Thursday, May 08, 2008

If Denmark is a special case it has nothing to do with invisible hands

Tim Worstall, a prolific Blogger in his own right (HERE), a contributor to several other Blogs, and also a co-Fellow of the Adam Smith Institute (London), picks up on a brief extract of 500 words out of over 5,000 words) from a researched article in Foreign Affairs (March/April 2008) (HERE):

The Copenhagen Consensus: “Reading Adam Smith in Denmark” by Robert Kuttner (Co-Editor of The American Prospect, a Senior Fellow at the think tank Demos, and the author of The Squandering of America: How the Failure of Our Politics Undermines Our Prosperity. He conducted the research for his article as a German Marshall Fund Journalism Fellow):

Summary: Denmark has forged a social and economic model that couples the best of the free market with the best of the welfare state, transcending tradeoffs between dynamism and security, efficiency and equality. Other countries may not be able to simply copy the Danish model of social democracy, but it nonetheless offers important lessons for governments confronting the dilemmas of globalization.

Adam Smith observed in 1776 that economies work best when governments keep their clumsy thumbs off the free market's "invisible hand." Two generations later, in 1817, the British economist David Ricardo extended Smith's insights to global trade. Just as market forces lead to the right price and quantity of products domestically, Ricardo argued, free foreign trade optimizes economic outcomes internationally.

Reading Adam Smith in Copenhagen -- the center of the small, open, and highly successful Danish economy -- is a kind of out-of-body experience. On the one hand, the Danes are passionate free traders. They score well in the ratings constructed by pro-market organizations. The World Economic Forum's Global Competitiveness Index ranks Denmark third, just behind the United States and Switzerland. Denmark's financial markets are clean and transparent, its barriers to imports minimal, its labor markets the most flexible in Europe, its multinational corporations dynamic and largely unmolested by industrial policies, and its unemployment rate of 2.8 percent the second lowest in the OECD (the Organization for Economic Cooperation and Development).

On the other hand, Denmark spends about 50 percent of its GDP on public outlays and has the world's second-highest tax rate, after Sweden; strong trade unions; and one of the world's most equal income distributions. For the half of GDP that they pay in taxes, the Danes get not just universal health insurance but also generous child-care and family-leave arrangements, unemployment compensation that typically covers around 95 percent of lost wages, free higher education, secure pensions in old age, and the world's most creative system of worker retraining.

Does Denmark have some secret formula that combines the best of Adam Smith with the best of the welfare state? Is there something culturally unique about the open-minded Danes? Can a model like the Danish one survive as a social democratic island in a turbulent sea of globalization, where unregulated markets tend to swamp mixed economic systems? What does Denmark have to teach the rest of the industrial world?

These questions brought me to Copenhagen for a series of interviews in 2007 for a book I am writing on globalization and the welfare state. The answers are complex and often counterintuitive. With appropriate caveats, Danish ideas can indeed be instructive for other nations grappling with the enduring dilemma of how to reconcile market dynamism with social and personal security. Yet Denmark's social compact is the result of a century of political conflict and accommodation that produced a consensual style of problem solving that is uniquely Danish. It cannot be understood merely as a technical policy fix to be swallowed whole in a different cultural or political context. Those who would learn from Denmark must first appreciate that social models have to grow in their own political soil.

At the center of the current Danish model is a labor-market strategy known as flexicurity. The idea is to reconcile job flexibility with employment security. The welfare state is often associated with rigid job protections: laws and union contracts ...”.

This looks like a most interesting article and is part of the perennial debate we have in modern capitalist societies about the private-public balance in our economies.

Capitalism comes in several forms (among which are: Anglo-American, Continental Europe and its Scandinavian sub-set, Asian Tiger, (‘ex’)Communist State Capitalist, Latin American State Capitalist, Oil-based Capitalist, and African failing state capitalist) and I doubt if any one of them could be picked out as conforming to the commercial society of which Adam Smith wrote about, en passant of his critique of British mercantile political economy in Wealth Of Nations.

Adam Smith did not criticise the role of government as such (that’s a 19th century fiction) and a misreading or, more likely, a non-reading of Wealth Of Nations. He made specific criticisms (he called it a ‘violent attack on the commercial system’) applied to the specific set of circumstances of Britain in mid-18th century (which circumstances persisted into the 19th century and to some extent re-surfaced in the 20th century and are still with us).

