Sunday, August 21, 2005

Smith, Keynes and Greenspan

From today’s “Detroit News” a piece praising Adam Smith’s ideas (excellent) but gets part of them upside down (not so good). The intentions of the author are commendable, but as we know from the law of unintended consequences, things happen ‘betwixt cup and lip’.

“America benefits from the wisdom of Adam Smith” By Thomas Bray, The Detroit News, Sunday, August 21, 2005

Thomas Bray writes:

“… last February, no less than Alan Greenspan paid a remarkable homage to Adam Smith in a lecture in Kirkaldy, Scotland, Smith's birthplace.

"Emperors and armies come and go," Greenspan noted, "but unless they leave new ideas in their wake, they are of passing historic consequence. The short list of intellectuals who have materially advanced the betterment of civilization unquestionably includes Adam Smith."
So far so good, indeed, much better than good, excellent, full marks and could not be improved, for Adam Smith would be in any ‘short leet’ (as we say in Scotland) of those who have advanced civilized values for the betterment of millions

But then, calamity. That old problem that American academics do not seem able to overcome, the invisible hand re-appears and gets completely mixed up with self-interest in a manner that Smith never said, never meant and never intended.

Thomas Bray continues:

“Smith argued that the "invisible hand" of self-interest, if allowed to work, would promote the public good by leading individuals to invent new products and processes, employ more people and steadily grow more productive. "It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest," Smith famously asserted."

The quotation is correct – Smith did famously assert it, but not quite as Thomas puts it. As for the ‘invisible hand’, the metaphor, used sparingly by Smith (only once in “Wealth of Nations”)and not as a general rule in respect of self interest, which, as Smith was at pains to point out could and did lead ‘merchants and manufacturers’ into the self-interested economic crimes of monopoly, restrictions on supply and high prices to earn high profits at the consumers’ expense, and, therefore, cannot be made to ‘assert’ what Smith did not say.

The self interest of the ‘butcher, the brewer and the baker’ leads them to prepare our supplies for dinner, but that is only part of the equation. There is our self interest too. And Smith’s quotation in context is not saying that that is the end of the matter – it is only the beginning. ‘Self love is insufficient’, said Smith. The mechanism for making it sufficient is found in his other famous quote: the ‘propensity to truck, barter and exchange.’ The alignment of the self interest of the parties to a transaction comes about through their bargaining: what they give up to get what they want.

Smith explicitly cautions readers not to rely on explaining why it is the readers’ self interest for the ‘butcher, the brewer and the baker’ to supply readers with their dinners. That would never do in a Smithian market: he exhorts readers to explain to the ‘butcher, the brewer and the baker’ why it is their self interest to supply readers with their dinners. And the device for mediating these conflicting self interests (readers preferring lower prices for their dinners and the ‘butcher, brewer and baker’ preferring higher prices in exchange for meat, beer and bread) is bargaining over prices, or the price system.

When bargaining results in an exchange of money for dinners the self interests of the parties are met and each party to the transaction has voluntarily adjusted their offer prices and supply prices to the identical price. If they left it to their own self interest they would never come to a deal. Bargaining mediates the discrepancies between the prices preferred by buyers and sellers. ‘Self-love is insufficient’ to do so.

Thomas Bray concludes:

“Nonetheless, intellectuals and politicians forgot about Smith. They rushed to embrace Keynesian theory, whose near-mystical complexities allowed them to believe government could stimulate the economy to even higher performance. Alas, most of their imagined improvements turned out to have counterproductive long-term effects. As a result, Smith is getting a fresh hearing, as the Greenspan lecture suggests.”

I was an economics student during the high-tide of Keynesian economic theory (though I did not find it ‘near mystical’; just unworkable in a full-employment economy because it led to inflation). Bray is right though: Keynesian economics as interpreted by politicians led to it being abandoned.

My concern is that if ‘Smith is getting a fresh hearing’, which version of Adam Smith is being listened to: what those who purloined his legacy say he advocated (the nonsense of the laissez faire version) or what he actually wrote about and advocated in “Wealth of Nations”?


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