About Adam Smith

Why study economics?

For one, it illuminates our world. The mix of public policy and regulation, of taxing and spending, of technology and productivity are described and discussed in the language of Karl Marx, John Maynard Keynes and Milton Friedman. Each day’s newsfeed is both tutorial and quiz of our understanding. Public dialogue requires some fluency.

For another, the tools of the economic discipline are useful in analyzing and forecasting the circumstances of our lives. For example, the traditional relationships between price levels and industrial production offer a means to assess the recurring trough to peak of the business cycle. Some enthusiasts think these correlations and trends can be extended into a comprehensive predictive economic model. Me? I am not comfortable with arbitrary predictions, but I do appreciate the techniques that combine outcomes and probabilities. In business as in life, it is worthwhile to consider risk.

Microeconomics, the discipline concerned with economic behavior at the company level, incorporates numerous concepts, such as equilibrium, elasticity, marginality that are useful in business planning. Also, with its language of industry structure, we can examine competitive behaviors through the lens of oligopoly or other archetypes.

I did not like introductory microeconomics at Tufts University. I thought then that equilibrium, the conditions where supply and demand are equal is not a real state; that realities were karma not algebra. I thought assignments where students calculated the “J-curve effects” (employment) of a change in government spending was bogus, even biased. It was the late 1960’s and I did not think the government had such omnipotence. Still don’t.

Economics has significantly changed since my school days. At the undergraduate level, it has replaced political science as the “go to “major for pre-law students. At the graduate level, extensive computation is used to measure and assess numerous phenomena. Recent Nobel Prizes for economics has been awarded for research about auction market functions, financial valuations, game theory, poverty & consumption and regulation.

More recently, published economics are most concerned with consumer behavior. There seems to be growing evidence that the consumer is not the entirely rational, benefit-maximizing actor that traditional theory posits. Who knew? The application of social media technique will probably extend this research focus, to the profit of many authors.

But today, as I try to convey the value of a coherent and principled world view, I look backward to the writings of Adam Smith, the Scot moral philosopher, best known for his The Wealth of Nations, published in 1776, a five-book series that sought to reveal the nature and cause of a nation's prosperity.

Adam Smith (see Wikipedia for key stats) reputation rests on his explanation of how rational self-interest in a free-market economy leads to economic well-being. Someone earning money by his own labor benefits himself. Unknowingly, he also benefits society, because to earn income on his labor in a competitive market, he must produce something others value. In Adam Smith's lasting imagery,

By directing that industry in such a manner as its produce may be of 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 his intention.
The “invisible hand” metaphor has become central to capitalist economic theories, justifying the pursuit of private gain as well as the satisfaction of private desires. For Smith, “augmenting fortune” is a legitimate, even praiseworthy activity. This trope alone has established his preeminence in the Hedge Fund Hall of Fame

Smith also captured the philosophe attention through his description of the division of labor as the main cause of prosperity. Smith gave the famous example of pins. He asserted that ten workers could produce 48,000 pins per day if each of eighteen specialized tasks was assigned to particular workers. Average productivity: 4,800 pins per worker per day. But absent the division of labor, a worker would be lucky to produce even one pin per day.
Smith’s view, which is representative of the classic liberalism of his time, stands in sharp contrast to the mercantile strategies then favored by monarchies. Mercantilism protected domestic industry with import tariffs and sought to maintain high gold balances. Contrarily (but respectfully) Smith argued in favor of increasing trade, in keeping with the wisdom of efficient allocation of labor and capital, as well as the benefits of production specialization. Smith also opposed the martial consequences of trade competition; a view which led him to support American colonial grievances.

In our day, or at least in mine, Smith’s Invisible Hand argument is most invoked as an alternative wholly superior to any socialist alternative. Smith does not specifically dismiss public works or collective action. But he emphasizes that the un-regulated market place will be more efficient in performance because of better capital allocation. Smith accepts the in-equities of distribution because it encourages philanthropy and a rising tide lifts all boats.

The issues addressed by Smith were largely about trade and the taxation at a time of relatively simple commerce. Whilst our planet has many varieties of governance, there are important distinctions in the nature and degree of government (or party or clerical) authority. Smith reminds us there are costs, always economic and often political, associated with these interventions.

The Smith political legacy is a continuing factional contest. Conservatives applaud his endorsement of local control and use-based taxes; Libertarians emphasize his preference for limited government. Even today’s liberals, different from his classic version by their emphasis of inequalities, are comfortable with the humanist quality of Smith’s writing, as well as his arch observations about the landlord and merchant classes.

Smith’s views and examples are based on the observable commerce of his day; and it is for us to wonder how his attitude of un-regulation adapts to a complex economy where cooperation and compatibility may be as important as a competitive ethic.

It is also a wonder how Adam Smith’s Malthusian temper, reflecting a world of limited capital, would engage with our world of plenty today, tomorrow unknown.

Which explains why we study economics?

BizProf100