Sunday, February 05, 2012

Listen to Adam Smith Not Keynes

Arnold Kling, an American economist and author of the Adam Smith Institute's latest paper, "Patterns of Sustainable Specialization and Trade, writes in the Wall Street Journal (Europe) HERE

“Government Cannot Create Sustainable Jobs”

“Useful jobs don't exist until producers discover them. Stimulating demand can at best return an economy to the pre-slump status quo.

Borrowing and spending is a tough job, the Keynesians say, but somebody has to do it, and that somebody should be the government.

Unfortunately, this view may not be correct. Instead, I believe that the process of creating employment is explained not by the theories of Keynes, but rather by the theories of Adam Smith and David Ricardo. Smith famously described the advantages of specialization and division of labor. Ricardo pointed out the gains from trade that come from consuming goods that others produce more efficiently. From the perspective of Smith and Ricardo, real jobs emerge in the context of patterns of sustainable specialization and trade (PSST).

Unfortunately, the patterns of specialization and trade that had emerged five years ago were not sustainable. Many jobs in home construction, durable-goods manufacturing and distribution, and mortgage finance were dependent on housing markets with ever-rising prices. In the U.S. and the U.K. in particular, the finance industry expanded well beyond its true economic value. Once the property bubbles burst, these jobs were exposed as not viable. Meanwhile, ongoing creative destruction brought about by the Internet and globalization have continued to allow substitution of capital and emerging-market labor for industrialized countries' labor in many sectors. Together, these phenomena have caused widespread dislocation.
More government spending will not bring back the days when supposedly triple-A-rated mortgage securities could be fashioned out of dodgy loans to unqualified borrowers. Doing so would not halt the ongoing improvements in productivity in manufacturing and retail trade. It would not facilitate the adjustments that are needed in the mix of skills in the labor force. The necessary adjustments can only be made by the decentralized efforts of entrepreneurs.

How are jobs created?

For Keynesians, job creation is simple. Entrepreneurs have knowledge of how and what to produce. All that is required is more demand, in order to induce them to undertake more hiring. In contrast, in our Smith-Ricardo story, the knowledge of how and what to produce has to be discovered. Entrepreneurs have to figure out ways to utilize resources that satisfy wants in an efficient way. The market mechanism first must undertake trial and error to create production processes that exploit comparative advantage. Until these new patterns of sustainable specialization and trade are discovered, there are no job slots.
Experimenting with new patterns of specialization and trade is relatively easy. Discovering patterns of sustainable specialization and trade is much harder. Our economic well-being depends on the ability of entrepreneurs to make these discoveries. …

A breath of fresh air at last into the muddle that passes itself off as applied economics today. I think Arnold Kling is on to something here (though it has been around a long time).

Expecting demand to recover for goods and services doing well before 2007 is at best heroic, and at worst, very wrong, and thereby hopelessly wasteful.

Follow the link and read the full article.

(Thanks to Don Beaudreaux of Café Hayek HERE for the pointer).


Blogger airth10 said...

The WSJ article ignores the fact that government is the first line of defense and initial source of sustainability. Fundamentally it is the government that creates and maintains the arena in which entrepreneurship and sustainability is possible.

The financial crisis was in itself brought about by the fact that government forgot its fiduciary duty, by being lax and irresponsible in its policing and oversight responsibilities.

Too many economists like Arnold Kling insist it's an either/or choice situation between government and business, when it's really a symbiotic relationship between the two that makes for successful and sustainable economic environments.

11:00 pm  
Blogger Stephan said...

Aha. Police Officers, Firefighters, Teachers, all these Econ Profs don't have a sustainable job. I would suggest to start the transition to useful private sector jobs by terminating the unsustainable useless jobs of Econ Profs.

12:42 pm  
Blogger Gavin Kennedy said...

I agree in principle with you (as did Adam Smith in terms of the balance between state and commerce). However, the state's role has extended well beyond its proper functions in many areas, some of it under the influence of legislators under semi-personal motives by adding clauses to executive bills that have nothing to do with the bill for their favourable vote, and also from misguided political interference in market conditions (against lower-cost imports that lower living costs for poorer families).

This has nothing to do with hostility to state roles.


8:02 am  
Blogger Gavin Kennedy said...


I note your point but could not possibly comment on your general proposition!


8:04 am  
Blogger Blue Aurora said...

Didn't you write a post where there was talk about Smith and Keynes being very similar on financial speculation? Have your views changed since then?

Also, have you read Keynes's magnum opus, The General Theory of Employment, Interest, and Money? Lord Keynes does invoke Adam Smith...

2:32 am  
Blogger Gavin Kennedy said...

Blue Aurora

Many thanks for your insightful comment.

Indeed you are right in a narrow sense. To say that Keynes and Smith agreed in one (or many) areas does not mean that they agreed on everything, and, similarly, the reverse (disagreeing on one thing does not mean they disagreed on everything).

Financial speculation and government public works are two different categories of seeking different objectives. Kling states that, at best, government spending may return an economy to the pre-recession status quo, but not necessarily so.

Financial speculation may be one-way bet to untold wealth; it may also be the road to ruin.

I read Keynes' 'General Theory' in the later 1950s, and then studied it at University in the middle 1960s.

Keynes mentioned Adam Smith in many contexts - he was a Cambridge (UK) scholar and faculty member and part of the 'oral' tradition of the early decades of the 20th century (see paragraph 1 above).

8:07 am  
Blogger Blue Aurora said...

I see. Dr. Kennedy, have you ever considered writing a post or an article comparing and contrasting Smith and Keynes from your own perspective? I think it would be a worthwhile exercise to compare Dr. Smith's The Theory of Moral Sentiments with Baron Keynes's A Treatise on Probability, or to compare the economic concepts found in The Wealth of Nations with the economic concepts of The General Theory.

5:53 pm  

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