the path to adam smith pekka sutela aalto university 26 february 2015b [email protected]...
TRANSCRIPT
Pekka Sutela 2
Mercantilism
• Favourite bete noire of Smith’s and a term still used to condemn some views on foreign trade and capital flows– This tends to exaggerate the uniformity and consistence of
mercantilism as it was a political ideology and set of policy recommendations (rather than a theoretical system)
– Two views on a wider question: are we ”standing on the shoulders of past giants” (Marx) or ”prisoners of long-dead economists” (Keynes)?
– What actually is the transmission mechanism from theory to policy (if any)?
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• Question: what should be done to promote the wealth, power and interests of a nation relative to others?– No distinction yet between nation, state and the
sovereign (king)– Frequent wars between European states– Competition for access to resources outside Europe
(colonialism)• The role of blue ocean going navies• Austria, Turkey and Russia as the continental states
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The mercantilist view• Answer: everything that can be should be produced within the
country– Restrict imports by means available, concentrating imports on necessary
raw materials. Also promote exports through industrial policies.– If everybody was following this rule, promoting exports would
necessarily be secondary, but having colonies helps both ways: they provide both raw materials and markets• Case of Indian-British cotton trade
• Access to money (gold and silver) which was needed for domestic payment traffic. If not available at home, can be earned through trade balance surplus. – Or else, surrogate monies not used generally may be used (animal skins,
copper, shells etc, even cut huge stones)
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• This however– Neglects all considerations of cost and productivity– Leads to thorough controls of economy beyond foreign trade
• Especially as the sovereign ”owned” the whole economy• There were any amounts of controls left from earlier times concerning professions
(also through guilds), technologies, trading (market towns and days) and the rest
• But then the emphasis on money as general purchasing power is understandable, as money is handy– For instance if you need emergency purcases of weapons, mercenaries and
such, as was often the case. – Alternative: rob your subjects or turn to money lenders– This also helps to understand why taxation was a key topic in early economics– As paper money (~ IOU’s, privately issued debt paper) was often not reliable,
emphasis on ”species”, metal minted for money)
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Physiocrats• France was an agrarian country
– also producing luxory goods for consumption by gentry at the huge court and armaments for continuous wars
• To maximize the latter items, agriculture like the rest of the economy had become very controlled. State-controlled corporations, restrictions of movement, internal tariffs, feudal restrictions.
• Physiocrats: agriculture is the only productive activity– Work instead on trading, like in mercantilist thought– At least the surplus is easily visible– Francois Quesnay (1694-1774), surgeon
• shows with a tableau (”panorama”) – static numerical model – how the surplus then circulates in the economy • Argues that hindrances to circulation should be abolished (like those to blood circulation, but this was not his
original idea)• His followers (the first ”school” in economics) call this the ”laissez faire, laisser passer” principle
• A.R.J. Turgot (1727-81), short-time finance minister to Louis XVI– Laissez faire was not favoured in Versailles, which the physiocrats regarded a parasite – Law of diminishing returns (in agriculture)– Optimal capital input (in agriculture)
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• Single tax– Wealth should be taxed where it arises: agriculture– Taxes raised elsewhere anyway fall on the only productive activity
• Keep it simple!• American Henry George (1839-1897) argued that land ideally belongs to all
and there should be a single tax on unimproved land value. The idea had political support in countries like US, Australia, Scotland and Denmark. Later M. Friedman had theoretical sympathies with it.
• Influence on Smith – In addition to Britain, Smith only visited France (and Geneve)– Distinction between productive and unproductive activities– Economic freedom– Physiocrats were the only previous economists Smith respected
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David Hume
• 1711-76 (sic!), probably the greatest English-language philosopher ever– Theory of knowledge, moral philosopher– Economics still part of moral philosophy also including what
we would call ethics, political science etc– Senior friend whose shadow Smith had difficulties of escaping
• Monetary theory– J.S. Mill (1848): ”nothing is less important in the economy
than money”– M. Friedman (1975): ”we have learned little since”– R. Lucas (1996): ”the beginning of modern monetary theory”
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Standard interpretation of Hume
• Quantity theory of money– Money is neutral: increased money supply increases prices; no
changes in the real economy– Essentially money is a crease of economic wheels
• Open economy monetary theory– The species-flow mechanism (species by now = gold)– Assume two countries, gold-standard and equal prices– Monetary growth in homeland increases prices. With ensuing
lower competitiveness a trade balance deficit follows, and therefore a species flow to foreign land. Prices there increase until prices again equalized. New equilibrium in real terms identical with the original one.
