clearly seen for what it is; the age old whine of domestic producers about their customers being able to buy cheaper goods from foreigners (thus raising the real wages of domestic consumers, i.e., what they can buy per dollar, or pound, or euro) to the disadvantage of domestic producers who prefer to charge them more (i.e., lower the real wages of domestic consumers), not necessarily to make greater profits, though that is not precluded, but sometimes just to break-even (which suggests they should get out of that business and use their capital for something more productive).

But when rival foreign countries (in this case China – in aircraft manufacture it is Europe) threaten competition in third countries, the whine of domestic producers shifts a gear to see sinister intent behind the foreign competition, which is soon picked up and articulated by domestic politicians.

That China has an appalling human rights record, is a communist dictatorship and has a growing military presence, lends the protectionist groans a smidgen of justification in the eyes of legislators.

It is from such roots that the 19th-century imperialist adventures of Europe grew from. That is a real danger. A much better response from the US would be to unilaterally abandon its domestic agricultural subsidies and other existing protectionism measures and thus enable nascent markets in Africa to grow from trading with the US (and China and whomsoever else). The enrichment of Africa and the reduction of poverty would do more for US competitive trade relations and their success than any of the dark adventures to which Congress could drift if the protectionist drums increase their beat.

Adam Smith understood this. Do the people who quote him also understand this and is Congress listening when Adam Smith’s name is quoted?

Hurrah for CAFTA - A First Step to something better

The US House of Representatives voted 217 to 215 for the Central American Freet Trade Area agreement. Great news despite the total opposition (except for 15 heroic Democrats voting for the deal) of the US Democratic Party.

Having read some of the statements of Democratic Congress men and women ('I support free trade BUT...) I see sectional interests of some constituencies welded to hostility to anything sponsored by George Bush.

Typical opponents include the unaptly named Congressman Adam Smith from Washington State who produced what I can describe with justice, weasel words to work against the interests of both US consumers and workers, and the intetests of the much poorer people of Central America and the Dominican Republic. Because CAFTA did no correct every injustice immediately (how could it?) he opposed this CAFTA until a better one came along.

This reminds me of Lord Home, former British Primeminister, who intervened in the devolution debate in Scotland in 1979 with the spurious line that if the Devolution Bill on offer was rejected, then it would allow a 'better bill to be introduced later'. Some silly people believed him - he had a high reputation in Britain - and the referendum was lost. Of course, no such 'better' , or any, devolution Bill appeared until after 1997, when a new Labour government was elected.

If Congressman Adam Smith believes a 'better CAFTA' will come along if Congress had voted against the one of offer, he would have been unlikely to live long enough to see it. If he does not believe there is a better one likely to be on offer, then he is a cynical protectionist, disguising himself as in favour of free trade. Politics is about compromises and having to accept less than perfect solutions to problems. The original Adam Smith understood that; Congressman Adam Smith apparently does not - yet.

CSR and corporate self interest

I have written a longer post below because it raises themes that should be discussed and not just left to those defending private companies under guise of allowing them to act with impunity with the pretense that whatever they do is for society's good and that Adam Smith said so.

Corporate Social Responsibility (CSR) is about requiring private companies to consider ways in which they can do more than maximise their profits. The ‘more’ bit is controversial, with governments, political parties, trade unions, consumer groups and single issue campaigners all adding to the pile of additional objectives for companies to add to their traditional role of maximising shareholder value.

Some companies (Shell, BP, for example) have gone with the flow and directed some of their expenditures into projects that provide good public relations; other sponsor all kinds of events which also attract welcome publicity (Royal Bank of Scotland sponsors UK rugby) and the ‘feel warm’ factor towards them.

The history of company behaviour since the original Joint Stock Companies of the 18th century, and their successors in the capitalist era from the 19th century, shows that intervention by the law has been necessary to curb, even prohibit, unwelcome practices to which many of them were wont to engage in when left alone (laissez faire) to do whatever was in their self interest. The list is long and can be represented by mentioning the ‘Truck Acts’ (against paying workers in kind or in good from company shops at company determined prices, instead of cash); restrictions on the employment of women and children in coal mines; shorter hours (the 10-hour day took a mighty effort to pass); the careless use of hazardous chemicals; the dumping of pollutants and effluent into rivers or in piles on land; and more recently, legislation against discrimination, unfair dismissals, and unsafe working practices.

I raise these by way of introduction to a contribution on CSR by Johnny Munkhammar, a Director at Timbro, a free-market institute in Sweden, in Tech Central Station (‘where free markets meet technology’) on 27 July 2005. I think that Johnny Munkhammar writes clearly about the issues, but by not referring to the history of imposing on private companies, he sanitises and ends up with a slightly confused response to the very questions he poses at the head of his article.

He writes:

“In recent years, the CSR trend has become very strong. Political decisions and public opinion are building momentum behind the concept. Since companies are the route to prosperity, the debate is essential. And since companies are the core of capitalism - the expression of man's creativity protected by private property and freedom - it is also a discussion about principles.”

Fair enough. We know where we are going. Or do we?

He continues:

“A basic starting-point for a discussion of CSR could be a famous quote which states a principle for a free society and its effects:

"…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. …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."
--Adam Smith, The Wealth of Nations, 1776”

Oh, dear! By neglecting to quote the entire passage (Wealth of Nations, page 456: Book IV.ii.9), the resultant quote appears as a general principle applying to the entire range of behaviours of individuals and companies in all circumstances and all periods. This enables self interest to be elevated to a axiom when in fact it needs to circumscribed with appropriate qualifications to prevent us assuming that self interest (and the invisible hand) is of divine purpose.

Yet a moment’s reflection cautions against such a conclusion and an acquaintance with the philosophy and political economy of Adam Smith leads us in a different direction. Smith was talking about how a preference for the home market led individuals to boost national annual revenue and thereby the exchange value of national revenue (the two being equal), whereas a preference for distant investments abroad would not be as productive for the national economy. He was not giving a carte blanche to companies, or individuals, to do what they liked under the misbelieve that somehow divine providence intervenes and mysteriously makes the most selfish acts beneficial to society.

A large part of Wealth of Nations is a polemic against ‘merchants and manufacturers’ promoting their self interests at the expense of society through monopolies, price cartels, restrictions on outsiders (from the next village and abroad) entering local markets. He railed against feudal lords and their incredible selfishness (he called the history of the rulers of mankind ‘vile’ in their tyrannical self interest). This is why Smith never wrote in favour of laissez faire. He advocated the State should take over the guaranteeing of weights, the quality of precious metals, the ending of cheating workers of their wages by paying in company tokens exchangeable at company run stores, the education of children and expenditures against ‘noxious’ diseases.

Johnny Munkhammar writes:

“The pursuit of self-interest creates wealth. That is what changed after thousands of years of misery and poor conditions for people. Today, the average person in the US or Europe lives better than the kings and queens of the Middle Ages.”

The one-sided pursuit of self-interest does not produce wealth. If it did then we would have a history of wealth creation despite the ravages of barbarianism against wealth creating societies for millennia. Markets create wealth when individuals trade their output for the output of others. Violence (self interest in the extreme!) does not create wealth; only the division of labour and the propensity to ‘truck, barter and exchange’ creates wealth. That, after all is what Smith’s ‘Inquiry in the Natural and Causes of the Wealth of Nations’ was about.

Markets are free. They operate in harmony as individuals mediate their self interest with the self interest of others. They appeal not to their own self interest in trying to conclude a bargain, but to the self interest of the other party. Companies, a more modern phenomenon that post-dates Smith’s life (1723-90), must mediate their self interest with consideration of the self interest of their customers, and in a more general sense, with the self interest of the society that enables them to manage their private property under the protection of the law. For this to work, they must obey the law and operate within its constraints. Laws are passed by democratic parliaments in free market countries.

“Companies, focusing on their main aim, promoted the general interest,” write Johnny Munkhammar, as if he has proven his point, but by neglecting the full Smithian agenda, he slides into that carte blanche again. Recent history of corporate fraud shows how little has changed from when ‘merchants and manufacturers’ were left to their ‘main aim’, profit maximisation, in Smith’s day.

Munkhammar continues:

“What does this have to do with CSR? To me, CSR is about making companies and their owners focus on other things besides their self-interest. They should not only concentrate on producing the best clothes, for example, but also on social matters. And they should not be allowed only to seek profit, if that is what they wish, since that is not ‘responsible’.”

