Sunday, October 14, 2007

Maynard Keynes Would Have Benefited from Reading Adam Smith Instead of Repeating Distortions of His Legacy

I reported yesterday that I had read the first three chapters of Paul Davidson’s John Maynard Keynes’ ( Palgrave, 2007: Great Thinkers in Economics; series editor, Tony Thirlwall). I turned to Chapter 4 shortly afterwards and was confronted with assertions by Paul Davidson which I found disappointing. (True, he has not yet read my manuscript on Adam Smith!)

Let me explain. Davidson’s argument about Keynes is developed against a background in which Keynes’ criticism of prevailing economic policy is labelled as an alternative to ‘classical’ economics, in particular the notion of laissez faire, that is, that governments should not interfere in markets or non-performing economies for any reason. Davidson is correct, but goes further.

Classical economics is identified with a fallacious set of policies attributed to ‘the founding fathers of classical economics such as Adam Smith and David Ricardo’ and ‘although the phrase laissez faire does not appear’ in their books, nevertheless ‘the idea is there’. (Davidson, P. 2007: p 22) This erroneous academic consensus on Smith’s legacy continued long after the ‘General Theory’ (1936).

Davidson captures Keynes’ exasperation with the notion of laissez faire as practised by British (post-First World War) and American (post-the 1929 Great Depression) governments, and by 19th-century governments, influenced by the ‘Manchester School’, and John Stuart Mill. Prejudices in favour of laissez-faire ruled in practice and in the universities. But these ideas had little to do with Adam Smith.

All economics courses need to study the history of economic ideas and methods to avoid the glaring error of attributing laissez-faire to Adam Smith, thus giving it an undeserved and uncritical authority. If they had read Adam Smith correctly (in many cases, sadly, if they had read him at all!), the Smithian alternative to laissez faire would have been in contention, instead of the field being left to the socialist and Marxist criticism that regarded markets as the problem, and not the Smithian solution.

Paul Davidson offers supporting evidence from Adam Smith, which he says is ‘in his 1776 classic, The Wealth Of Nations’, where Adam Smith wrote:

It is not from the benevolence of the butcher, the brewer, or the bakers that we expect our dinner, but from regard to their own self-interest. We address ourselves, not to their humanity but to their self love, and never talk to them of our necessities, but of their advantage … Every individual is continually exerting himself to find out the most advantageous employment for whatever capital he can command. It is his own advantage, indeed and not that of society which he has in view …. He intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which is no part of his intention. By pursuing his own interest he frequently promotes that of the society more effectually than when he intends to promote it.’

The sole reference given for this quotation is: ‘Smith, 1776, p 14’.

Now anybody reading the quotation, and knowing nothing about Wealth Of Nations, would conclude that the ten-line quotation came from ‘page 14’ of Wealth Of Nations, when in fact only the first three-and-a-half lines come from the page 14 (Wealth Of Nations, ed. Canaan, 1937; or find them in Book I, Chapter 2, pp 26-27, Glasgow edition, 1976) These lines refer to bargaining behaviour, not laissez faire, and do not refer to the pursuit of self-interest as interpreted by classical economics; Adam Smith was at pains to stress the need to mediate self interest by addressing the self interest of others. (Search Lost Legacy for many discussions of this very point).

The other six-and-a-half-lines come from a different section of Wealth Of Nations (Book IV. ii. 9. p 456), and refer to the quite different subject of the risk avoidance of merchants, if freed from import protection.

Does this matter? Very much so, because Keynes’ history of laissez faire and self interest only repeated what orthodox economists presumed solely by repetition, to which Paul Davidson added the link to the ‘invisible hand’, which Adam Smith referred to only once in Wealth Of Nations in Book IV, but not in connection with his theory of the origins of the propensity ‘truck, barter, and exchange’, and his theories of how markets work (Books I and II).

Davidson promotes Adam Smith’s use of a common literary metaphor in 17th-18th century literature to the high status of a ‘paradigm’, possibly the slimmest of foundations for any paradigm in any known science.

Keynes’ critique of what he called classical economics stands fairly solid without him having to make any obligatory reference to the quite different purposes of Wealth Of Nations, which by doing he distorts Adam Smith’s legacy in the midst of exposing 21st-century distortions of Keynes’ legacy.

Consider briefly what Adam Smith wrote in Wealth Of Nations, how might we explain why such distortions are important and why, by refraining from them, we also achieve a better insight into the problems that Maynard Keynes addressed, which are still with us?

Wealth Of Nations is an historical (backward looking) account of how Britain’s commercial economy revived from the 15th century to its slow and gradually growing opulence in the second half of the 18th century. He did not project these trends into the 19th century (with the exception of predicting that North American would be the dominant economic power within a 'hundred years’).

