Wednesday, February 16, 2011

Political Scientist Gets Adam Smith Wrong

Louis René Beres (professor of Political Science at Purdue University in West Lafayette, IN) writes in the OUP Blog (HERE):

"Economic Volatility, Hyper Consumption, and the “Wealth of Nations”

Adam Smith published his Inquiry into the Nature and Causes of the Wealth of Nations in 1776. A revolutionary book, Wealth did not aim to support the interests of any one particular class, but rather the overall well-being of an entire nation. He sought, as every American high-school student learns, “an invisible hand,” whereby “the private interests and passions of men” will lead to “that which is most agreeable to the interest of a whole society.”

Still, this system of “perfect liberty,” as he called it, could never be based upon encouragements of needless consumption. Instead, argued Smith, the laws of the market, driven by competition and a consequent “self-regulation,” actually demanded explicit disdain for any gratuitous or vanity-driven consumption.

What does this all mean for better understanding current economic dislocations and volatility? Above all, it suggests that modern commentators and pundits often speak in blithe disregard for Smith’s true beliefs, ignoring that his primary concern for consumption was always tempered and bounded by a genuine hatred for “conspicuous consumption” (a phrase to be used more pointedly by Thorsten Veblen in a later century).

For Adam Smith, it was only proper that the market regulate both the price and quantity of goods according to the final arbiter of public demand, yet, he continued, this market ought never to be manipulated by any avaricious interferers. In fact, Smith plainly excoriated all those who would artificially create or encourage any such contrived demand as mischievously vain meddlers of “mean rapacity.”

What “every American high-school student learns”, including apparently Professor Louis René Beres, about “an invisible hand” is, in fact, mostly nothing to do with Adam Smith, but was invented in modern times by professor of economics at the University of Cambridge (England) and the University of Chicago and published throughout the profession by authors like Paul Samuelson (Economics, 1948, McGraw Hill, 19 editions to 2010), and the many derivatives ‘look alike’ textbooks that appeared from the 1950s onwards.

Once the professors working at the frontiers, opened by Professor Pigou, in Cambridge, in his Welfare Economics (1922) and Arrow and Debrue in General Equilibrium (1960) latched onto the metaphor of ‘an invisible hand’ (used by Adam Smith in a entirely different and much more simple context), they pushed its new status as a ‘theory’, ‘concept’, and near theological ‘doctrine’. As they say, a new ‘paradigm’ was born, believed today with near-messianic status by true believers everywhere, few of whom have ever tracked the simple uses by Adam Smith in his Theory of Moral Sentiments and his Wealth Of Nations, and wondered why so much fuss has been made of it by exponents of a supposed science

Professor Louis René Beres presents Smith’s metaphor as stating that “the private interests and passions of men” will lead to “that which is most agreeable to the interest of a whole society.” That is far too strong. Other go much further, and assert that even the ‘selfishness’ of individuals can lead to this startling result, other that it works through to bring about the ‘best of all possible’ outcomes when unfettered markets are left unfettered.

In Wealth Of Nations (Book IV, chapter 2, paragraphs 1 to 8), Smith observes that some, but definitely not all, merchants who feel insecure about sending their capital abroad prefer to invest locally at home, and, as a consequence, without intending it, add to ‘domestic revenue and employment’, which means that domestic investment is higher than it would otherwise be if they exported abroad. Not an other than blindingly obvious and safe conclusion: the whole being the sum of its parts.

Now this was nothing to do with ‘perfect competition’ (such ideas were advanced 100 years later), nor did it have anything to do with ‘Natural Liberty’ (a 17th theory, due to Grotius and Pufendorf). In fact, Smith, ever the observer of the real world, wrote about 18th-century mercantile political economy, then operating in Britain, which featured tariff protection and prohibition regimes, interventionist laws, imposed for other reasons, in the form of Incorporated Towns and Guilds, with their legal monopolies of most known trades from the 16th century, the Statute of Apprentices, which limited trades to 2 apprentices per master (7 years), which legally restricted competition, to Settlement Acts, which prevented people from, leaving one parish to join another, and, at sea, the Royal Navy and the Customs Officers prevented foreign ships from carrying British cargoes to and from the North American colonies. Added to which the laws of primogeniture and entails prevented the redistribution of land to new owners, and the Chartered Trading monopolies.

None of these had anything to do with “that which is most agreeable to the interest of a whole society”. So where was this alarming conclusion and absurd assertion made by Adam Smith? It wasn’t.

Professor Louis René Beres is completely wrong about Adam Smith and the ‘invisible hand’.

The real problem is that he is not alone, either amongst political scientists or most modern economists.

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