No, no, and no again. They must always go beyond their self interest if they are to serve their customers and compete fairly with others. It’s in Book I of “wealth of Nations” and applies throughout the other four books. To do so is not to sacrifice legitimate profit as mediated within their markets. They could make more profit by reversing laws that intervene on their private greed but protect society as a whole.

He finishes with a flourish:

“All the goods and services, all the jobs and all the prosperity in the world, come from companies. If companies try to give more by being less focused on their self-interest, they could end up giving less. In that case all of society loses. The defense of companies and their right to pursue their self-interest is not only the defense of capitalism. It is also the defense of a society in which there is constant progress - and that includes social progress.”

Companies are not separate from society. They operate within it and are subject to its laws. Without these laws, no company would operate for long with impunity. The barbarian is always at the gate and sometimes creeps surreptitiously into the very citadel.

No company has the absolute ‘right’ to ‘pursue its self interest’; its rights are to pursue the self interests of its customers, because by doing so it benefits its own self interest best. And what is true for companies is also true for every individual too. That is the true meaning of Adam Smith’s legacy (and CSR).

A skinny latte and an Americano, please

In "Monthly Review", USA, Michael Hoover, professor of political science at Seminole Community College in Central Florida and author (with Lisa Odham Stokes) of City on Fire: Hong Kong Cinema, writes an interesting piece on Starbucks. Basically, it is about what makes Starbucks work as a mega-sized marketing chain of coffee shops.

Hoover introduces Adam Smith into his discussion in a most interesting way:

“What can Starbucks tell us? In a nutshell, contemporary "counter-cultures" -- cultures that are not counter to anything but are in fact part and parcel of the dominant culture sold over the counter everywhere -- are merely attempts to stylishly wed Adam Smith's "homo economicus" theory of markets in The Wealth of Nations with a regard one should have for others that Smith expresses in The Theory of Moral Sentiments -- in other words, capitalism with a "humane face" that leaves one "feeling groovy."

I congratulate Professor Hoover for showing evidence of understanding something of Smith’s legacy beside the usual tripe about laissez faire, invisible hands, the absence of
government and no matter what corporate giants do it will all work out right in the end.

Starbucks stats are impressive: founded in 1971 in Seattle, it now has 9,000 locations (6,500 in US) in 31 countries. It turns over $4 billion a year from 33 million customers daily and is worth $10 billion. Opens 3 new coffee shops some where each day.

Monthly Review is a left leaning magazine of some long vintage, from Herndon, VA, USA.

Scare Mongering?

I am not sure yet how to take finally the following article by Carlos Alberto Montaner on “China: Leaders still behave as communists”, in The Miami Herald, 26 July 2005.. It starts with the good news:

“Amazing. In the course of barely one decade, 300 million Chinese have risen from poverty thanks to globalization. The transfer of technology, foreign investment and an intense foreign trade accomplished the miracle. Humanity had not seen a similar phenomenon in all of its history. Never before has a human mass of such proportion gone from indigence to integration into the social middle class in such a brief period.”

This theme is becoming quite common now in western media – recently a journalist spoke about Vietnam being a country run by “Marxists and Adam Smith” (a wild exaggeration, of course; communist tyranny is not compatible with Adam Smith's decent society).

Next we get the first signs of concern:

“But China's spectacular development could end in the worst possible disaster if its top leaders -- who were, after all, brought up in a dogmatic Marxist rigidity -- persist on the huge mistake of producing as modern capitalists while behaving as old-fashioned communists.”

And then we get the nightmare stuff:

“It also explains why their military budget has risen to $90 billion a year, the result of an effort to create a dangerous offensive force replete with intercontinental missiles and long-range bombers.”

As a veteran of the Cold War (at the academic level from my interest in defence economics) I need no introduction to the dangers of Soviet and Chinese militarism. But I am worried slightly that this type of approach adds to the recent clamour from protectionists in the US legislature and government to ‘do something’ about Chinese exports before the US ‘goes bust’ school of economics (along with non-relevant quotations from Adam Smith from his lost legacy).

Now I am not accusing Carlos Alberto Montaner of crude scare-mongering. I do not yet know enough about his views. But the use to which his piece might be put by others, by lifting his ideas and theme to support their case against China’s export successes, which have created wealth for the 300 million mentioned above and increased living standards by raising the real wages of Americans, and everybody else with whom they trade.

The drum beats of hostile protectionism are muffled presently, but we can hear them nevertheless in the distance. Nothing is more likely to induce international conflict among countries that fall for the protectionist nonsense when hostile acts against China’s (or anybody else’s success) in exporting higher living standards to the rest of the world, are implied as being necessary in such articles as “CHINA: Leaders still behave as communists”.

Carlos Alberto Montaner ends his article with some sound advice, behind a barbed criticism:

“When China's engine of production was communism, it was natural for the leaders in Beijing to cling to Marx's absurdities. But if indeed the leaders have embraced capitalism, they should begin to read Adam Smith seriously before they needlessly destroy the planet on which we all live.”

It all depends on what version of Adam Smith are they going to read about: what he actually wrote in “Moral Sentiments” and “Wealth of Nations”, or what passes for Adam Smith’s economics in modern US academe (‘invisible hands’, ‘laissez faire’, ‘father of capitalism’, and so on as critiqued in “Adam Smith’s Lost Legacy’ (Palgrave 2005) and on this web site?

You cannot have Smithian markets without the rule of law, stable government, natural liberty and democratic institutions (including the separation of powers). Nor can Smithian markets operate in conditions where monopolies, intrusive regulations to protect special interests other than those of consumers, and alongside widespread fraud and protection t the highest levels in coporate America. In this regard, China (and Vietnam) is a long way from the necessary institutional changes (amounting to regime change) to embark on a Smithian economy.

For that matter, so is the USA in respect of agricultural protectionism, corporate monopolies, state assisted support and imbalanced defence preparedness. It would do the US political leaders good to read Adam Smith too and, like the Chinese, gradually change their stance in these areas. Unlike the Chinese communists, the US is more than half-way able to implement Adam Smith’s advice in support of its democratic constitution, the rule of law and the separation of powers.

Its other advantage is that the USA is more than strong enough economically to adapt to the presence of a new player in the global economic system without panicking over marginal adjustments to its present configuration of its allocation of factors of production and distribution.

Adam Smith understood that the prosperity of trading partners is never a cause of concern in an international trading system; it is the absence of prosperity of neighbours that poses problems for opulent countries like the USA. Hence, the hand wringing of some US legislators, labour unions and corporations over CAFTA and China is more worrying than China apparently wasting $90 billion on weaponry.

The article can be read at: www.miamiherald.com

A Step Forward, a Leap Backwards

In Magic Morning Star, Millinocket, Maine USA (© Copyright 2005 by Magic City Morning Star), 25 July 2005, there is a piece by Stephen Crocket, “Breaking Monopoly Power”

It contains some interesting steps towards an analysis of Adam Smith’s writings that uncovers the fact that modern day capitalism is not what Smith wrote about or supported. However, it manages to get everything upside down and back to front.

Stephen Crocket writes:

“Traditional students of economic theory understand that Adam Smith put forward a great argument for capitalism. He outlined a capitalism that served the greater good of mankind and society as a whole based on individuals advancing their individual economic interests. His theories were based on premises that include free and equal access to capital (money) and knowledge. He supposes that no individual economic entity would have more market power than other. All players should be equal and not have undue advantage over others. Any system that permits such advantages is not truly capitalism.

Capitalism breaks down as an efficient economic system the more these premises are denied by reality. Nothing threatens these premises more than monopoly power. True capitalists should support government actions that create a truly capitalist economic system.”

Now that is not what Adam Smith wrote about. Smith neither knew of the phenomenon of capitalism, nor even the word (first used in 1858, not 1790 when Smith died). Smith never made an argument for capitalism; nor did he outline an argument that the greater good of mankind and society as a whole was advanced by people seeking their self interests. His premises did not include free and equal access to capital and knowledge (indeed, he recognized that these were not distributed equally), nor was market power distributed equally. The idea that he bemoaned any system that permitted inequality was not “truly capitalism”, a silly ideas as he did not know anything about capitalism, which developed a in the 19th century, not the 18th.

