Monday, June 01, 2009

Adam Smith on State Intervention

Confessions of a Bipolar Virgin (31 May) HERE:

First, let's analyze some of the things that happened to people during the Great Depression. Unfortunately, when this awful event in U.S. history happened, there was no unemployment compensation, no FDIC, no SEC, and none of the fiscal and monetary policies we now have in place. In a sense, it was a total free market system, guided by Classical Economics (i.e. Say's Law and Adam Smith). The most prominent economic work of this time frame was Adam Smith's book "The Wealth of Nations" that introduced the theory of "The Invisible Hand." This theory states that the market is governed by an "invisible hand," and less interaction by the government in the market, the better (i.e. laissez faire). This proved to be a disaster (at the time) and Keynesian Economics quickly became the new "economic theory" in place (long story-LOL!). Keep in mind that this is a very SIMPLE description and I am keeping a LOT of IMPORTANT facts out of play here (note: we still have Classical Economics in place today, as it does serve a purpose).

The author self-describes himself/hereself as ‘bipolar’ (a modern term for depressive) and I am commenting in the hope of lessening the load by explaining what Adam Smith actually wrote in Wealth Of Nations (1776) and its difference from what he is alleged to have written, with a view to elucidate the controversy about what to do in the current situation.

In a sense, it was a total free market system, guided by Classical Economics (i.e. Say's Law and Adam Smith). The most prominent economic work of this time frame was Adam Smith's book "The Wealth of Nations" that introduced the theory of "The Invisible Hand." This theory states that the market is governed by an "invisible hand," and less interaction by the government in the market, the better (i.e. laissez faire).”

What Adam Smith actually advised was that the wrong interventions in a commercial market by government should be, first, reversed and secondly those wrong interventions should be avoided, and other interventions of governments should be encouraged. This is not the same thing as being against government intervention as a whole. He wasn’t of the opinion ascribed to him by modern economists since the 18th century. In fact, Adam Smith advised that certain interventions, not in his time undertaken with much consistency by government, should be undertaken as soon as possible.

For example, besides government expenditures on defence against foreign invasions (not defence expenditures to intervene in European dynastic quarrels and wars for trivial ends, including defending loss-making colonies) and on the provision of systems of justice, minimally such as independent judges, jury trials, Habeas Corpus, and the rule of law, not men.

He suggested what amounted to a substantial public investment in public works, such as roads (Britain’s roads were appalling, right into mid-19th century), public bridges, safe harbours, and canals, as well as public investment in a national educational system through a ‘little school’ in every parish (about 60,000 of them!) to educate all boys between 6 and 14 (at the time the mode was not to educate girls in public schools, only at home), in ‘reading, writing, and account’, with a smattering of geometry and such skills useful for earning a living and be productive.

Public expenditure was to be paid for initially from taxation on the richer sectors of the population and their maintenance financed by charging tolls or user-charges of public facilities for the costs of repairs to roads and bridges, plus subscriptions according to potential means to pay for teachers, books, and school prizes, and to pay for palliative care for sufferers from ‘leprosy and other loathsome diseases’.

Government also should develop the postal service for public use (it was originally set up by government to monitor control of the nation’s territory by regular contact with its farthest reaches), it should provide assay officers to determine hallmarks on gold and silver bullion, and on quality standards of woollen goods, cloths and paper. It should also run an official mint to guarantee the purity of the coinage. He also was in favour of a central bank (the Bank of England) to manage government debt and to introduce necessary regulations to stop drawing and redrawing bills of credit and over-trading, to set maximum interest rates, and the minimum amount denominated on the promissory paper notes issued by private banks.

Altogether, this is a formidable list even for the 18th century, contrary to his modern image of him being against government intervention on some sort of laissez-faire (incidentally, a term Smith never used) principle. What then did Smith consider inappropriate for government intervention?

The list is quite specific and is wrongly interpreted as being directed at all government interventions. Smith’s Wealth Of Nations is not a textbook of economics as we understand it today. It was a critique of the mercantile political economy of British governments from the 16th century, which still dominated public policy making in the 18th century (and in many respects still does so today in various forms).

Legislators and those who influence them are susceptible to all kinds of erroneous ideas about how commercial societies work; fads and fancies are spread with conviction that have no scientific basis, much as the everyday observation that the ‘sun rises in the east and sets in the west’ led people to believe that the sun (and the planets) orbited the earth. Indeed, for millennia it was an article of religious faith, against which those who questioned it were dealt with severely (think of the famous case brought against Galileo).

Among mercantile fallacies were such notions as the balance of trade required to be positive in favour of exports, so that a nation could accumulate stocks of gold and silver (which the King could use to fight wars against neighbours - you can see why kings were easily converted to the nonsense!).

