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Tuesday, July 2, 2013

The Myth Of Laissez-Faire

If, then, Adam Smith contributed nothing of value to economic thought; if, in fact, he introduced numerous fallacies, including the labour theory of value, and thereby caused a significant deterioration of economic thought from previous French and British economists of the eighteenth century; did he make any positive contribution to economics? A common answer is that the significance of the Wealth of Nations was political rather than analytic: that his great achievement was to initiate and take the lead in the advocacy of free trade, free markets, and laissez-faire. It is true that Smith articulated the political-economic sentiments of his day. As Joseph Schumpeter wrote: ‘Those who extolled A. Smith's work as an epoch-making, original achievement were, of course, thinking primarily of the policies he advocated...’ Smith's views, Schumpeter added, ‘were not unpopular. They were in fashion.’ In addition, Schumpeter shrewdly noted that Smith was very much a ‘judiciously diluted’ Rousseauan in his eighteenth century egalitarianism: ‘Human beings seemed to him to be much alike by nature, all reacting in the same simple ways to very simple stimuli, differences being due mainly to different training and different environments.’

But while Schumpeter's explanation of Smith's vast popularity – that he was a plodder in tune with the Zeitgeist – holds part of the truth, it still scarcely accounts for the way in which Smith swept the board, blotting out general knowledge of all previous and contemporary economists. This puzzle will be examined further in the next chapter. For the mystery of Smith's total triumph deepens when we realize that he scarcely originated laissez-faire thought: as we have seen, he was merely in an eighteenth century tradition flourishing in Scotland and especially in France. Why then were these preceding economists, analytically far superior to Smith and also in the laissez-faire framework, so readily forgotten?

Smith's greatest achievement has generally been supposed to be the enunciation of the way in which the free market guides its participants to pursue the good of the consumers by following their own self-interest. As Smith wrote in perhaps his most famous passage: A man

will be more likely to prevail if he can interest their self-love in his favour, and show that it is for their own advantage to do for him what he requires of them... 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. We address ourselves, not to their humanity, but to their self-love, and never talk to them of our own necessities but of their advantages.

And in an equally famous passage bringing out the general principles of this point:

As every individual, therefore, endeavours as much as he can both to employ his capital in the support of... industry, and so to direct that industry that its produce may be of the greatest value; every individual necessarily labours to render the annual revenue of the society as great as he can. He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it... (B)y 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 his intention.

Smith goes on to caution wisely against alleged aims to promote the ‘public good’ directly:

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. I have never known much good done by those who affected to trade for the public good.

Hostile critics of laissez-faire have latched on to Smith's terminology of the ‘invisible hand’ to indict him for ostensibly beginning his analysis with a mystical and therefore flagrantly unscientific a priori assumption that Providence manipulates people for everyone's good ‘by an invisible hand’. Actually, Smith was simply engaging in an a posteriori conclusion from his scientific analysis, and from the free market analysis generally, that pursuit of self-interest on the market leads to advancing the interest of all. Similar pursuits in government by no means lead to the same harmonious and happy result, Smith being alive to the pernicious consequences of government's creation of monopolies and its conferring privileges on special interest groups. Smith, a religious man, was simply expressing his quite justified wonderment at the harmonizing influence of the free market, and his ‘by an invisible hand’ was a metaphor which contained an implicit ‘as if before his use of the phrase.

Despite the undoubted importance of these passages, however, Adam Smith's championing of laissez-faire was scarcely consistent. In the first place, Smith retreated from the absolutist, natural law position that he had set forth in his ethical work, The Theory of Moral Sentiments (1757). In this book, free interaction of individuals creates a harmonious natural order which government interference can only cripple and distort. In Wealth of Nations, on the other hand, laissez-faire becomes only a qualified presumption rather than a hard-and-fast rule, and the natural order becomes imperfect and to be followed only ‘in most cases’. Indeed, it is this deterioration of the case for laissez-faire that German scholars were to label Das AdamSmithProblem.