Smith certainly opposed monopolistic power but the monopolies he railed against were impositions imposed on markets by government regulations, local corporate laws and the petitions of “merchants and manufacturers”, adopted by gullible legislatures.

Stephen Crockett is misled by the belief that Smith was an advocate of capitalism. He was not. He wrote about mid-18th century markets – street markets and local fairs, selling local produce to local people and the activities of local skilled tradesmen supplying products and services to local agricultural interests and consumers.

He took inequality as part of the natural order and saw such inequalities being lessened by economic growth through the division of labour and the widening and deepening of markets. He had no idea that the joint stock company, of which he was suspicious and critical, would become the main vehicle of capital accumulation in the capital hungry centuries that followed.

So, Crockett and Smith in their intentions were similar but the foundation of Smithian economics was completely different from Crockett’s premise, namely that capitalism was something embedded in Adam Smith’s thinking. That is a myth developed by economists in the 19th and 20th centuries who had not bothered to read his books for themselves. If there is to be change in the way the economy works it is essential to first understand from where Adam Smith was coming from.

Crockett has made the first step; it is now time for him to focus on the real contribution of Adam Smith in “Moral Sentiments” and “Wealth of Nations”. He should start by reading "Adam Smith's Lost Legacy" (Palgrave 2005)

Stephen Crockett is a co-host, Democratic Talk Radio: www.DemocraticTalkRadio.com) Mail: 7A Planville Drive, Fayetteville, TN 37334. Email: midsouthcm@aol.com.

Same Problem, similar solutions

Earlier last month, I wrote about interruptions in electricity supply in Russia and this week a similar problem is expected to emerge in Boston, USA. Similar disenchantment with Adam Smith (why does he always get blamed?) is expressed, yet the same remedies are available.

In an Editorial piece in the "Boston Globe", under the heading "Electricity Overlord", we read the following:

“With deregulation, the theory went, enterprising power producers would foresee a shortage and, on their own, build or expand plants to fill the market need.
The theory hasn't worked.

Gordon van Welie, chief executive of the ISO, or independent system operator, that oversees New England's electricity system, fears that the region could face brownouts by 2008 unless new capacity is built. But, outside of the wind farm proposed for Nantucket Sound, no big projects are in the pipeline. So van Welie is trying to get approval from the Federal Energy Regulatory Commission to send a signal to power producers by raising rates, with special bonuses going to producers in areas like Boston and southwestern Connecticut that are underserved with transmission lines.

The problem, as Massachusetts Attorney General Thomas F. Reilly and the other five New England states' consumer defenders have pointed out, is that this could cost regional ratepayers as much as $13 billion over five years. The high cost of the plan has also earned the opposition of the Energy Consortium, a group of large power users. Moreover, there is no guarantee that any new plants actually will be brought on line.

There has to be a better way, and there is. ISO New England should conduct an auction in which power generators are invited to bid for the right to supply the new capacity, with the award going to the firm willing to do it for the lowest increase in rates. If this looks like a partial return to the old days of the regulated market, so be it. The ISO's top-down imposition of a rate increase that would raise Bostonians' bills by 21 percent by 2010 (on top of fuel costs) does not come out of Adam Smith's free-market playbook, either.”

In the tussle between Regulation of power companies and total Deregulation there is something forgotten, which Adam Smith would have reminded his readers if he had been writing about a similar problem. At root of the problem is the lack of re-investment in very expensive capital projects. In Boston those affected appear to be playing ‘pass the parcel’ to avoid footing the high cost of investing sufficient capital to avert ‘brownouts’.

In Russia, you may remember, the ‘brownouts’ were happening now, not in 2008. Commentators suggested re-nationalising electricity supply, a perhaps overly drastic response to a basic problem: suppliers, Smith would have reminded readers (accepting, of course, that Smith knew nothing of our modern dependence on ‘electricity’), were in breach with the customers they had contracted to supply their product.

If they did not invest sufficient capital to ensure delivery of what they had promised, they should be vulnerable to court fines and damages. If such fines were paid by the firms, or if they declared bankruptcy, were collected from the owners and shareholders (to the full value of their personal wealth in my opinion, given the strategic importance of electricity supply), then owners and investors in electricity supply would take due care that they met their promises by investing to avert brownouts in 2008. The extra costs would be collectible from consumers of electricity (and from consumers of products using electricity in their production). They would price accordingly.

In Boston, a similar solution would follow similar paths. The idea of an auction to select a supplier willing to undertake the most efficient solution of supplying sufficient capacity is a good one, provided that it is backed with a Smithian contract to secure their promises against their corporate (and, in extremis, their personal) wealth.

Smith did not advocate ‘free markets’ in all cases. In Book V, “Wealth of Nations”, he clearly stated that where necessary civil projects could not be afforded by private individuals they should be funded by the State. Today, electricity supplies are in the same category as the 18th-century roads, harbours and canals of Smith’s day. How they are managed (state versus private) and how they are charged (Smith preferred they should be paid for by users) was left open to practical solutions based on utility (i.e., which methods worked?). His precepts remain relevant today.

Early sighting of Vultures

The merchants of panic, doom and disaster are really gathering in their hundreds, probably thousands. It’s all due to the Chinese economy and its alleged threat to the USA (where xenophobia is showing early signs of becoming rampant) and to Europe.

A few years ago it was Japan that threatened the West. ‘Learn Japanese’ became a fad at Business Schools. Now it’s “Learn Chinese”. Meanwhile, Chinese school kids learn English.

A particular example of the genre is in the piece below, from a rather excitable site: www.mathaba.net (the Mattaba News Network, or MNN from Africa), which, of course, drags in Adam Smith and the invisible hand into its screech about World War III:

“World War III: The next war has already started”From: Raw Story


By John Steinberg RAW STORY COLUMNIST

“China, which may be less than a true free market at home, has no problem bitch-slapping us with Adam Smith's invisible hand at the most macro level. So it seems rather obvious that China will flex its growing muscles and buy its own secure supply by bidding on bigger and bigger helpings of Big Oil.”

Why international trade must lead to, or be associated, with world war is not clear. How the metaphor of the invisible hand elucidates the situation is not clear either, unless it is Shakespeare’s (“thy bloody and invisible hand”, Macbeth: 3.2) that John Steinberg has in mind, not Smith’s which was entirely peaceful, and had nothing to do with trade, markets or the macro level.

We can expect more of this rising cover for protectionism in the coming months and years. Sad, really. Smith made clear that our neighbours’ prosperity cannot be a disadvantage to the UK, or the USA (or Africa). Globalisation is good for everybody, and certainly better than the protectionist and sinister alternatives.

The original article is at: http://mathaba.net/0_index.shtml?x=287384

Good News from Lucknow, India

Surat Singh, President of the Harvard Club, India, addressing businessmen and women, makes a speech on leadership and losing. Among other things he makes a reference to Adam Smith that is both accurate and revealing. He clearly understands what Adam Smith was about (whereas most economists do not).

Reporting the speech, Rohit Joshi & Anuradha Banerji, summarise his words:

"Quoting Adam Smith, the famous economist, [Surat Singh] said every body is guided by self interest, but only enlightened people are guided by enlightened interest (in short, adopt a negociative and diplomatic approach in life)."

Note the tail-ender: "in short, adopt a negociative and diplomatic approach in life". What could be clearer? How is that Surat Singh correctly gets Smith's point, but so many others do no?

Adopting a "negociative and diplomatic approach to life" is precisely what "Moral Sentiments" and "Wealth of Nations" are about. These behaviours permit people to harmonise their disparate motives, wants and needs and to endure the total dependence each person has on others.

How different this is from the "red in tooth and claw" approach to market dependence? Those, like our Texan banker of some weeks back who saw "the market" as a massive demolition ball of iron smashing the opposition to pieces, are so wrong about Smithian markets, and worse do not realise how wrong they are.

The division of labour is mediated by negotiation ("truck, barter and exchange"), not by a cut throat, ruthless war of the big shots on the little shots. Surat Singh shames such people by contrast.

More good Smithian analysis

Andrew Cassel on Philly.com visits a base ball game and notes that it was followed by an hour of fireworks costing around $100,000 paid for as a marketing expense by “Independent Blue Cross”, a health fund that acts as a non-competitive business.