From this fallacy, policies of protection against imports were developed, supported by tariffs and prohibitions, even though this meant that large numbers of goods cost domestic consumers much more from higher prices (and profits) than importing them would have allowed – you can see why many ‘merchants and manufacturers’ were enthusiastic true believers in this fallacious idea, and still are!

Moreover, the obsession with high bullion stocks led to ‘jealousies of trade’, in which nations adopted hostile stances to neighbours, some of it spilling over into wars, unofficial piracy and destruction of foreign shipping and ports – you can see why the 18th-century military and navy were enthusiastic proponents of ‘national glory’ from heavy investment in war-making!

Smith opposed such government interventions because they held back mutually advantageous trade from which peaceful trading countries could increase the opulence of their peoples. Many of the trade items added to the long lists (which grow ever longer) of protected trade were derived, not from economic principles or national secureity but from the lobbying of legislators and the hiring of influencers (with not a little bribery) on behalf of domestic ‘merchants and manufacturers’, who profited by narrowing the supply and widening the higher-priced market for their goods.

The richest countries in the world today still engage in such fallacious policies, not just against each other, but also against the poorest countries, for which the richer countries' taxpayers spend small fortunes each year in subsidies, gifts and donations, not to make them richer but the ameliorate their poverty induced by less trade than they could otherwise enjoy.

At the time, Smith observed that certain domestic laws also made matters worse, such as the award of monopolies to the chartered Guilds in towns for the production and processing and selling of scores of goods, and which prohibited outsiders in nearby towns from competing in the markets and fairs of other towns with better goods at lower prices.

These Acts were supported by the Statute of Apprentices which required ‘skilled’ tradesmen to serve 7-year apprenticeships in the town where they wished to trade, keeping out equally good tradesmen from elsewhere by law. James Watt, an apprenticed instrument-maker was not allowed to ply his trade in Glasgow because he had served his apprenticeship elsewhere (fortunately Adam Smith persuaded the university senate to appoint Watt to the University where he worked for several years and began his researches on steam power, essential for the future industrialisation of the world).

Perhaps the worst example of government intervention were the Acts of Settlement preventing labourers from moving from their home parish to another one in search of work.

Altogether, Smith considered these government interventions a breach of natural liberty, introduced originally for arguably good reasons (the development of trade in Britain), but through time generating unintended consequences. In fact, they became major obstacles to the development of free trade in goods and work opportunities in Britain, which together would have fostered the emergence and extension of a commercial society and the spread of opulence through to the majority of the very poorest families in society earlier than happened, for which, of course, the poor paid the highest price.

From experience of legislators and those who influenced them – and Smith met and conversed with, and listened to, members of this exclusive club, from opinionated individuals through to Cabinet ministers and Prime ministers – and he did not think highly of their business judgement and acumen.

He observed that the complexity of the detail in any business decision was formidable at any level beyond the most basic – if demand rises for your products make more of them; if it falls produce something else – and such decision-making was best left to the dispersed individuals involved who profited if they were right and lost if they weren’t, and should not be assumed by any ‘single person [or] no council or senate whatever, and which nowhere [would] be so dangerous as in the hands of a man who had folly and presumption enough to fancy himself fit to exercise it’ (WN IV.ii.10: 456).

It is that passage which exponents of the distorted view that Adam Smith opposed all interventions of governments across the board base their enthusiastic convictions upon, forgetting (or not being aware of – not all ‘expert’ quotation-spreaders read Wealth Of Nations) how specific Smith was about the important and necessary role of well-managed State in providing support for the working of a commercial society, which today is bound to be larger than in the 18th century, though not as large as most modern state sectors have become.

In so far as Bipolar Virgin recognises that there is a role for State interventions in certain specific areas - private enterprise where possible, state interventions only where necessary - we may find agreement in a truly Smithian manner.

[Note: I have not taken up the mythical metaphor of the 'an invisible hand' on this occasion: see my paper: Adam Smith and the invisible hand: from metaphor to myth HERE

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Blogger Gary said...

Hello Sir...My name is Gary B and I am a retired store clerk. I have no economics background and a BA in psychology which I have never used. However, I have the inclination and, finally, the time to learn.
I have been reading Adam Smith and I am absolutely facinated by what I don't know. I found this post in a search for an exact definition of "free market" and I am quite delighted to be able to say that I understand your post completely. I don't know if I agree with it, though, because I lack knowledge of the other side of the argument; which leads me to the purpose of this comment: who or what should I read next?

Your advice would be appreciated and thank you for taking the time to read my comment.

9:05 p.m.  

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