Smith expressed no views about the future of the commercial economies he knew about, which creates today’s confusion, primarily on the ‘Right’, about how Smith’s ‘ideal’ economy may have looked. The more extreme of them (the ‘anarcho-libertarians’) strip out his specific criticisms of how mercantile states intervene in their economies, re-cast whole sentences as if they refer to corporate capitalism, and lump all and any state expenditures, beyond the main headings discussed in Book V of Wealth Of Nations (defence, justice, limited public works and institutions, education and the ‘dignity of the sovereign’), as unwelcome and improper. Advocates of cutting back on that list deeper inhabit their wilder shores.

The opposite mistake that some make (primarily on the ‘Left’) is to find in his
writings in minute selections from them support for their claim that justifies a ‘social democratic’ interpretation of how a commercial economy should work. They also re-cast whole sentences as if they refer to corporate capitalism and the normal behaviours of modern businesses (for example, Smith’s staunch critique of the East India Company is transformed into a critique of modern corporate structures, and his paragraphs on the iniquities of local Guild monopolies from the 16th century onwards are portrayed as applying today).

Adam Smith was circumspect about the positive reforms he encouraged, such as equity justifying ‘liberal’, i.e., ‘higher, wages for the mass of the labouring poor, but whether this can be stretched to the social-democratic Scandinavian model is more than a little disingenuous. In Smith’s time, and from long before, redistribution of income was not advocated nor agenda. All modern states redistribute income to some extent with varying results. The Scandinavian model is so far confined to capitalist economies with small populations, a much more manageable political consensus than the major European and North American capitalist economies.

When Robert Kuttner writes: ‘Adam Smith observed in 1776 that economies work best when governments keep their clumsy thumbs off the free market's "invisible hand." ’ he takes liberty with what Adam Smith actually wrote, as regular readers of Lost Legacy should know well. The mercantile British economy was lop-sided in the dependence of its economy on its North American colonies.

Too much capital was diverted to its trade monopoly to and from the colonies, because of higher profits to cover the risks of long distance and round-about trade. The Cromwellian Navigation Acts enforced that monopoly, which was protected by prolonged and expensive wars with European neighbours that diverted capital from investment via government taxation and borrowing. The Seven-Years war (1756-63) cost British taxpayers £175 million which otherwise could have been invested in domestic industry.

The so-called ‘invisible hand’ metaphor in Book IV was about the risk avoidance of some British traders who invested in the lower-risk (because better known) local trade in preference to the higher risks of foreign trade (but which many compatriots were willing to risk for the higher profits) and the consequences of the decisions of the traders. Adam Smith explains this clearly before he mentions the metaphor of ‘an invisible hand’ supposedly guiding those who invest locally into contributing their capital to the total of the nation’s capital and by doing so they ensure that domestic capital is larger than it would be if they behaved differently by investing abroad.

Not all of Adam Smith’s readers were well educated in political economy and he used the metaphor (the only time he did so in Wealth Of Nations: see WN IV.ii.9: p 456) to support his explanation for the general reader (aristocratic legislators and those who influenced them). Basically, his point was the arithmetical whole is the sum of its parts: increase the number and the size of the parts and the whole is consequentially larger than it would be with fewer and smaller parts.

Modern economists understand his explanation but somehow credit the isolated metaphor with mystical content – a disembodied body part – when literary readers in the 18th century would recognise the metaphor from its widespread use in other contexts by other authors.

Be clear, the invisible hand was not a ‘theory’ and neither did it have anything to do with Adam Smith’s analysis of markets (fully discussed in Books I and II of Wealth Of Nations). Indeed, in Books I and II Adam Smith provides over 50 instances of self-interested actions in which the outcomes were bereft of being beneficial for society.

Interestingly, he did not mention ‘invisible hands’ in any connection with the working of markets, nor did he mention it when he identified the ‘clumsy thumbs’ of government intervening in the economy anywhere in Wealth Of Nations.

Strange, for a ‘theory’, or rather the ‘fiction’, that he did not do so.


Post a Comment

<< Home