He points out that Adam Smith said that countries that prevented competition in certain markets did worse than those that didn’t. Good sense; good insight; good point.

Tim Cohen - a welcome breath of fresh air

From Johannesburg, South Africa, in Business Daily (“news worth knowing”) on 22 July 2005 an article on “Stakeholder capitalism” that carries a most welcome approach to linking the name of Adam Smith with modern market economies under the guise of the so-called invisible hand.

Tim Cohen, editor at large, writes a remarkable rebuttal of the misuse of Smith’s metaphor. The heading says that “Stakeholder capitalism” (which sounds like welfare capitalism plus state regulation) is “one more bind on Smith’s invisible hand” and proceeds to demolish the whole concept behind stakeholder capitalism.

It also makes an unusual move in articles on Smith and the invisible hand. It actually suggests readers look at what Smith actually said in “Wealth of Nations” and decides that the invisible hand has no role in markets! Wonderful!

Tim writes:

“Adam Smith was not an economist, he was only feeling his way towards the idea in 1776. He was a moral philosopher. His insight was so profound because he recognised early, and judged correctly, the moral effect of people acting according to their own interests, and found, to his own surprise almost, the result was not entirely distasteful. What’s important here is that he was merging mass commercial activity with individual psychology; not with structure or function or class role, but the essential striving nature of humankind. He was not endorsing greed, nor theorising about market perfection, nor necessarily supporting the merchant class.”

And he ends with a suggestive assessment of the invisible hand as Smith meant it to be:

“The only thing that stands against them is a simple, crisp, trenchant, time-tested insight, or, to put it another way, modern economics. But proponents of the invisible hand should take heart, because its detractors have no idea of the power they oppose. They are not opposing a system, or a class, or a political group — they are opposing human nature. That is the real invisible hand.”

Congratulations to Tim Cohen; an excellent candidate for July’s Lost Legacy Prize.

In Your Dreams

The Socialist Party, one of many tiny leftwing sects competing for the same diminished constituency, celebrates what it considers a boost to its future prospects with the announcement that BBC Radio 4 listeners “had voted Karl Marx the 'greatest philosopher of all time”.

The article appeared in the 21-27 July edition of The Socialist under the heading: “The Greatest Philosopher of All Time” by Tony Saunois.

The hyperbole continues:

“The vote for Marx was overwhelming, winning 27.93% of the vote compared to his nearest rival, the free trade supporter and contemporary of Adam Smith, David Hume, who received only 12.67% of the vote. This vote represents a blow to capitalist commentators. It illustrates hostility towards modern capitalist society amongst even sections of the middle class.”

Out of such exaggerations a belief becomes heady for those infected. Yet, in a moment’s reflection, Tony Sauvnois might ponder that if 27.83 per cent voted for Karl Marx, then 72.07 per cent voted for other philosophers, which suggests the Red Dawn is postponed again, as it has been for far longer than the Socialist Party has been in the propaganda business.

Of course, that 12.67 per cent voted for David Hume (an astonishing result given how little is known about Hume) and even fewer voted for Adam Smith whose philosophical contributions remain unknown to many (the majority?) who see Smith as an economist, the result might be thought to be dispiriting for those enthusiastic about the public recognition of both men. On the contrary, Hume and Smith are not celebrities, but their ideas have had more impact on the global economy and societies than is measured by popular polls.

However, while socialism has come and gone (and was hardly an advertisement for human achievement), markets have gone on from strength to strength. The Dictatorship of the Proletariat turned out to be just that – a nasty dictatorship and few BBC Radio 4 listeners (I am not so sure of all BBC staff) would vote for one being formed in the UK (if they are allowed a vote by the socialists after they got into power). Socialists from Lenin and Mussolini onwards – including the interlude for the National Socialists of Hitler’s Third Empire – have not allowed democratic votes once they seize power.

Countries run by socialists become poorer; it is a race to the bottom. Everybody is equally impoverished, tyrannized and wishes they were somewhere else. It is better that Tony Saunois dreams his dreams in a capitalist country; he would only have nightmares in a socialist one.

Progress in Daily Visitors and their Use of the Site

Great news of the advance of 'lost legacy' in the number of daily regular visitors.

The largest daily visit in terms of 'pages' of the web site looked at was 1,034 pages this week on Tuesday. As that was from 67 'unique visitors' (does not include multiple visits on the same day), I am pleased with our progress.

Since March, 6218 'unique' visitors have dropped into see 'lost legacy' which includes return visits on different days (up from a maximum of 105 in March).

The breakdown of the regions from which our visitors originate shows a predominance from the USA (the country most in need of correcting its misuse of Adam Smith's Legacy), and within the USA, California is the most represented State. The UK trails well behind at 5.58 per cent on total visits, with the rest spread around the entire world.

Correct Analysis of Motivation to Work

Excellent analysis from Edward Lotterman, an economist from St Paul’s, Minnesota, USA, published by Pioneer Press (TwinCities.com) in an article discussing a court case over payments to part-time governors of a non-profit hospital.

The pay dispute, while interesting, is not the focus of my comments. These focus on Edward Lotterman’s reference to Adam Smith on the reason why people work in a market system.
Edward Lotterman’s statements follow which are right on target for their accuracy (so unusual in most quotations of his views):

“What motivates humans to work? Economics assumes that people base all actions on maximizing satisfaction in life. Satisfaction can come from meeting physical needs and wants. It also can come from how others regard you or the simple self-satisfaction involved in many activities, even tiring ones.

Earning money to buy goods or services is an important reason most people work. Adam Smith famously argued, "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." Or as a modern bumper sticker puts it, ‘I owe, I owe, so off to work I go.’

But earning a living is not the only reason people exert themselves. People sweat to achieve a beautiful lawn or dining room. They put in hours organizing a church program or scouting event.” (Copyright: Twincities.com)

It is good to see an economist looking beyond the cash reason for working, while, of course, it most often is a major reason, given the total dependence upon others that we are subject to in our modern market society.

Adam Smith's Society is Based on Outcomes

An interesting philosophical discussion in today’s Global Politician: “an independent magazine providing objective, in-depth analysis of events in the world today” (19/07/05) by Sam Vaknin, Ph.D.

Sam Vaknin is the author of Malignant Self Love - Narcissism Revisited and After the Rain - How the West Lost the East. He served as a columnist for Central Europe Review, PopMatters, Bellaonline, and eBookWeb, a United Press International (UPI) Senior Business Correspondent, and the editor of mental health and Central East Europe categories in The Open Directory and Suite101. Until recently, he served as the Economic Advisor to the Government of Macedonia.

Sam Vaknin’s article is about a question that Adam Smith also addressed in “Moral Sentiments”: to what extent must a moral action be motivated by benign (in a moral sense) intentions? Smith disagreed with his mentor, France Hutcheson that a moral act (benevolence) is compromised if the motives of the person acting benevolently were tainted with self interest. Smith’s view was that the ’passions’ could motivate virtuous acts and we should judge the act by the outcome not the motives which may not be knowable. Also intentions are too onerous a burden to impose on the merits or demerits of a moral action and, except for the Deity, are unknowable to human beings, and therefore, we must conclude, unknowable to philosophers and economists.

This has not stopped philosophers and economists theorising about the intentions of participants. John Nash set out the conditions for a solution of the bargaining problem using numerical utility and mathematics. Vaknin notes this and writes: “Still, in most cases, the players settle down to one of the Nash equilibria solutions. Their actions are constrained by the existence of the others.” Nash states the solution, not the process leading to it. He defines the optimal outcome as the exchange where their net gains are maximised. The fact that this is based on unrealistic assumptions does not alter the definition of the outcome.

Vaknin writes: “The "Hidden Hand" of Adam Smith (which, among other things, benignly and optimally regulates the market and the price mechanisms) - is also a "mutually limiting" model. Numerous single participants strive to maximize their (economic and financial) outcomes - and end up merely optimizing them. The reason lies in the existence of others within the "market". Again, they are constrained by other people’s motivations, priorities ands, above all, actions.

His first error is in seeing the ‘invisible hand’ as “benignly and optimally regulat[ing] the market and price mechanism”. Readers of this Blog will know that the invisible hand as applied by Smith had nothing to do with markets or the price mechanism in any of three occasions that he used it. The notion that it is to do with markets and prices is a 20th-century accretion to it by economists and philosophers too lazy to read his references (for details see below in the Blog archives).