Indeed, the list of exceptions Smith makes to laissez-faire is surprisingly long. His devotion to the militarism of the nation-state, for example, induced him to take the lead in the pernicious modern view of excusing any government intervention that might plausibly be labelled for ‘the national defence’. On that basis, Smith supported the navigation acts, that bulwark of British mercantilism and systemic subsidy for British shipping. One of Smith's reservations about the division of labour, indeed, is that it leads to a decay of the ‘martial spirit’, and Smith goes on at length about the decay of the martial spirit in modern times, and about the great importance of restoring and sustaining it. ‘(T)he security of every society must always depend, more or less, upon the martial spirit of the great body of the people.’ It was an anxiety to see government foster such a spirit that led Smith into another important deviation from laissez-faire principle: his call for government-run education. It is also important, opined Smith, to have governmental education in order to inculcate obedience to it among the populace – scarcely a libertarian or laissez-faire doctrine. Wrote Smith:

An instructed and intelligent people besides are always more decent and orderly than an ignorant and stupid one. They feel themselves, each individually, more respectable, and more likely to obtain the respect of their lawful superiors, and they are therefore more disposed to respect those superiors. They are... less apt to be misled into any wanton or unnecessary opposition to the measures of government.

In addition to navigation acts and public education, Adam Smith advocated the following forms of government intervention in the economy:

Regulation of bank paper, including the outlawing of small denomination notes – after allowing fractional-reserve banking.

Public works – including highways, bridges and harbours, on the rationale that private enterprise would not ‘have the incentive’ to maintain them properly(!?)
Government coinage.

The Post Office, on the simple grounds – which will draw a bitter laugh from modern readers – that it is profitable!

Compulsory building of fire walls.

Compulsory registration of mortgages.

Some restrictions on the export of ‘corn’ (wheat).

The outlawing of the practice of paying employees in kind, forcing all payment to be in money.

There is also a particularly lengthy list of taxes advocated by Adam Smith, each of which interferes in the free market. For one thing, Smith paved the way for Henry Georgism and the ‘single tax’ by urging higher taxes on uncultivated land, displaying his animus against the landlord. He also favoured moderate taxes on the import of foreign manufactures, and taxes on the export of raw wool – thus gravely weakening his alleged devotion to freedom of international trade.

Adam Smith's Calvinist abhorrence of luxury is also seen in his proposals to levy heavy taxes on luxurious consumption. Thus he called for heavier highways tolls on luxury carriages than on freight wagons, specifically to tax the ‘indolence and vanity of the rich’. His puritanical hostility to liquor also emerges in his call for a heavy tax on distilleries, in order to crack down on hard liquor and induce people to drink instead the ‘wholesome and invigorating liquor of beer and ale’. His devotion to ale, however, was minimal, for Smith also advocated a tax on the retail sale of all liquor in order to discourage the multiplication of small alehouses.

And finally, Adam Smith advocated the soak-the-rich policy of progressive income taxation.
Perhaps Smith's most flagrant violation of laissez-faire was his strong advocacy of rigid usury laws, a sharp contrast to the opposition to such laws by Cantillon and Turgot. Smith did not indeed wish to adhere to the medieval prohibition of all credit. Instead, he urged an interest rate ceiling of 5 per cent, slightly above the rate charged to prime borrowers: a ‘price which is commonly paid for the use of money by those who can give the most undoubted security’. His reasoning followed his predilection, as we have already noted, for hostility to free market time-preferences between consumption and saving. Driven by Calvinist hostility to luxurious consumption, Smith tried to skew the economy in favour of more ‘productive labour’ in capital investment and less in consumption. By forcing interest rates below the free market level, Smith hoped to channel credit into the sober hands of prime borrowers, and away from credit into the hands of speculators and of ‘prodigal’ consumers. As Professor West admits, Adam Smith condemned the demand for loans by ‘prodigals and projectors’, in which the prodigal ‘dissipates in the maintenance of the idle, what was destined for the support of the industrious’. In that way, the ceiling on interest rates, as West notes, ‘would reallocate credit into the most productive hands’.
Yet, West, a free market adherent who is generally an uncritical admirer of Smith, then maintains that Smith was curiously inconsistent in not realizing, in this one case, that price controls would create a greater shortage of credit. Here, West echoes the brilliant essay The Defence of Usury by the Smithian Jeremy Bentham in accusing the master of inconsistency in his usual advocacy of the free market. But, as Professor Garrison indicates in his comment on West, Smith knew only too well what he was doing. In urging a reallocation of credit by the government ‘into the most productive hands’, Adam Smith was precisely trying to create a shortage of credit for consumers and speculators, and thereby to channel credit into the hands of sober, low-risk businessmen. As Garrison points out,

