Tuesday 29 July 2008

Adam Smith in less than 800 words

Gavin Kennedy at the Adam Smith's Lost Legacy blog points us to this piece in the The China Post in Tapei, Taiwan. The article is Adam Smith: Economics can set you free by Eamonn Butler. Butler is director of the Adam Smith Institute, London. This short piece is about as good as it get in explaining Smith's ideas in so few words.
Adam Smith: Economics can set you free

The pioneer of modern economics and the most influential thinker Scotland ever produced has at last been honored in his homeland with the first public statue of him in the United Kingdom. His message of freedom has worked wherever it has been tried, but it still needs spreading further.

Adam Smith's great and practical 'An Inquiry into the Nature and Causes of the Wealth Of Nations' (1776), is one of the most influential books ever written. It transformed our understanding of economic life from an ancient to a modern form, based on a completely new understanding of how human society works.

His 10-foot classical bronze statue was unveiled on July 4 (he was a friend of American independence) on the historic Royal Mile in Edinburgh by Nobel Prize-winning economist Vernon Smith (no relation).

Before Adam Smith, people assumed that the measure of a nation's wealth was the gold and silver in its treasury. Imports were bad because this gold and silver must be given up in payment. Exports were good because these precious metals came in. Trade benefited only the seller, not the buyer, and a nation could get richer only if others got poorer.

So countries erected vast trade barriers and controls to prevent money going out of the country -- taxing imports, subsidizing exports and protecting domestic producers (as many still do, hampering the World Trade Organization's troubled Doha Round negotiations).

Over 240 years ago Smith showed this was counterproductive.

He started not with theories, but from the fact that in any free exchange, both sides must benefit. The buyer profits, just as the seller does, because the buyer values the cash less than the goods it buys. That's why you buy things.

Since trade benefits both sides, said Smith, it increases our prosperity just as surely as do agriculture or manufacture. It is not gold and silver that measure a country's wealth, but the total of its production and commerce. Today we call that Gross National Product.

This blew a hole through the trade walls that had persisted for centuries. Leading politicians to read the book. They were convinced, cutting back trade restrictions and subsidies. That led to the great 19th-Century era of free trade and rising world prosperity.

Smith told politicians to get out of the way and let people trade freely: Social and economic harmony did not need to be planned from the center. It emerged naturally as human beings struggled to find ways to live and work with each other. Freedom and self-interest did not lead to chaos but -- as if guided by an "invisible hand" -- to order and concord.

All that was needed was an open society and free markets, with rules to maintain that openness and freedom. But those rules, of justice and morality, would be general and impersonal, not for the benefit of minority cliques.

It was not 'The Wealth Of Nations' which first made Smith's reputation, but a book on ethics, 'The Theory Of Moral Sentiments.' That book argues that the source of human morality is our natural sympathy for others (today we might say empathy). By seeing things from other people's point of view, we learn how best to live happily alongside them.

Some wonder how the self-interest that drives Smith's economic system can be reconciled with the sympathy that drives his ethics. But Smith understood that human nature is complex. The baker does not supply us with bread out of benevolence, but nor is it self-interest that prompts someone to dive into a river to save a drowning stranger. Self-interested human beings can -- and do -- live together, peacefully and productively.

So 'The Wealth Of Nations' is no endorsement of dog-eat-dog capitalism, as sometimes caricatured. Self-interest may drive the economy, but freedom is a force for good. Smith believes in free markets because the poor will benefit most from them. Only the rich and powerful benefit from other systems.

Now Smith dominates the main street of the city where he worked and, in 1790, died. Tourists from all over the world pose for pictures and guides use the prominent monument as a natural assembly point. Many wonder who Adam Smith was and why he deserves such prominence.

In an age when governments claim to be able to solve every problem, people will find his message refreshing: When we reject political interventionism and rely on natural liberty, we find ourselves, unintentionally but surely, in a harmonious, peaceful and efficient society.
For a (short) book length, "general reader", discussion of Smith's ideas try Adam Smith - A Primer by Eamonn Butler. For a more academic discussion try these two books by Gavin Kennedy, Adam Smith's Lost Legacy and Adam Smith: A Moral Philosopher and His Political Economy. Assuming you can actually afford them!

2 comments:

Pete Murphy said...