The second error is seeing single participants in the market striving “to maximise their (economic and financial) outcomes”. People do not participate in markets as “individuals” – necessarily they must do so in (at least) pairs (otherwise it is not a Smithian market). Hence, of course, they end up ‘optimising’. To say that the ‘reason lies in the existence of others within the “market” is blindingly obvious – no market can exist with only one person in it. Again, this has nothing to do with ‘invisible hands’.

Vaknin adds: ”If a person does something which is supposed to increase the overall utility - but does so in order to increase his own utility more than the expected average utility increase - the resulting increase will be lower … We are envious because we think that the utility increase was unevenly divided (when adjusted for efforts invested and for the prevailing cultural mores).”

As utility cannot be measured for comparisons between two people it is not fruitful to see the utility available as a fixed sum. Nor is it fruitful to see individuals comparing their ‘gains’ against an ‘unevenly divided’ criterion. Even in Nash the division need not be the same – the optimal division is not necessarily the ‘mid-point’ in the utility frontier which is a common error in degree examinations (the area under the frontier need not be a square).

Vaknin’s assessment below is more satisfactory:

“Adam Smith, on the other hand, adopted the spectator theory of his teacher Francis Hutcheson. The morally good is a euphemism. It is really the name provided to the pleasure, which a spectator derives from seeing a virtue in action. Smith added that the reason for this emotion is the similarity between the virtue observed in the agent and the virtue possessed by the observer. It is of a moral nature because of the object involved: the agent tries to consciously conform to standards of behaviour which will not harm the innocent, while, simultaneously benefiting himself, his family and his friends. This, in turn, will benefit society as a whole. Such a person is likely to be grateful to his benefactors and sustain the chain of virtue by reciprocating. The chain of good will, thus, endlessly multiply.”

However, there are differences between Adam Smith and Francis Hutcheson on the role of the impartial spectator. For Smith there are no absolute virtues held abstractly. Moral Sentiments are established by people observing (as they grow and mature) what is acceptable to others and to win their approval (as others strive to win ours) we learn how to behave. Standards of behaviour can vary, upwards and downwards, depending on how we all behave. Where the positive virtues are practised to a degree, and where the rule or law (justice) obtains the protection of Natural Rights and Liberty, society is likely to be harmonious. But there is a ‘lot of ruin’ in a nation, and standards can vary downwards without society collapsing (this may be what is happening in the UK with public behaviour presently).

Smith’s “Moral Sentiments” and “Wealth of Nations” show how society is cohesive in both the moral and the market spheres. People, family to some, friends to a few, acquainted with a few more, but strangers to others (who themselves are family, friends, acquaintances and strangers to others - think of the interlocking circles in a mill pond, not just the one you are in) are affected by the constraints of others. Our dependence upon others is total – the ‘others’ in a global context are more numerous and anonymous – and what matters to us is not their intentions, but their outcomes. We can never know the former, only the latter.

The anonymity of the people we depend upon to feed, clothe and shelter ourselves, to provide the ‘decencies’ of life and those luxuries we enjoy in a functioning market economy, and also to walk by us in the street without assaulting us, or worse, is a Smithian society, not one peopled by people with known, or knowable, virtues. I suggest a closer reading by Sam Vaknin of what Adam Smith actually wrote than exhibited by some of the ideas presented in his article.

Sam Vaknin's Web site is at http://samvak.tripod.com

Diary of Writing a Book on Adam Smith

I have been commissioned to write a volume for the new Palgrave “Great Thinkers in Economics” series and though the series is focussed on economists of the 20th century (Marshall, Hicks, Robinson, Samuelson, Arrow, Stigler and such like) two exceptions have been made in the persons of Adam Smith and David Ricardo. There will be 23 volumes in all. My volume is the one on Adam Smith.

What I shall call my “Smith 2” projectI began working on this month. It might be an interesting exercise to keep a diary to record the off-page work that goes into producing a book of this sort.

The diary is partly for my own satisfaction – writing can get stressful, with highs and lows, joys, disappointments and exhilaration, and sharing them with you might help me – and partly I shall keep a diary because it might help other writers cope with their projects.

I have no idea if my diary will “work” for me, let alone my readers (if I have any left over the two years it will take). I have no idea what I will write about or how regularly I will write about anything. It may arrive still-born; it may be aborted as a project (the diary, not, I hope, Smith II). Hopefully, it will be completed as the manuscript goes off to Palgrave sometime in early 2007.

Well, that at least is the plan, my “best laid scheme”, hopefully not sharing the fate of the hubris of mice and men that Burns noted in his famous poem.

Smithian Moral Markets

The Times of Malta 18 July 2005

Continuing the moral theme, Gordon Brown, addresses an EU meeting and his speech is reported by Joseph Muscat, obviously impressed with his performance (though he thought it did not quite match Tony Blair’s earlier in the week).

Muscat’s article introduces original themes by Adam Smith into Malta and, clearly, Gordon Brown, properly understands Adam Smith’s legacy:

The invisible and the helping hand
Joseph Muscat

“Finally, the Chancellor of the Exchequer [Gordon Brown] stressed that, in a time of unprecedented globalisation, there is more than ever the need for a social model that protects people from poverty. Taunted about the fact that he hails from Adam Smith's birthplace, he replied that the Scotsman did not write only about the "invisible hand" (in Inquiry Into The Nature And Causes Of The Wealth Of Nations) but also about the "helping hand" (in The Theory of Moral Sentiments). This is the essence of his approach.”

The author, Mr Muscat, is a Labour member of the European Parliament and a member of the Economic and Monetary Affairs Committee.

Markets and Morality

WorldNetDaily.com

"Commerce without morality: The tale of 2 CEOs" by Craig R. Smith
July 18, 2005 © 2005 WorldNetDaily.com

In an article about the spate of criminal trials in the US involving CEOs and others, Craig R. Smith makes some acute observations. He also notes Adam Smith’s broader concept of market behaviour than is apparent in many US academic and journalists’ comments on his views and, in practice, in the behaviour of people running corporations (a point that would not have surprised Adam Smith given his views on the perfidy of “merchants and manufacturers” in the much simpler 18th-century markets with which he was familiar).

Craig writes:

“But in Adam Smith's classic "Wealth of Nations," the 18th century Scottish moral philosopher proclaimed that self-interest leads to the common good only if most people in society have internalized a general moral law as a guide for their behavior.''

Craig Smith’s understanding of Adam Smith’s complete legacy – moral sentiments and markets – is encouraging because for too long the distortion of Smith’s legacy into approving anything that corporations do has dominated popular accounts and quotations.

For interest, here are some others that Craig Smith quotes in his article:

"In 2004 alone, Forbes reports that Wall Street firms paid over $4.5 billion in fines;

A former top hedge-fund trader, Steven Markovitz, copped a plea to making improper "market timing" trades with mutual funds;

Alliance Capital became the fifth fund manager to admit allowing such trades;

Prudential Securities (now Wachovia) and Merrill Lynch canned employees for improper fund trading;

JPMorgan Chase paid $25 million to settle charges that it violated rules covering initial public offerings of stock"

This is set alongside the 25-year jail sentence on Bernard Ebbers, ex-CEO of WorldCom.
© 2005 WorldNetDaily.com.

A Suggestion to Tim Hames

Tim Hames in The Times, 18 July 2005, “Thin Man gets it wrong (again”) which is an amusing piece on fellow journalist, Matthew Parris, about the turmoil in the Conservative Party over the election of a new leader.

Hames invokes the “invisible hand” from Adam Smith to make a point:

‘The “invisible hand” in Mr Cameron’s conservatism has not been that of Adam Smith, but Michael Howard’s support for him.’

I would have thought, given the context of an in-party fight for Leader that the version used by original writer of the invisible hand metaphor, William Shakespeare, in Macbeth (3.2.47), would have been more appropriate:

“The ‘bloody and invisible hand’ in Mr Cameron’s conservatism has not been that of William Shakespeare, but Michael Howard’s support for him.’

James McCusker in the Right Direction

From: The Everett Herald, Everett, Washington (State), USA. Sunday, July 17, 2005
Business

"Point A to Point B is about efficiency
By James McCusker

“From the beginning, economics has been about efficiency.
From Adam Smith's "Wealth of nations" to the latest pages of incomprehensible math squiggles in the "American Economic Review," the focus of economics is on the efficient allocation of resources - getting the most out of what we've got.

