Sunday, February 05, 2006

Smith was Not Naive about Corruption in Markets

Simon Longstaff, executive director of a St James Ethics Centre, writes in the Sydney Morning Herald, 5 January, a piece, “Free Trade Cheats Caught in a Loser’s Game”, on corruption in trade markets and whythis is not how the 'theory' according to Adam Smith supposed it would work. (Read it at:

Adam Smith is often credited with providing the intellectual foundation for free trade. So what would he make of the evidence emerging from the Cole commission into alleged kickbacks from Australian companies to the regime of Saddam Hussein?

Smith was not an economist; rather, a professor of moral philosophy at the University of Glasgow. He had a robust and pragmatic view of the ethical underpinning needed for any free market to operate.

Smith knew that if a market is to be truly free, then its participants must never lie, cheat or use their power oppressively to secure advantage over their competitors. It is not simply that lying and cheating are "wrong" - of equal importance is the fact that such behaviour brings distortions to the market. The effect of these distortions is that people end up paying the wrong people the wrong price for the wrong products.

Smith would urge us to create a level playing field in which honest traders win or lose on the basis of the price and quality of the products they offer to sell. He would be appalled by any suggestion that Australians have profited from duplicity. That's the theory

Several minor errors here. Smith’s contribution was not in economics (a subject not generally thought of as such in the 18th century). Longstaff is correct to describe him as a Professor of Moral Philosophy and not as an economist, but in 18th century Scotland, courses in moral philosophy incorporated not just ethics, but also ‘natural religion’, ‘jurisprudence’, ‘rhetoric’ and ‘political economy’, the latter known as ‘police’ (the government’s job to ensure the provision of food and products for the population).

The idea that Smith did not understand ‘economics’ because he was a moral philosopher instead, if that was the point that Longstaff is trying to make, is misleading; his knowledge of political economy was as good as any other political economist among his contemporaries. Smith studied political economy under Francis Hutcheson (1737-40) and also read widely.

That Smith is “often credited with providing the intellectual foundation for free trade” is true, but sadly he is credited with more than this assertion; he is credited, falsely, with being the founder of laissez faire, being the ‘high priest of capitalism’ and other similar nonsense, mainly by people who have not read his books, ‘The Theory of Moral Sentiments’ and ‘Wealth of Nations’, neither of which was a textbook on economics, at least not how we think of textbooks today.

Smith’s scepticism about free markets, in the guise of what people today think of as laissez faire (words Smith never used), was evident in his oft repeated caution about allowing ‘merchants and manufacturers’ to have an absolutely free reign in their markets – because they tend to conspire against the public interest by forming monopolies, restricting supplies (e.g., keeping put imports if they can; persuading gullible governments to impose tariffs if they can’t) and secretly agreeing to rig prices, and dump externality costs on communities.

Smith was not naïve about how individuals operate in market relationships. He did not use words like ‘must must never lie, cheat or use their power oppressively to secure advantage over their competitors.’ He expected them to do that regularly, if they were left to do what their selfish sides motivate them to do. If people lied and cheated, it was not something that would ‘appal’ him; it was an unintended amoral consequence of the choices made by individuals. Smith considered himself a ‘man of the world’ (he often berated younger men who were naive about the world they hoped to prosper in). He knew how his world worked and often advised others of these facts.

Smith’s concerns about such behaviours were related to their consequences, as much as his ethical disdain for their conduct. Anything that distorted markets from working effectively resulted in a slower growth and, therefore, a prolongation of outcomes that were less than what they could be in the absence of such behaviours. For the poorest labourers and their families, this prolonged the period in which they were deprived of modest affluence. His book was an inquiry into to nature and causes of the wealth of nations, and by wealth he meant not mere riches in gold, silver and trinkets, but real goods and services that were produced annually.

Funds diverted to feed the petty desires of those able to cheat, lie and monopolise their markets, took that productive capital away from other fields where it could set productive labour (including that of the poorest labourers) to productive work, and, by doing so, reduced the annual output of a society shareable among its citizens. That was more of a social crime than the petty gains of unscrupulous individuals. He had a strong moral sense of 'self command' and expressed it in his Works.

That, Mr Longstaff, is Smith’s ‘theory’. That there is corruption in trade (not ‘free trade’, because trade cannot be free if it is distorted) was the norm in Smith’s day, partly by the unethical behaviours of those inclined to behave that way and partly by the adoption of anti-growth policies by gullible governments.


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