Our enormous trade deficit is rightly of growing concern to Americans. Since leading the global drive toward trade liberalization by signing the Global Agreement on Tariffs and Trade in 1947, America has been transformed from the weathiest nation on earth - its preeminent industrial power - into a skid row bum, literally begging the rest of the world for cash to keep us afloat. It's a disgusting spectacle. Our cumulative trade deficit since 1976, financed by a sell-off of American assets, is now approaching $9 trillion. What will happen when those assets are depleted? Today's recession may be just a preview of what's to come.

Why? The American work force is the most productive on earth. Our product quality, though it may have fallen short at one time, is now on a par with the Japanese. Our workers have labored tirelessly to improve our competitiveness. Yet our deficit continues to grow. Our median wages and net worth have declined for decades. Our debt has soared.

Clearly, there is something amiss with "free trade." The concept of free trade is rooted in Ricardo's principle of comparative advantage. In 1817 Ricardo hypothesized that every nation benefits when it trades what it makes best for products made best by other nations. On the surface, it seems to make sense. But is it possible that this theory is flawed in some way? Is there something that Ricardo didn't consider?

At this point, I should introduce myself. I am author of a book titled "Five Short Blasts: A New Economic Theory Exposes The Fatal Flaw in Globalization and Its Consequences for America." My theory is that, as population density rises beyond some optimum level, per capita consumption begins to decline. This occurs because, as people are forced to crowd together and conserve space, it becomes ever more impractical to own many products. Falling per capita consumption, in the face of rising productivity (per capita output, which always rises), inevitably yields rising unemployment and poverty.

This theory has huge ramifications for U.S. policy toward population management (especially immigration policy) and trade. The implications for population policy may be obvious, but why trade? It's because these effects of an excessive population density - rising unemployment and poverty - are actually imported when we attempt to engage in free trade in manufactured goods with a nation that is much more densely populated. Our economies combine. The work of manufacturing is spread evenly across the combined labor force. But, while the more densely populated nation gets free access to a healthy market, all we get in return is access to a market emaciated by over-crowding and low per capita consumption. The result is an automatic, irreversible trade deficit and loss of jobs, tantamount to economic suicide.

One need look no further than the U.S.'s trade data for proof of this effect. Using 2006 data, an in-depth analysis reveals that, of our top twenty per capita trade deficits in manufactured goods (the trade deficit divided by the population of the country in question), eighteen are with nations much more densely populated than our own. Even more revealing, if the nations of the world are divided equally around the median population density, the U.S. had a trade surplus in manufactured goods of $17 billion with the half of nations below the median population density. With the half above the median, we had a $480 billion deficit!

Our trade deficit with China is getting all of the attention these days. But, when expressed in per capita terms, our deficit with China in manufactured goods is rather unremarkable - nineteenth on the list. Our per capita deficit with other nations such as Japan, Germany, Mexico, Korea and others (all much more densely populated than the U.S.) is worse. In fact, our largest per capita trade deficit in manufactured goods is with Ireland, a nation twice as densely populated as the U.S. Our per capita deficit with Ireland is twenty-five times worse than China's. My point is not that our deficit with China isn't a problem, but rather that it's exactly what we should have expected when we suddenly applied a trade policy that was a proven failure around the world to a country with one sixth of the world's population.

Ricardo's principle of comparative advantage is overly simplistic and flawed because it does not take into consideration this population density effect and what happens when two nations grossly disparate in population density attempt to trade freely in manufactured goods. While free trade in natural resources and free trade in manufactured goods between nations of roughly equal population density is indeed beneficial, just as Ricardo predicts, it’s a sure-fire loser when attempting to trade freely in manufactured goods with a nation with an excessive population density.

If you‘re interested in learning more about this important new economic theory, then I invite you to visit my web site at OpenWindowPublishingCo.com where you can read the preface for free, join in the blog discussion and, of course, buy the book if you like. (It's also available at Amazon.com.)

Please forgive me for the somewhat "spammish" nature of the previous paragraph, but I don't know how else to inject this new theory into the debate about trade without drawing attention to the book that explains the theory.

Pete Murphy
Author, Five Short Blasts

Anonymous said...

Jeepers, there is more economic fallacies in that one post than you could shake a stick at!