If your lifetime focus is on efficiency, it's understandable why chalkboards, textbooks and equations might be more attractive than the real world we live in. Forced to contemplate how our commercial airline system actually works, for example, a trained, experienced economist might still be unable to decide whether to laugh or cry.

One of the areas, and there are several, of inefficiency plaguing commercial airlines is the ticketing process. It has been a major source of misallocated resources since the dawn of commercial aviation. And while deregulation and more recently the Internet have helped matters, there is still a mismatch between supply and demand. Here we are, 10 years after Amazon.com, 10 years after Google, 10 years after eBay, and we still have scheduled commercial jetliners cruising the skies with empty seats and lost revenue that can never be recovered."

James McCusker is a Bothell economist, educator and consultant. He also writes "Business 101," which appears monthly in The Snohomish County Business Journal.

Comment:

What good sense McCusker writes. His analysis of the 'economics' of air travel is informative and worh reading. Economics as it should be: about efficiency. The options for how society might be is about morality nd markets in theri historical context. How correct McClusker is about the way economics has drifted into a sub-branch of mathematics from Adam Smith’s “Wealth of Nations”. Economics long ago ditched Adam Smith’s political economy and preserved wholly incorrect parts of it. However, that is not the only problem.

Economics became a ‘science’ after Ricardo (and in losing its literary roots, it became less readable or understandable, a process finally completed in abstract equations). Once it lost its historical perspective, it lost its way. Regular events became instant ‘problems’, the merest perturbation in an economy and a world crisis became imminent according the the media, and the need to ‘manage’ politicaly the economy emerged with no understanding of political economy and forgetting Adam Smith’s advice to fanatics (and what else is someone who believes he or she can direct the activities of people as if they are “pieces on a chess board”) to desist from their fantasies.

Instead, support the conditions for wealth creation and suppress the conditions that undermine it (largely by not allowing non-competitive policies to take root, such as monopoly, protection, subsidies and tax breaks) and direct such public expenditures as are necessary to encourage education, health and citizenship. Apart then, for the expenditures on defence, law and order and government (including the strict separation of powers, not yet achieved in the UK), lower taxation levels should be a major barrier to increasing public expenditure in ‘schemes’ of unproven value but predictable unexpected expense.

The institution of a Flat Tax would go some way to making public debate on the appropriate level of taxation focus on a simple notion (‘should it be 15, 20, or 25 percent?’) and the impact of fiscal probity and incentives to be productive would have positive effects on the foundations of society.

Fred Cederholm and Marketing Flim Flam

Fred Cederholm, CPA/CFE, is a forensic accountant and regular columnist in The Weekly Observer in Creston (Ogle County), Illinois, USA. He also is regularly syndicated in VHeadline, published from Houston, Texas, an on-line outlet, also featuring in Venezuela (where VHeadline.com “remains 100% independent of all political factions in Venezuela” – not surprising considering the volatile political situation there).

His article published on Sunday, 17 July, heads with:

“Stimulation, automobiles, consumer durables, housing, diplomacy and Adam Smith”

Looks promising as he opens with:

“I’ve been thinking about incentives ... stimulation, automobiles, consumer durables, housing, diplomacy and Adam Smith. We are half way through the summer of 2005 and things are really heating up, but I’m not talking about the weather temperatures.”

Then follows Fred’s spirited critique of modern marketing, promotions, special offers and so on. Fred is an accountant and accountants do not like the money spent on marketing flim flam at all, hence marketing, US style must drive them nuts at its extravagant waste.

He ends with:

“If there is a need, the market will fill it and all will benefit. It is the invisible hand, which should drive economies, sales, and prices, not the invisible/visible handouts of governments, retailers, and manufacturers on a perpetual basis.
If things are so good, why must we still keep priming the pump?”

That’s a fair point. But why, oh why, does Fred drag in Adam Smith’s name and the invisible hand? Is it dim memories of Economics 101, where badly taught tutors pass on the myths about Adam Smith that they learned as undergraduates? Can nobody write about modern markets in the US without linking them to the so-called invisible hand which was not about markets anyway?

(New visitors may scroll down the page and see how often I comment on the misuse of the invisible hand and Smith’s name.)

Why You Must Also Read Alex Singleton at www.globalisationinstitute.org

Why you must read also Alex Singleton at www.globalisationinstitute.org:

The piece below is verbatim from his web site. It is perfectly correct and absolutely in no need of amendment. Read it, and his web site, and be cheered up - there is hope still in the world that we will pull through current little difficulties.

So many commentators are wildly wrong in their analyses, whether it be globalistation, climate change, Chinese low priced exports, which raise living standards and the real wages of employees in importing countries; the surplus released they spend on other products, or save, both making them better off, that there is a danger that the anti-Chinese lobby captures the political agenda and imposes policies holding back the creation of wealth. Always remember that Adam Smith's concept of wealth is the net addition to annual product, or what is the same thing, to what annual revenue purchases.

Alex Singleton is right on target:

"Why we should favour the economic rise of China
By Alex Singleton 16 July 2005

In the run-up to the Iraq war, some anti-war campaigners made the argument that capitalism and war go hand-in-hand. Because we are running out of resources, they said, the ever-increasing quest for oil and other raw materials would lead to more conflict.

In fact, nothing could be further from the truth. Firstly, we are not running out of resources. This is a counter-intuitive argument, but scarcity of resources, as measured by price, is decreasing. New resources are being found, new technology means that resources are used more efficiently. Higher prices for resources lead to investment in technology or new thinking about how to accomplish end products - leading to less scarcity. While oak furniture is often real wood, my sturdy Ikea bookcases are only Beech veneer because that's the way to make them cost-effectively. Cars of the future will run on hydrogen - not because we run out of oil but because they will be cheaper.

Secondly, while war may be in the interests of defence companies, it is not in the interests of business in general. War gets in the way of commercial interests. It leads to greater uncertainty and higher taxes. In The World Is Flat, Thomas Friedman formulates the Dell Theory: "The Dell Theory stipulates: no two countries that are both part of a major global supply chain, such as Dell's, will ever fight a war against each other as long as they are both part of the same global supply chain, because people embedded in major global supply chains don't want to fight old-time wars any more."

So why should we support the economic rise of China? It is partly because it will make us better off. China is already helping us to benefit from lower-cost products. But we should also favour China's increasing interaction in international trade because trade is the best way to promote liberal democracy around the world.

Some conservatives in the US think people should boycott China - either Chinese products or the China Olympics - because of human rights abuses. That would be a mistake. Countries without middle classes are the easiest for governments to control. Conversely, countries where trade has created a large middle class are difficult for government to control. If we want to help China become a free society, trade is the best answer."

Thanks to Alex Singleton for a lot of sense in a few score words.

An Interesting Interview - are they right?

From: HoweStreet.com (‘the source for market commentary’) published Jay Taylor’s ‘Gold and Technology Stocks’ column (http://www.miningstocks.com/select.shtml) with an interview with Professor Ravi Batra called “Greenspan’s Fraud”. Ravi Batra has a web site: www.ravibatra.com.

I quote an extract:

“Batra: The main reason wages are not keeping up with productivity here is the merger mania that the government allows or fosters. I think that is against my free market thinking. If you have too many mergers, you restrain competition, and competition is desirable. If competition becomes limited, that lowers the living standard, and I think that is against the free market principles. That’s why in this book I have said that big companies should not be allowed to merge if they are very profitable. If companies are losing money and to stay afloat they need to merge, that is different.

Taylor: So you are a very strong advocate of the Sherman Anti Trust legislation?
Batra: That is right—merely to keep markets competitive—and that is my definition of free markets.

Taylor: Would Adam Smith not have held that if governments had stayed out of the way to start with you would have had free competition or pure competition? But in fact it was government intervention that led to this lack of free competition to start with. For example, Sarbanes-Oxley legislation puts enormous cost hurdles in front of small companies and thus keeps them from competing against larger firms .

