Wednesday, February 11, 2009

To Predict It Is Necessary to Know Your History

Dani Rodrik, Professor of Political Economy at Harvard University’s John F Kennedy School of Government, writes in the Business Standard (India) HERE:

Those who predict capitalism's demise overlook its historical malleability.”

“Capitalism is in the throes of its most severe crisis in many decades. A combination of deep recession, global economic dislocations, and effective nationalization of large swathes of the financial sector in the world’s advanced economies has deeply unsettled the balance between markets and states. Where the new balance will be struck is anybody’s guess.

Those who predict capitalism’s demise have to contend with one important historical fact: capitalism has an almost unlimited capacity to reinvent itself. Indeed, its malleability is the reason it has overcome periodic crises over the centuries and outlived critics from Karl Marx on. The real question is not whether capitalism can survive — it can — but whether world leaders will demonstrate the leadership needed to take it to its next phase as we emerge from our current predicament.

Capitalism has no equal when it comes to unleashing the collective economic energies of human societies. That is why all prosperous societies are capitalistic in the broad sense of the term: they are organized around private property and allow markets to play a large role in allocating resources and determining economic rewards. The catch is that neither property rights nor markets can function on their own. They require other social institutions to support them.

So property rights rely on courts and legal enforcement, and markets depend on regulators to rein in abuse and fix market failures. At the political level, capitalism requires compensation and transfer mechanisms to render its outcomes acceptable. As the current crisis has demonstrated yet again, capitalism needs stabilizing arrangements such as a lender of last resort and counter-cyclical fiscal policy. In other words, capitalism is not self-creating, self-sustaining, self-regulating, or self-stabilizing.”

“The history of capitalism has been a process of learning and re-learning these lessons. Adam Smith’s idealized market society required little more than a “night-watchman state.” All that governments needed to do to ensure the division of labour was to enforce property rights, keep the peace, and collect a few taxes to pay for a limited range of public goods.”

“The share of public spending in national income rose rapidly in today’s industrialized countries, from below 10 per cent on average at the end of the nineteenth century to more than 20 per cent just before World War II. And, in the wake of WWII, most countries erected elaborate social-welfare states in which the public sector expanded to more than 40 per cent of national income on average.”
“The lesson is not that capitalism is dead. It is that we need to reinvent it for a new century in which the forces of economic globalization are much more powerful than before. Just as Smith’s minimal capitalism was transformed into Keynes’ mixed economy, we need to contemplate a transition from the national version of the mixed economy to its global counterpart.”

This means imagining a better balance between markets and their supporting institutions at the global level. Sometimes, this will require extending institutions outward from nation states and strengthening global governance. At other times, it will mean preventing markets from expanding beyond the reach of institutions that must remain national. The right approach will differ across country groupings and among issue areas.

Designing the next capitalism will not be easy. But we do have history on our side: capitalism’s saving grace is that it is almost infinitely malleable.”

Dani Rodrik is an excellent economist and thoughtful commentator, and I have considered his contributions to international debate as constructive. I have to make some fairly basic points about his post in the Business Standard (you should read his article in full by following the link).

He starts off well, even prophetically: “Those who predict capitalism's demise overlook its historical malleability”, which is well worth many current commentators reading and thinking about, who, jumping the gun, predict the imminent demise of all forms of capitalism, much of it in the form of the State-Capitalism most of us live in.

Those who approach such a prospect with joyful hope are going to be disappointed.
As I was disappointed to read Dani’s paragraph:

Adam Smith’s idealized market society required little more than a “night-watchman state.” All that governments needed to do to ensure the division of labour was to enforce property rights, keep the peace, and collect a few taxes to pay for a limited range of public goods.’

This is a crude caricature of Adam Smith’s observations about the commercial society he lived in, and what he proposed for it as it increased the annual output of the ‘necessaries, conveniences, and amusements of life’ and, not forgetting, as it ‘spread opulence’ towards the labouring poor. His time-scales somewhat longer than a politician’s electoral horizon – even longer than a dictator’s life expectancy.

Dani uses the well-worn phrase, “night-watchman state” in association with the name of Adam Smith, as if the two go together in an eternal association. Strange! Given that the “night-watchman state” was uttered first by Ferdinand Lassalle, the fire-brand, 19th-century State Socialism, when he was mocking the laissez-faire politicians of the right for fiddling for penny profits in business and ignoring (what was obvious to socialists like Lassalle and his ilk) the far greater power and authority that would come from gaining controlling the State. No piddling capitalist ever controlled as much wealth and command over resources of the most petter politician!

But Adam Smith’s ideas were not limited by visions of a “night-watchman state”.

