FLAWED KNOWLEDGE OF ADAM SMITH'S POLITICAL ECONOMY YIELDS POOR RESULTS

Hans-Werner Sinn, professor of economics and public finance at University of Munich, posts (20 January) in Global Times HERE 

“How classic concepts can lead to flawed decisions -

In some cases, rational behavior yields poor results”

“There is much to criticize in economics nowadays. For example, the profession focuses far too little on political issues and far too much on beating students to death with mathematics. But much current criticism of the profession is based on misunderstanding and ignorance.

Consider Adam Smith's concept of the "invisible hand," which implies that a market equilibrium is efficient if perfect competition prevails and well-defined property rights exist. Contrary to what many critics suppose, mainstream economists do not assume that these ideal conditions are always present. On the contrary, economists tend to use these conditions as a benchmark for analyzing market failures.”

Comment

Smith could not imply what is suggested as ‘market equilibrium’, ‘Perfect competition’, or ‘ideal condtiions’, because these were unknown concepts in economics while Smith was alive. 

“In this respect, economists are like doctors, who have to know what a healthy body looks like before they can diagnose disease and prescribe treatment.”

Dr Quesnay, a French man of medicine and a contemporary of Smith’s. They had several discussions when they met in France (1764-6) and whom Smith admired. He was sharply criticised by Smith in Wealth of Nations (Book V)  for linking an economy’s healthy state as a pre-condition of it moving a nation opulence.  If that was a necessary pre-condition, Smith observed, then no economy would ever achieve opulence.

Hans-Werner Sinn goes on in his article to describe markets in terms of the entirely modern notion of ‘market failure’, none of which is relevant to Adam Smith: 

“Environmental regulation addresses a particularly striking example of market failure. Markets are generally efficient if companies' revenues correctly reflect all the benefits that their output bestows on third parties, while their costs reflect all the harms. In this case, maximizing profit leads to maximizing social welfare.

But if production entails environmental damage for which companies do not pay, incentives are distorted; companies may turn a profit, but they function inefficiently in economic terms. So the state "corrects" firms' incentives by levying fines or issuing bans.”

Comment

Professor Hans-Werner Sinn displays a touching faith in the efficiency of modern States correcting the inefficiencies of modern firms.  Governments are often complicit in crony-capitalism when they are ‘captured’ by powerful corporate interests.

Overall a poor post.