Wednesday, July 18, 2007

Adam Smith on 'Stagnation'

Chris Dillow writes in Stumbling and Mumbling:

The tendency for the rate of profit to fall comes straight from Ricardo - it's just the law of diminishing returns. Ricardo - and indeed Smith before him - thought this would lead to a "stationary state" in which economic growth ceased.

Just to set the record straight on Smith’s ‘stationary state’, he reported where the dynamics of his theory of growth would lead, unless something else intervened. Smith foresaw ‘increasing returns to labour in the division of labour’, not Ricardo’s ‘diminishing returns’ which led to a dead end. Smith’s argument for endogenous growth was different from Ricardo's and much neoclassical thinking. That neoclassical economists are changing track on this is encouraging.

The value of his ‘prediction’ was related to the situation when a country had
acquired that full complement of riches which the nature of its soil and climate, and its situation with respect to other societies allowed it to acquire; which could, therefore advance not further and which was not going backwards, both the wages of labour and the profits of stock would probably be very low.’ (WN I.ix.14: p 111) This was the ‘logic’ of his model, not a time-bound prediction.

He adds in the next paragraph: ‘But perhaps no country has ever yet arrived at this degree of opulence’ (WN I.ix.14: p 11). And this, plus experience since Smith’s day, shows why Smith did not predict so much as derive the conclusions of his growth model. The technological impact of the 19th-20-21st centuries show that in practice in the real world, there is no danger of a country ‘acquiring that full complement of riches which the nature of its soil and climate, and its situation with respect to other societies allowed it to acquire.

Smith also noted that a country could deliberately reach such a state of no growth, as China had done to become stationary: ‘China seems to have been long stationary, and had possibly long ago acquired that full complement of riches which is consistent with the nature of its laws and institutions’, which was ‘inferior to what, with other laws and institution, the nature of its soil and climate, and situation might admit of.’ (WN I.ix.15: p 111-2)

Note that the key restrains in Smith’s model were ‘its soil and climate, and its situation’, reflecting the predominantly agricultural base of 18th century economies, and also the choices that it makes, ‘consistent with the nature of its laws and institutions.’

If it chooses to ‘opt out’, as China did deliberately by whim of the then Emperor in the 15th century (just as the commercial revival began in Western Europe) what happened is history. Chinese advanced technology withered; Western technology and science slowly and gradually flourished; China became backward; Western Europe advanced beyond the constraints of ‘soil, climate, and its laws and institutions’. China is now catching up, having stagnated under the Marxists, until they switched from Marxism towards capitalism.

Chris cites this idea from an otherwise interesting paper ‘Classical Growth Theory: from Smith to Marx’ by Gonçalo L. Fonseca

I can see also the influence of Robert Heilbroner’s popular exposition, The Worldly Philosophers: the lives, times and ideas of the great economic thinkers, Simon & Shuster, and his essay on the subject, ‘The Paradox of Progress: decline and decay in The Wealth of Nations’, in Andrew Skinner’s and Tom Wilson’s, eds, Essays On Adam Smith, 1975, Oxford University Press, both of which I criticise in Adam Smith’s Lost Legacy, 2005, Palgrave Macmillan.


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