Smith was not interested in reducing the cost of borrowing with his credit controls. He was trying to reduce the amount of funds borrowed for certain categories of loans. And his anti-usury scheme was well suited for this. Smith notes that money is lent to the government at three percent, and to sound businessmen at four, and four and a half. Only ‘prodigals and projectors’, people who are most likely to ‘waste and destroy’ capital, would be willing to borrow at eight or ten percent. Smith therefore recommended an interest ceiling at five percent. This policy was not aimed at allowing the prodigals and projectors to obtain funds more cheaply, but at preventing them from obtaining any funds at all. These funds would be diverted, then, into the hands of those who are more future oriented.

In short, Smith knew full well that a low interest ceiling would not benefit marginal borrowers by providing them with cheap credit. He knew that usury laws would dry up credit altogether for marginal borrowers and he sought precisely that result. For Smith virtually embraced the idea of zero time-preference as the ideal – the non-time-preference of his mythical ‘impartial spectator’ – and, concludes Garrison, ‘It is not difficult to see how Smith's standard of zero time preference coupled with his awareness of sharply positive time preferences could lead him to make the very policy recommendations that West found to be surprising. He sought to reallocate resources away from the present and toward the future...’

Perhaps most important of all, how do we square Smith's alleged role as champion of free trade and laissez-faire with his spending the last 12 years of his life as a commissioner of Scottish customs, cracking down on smugglers violating Britain's extensive mercantilist laws and evading import taxes? Did he treat the job as a sinecure? No: recent studies show that his role as a top enforcer of mercantilist laws and tariffs was active and hard-working. Was he driven by penury? Hardly, since, with his great reputation, he probably could have commanded an equivalent sum in a top academic post. Did he suffer from qualms of conscience? Apparently not, since he not only approached his job with enthusiasm, but was also particularly, vigilant and hard-nosed in trying to enforce the onerous restrictions and tariffs to the hilt.

Edwin West, an inveterate admirer of Smith as an alleged devotee of laissez-faire, speculates that he entered the high customs bureaucracy as a practical free trader trying to remove or lighten the customs burden on the Scottish economy. But as Anderson et al. reply, ‘If Smith had been deeply concerned with reducing the cost to the economy resulting from customs, the most effective strategy at the level of his responsibilities would have been to reduce the efficiency of the enforcement apparatus. But Smith did not do this’. On the contrary, Smith showed no appreciation whatever of the social and economic value of the underground economy or the great British tradition of smuggling. Instead, he tried his best to make enforcement of the mercantilist laws and burdens as efficient as possible. Neither did he use his high post to promote reforms in the direction of free trade. On the contrary, his major ‘reform’ proposal as commissioner was for compulsory automatic warehousing of all imports, which would have made inspection and enforcement far easier for the customs officials, at the expense of the smugglers, international trade and the nation's economy. As Anderson et al. note, ‘Smith was proposing a reform that was likely to increase the costs to the economy from customs duties’. And finally Smith's correspondence as commissioner shows no particular desire to cut tariffs or restrictions. In contrast, his dominant emotion seems to have been pride at cracking down on smugglers and thereby increasing government revenue. In December 1785, he writes to a fellow customs official that

it may, perhaps, give the Gentleman pleasure to be informed that the net revenue arising from the Customs in Scotland is at least four times greater than it was seven or eight years ago. It has been increasing rapidly these four or five years past; and the revenue of this year has overleaped by at least one half the revenue of the greatest former year. I flatter myself it is likely to increase still further.

Well, happy day! This from an alleged champion of laissez-faire!?

Austrian Perspective on the History of Economic Thought (2 volume set)

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