Adam Smith

1. Adam Smith An Inquiry Into the Nature and Causes of the Wealth of Nations

2. Introduction • Recall: Ethics, economics as part of a broader system of social science • Theory of Moral Sentiments: An exercise in moral, social philosophy • Wealth of Nations: Extends this to provide a working model for social interaction: the “System of Natural Liberty” as a vehicle for directing our self-regarding propensities

3. A response to to the challenge directed toward Smith’s moral theory: Will the Impartial Spectator be sufficient to control “the passions”? • Is the available information sufficient? • Is that information really always interpreted impartially?

4. Our claim: society needs institutional structure • But TMS does not tell us where this comes from

5. Links to Kuhn: Smith’s Disciplinary Matrix • A systematic • Exploration of the natural order underlying the social world • Application of that understanding to social and economic issues • A unified system of explanation • A definitive technique of analysis

6. Provided economics (political economy) with its first generally accepted system of theories, concepts, analytic techniques: its first disciplinary matrix • Part of his general theory of society

7. That is: he gave it • An organized structure of assumptions • A problem orientation • A value system • An analytic framework • (later) a self-conscious intellectual community

8. Much popular appeal of this paradigm • Relevance to immediate policy problems • Population explosion; concern for Poor Relief; economic growth issue • Corn Laws; and commercial policy

9. Belief that political economy could provide • A simple, effective method of analyzing these complex problems • A reasoned approach to useful policy recommendations • Ricardo, Malthus, others, as puzzle-solving: doing normal science

10. Fundamental Issue • Under what conditions will society operate so as to maximize human happiness? • TMS: Human happiness promoted by obeying the moral virtues under the observation of the Impartial Spectator; grounded in need for social approval

11. WN: • More explicit recognition of the problem of opportunistic behavior • Implications for the kinds of reforms necessary to bring society closer to the system of natural order that would maximize happiness • Note Smith’s location in time and space

12. The machine metaphor: under what conditions does it operate best? • The importance of policy • WN as probably the first unified socio-economic model

13. The Major Themes • Economic growth, development: society’s laws of motion • Social coordination: How does a society in which each individual follows own self-interest keep from falling apart?

14. Economic Growth • What’s the “wealth” of nations? • Mercantilist presumption • Smith: “Wealth”, from “weal”, well-being • What’s necessary for the “good life”? • For whom? • Growth measured in terms of output per person

15. Sources of productivity: where does growth come from? • Now: Focus on • Technology • Capital per worker • Institutions • Incentives

16. Smith: Source of productivity growth in specialization, division of labor • The pin factory • Why does this happen? • Improved dexterity: learning-by-doing • Time saved moving from operation to operation • Inventing labor-saving machines

17. Who benefits? • Origin of division of labor? “Propensity to truck, barter, and exchange . . .” • We need the cooperation of many others to survive; do we get that cooperation by appealing to their benevolence? • The social division of labor as important

18. What affects the degree of specialization? The importance of the extent of the market • Examples

19. The Importance of Money • Specialization as implying exchange • Barter, and the problem of transactions costs • Commodity vs. fiat money • The diamond/water paradox: a scientific puzzle

20. The Policy of Europe • A first look at Smith’s argument for the “system of natural liberty” • A way for Smith to talk about the consequences of interference with free exchange • Examples: exclusive privileges; restrictions on labor mobility; the threat of monopoly

21. The Importance of Capital Accumulation • Smith’s problem: How do we support ourselves until we produce and sell our own output? • In our language: • Capital stock as necessary for more division of labor • Capital, thus, as a major source of productivity growth

22. Productive vs. unproductive labor: What’s going on here? • Distinction between output produced for • Current consumption (consumer goods) • Future consumption (capital goods)

23. How does society increase productive labor (capital accumulation)? • Parsimony: saving • Link to TMS, and saving as a dimension of prudence/self-love

24. The importance of good public policy • Smith’s warnings against a large public sector: why? • The direction of spending matters: Spending for luxury goods in a poor country as blocking economic development

25. The System of Natural Liberty • Book IV, and further discussion of mercantilist legislation • The trade balance: • Do we need to worry about trade deficits? • Are gains to one trading partner matched by losses to the other?

