Tuesday, January 01, 2008

Misleading Tapes About Adam Smith Do Him No Favours

Jeffrey at Bethlehem Road (here)
1 December, discovers Adam Smith (or a version of his thinking) and writes: “Adam Smith, The Wealth of Nations, and Gutter Cleaning”:

It was 180 miles each way, and I listened to a book on tape about Adam Smith and his masterpiece of economics, the Wealth of Nations, in which he argues that, by each person's looking out only for his own self-interests, the actions and decisions of many persons (as if guided by "an invisible hand") form a rational economic system that maximizes the wealth of a society. Part of the emergent behavior is that persons will find that specialization is their best chance of success. (Another aspect is the appearance and adoption of a currency that does not lose value and can be divided into very small portions.)

Those ideas of specialization and of self-interest were very real today, as the guy cleaning the neighbor's gutters knocked on our door and wanted to know if we needed his services as well. Actually, we did need our gutters cleaned (and I don't do gutters). So it was a win-win: he earned some income doing something in which he specializes, and we got our gutters cleaned while I graded papers

He followed this up on 31 December with (here)
Free Trade

"In the past, I tended to ignore news about economics and trade agreements. But since learning more about Adam Smith, I'm beginning to understand, and it's become more interesting.

On Wednesday, December 26, 2007, The Washington Post had two items related to free trade: the first was an article describing how free trade is helping some American manufacturers by increasing their opportunities to export goods. The article includes examples of American firms that make high-quality goods. A supervisor at a plant that makes and exports precision valves states:

‘It wasn't that long that guys looked at globalization like it is going to cause us all to lose our jobs. Now it's probably going to save our jobs.’

However, will the trend towards free trade last? Or will countries pursue political interests by restricting trade (perhaps Russia will refuse to export oil to Europe)? That is the question raised by Robert J. Samuelson in an op-ed in the Post the same day. He argues that a rising tide of nationalism has some countries moving away from global trade and economic interdependence and reverting to mercantilism (the policy that Adam Smith attacked).

Not all are convinced. In today's paper, Clyde Prestowitz, a U.S. trade negotiator in the Reagan administration, criticizes both these items and adds:
America has pursued free trade, but mercantilism has been the secret of the Japanese, Korean, Chinese, Irish and other economic miracles. There has never been an era of global free trade

No wonder it is confusing when intelligent and articulate people are introduced to Adam Smith with a major divergence from what he actually wrote. The author of the tape on the Wealth Of Nations passed on a modern myth about Adam Smith by rolling two separate statements allegedly from Adam Smith that come from different parts of his book.

Adam Smith
did not say “by each person's looking out only for his own self-interests, the actions and decisions of many persons (as if guided by "an invisible hand") form a rational economic system that maximizes the wealth of a society.” That is a 20th century re-writing of Smith’s legacy.

He did not advise that people look ‘out only for his owns self-interest’. In Book I, which includes the famous paragraph on seeking our dinner from the ‘butcher, the brewer, and the baker’ and the reference to self-interest, we would get our dinner by addressing the self-interests of the three of them, for which act we would curtail mentioning our own self-interest.

In short, by mediating our self-interests in the process of bargaining, we serve our self-interest by serving the interests of the others.

Adam Smith did not say that 'the actions and decisions of many persons (as if guided by "an invisible hand") form a rational economic system that maximizes the wealth of a society.’

In the only occasion in Wealth Of Nations that he mentioned the metaphor of ‘an invisible hand’ it had nothing to do with markets.

He was talking about the risk aversion of merchants considering whether to place their capital locally or abroad. It was their risk aversion to trusting their capital abroad that caused them to prefer to invest it locally. Because they sought to invest wherever their profit would be highest (net, of course, of the likelihood of losses, which when it was out of their sight, it could be stolen), it necessarily followed that the aggregate of all such investments locally would raise the total profit higher than it would be if their capitals where dispersed abroad.

This appears in Book IV of Wealth Of Nations (p 456). Having explained why this is so, he added the metaphor of ‘an invisible hand’ that had led them to choose the local option when he had already explained why they chose this option (and note it was not ‘as if’ there were guided; another incision from the 20th not the 18th century).

Adam Smith did not refer to ‘a rational economic system that maximizes the wealth of a society’. That is a conclusion from modern rational economics and not something Adam Smith wrote about. He wrote about the real world, not abstractions from it.

Adam Smith criticized ‘mercantile political economy’ and not ‘mercantilism’, a word derived from German in the 19th century and not a word that Adam Smith used.

In mercantile political economy, governments, legislators, and some ‘merchants and manufacturers’ and their lobbyists, adopted policies that interfered with the economy to their own advantage and profit. These policies led to notions of ‘jealousy of trade’, awe and fear of their trading partners, and wars that destroyed trade and economic change and slowed the spread of opulence.

In so far as historical fact goes there never has been global free trade. Adam Smith’s criticism in Wealth Of Nations was directed at mercantile political economy in general, and at Britain’s colonial policy in North America in particular. The latter diverted scarce capital from where it would have been invested without such interventions into a lop-sided capital drain to take advantage of the colonial monopoly exercised by the British parliament, enforced by the monopolistic Navigation Acts which only allowed British merchants to trade with the American colonies and British merchants to trade on behalf of the American colonies.

Following the loss of the American colonies, Britain’s first empire, instead of adopting, as Adam Smith advised, global free trade, a train of events commenced which resulted in the second British Empire, which lasted until the 1950s-60s.

Free trade does not exist anywhere, but there is a global market, nevertheless. There are also two vast trading blocs (USA in NAFTA, and Britain, and Ireland, in the EU). Adam Smith did not think that free trade would ever by ‘restored’ - he called it ‘absurd’ to think it would be (Wealth Of Nations, Book IV, page 471).

Hence, the trade situation is far more complicated that the author of the audio tape, and perhaps Robert J. Samuelson, credit it.


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