Batra: Yes, exactly. The main thing is that the government is controlled by the rich. They use all kinds of excuses and theories to maintain control in the hands of the wealthy. They come up with various theories, but Adam Smith was against all those monopolies, and so am I.
Taylor: So given the fact that we have this political reality—that the rich have managed to shape government and economic policy in their favor—and I would argue they do it largely through the Federal Reserve as well as legislation, but given that fact, what you are advocating is a reduction of taxes for the lower income people in one way or another?

Batra: That’s right—reduce taxes on the poor. How you raise money for the government and how much government is going to use is a question for society. But at least don’t tax the poor because that is very bad for the economy.”

Comment:

The article itself is warning of an imminent depression in the US; it’s all the fault of Greenspan and President Bush, they both have ‘hidden agendas’; he opposes tax cuts for the rich and favours some linkage between the quantity of money and gold (though not 1:1).

In so far as his views on Adam Smith are concerned he is correct, though I am not sure that both Taylor and Batra are clear that Adam Smith was of the view that the ‘natural’ propensity for “merchants and manufacturers” was towards monopolies if left alone to their own devices. The only power capable of deterring such monopolistic tendencies is government.

To suggest, as Taylor does in his question and follow-up: “Would Adam Smith not have held that if governments had stayed out of the way to start with you would have had free competition or pure competition? But in fact it was government intervention that led to this lack of free competition to start with” requires further questions as to what he means.

Is he suggesting that monopoly and impure competition a fault of government intervention? Is he in favour of a complete withdrawal of government from the economy? He says he is a ‘Libertarian’ (as does Batra) but that is a very broad church covering multitudes of shades from the Libertarian Right through to the Libertarian left (and some who seem unable to make up their minds).

Another Letter to Peter Asmus

To the Editor of Buffalo News, Buffalo, USA on the syndication of thearticle by Peter Amus (mis)quoting Adam Smith against nuclear power ((see also blog for 4 July below):

Sir,

Peter Asmus is incorrect about Adam Smith “rolling in his grave” in Edinburgh over government funded nuclear power.

Smith advocated government funding when it would not be viable for private persons to do so, if there were benefits to national commerce. Smith’s large projects were national roads, canals, harbors and street lighting, all beyond the commercial reach of 18th century individuals. He considered that “without government intervention there would be no” such projects completed.

Smith remained skeptical of their management (private commissioners or government employees). He favored users being charged fees for the benefits they obtained.

Peter Asmus drags Smith’s name into his attempt to embarrass President Bush’s “love of free markets and disdain for regulation and subsidy”, itself a tenuous statement. Adam Smith was never a free market or laissez faire ideologue.

Gavin Kennedy

The Cure of Poverty

Also in today’s Times another reference to Adam Smith, this time with more justification because its author, Tim Montgomerie, editor of Conservativehome.com, correctly notes what might seem to be obvious but which is often missed, that Smith wrote about the causes of wealth while many other focus on the causes of poverty. Creating wealth cures poverty and only sure way to create wealth is to let markets and the division of labour flourish.

We cannot tax our way to wealth, the fallacy of today’s politics, or pray our way to wealth, the fallacy of yesterday’s religions. The lilies in the field are not a role model for humans, contrary to what our anarchist friends tell us.

Smith noted that people are interdependent; they depend totally on others for their every need. Allowing others to supply those needs we acquire our needs by exchanging our contributions to the needs of others in ‘truck, barter and exchange’. We grow wealthier as the extent of and the complexity of markets increase. The absence of viable divisions of labour and facilities for the exchange of contributions is the abiding image of poverty, whether it is a rundown neighbourhood or an African village.

Understand how wealth is created (and by wealth I mean what Smith meant, the aggregate annual product of a society or, what amounts to the same thing, the aggregate annual revenue obtained from producing the annual product), and the practical remedies for poverty are apparent.

Look how Tim Mongomerie puts it in today’s Times:

“Finally . . . a breakthrough idea for the ToriesTim MontgomerieTo slim down a bloated State the obvious answer is to cut spending. But wait, that's the wrong end of the stick

PROGRESS DOES NOT just depend upon the invention of things. The discovery of new thinking can also drive societies forward. Adam Smith’s 1776 book The Wealth of Nations, and its inquiry into the causes of prosperity, produced one intellectual leap forward. Earlier economists had obsessed over the causes of poverty. That was a fruitless inquiry. The worthwhile question was Smith’s ‘What causes wealth?’ ”


The rest of his article is about how the British Conservative Party (the Tories) could re-establish themselves as a government if they adopted certain strategies (concentrate of wealth creation) and applied them to practical policies.

Read his article: www.thetimes.co.uk for 15 July in the Opinion section.

Nothing Mysterious About Markets

From today’s Times: Trade needs that moral dimension by Graham Searjeant, Financial Editor, 15 July 2005:

“In the Age of Enlightenment Adam Smith showed how an “invisible hand” of competitive markets translates the pursuit of individual self interest into the common good. But that applies strictly to the best use of resources to create wealth.”

Adam Smith said nothing of the kind. The metaphor from Shakespeare (Macbeth: 3.2: 47: ‘thy bloody and invisible hand’), that he used only three times in three publications (‘History of Astronomy’; ‘Moral Sentiments’ and ‘Wealth of Nations’), had no direct connection to competitive markets. That it is continually linked, as in Graham Searjeant’s article, is testimony to the extent that Adam Smith’s legacy has been usurped by academe and journalists for purposes he never intended.

Smith’s use of the invisible hand metaphor was about human motivation and the unintended outcomes that could follow, sometimes benign but other times not. That pagan superstition ('History of Astronomy') used the ‘invisible hand of Jupiter’ (the Roman god) to explain the mysteries of life was not about markets; that Feudal lords('Moral Sentiments') distributed food, etc., to their retainers and serfs to produce nearly the same distribution by an invisible hand as would have happened had the land been equally divided, was not about markets, and nor was the fact that because local merchants ('Wealth of Nations'), led by an invisible hand, preferred to use their capital locally rather than in distant lands, about markets.

Smith’s writings on markets and the relationship between ‘market’ and ‘natural’ prices (supply and demand) are in a separate chapter in ‘Wealth of Nations’ to his single reference to an invisible hand. It could as easily be argued that when a firm dumps toxic chemicals in the river it is led by an invisible hand to cause something it did not intend, and so on. Smith spent many pages in ‘Wealth of Nations’ denouncing the activities of ‘merchants and manufacturers’ whose self interests brought about monopolies, restricted supplies and higher prices.

Using the invisible hand as Graham Searjeant does to say that Smith: ‘showed how an “invisible hand” of competitive markets translates the pursuit of individual self interest into the common good’ is a travesty of his themes. The self-interested actions of polluters, thieves, rogues and corrupt officials debase the morality of markets. As we do not know which people in competitive markets are in which group (benign or malign) until after the event, we cannot ascribe a general law of approval to their motives and the common good.

Markets are composed of people, acting in concert, but not necessarily in tune, and there is nothing miraculous or invisible about their outcomes (modern economists have bled dry the vibrant, local markets of Smith’s “Wealth of Nations” in their mathematical abstractions). Smith wrote clearly and showed how prices tended to gravitate towards their natural prices. There was nothing invisible in this process and it needed no metaphor.

Idiocy of the Week?

In today’s Tech Central Station (‘where free markets meet technology’) a piece by Jon Haber that is a shoe-in for the “Idiocy of the Week” (a weekly “award” for the most idiotic misapplication of Adam Smith’s name to which some author has resorted).

The article is entitled “Time Travel” by Jon Haber, who “has worked as a film writer for the Boston Globe and movie reviewer at WBUR in Boston. He now runs SkillCheck, Inc., a software publisher in Burlington Massachusetts, and occasionally finds time to write about the intersection of politics, film and culture.”

On its own merits the article is interesting and well written. His "hook" is showing his 6 year-old an old film about Time Travel and four young boys from New York. Jon Haber is obviously well informed on the minutia of the origins of obscure films that have there own merits from around the world. After recounting the derivation of several films for US genres following the opening up of Eastern European and Russian film archives, he arrives at Adam Smith (who else?). Habor’s piece on film editing is supposed to be meeting “free markets” and he does what many US journalists often do, drags in Adam Smith to give his piece unnecessary “street credibility”, presumably among readers who also know a little about Adam Smith:

‘Thus does the "invisible hand" work its will on culture as it does in commerce in ways Adam Smith would have never imagined (although his kids might have enjoyed).’