Writing in the mid-18th century, Smith’s agenda for government was already extensive, and promised by inevitable osmosis a far from insignificant state employing ‘night watchmen’.

At the time, defence was already a major expense of government; it did not diminish in the coming century, with its global reach of the Royal Navy and a military reach to match.

The growth of the expense of justice was already threatening to reach beyond the relatively passive bounds of local magistrates, especially as the list of capital crimes grew inexorably beyond the capacity of jails and ship’s hulks to hold those not hanged, so much so that the expense of founding a new colony in New South Wales was undertaken in 1788.

Smith’s agenda for public works and public institutions that ‘facilitated commerce’ was so extensive that it would take near on a hundred years to build and improve the necessary roads, canals, harbours and bridges, and by then whole new projects were added to the rising financial powers of municipal governance from the industrial ‘revolution’.

In education, universal provision across the 60,000 parishes of ‘little schools’ on the Scottish model, required 60,000 school buildings, teaching staffs, libraries and furniture, plus their annual maintenance, paid for partly by the state and by parents. He even had a scheme for gymnasia for exercises and crude martial fitness.

Significantly, Smith also alluded to primitive health measures in Wealth Of Nations, worthy of the government’s ‘most serious attention’ to prevent the spread of ‘leprosy or any other loathsome and offensive disease’. It would start there and expand when dealing with other health issues considered to be ‘so great a publick evil’. (WN V.i.f.60: pp 787-88)

Similarly, policies to meet the ‘police’ obligations of Britain’s towns implied considerable municipal expenditures (and taxes) to meet the needs for night lighting, pavements, disposal of soil and rubbish, and the maintenance of law and order.

True, the total expenditure required in Adam Smith’s Britain was relatively small alongside the total expenditure that would be required in the continental United States by the time of Ferdinand Lassalle (1870s). But it was much, much more than a ‘night watchman state’.

Dani claims that Smith believed: “All that governments needed to do to ensure the division of labour was to enforce property rights, keep the peace, and collect a few taxes to pay for a limited range of public goods.”

This is journalism, echoing the 1755 paper of Smith's, but is not a proper audit of Smith's ideas by a leading economist.

I suspect that Adam Smith and ‘division of labour’ go together in the minds of Dani’s readers, but with industrialisation, the division of labour in the pin factory had been superseded by the much more significant increasing division of labour of the kind alluded to by Adam Smith in his example of the day labourer’s ‘woollen coat’ and the long and complex supply chain required to produce this simple item. (WN I.i.11: pp 22-24)

The implications of this less well-known example of Smith’s insight (how few read on past the pin factory?) has been reactivated following the ‘re-discovery’ of Allyn Young’s 1928 article, ‘Increasing returns Increasing Returns and Economic Progress’, (Economic Journal, vol. 38. 1928: pp: 527-42).

Dani anticipates that “Designing the next capitalism will not be easy”. But if the ‘next capitalism' is down to ‘human design’, I must express scepticism as to its practicality. Capitalism was not designed, though futile attempts at socialism were ‘designed’, but unfortunately did not work out for those who had to endure the experiments.

Societies can legislate for this or that form of parts of their economies; sometimes they work, and last for a while, voluntarily; most often they don’t.

Social evolution is not about design, it’s about experimenting, sometimes intentionally, sometimes unintentionally. It has ever been thus. That is why history if littered with social experiments – the pyramids, the ‘hanging gardens' of Babylon, the Great Wall of China, the Scottish clans, the French majesties, ancient Greece and Rome, the hordes of Genghis Khan, Mahomet’s promises, the Czar’s empire, and the anonymous stone-tool makers of pre-history.

Globalism does not make co-ordinated design any easier, or local initiatives more difficult.

At root, when all else is failing, the Smithian urges to ‘self-betterment’, the ‘propensity to truck, barter, and exchange’ to ‘avoid toil and trouble’, will assert themselves, no matter what else is happening, somewhere among some people, humanity will start over.

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Blogger michael webster said...

Robert Nozick of course popularized the legitimacy of the "night watchman state". This was in the context of heated debates about the proper construction of the social contract from the state of nature. Hobbes, Hume, Locke and Rousseau were taken to be the progenitors of this debate.

To see that economist of the stature of Rodrik fall prey to the myth that Adam Smith argued for the idealized market as the nigth-watchman state is eye opening.

4:30 pm  
Blogger Gavin Kennedy said...


I agree that it is surprising that Dani Rodrik passed this idea off as Adam Smith's.

Errors of attribiton of many ideas to Adam Smith are without foundation, though I am less surprised than I used to be.

I had forgotten Robert Nozik's attribution of the nightwatchman state to 'classical liberal theory (Anarchy, State, and Utopia', 1974, p 26).

Thanks for the reminder.

5:41 pm  

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