Book I and II are about the evolution of the commercial ‘age’ from ‘hunting’, which large parts of the world were still stuck in, towards opulence, where the division of labour and expanding markets were slowly enriching (unequally) societies in Western Europe.

The difference in living standards, not measured by per capita income, though that was slowly changing, but by the gross income of society, between hunting and commercial societies was observable in the lack of accoutrements of the ‘savage’ hunter compared to those possessed by the poorest employed common labourer in Europe. And Europe also showed the detritus of stone monuments of past and current civilisations not found in any scale, or at all, in the ‘new worlds’ of the hunters in Africa, the Americas, and Australia. He explained how commercial societies worked through markets and how (primitive) economic growth was sourced in the net profits of undertakers, renting land and hiring labour in commerce and agriculture.

Book III is a short history of the evolution of economies (much of it expanded from his Lectures in Jurisprudence, and the ‘Early Draft’ in the 1760s). Book IV is a polemic and detailed analysis of the how ruling governments in Europe distorted market relationships in monopolistic town markets, protectionist national policies exacerbated by the jealousies of trade, formed monopoly colonies and trading companies, engaged in fruitless wars (£170 million spent of wars against the French), crippled free labour markets with oppressive legislation and undermined the ‘Perfect Liberty’ of the population (a concept from jurisprudence, not perfect competition).

Smith considered the colonial ventures in North America as a major brake on the natural evolution of markets in Britain and Europe and sourced the problem in the legislatures and among those who influenced them. His model of a distorted economy is made explicit in Book IV.

His critique of mercantile political economy was against those forms of government intervention that were influenced by and for the private benefit of special interest groups, whose exercise of their self-interest led to a lowering of society’s ‘wealth’, which was the annual output of ‘the necessaries, the conveniences, and the amusements of life’.

In Books I and II, he gives over 50 instances of where individual self interest undermines society’s economic growth, few, if any, of which are ever quoted with the same frequency as the single ‘invisible hand’ metaphor in Book IV by those keen to link Adam Smith to the all powerful, even invisible, drive of people exercising their so-called 'beneficial' self interest, from which leaving them alone to rip off from the public higher prices and profits is 'legitimised' in Adam Smith's name! This is a corruption of Smith’s legacy.

Smith did not favour laissez faire (he never mentioned it), nor did he oppose all government intervention (see Book V of Wealth Of Nations), and nor did he consider that free markets (or ‘Perfect Liberty’) were a necessary or sufficient condition for progress towards opulence (see WN IV.ix.28: p 674). In this rebuttal, Adam Smith referred by name to Dr Quesnay and Physiocrats, some of whom advocated laissez faire and were its original source. To link Smith to laissez faire is a major error of attribution.

His view was that if people were left to place their capital where they could make a profit, and were free to ply their trades as labourers where they could earn a wage, then economic growth would be augmented above what it was likely to be where governments, monopolists, protectionists and such like attempted to do this for them.

But note, he stated that in the absence of freedoms to do what they might otherwise do, society still made progress (Book IV). There were circumstances where governments which provided the capital for public projects to aid commerce (Book V), identifying harbours, canals, viaducts, roads, civic amenities such as pavements, street lighting and rubbish removal, as well as police, and, most significantly, public education of all children – a ‘little school in every parish’, all 60,000 of them!), would assist the progress to opulence. Smith’s was not a laissez-faire agenda, and nor was it a socialist charter. The prerequisite for continuing progress was the existence of active commercial markets. Also, public funding did not mean public management (that's a 20th century trade union 'achievement').

Where private capital was too risk averse, or where it would be unprofitable, he saw a role for government-funded activities. Consistent with these 18th-century thoughts, it is not beyond safe sense to see how Adam Smith’s approach could be applied to the kind of 20th and 21st-century problems identified by Maynard Keynes and others in certain circumstances.

If modern economists read what Adam Smith actually wrote and resisted rummaging around second-hand selected quotations of what he is alleged to have written, it could be that his Works and approach might prove a fruitful source in the study of the consequences of the continuity of mercantile political economy that has so bedevilled the recent history of Europe and North America.

I should add this is a specific criticism of Paul Davidson’s attributions to Adam Smith in support of Maynard Keynes’ misattribution to him of the Manchester School’s version of laissez faire and the beneficial effects of over riding self-interest, in common with the dominant ideas of the 20th century. It is not a criticism of Paul Davidson’s excellent presentation of Maynard Keynes’ original ideas expressed in The General Theory, with which I concur from what I have read so far.


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