Monday, June 01, 2009

Adam Smith and J. M. Keynes

Natural Economics in My Fox (Dallas Fort Worth) HERE:

While reading “Biblical Economics” by R. C. Sproul, Jr., I learned about Adam Smith, history’s first economist, according to Sproul. Smith espoused the theory of the “invisible hand”. Quote from the book: “Simply put, the invisible hand is the force that takes the combined interests of all members of society and creates a well-ordered marketplace.”

I learned that Adam Smith’s theory (Nature and Causes of the Wealth of Nations, published 1776) starkly contrasts with that of John Maynard Keynes. Smith’s ideas are the foundation of contemporary conservative thought; Keynes’ ideas drive contemporary liberal thought that government manipulation produces a “more ordered and prosperous society than that produced by the blind forces of nature working in a free market.”

I wanted to discover their respective belief systems to better understand their values. It seems to boil down to this: Adam Smith advocated savings and Keynes thought too much saving was a market evil. Smith believed in natural market equilibrium – Keynes believed government should regulate markets to manage stability

So many fallacies in a short article, apparently derived from R. C. Sproul, Jr and his book, Biblical Economics, which is unreliable (putting it politely).

Simply put, the invisible hand is the force that takes the combined interests of all members of society and creates a well-ordered marketplace.”
That is not something that Adam Smith ever wrote, nor did he ever espouse ‘the theory of the “invisible hand

Modern economists in the 20th century ‘espoused’ such a theory, but not Adam Smith. It was their theory derived from the oral tradition in Chicago University in the 1930s and given life by the modern theorists of general equilibrium.

See Paul Samuelson, the main source for the modern myth in his textbook, Economics (1st to 18th edition), and the hundreds of thousands of his readers, and the people they went on to teach until millions believed it across North America and English speaking campuses.

I have developed the case against the modern interpretation of the invisible hand myth in my recent book, Adam Smith: a moral philosopher and his political economy’, 2008: Palgrave Macmillan) and see also my paper, ‘Adam Smith and the invisible hand; from metaphor to myth’ HERE.

It is untrue that ‘Smith believed in natural market equilibrium’ – he suggested that natural prices (costs of supply) are ‘continually gravitating’ towards its ‘central price’, but he said no more than that, because market prices(quantity effectively demanded) – those actually paid by consumers and received by suppliers - are influenced by factors that are not directly involved in determining costs or effectual demand.

And remember, Smith’s prices are generated by ‘neighbourhood’ averages in every different ‘general circumstances of the society’ including ‘natural or improved fertility of the land’, to which we can add the composition of labour (skills, dexterities, machines facilitating and abridging its productivities) and access to capital and entrepreneurship.

Equilibrium is unlikely in these circumstances, especially as the division of labour is never static and supply chains increase labour productivity in ‘distance’ and complexity.

Keynes on savings addressed a different problem to Smith on savings. Briefly, Smith saw growth as an outcome of what revenue earners from the ‘great wheel of circulation’ did with their earnings. He was dealing with a less sophisticated mid-18th-century economy than Keynes was in the mid-20th century. Capital was relatively scarce and capital formation was really quite primitive and local.

Landlords were seen to dispose of their landed income with tendencies to prodigality, except for those ‘improvers’ who invested in draining land, fertilizing it, erecting fences, and repairing buildings and machinery.

Labourers, because of low wages, tended to spend their incomes without savings, except those fewer labourers who obtained supervisory positions, who tended to save small amounts and lend out at interest.

Stock-holders, the organizers of productive activities, tended to be the main savers, who added to their capital employed in their businesses what they saved from their profits to buy subsistence materials for supplying additional labourers between pay days, and to buy raw materials and machinery. The rest of their income they spent on consumption, as did landlords and labourers.

Smith observed, as savings were the sole source of investment, frugal savings were a social benefit; prodigality was a social menace. Wasteful government expenditures (the Seven Years War cost Britain £125 millions from taxation) plus the other sources of misplaced government interventions.

There was an inverse relationship between subsistence (when it became prodigality) versus investment (frugality). The more the employment of labour and capital stock, the higher the 'slow and gradual' rate of capital accumulation could be (compound interest). The greater was consumption ( when prodigality), the lower the slow and certain growth of employment and capital stock.

For Keynes, two hundred years later, and in a incomparably larger economy, with a much bigger role for government, he saw savings (hoardings) as a reduction in aggregate demand, which contributed to unused idle resources and unemployment. He suggested that governments should fill the employment gap by increasing public expenditures. These were not, are not, uncontested, indeed, his were controversial policies which featured for a large part of the 20th century.

I am not sure that Sproul’s Biblical Economics has much to add to the debate, except at the level, perhaps, as the Book of Job.



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