Haber manages to misunderstand Adam Smith’s reference to the “invisible hand” (which was about human motivations, not commerce or markets, i.e., the “law” of unintended consequences, for good or ill) and reveals that he did not know that Adam Smith was a bachelor and did not have any children (he probably had nephews and nieces among his cousins, uncles and aunts).

Anyway, unless a worse idiocy arrives by Saturday, Jon Haber wins this week’s “award”.

Gary North on Smith's Invisible Hand

Gary North published an article on rhetoric in war and peace (in www.lewrockwell.com) makes several interesting points. Adam Smith, whom he quotes later in the article, taught Rhetoric in Edinburgh during 1748-51 and Glasgow College (University) during 1752-64. In Lecture XVII he said:

“When the design is to set the case in the clearest light; to give every argument its due force, and by this means persuade us no farther than our unbiased judgement is Convinced; this is not to make use of our Rhetorical style. But when we propose to persuade at all events, and for this purpose adduce those arguments that make for the side we have espoused, and magnify these to the utmost of our power; and on the other hand make light of an extenuate all those which may be brought on the other side, then we make use of the Rhetorical style.” (Smith, Lectures on Rhetoric and Belles Lettres, ed. J. C. Bryce, Liberty Fund, p. 89) (spelling modernised).

Gary North says: “Most people most of the time are self-interested. This perception was Adam Smith's great legacy to the modern world. Or, rather, it was Bernard Mandevelle's legacy by way of Smith, who officially opposed Mandeville's Fable of the Bees.”

Smith’s criticism of Bernard Mandeville is given on pages 308-13 of his “The Theory of Moral Sentiments” (edited by D. D. Raphael and A. L Macfie, Liberty Fund). North says he ‘officially opposed” Mandeville’s presentation; what exactly does he mean? Smith specifically rejects the idea that human behaviour is singularly motivated and he stood a long way off from Mandeville’s interpretation of private vice – public virtue. In fact, North gets closer to Mandeville’s moral philosophy with his attribution of the “invisible hand” to the working of markets. I shall come back to that assertion in a moment.

North writes: “In peacetime, men pursue their self-interest. There are few joint endeavors that command both loyalty and self-sacrifice. Husbands and wives are tied to a treaty of mutual support. But the concentric circles of jointly bound people become progressively less influential the further out from the family they are.”

A significant point is appropriate here. Smith’s model of a society that holds together, allowing for quite wide variations in the degree of disharmony a particular society could experience before succumbing to total disorder (“there is great deal of ruin in a nation”; Correspondence of Adam Smith, ed. E. C. Mossner & I. S. Ross, Liberty Fund, p.262,n.3), involves more than the notion that the ‘concentric circles of jointly bound people’ within the notion that beyond the family, there are declining interest in first friends, then acquaintances and finally strangers. He saw these concentric circles, as North phrases them, overlapping in highly complex patterns – strangers on the outside of your circle are family, friends, or acquaintances of others. More than that, in “Moral Sentiments” (page 86) we find the revealing statement:

“Society may subsist among different men, as among different merchants, from a sense of utility, without any mutual love of affection; and though no man in it should owe any obligation, or be bound is gratitude to any other, it may still be upheld by a mercenary exchange of good offices according to an agreed valuation.”

Set this along side the “fundamental error”, as I call it (G. Kennedy, 2005. Adam Smith’s Lost Legacy, Palgrave Macmillan, chapters 21-25), that Smithian political economy was based on self interest (George Stigler called it a “stupendous palace erected upon the granite of self interest”, 1975) and we get a misreading of Smith. He did not see the exchange transaction as one based solely on your self interest. It was based on the other party’s self interest; you serve your own interest best by serving the interests of the other party. Read the famous reference in “Wealth of Nations” describing the transaction between you and the “Butcher, the Brewer and the Baker” and note the words carefully:

“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 to their advantages.” (WN I.ii.2: p. 26-27)

Here “Wealth of Nations” aligns itself with the “mercenary exchanges” of “Moral Sentiments”. It is in these trillions of exchange transactions every day among billions of people, sometimes on matters of friendly discourse (“Life is a great bundle of little things”, O. W. Holmes) and social intercourse, sometimes in markets, that social harmony and stability becomes possible. Break into these transactions on racial, religious, political, emotional and fanatical grounds, and the harmony within them is strained, perhaps broken.

This brings me back to the ‘invisible hand’, perhaps the most widely misapplied metaphor in Smithian political economy. Gary North writes:

“It takes long chains of reasoning to defend the free market as a means of coordination. Most people cannot follow these long chains of reasoning. Adam Smith invoked the rhetorical image of the invisible hand. That was an effective tactic. It worked because Western intellectuals in the mid-eighteenth century associated this image with providence. Of course, this image would not work well in tribal animist societies. They would conclude that free trade is good because, if you don't adopt it, the Hand will get you.”

Smith did not apply the invisible hand metaphor to the working of markets. In US academe the market and the invisible hand have become almost synonymous. The facts are quite different. I would go so far to say that the invisible hand was not dealing with markets at all. It was dealing with the unintended consequences of human motives.

Smith used the metaphor three times only in three separate books, i.e., only once in “Wealth of Nations”. He first used the metaphor in an Essay published posthumously in 1795: “The Principles which lead and direct Philosophical Enquiries illustrated by the History of Astronomy” in Essays on Philosophical Subjects, ed. W. P. D. Wightman and J. C. Bryce, Liberty Fund. The invisible hand in this early ‘juvenile’ essay (1743-48?) refers to pagan superstition: “the invisible hand of Jupiter” (the Roman God, not the planet). It had nothing to do with markets.

The second reference to the invisible hand is in “Moral Sentiments” (TMS IV.i.10: p. 184 - 1759). This time it refers to feudal lords in Europe, who when distributing the necessities of life (food, materials, shelter) to their retainers and serfs they “are led by an invisible hand to make nearly the same distribution” which would have occurred if the land was divided equally among every family. Again this had nothing to do with markets.

The third and final reference is in “Wealth of Nations” (1776) in reference to what today we call ‘GDP’. Smith is arguing that every person seeks the best use of his capital (which in his day referred to the skills, tools and a little money of the tradesman and not the vast capitals of today – “capitalism” was a hundred years away when Smith was writing). He draws attention to the intentions of such individuals – their own security – when they contemplated whether to invest their time, effort and capital in the locality where they lived or to invest the same in a distant country. They chose the local one and this had the consequence that the benefits of their activity were retained locally and helped to make the national product higher than it would have been if they had preferred a distant country. He “intends only is own gain, and he is in this, as in many other cases, led by an invisible hand to promote the end which was no part of his intention” (VI.ii.9: p. 456). This is only very indirectly related to markets, if at all.

The mechanism of the invisible hand is solely related to the intentions of the person and the outcome of those intentions. This definitely has nothing to do with how markets work. It is not the invisible hand of the market at work but the invisible hand of the law of unintended consequences. And this ‘law’ operates for good or ill. The person seeking to keep costs down does not intend to poison the water supply when he dumps waste chemicals into a nearby stream; ‘slash and burn’ farmers does not intend to start soil erosion and turn a rain forest into a desert; the employer who hires juveniles under 10 does not intend to cripple them before their teens with overwork, dust in their lungs, without education, and so on. We could as easily say that in “these and many other cases” they intend only “their own gain” and are ‘led by an invisible hand to promote an end which was no part of (their) intention”.

That is Smith’s meaning of the invisible hand. It was not intended by Smith to represent metaphorically the inevitable benign outcome of markets because intentions can lead unintentionally to malign outcomes. Smith did not accord to markets that wholly unjustified licence. He described the operations of markets in detail in respect of what we now call supply and demand and the relationship between “natural” and “market” prices in “Wealth of Nations” (Book I, Chapters V. VI and VII) without any reference or mention of the metaphor of the invisible hand.

The invisible hand has been hijacked by modern commentators to rhetorically associate it with markets and it is called “Smithian” out of respect for the man they call the “Father of Capitalism” (a word and a phenomenon Smith never knew or used). But the invisible hand was not Smith’s, it belongs to Shakespeare in Macbeth: “and with thy bloody and invisible hand” (Act 3. Scene II.48). (I don’t think Shakespeare was thinking of markets either.)

I enjoyed the rest of Gary North's article.