Friday, October 24, 2008

Adam Smith and Keynes

Susan Lee writes on a ‘A Keynsian Halloween’ in, 24 October HERE:

Keynes' central (and disputable) insight was that markets were not self-correcting during economic downturns. He rejected Adam Smith's idea that businesses, when they found they were holding too much inventory, would drop their prices. Lower prices would then entice consumers back into the market and the economy would perk up again.

Instead, Keynes argued that downturns could become protracted. When faced with too much inventory, businesses would cut back production and lay off workers. Since the unemployed wouldn't have money to spend, the economy could stagnate at low levels of production and employment

A bit unfair to Adam Smith, who was not in a position to speak of what all businesses would do, as might be inferred from what we know of a modern market economy. Dearth and feasts in his day came from agriculture and not the relatively small commercial sector, itself separated into local impacts only.
Notions of ‘managing an economy’ were two centuries later.

Even with this qualification, Susan Lee’s contrast between Smith and Keynes (surely ‘Keynesian’ and not ‘Keynsian’?) is not quite right. Smith spoke of what a seller would do in a local market – too many apples on the barrow would lead to a fall in price per apple.

Even if that local example of a seller’s reaction to a lack of buyers was extended to the entire country, it would still lead to a drop in prices. To suggest it wouldn’t is to deny experience.

Whether this would revive the economy or not is not an issue addressed by Adam Smith, though it might be addressed by post-Smithian economists who, across the board, claimed Smith authored their versions of economics popular from Mill, Marshall, and the neo-classicals, when clearly he didn’t, as a reading of Wealth Of Nations shows.

When Smith discussed ‘the natural and market Price of Commodies’ (WN.I.vii.pp 72-81), he followed his argument through as market prices fell. Landlords would withdraw their land as rent income fell; as wage income fell, labourers would look for other work; and employers would withdraw from that line of activity as prfots fell (WN I.vii.13: pp 74-5), and eventually market prices would adjust to their ‘natural rate’.

Smith discusses at length the effects on price of changes in ‘effectual demand’; he does not discuss general slumps in demand across all commodities; but for what he does discuss, his ideas are broadly correct. By the early 20th century, Keynes moved the discussion well beyond the simple effectual local demand ideas of Smith.

Indeed, late 19th century economists generalized Smith’s arguments pertaining to local market conditions into strong assertions about ‘laissez-faire’ as if they were Smith’s views (he never mentioned laissez-faire) and adopted the policy of leaving markets to solve the trade cycle, as if this was Smith’s view. The epigones were responsible for this turn of events.

Keynes, brought up, so to speak, with this so-called Smithian package, struck out in a different direction (‘The End of Laissez-faire’, 1926) and went on in the General Theory (1936) to prescribe solutions as he saw them for a stricken economy and not just a reaction by a market-stall holder of too many apples left over near closing time in a street market.

Hence, Susan Lee ascribes to Smith a view that he did not articulate about a condition he did not face and credits to Keynes a criticism he had no business making in regard to Adam Smith, but he did have grounds for his criticism if directed at contemporary 20th century economists. She should have written:

He rejected the contemporary idea popular among his contemproaries that businesses, when they found they were holding too much inventory, would drop their prices.’

As in so many other areas of economic commentary by columnists and professional economists, including Nobel Prize winners, they attack an innocent man for the doctrinal sins of his successors.



Post a Comment

<< Home