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But there were subleties
• Schabas and Wennerlind, Journal of Economic Literature 2011:3
• Hume compared long-run effects of sudden doubling of money volume
• In short run, he argues, increased money supply spurs economic activity– Less need for suspicious credits– Incoming species may be higher-quality: diluting gold was
frequent in Britain• So he took into account 18th century British institutional
specifics
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Hume’s subtleties continued…• What causes money growth?
– Makes a difference if it is due to increased exports or increased supply of state paper money
• The role of the state– State must stimulate development of the monetary sector; must prevent
leakage of species from circulation (cf. Keynes!)– Public money creation must be disciplined, avoiding debt creation
• Growth in luxury production is not self-evidently good– Wider trading is good, but even reasonable luxury goods are secondary
compared with reading a poem– Greed is insatiable, eternal, all-compassing and directly destructive of
society (The moral philosophies of Hume, Smith and later classical economists had a strong ingredient of pietism; greed for them was not good)
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• Thus the traditional economic virtue is modesty (also see in J.S. Mill later). Especially so when taught by Scottish moral philosophers
• There are rich and poor countries but their position varies. Global wealth increases through trade and peace.
• ”The Chinaman is diligent and works for a coin. If China were as close as France and Spain, we would only use Chinese products.”
• The best policy is to safeguard property rights and contracts. Industry and trade will follow.
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Final words on Hume
• Hume on economic laws– Being based on human behaviour, which we know, they are more
certain than laws of nature– This makes economic behaviour predictable
• Amartya Sen (Rational fools 1977) is a latter-day Humean: we do not calculate everything, as our innate needs to speak the truth and follow decency exclude that
• Decades matter– Hume wrote before Newton was fully absorbed and steam engines
were much improved by Watt• Hume did not found economics
– No attempt at systematic theory– Simplifying the writings of such authors is particularly problematic
Pekka Sutela 14
Adam Smith
• 1723-90• Excellent new intellectual biography by Nicholas
Phillipson (Adam Smith: An Enlightened Life, 2010)• Professor of moral philosophy (general social
science), tutor, Customs Board member (!) and bestselling author.
• The first economist whose writings are widely available, still fully readable (and highly recommended)
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• We know little about Smith: he burned all his papers when the end was near
• Read ”all” (like Marx and Schumpeter) but major influences clear– Scottish enlightenment and pietism (and fast development in Glasgow
and later Edinburgh– Self-study in Oxford (which he evidently loathed) – Physiocrats
• Planned four books but only finished two (two sets of lecture noted by students available)– Rhetoric (lecture notes)– Jurisprudence (lecture notes)– Ethics (Theory of Moral Sentiments 1759)– Political economy (Wealth of Nations 1776)
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The Theory of Moral Sentiments • 1759• Basic question of social thought in the 18th century: what prevents
the society from falling back to the Hobbesian state (Thomas Hobbes 1588 -1679)– War by all against all which had been as if escaped through a social contract
by free and rational men– Submitting to absolute power by sovereign
• Absolute sovereign not consistent witn Enlightenment. Feudal constraints matter of past (and should be). Whence modern solution?
• Most radical answer contrary to Hobbes by J-J Rousseau: – Man was originally good (”noble savage”) but society has spoiled her
• Smith: moral sentiments (or shared values, norms and expectations, to use the terminology of Erik Allardt 1961)
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Moral sentiments• How to interpret? J.R. Hicks (1942): The social framework of the
economy – Creates a sufficient social communality making competition and pursuit of
self-interest possible– Compare Hume, Sen– Economy is thus a narrower part of society. Contrast this with
• Neoclassicism since 1870s: economics does not study a part of society, but is an approach to studying the whole society (and other things)
• Especially George Stigler (1911-91): so-called economic imperialism
• But remember that Smith only knew Scotland, England and France– What would have been his take on democracy, immigration, global trade
and multiculturalism?– China, India, Japan etc little known, usually from stories of rare visitors– Good example: Marco Polo
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The Wealth of Nations (1776)• The source of wealth is work, not land, consumption or something else.
Work creates value (or exchange value) which need to have some connection with use value. Demand conditions present, but of secondary importance.– Exchanging deer against beaver!– Later debates: was a distinction between short and long run equilibrium prices
made? (More or less present in some of physiocratic literature) Smith distinguished between natural and market price.