26. Why see restraints on trade? • Contemporary versions • The basic idea: The competitive market as reconciling private, social interests; the social mechanism for regulating the economy • Imposes orderly rules of behavior on economic agents

27. Thus: The “Invisible Hand” • As working automatically to coordinate people’s individual decisions • As working best with minimum interference • Potential problems: • Desire to monopolize • Tendency for protectionism • Grounded in self-interest?

28. Where’s government in all this? To provide • Legal system: Administer justice • Anti-monopoly protection • Military security • Provide certain public works

29. In the End: The Central Theme of the Invisible Hand • Under certain social arrangements private and social interests can be harmonized • Market forces assure a social result that is independent of individual intentions • Self-interest works for general welfare only under appropriate set of rules

30. Does a market economy guarantee the “best of all possible worlds”? Is Dr. Smith really Dr. Pangloss in disguise? • Is government without fault? The incentives facing politicians, bureaucrats

31. The Evolution of Social Institutions • Unresolved issue: Where do social institutions (including government) come from? Why are they necessary? • TMS, and their necessity; but not how they come to be • WN, and a story about their origin (Books III and V): a “philosophical history”

32. How does human society begin? The propensity to “ . . . truck, barter, and exchange . . . “ • Necessity of defining, monitoring, enforcing property rights • Security, order as necessary for society; and social order requires system of law

33. So: how do institutions evolve? • Brief definition: Institutions as rules (explicit; or implicit) • Origin with the evolution of property • Sources of authority: • Age • Fortune • Birth • Personal qualifications

34. Stages of society • Subsistence (hunting, fishing) • Pasturage • Agriculture • Commercial • Evolution of differences in property ownership; and associated evolution of property rights • Importance of preconditions for growth

35. Why does Smith do this? To show how changes in the nature of the economy are reflected in institutional changes

36. The basic argument: • Humans are self-regarding is all spheres of society • Helps us understand the pursuit of wealth, security • Economic development creates different stages of society, each with its own characteristic institutional structure

37. Two case studies: • Western Europe after the fall of Rome • The manor as the basic unit of society • Disorder; conflict • Provided security • Mutual claims, lords and serf • Changes in system of property rights: entail; primogeniture • Limited growth possibilities

38. Emergence of a market economy • Links, town and country • Political alliances, monarchs and towns • Role of foreign trade • Decline in lords’ feudal power • Conversion of feudal obligations into cash • Dissipation of fortunes: buying goods and services • So: Commerce brought about what feudal violence could not: a decreased power for nobles

39. In the End . . . • “Whenever a person seeks to serve his own ends, he invariably serves the ends of society” • Did Smith provide a solution to this problem? Did he suggest the conditions (social arrangements) under which this can happen?

40. Self-interest makes the market system go • But benevolence (a moral sentiment) makes the market system possible • Social institutions important in harnessing, channeling, pecuniary motives • A set of policy prescriptions grounded in • The existing institutional structure • His analysis

41. Is the free-market economy the “best of all possible worlds”? Is Dr. Smith really Dr. Pangloss in disguise?

42. Another issue: Is market society (capitalism) civilizing or self-destructive? What’s the effect of capitalism on the social and moral order?

43. The “Doux-Commerce” hypothesis: Favorable effects of capitalism • Limitations on the powers of monarchs • A moralizing agent: people are useful to each other • Smith, and frugality, integrity, industriousness • The influence of continuing relationships

44. The “Self-Destruction” hypothesis: Capitalism as undermining the moral foundations on which any society must rest • Influence of the Industrial Revolution • Emphasis on individual advantage: atomism as corrosive of social cohesion • Rationalism undermines religious belief • “Commercial spirit” replaces “higher values”

45. Can both be held at the same time? • Is there an inevitable outcome for capitalism?