– Were constant returns to scale assumed? (surely not, think of division of labour)– What was the role of capital and land? Were they assumed quantitatively
unimportant?– Probable true answer: do not expect complete consistence from a founder of
discipline!– Notice: Emphasis on labour is consistent Smith’s Scottish moral philosophy Marx’s
approach would be a different one but both saw the core (essence?) of society in labour
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Division of labour• Division of labour is the source of productivity rise through
specialization.– Innate abilities, training, learning by doing (Arrow 1963)
• The curious pin making example– Production without specialization 1-20 pins per day per man, with
specialization 4800 (and now hugely more!)– Why marginally important pin making, why not something truly industrial?– Perhaps Smith understood that institutions are more important than
machines?– Also, not much machinery in use in the 1770s– Smith was friends with James Watt of steam engine improvement, but then
and earlier those were used to pump water out of coal mines.– A few decades later the emphasis could have been a different one, but was
Smith actually right in underlining an institution, not technology?
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”Extent of division of labour is limited by the size of the market”
• Embryo of growth theory– Clearly there is an embryo of self-feeding cycle of growth– A key part of modern development economics
• Against import substitution, trade constraints (though specialization has its risks)
• Low population density does not facilitate growth (compare with standard neoclassical growth theory!)
• International trade– Foreign trade is part of division of labour– Based on absolute advantage: nation should specialize in
producing what it can produce more cheaply than others – Smith the globalist?
Pekka Sutela 21
Wealth of Nations
• Paradoxically Smith does not really have a growth theory.– Division of labour, free markets, free trade and the proper role
of the state are important– Production of material goods is productive, that of services
unproductive. Still eg education is very useful for wealth!• This may be based on the ease of detecting the saving of goods for
investment. More difficult with services.
• Population growth is crucial– More workers, larger markets– More division of labour, learning by doing– Capital accumulation (investment) increases productivity and
thus wealth
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True role of self-interest
• Best incentive: ability to enjoy fruits of work• This must take place in the frame of moral
sentiments• Free markets (aka the invisible hand – the term only
appears once) are thus the key to the wealth of nations
• Remember the parallel with Isaac Newton– In a literal sense free markets were god-sent!
• Smith was a great persuader (like so many of the great economists), but not a propagandist
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The famous invisible hand
• In fact Smith only uses the term once and does not define it• Its is not the hand of God though it had been set going by
God• Probably best to define as self-interested action in free
markets– Against the visible (even grabbing (Shleifer et al 1998)) hand of
the state, guilds and mercantilism– Action within the frame of moral sentiments– Monopoly is bad; free entry and exit essential– There are higher values than wealth; eg security of state. Supply
security for crisis can have priority over division of labour.
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Close reading can be useful
• ”Every individual necessarily labours to render the annual revenue of society as great as he can. He generally, indeed, neither intends to promote the publick interest, nor knows how much he is promoting. By preferring the support of domestick to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of it. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it.”
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Smith was anything but naive
• ”People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices. It is impossible indeed to prevent such meetings, by any law which either could be executed, or would be consistent with liberty and justice. But though the law cannot hinder people of the same trade from sometimes assembling together, it ought to do nothing to facilitate such assemblies; much less to render them necessary.”
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Beware of the capitalists!
• Employers complain that high wages increase costs and thus damage competitiveness. High profits are not seen as a problem.– ”They are silent with regard to the pernicious effects
of their own gains. They complain only of those of other people.”
• Example of road tariffs– Tariffs based on weight of carriages are wrong.
Those carrying luxory goods should pay more per weight than those carrying necessities.
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A class-based society• Workers receive wages and other benefits
– Emphasis on other benefits important– Wages are constrained from below by subsistence mimimum, but often
higher• Fast growing America• Unpleasant jobs (hangman)• Entering some jobs is like a lottery (example: lawyer)
• Employers have capital for the wage-fund. To use it they must receive profits.– In pre-accumulation capitalism capital was equated with wage-fund– In a conflict between workers and employers the latter had stronger hand
as they could live for years on the wage fund. They are also fewer which facilitates collective action.
• Landowners (other natural resources included) receive land rent
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Value of a good
• Value (or prise) of the good is the sum of wages, profits and land rent.– They have their natural levels, which make them socially
acceptable.– In short run price can differ from the natural level, which
leads to re-allocation• Example: King’s death, public mourning and demand for black cloth
• Over longer run such deviation is to be condemned– It leads to conflicts and is economically inefficient– This is a problem in labour markets but also other input
markets due to asymmetry of market power
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Proper role of the state
• Key part of argumentation: against mercantilism– Free trade– Exceptions (like military industries) minor
• Not in favour of minimum state laissez faire– Internal and external security– Protecting citizens from oppession and lack of justice– Protecting institutions like property rights– Providing ”public goods”
• Roads, canals, health, education...