Smith, Hamilton, and the Revenge of the Mercantilists

Heinz Kurz recently gave a very stimulating lecture, "The Wealth of Nations (WN) at 250: The Revenge of the Mercantilists" at the Federal University of Rio de Janeiro, and I was the commentator. His central point was that Adam Smith has been badly served by both his admirers and his critics. Smith was not the apostle of selfishness, laissez-faire, and the minimal state imagined by later free-market ideologues. Political economy was, for him, a branch of the science of the statesman, concerned with the institutions and policies required to promote prosperity, liberty, and justice.

Kurz rightly emphasized Smith’s distrust of merchants and manufacturers. Smith understood that business interests do not automatically coincide with the public interest. Merchants frequently seek monopoly, protection, and political privilege. The “mercantile system” was objectionable not simply because it involved state intervention, but because the state had been captured by particular interests. This reminded me of what Bob Heilbroner used to say, the enemy in the WN is not the state, but monopolies.

Kurz also criticized the revival of economic nationalism associated with Donald Trump. Trump’s policies reproduce some of the errors criticized by Smith, especially the obsession with bilateral trade balances and the confusion of particular corporate interests with the national interest. But Trumpism is not really a restoration of historical mercantilism. Mercantilism was part of a broader process of state formation, institutional development, naval power, public finance, and industrial transformation. Trump has tariffs, but no coherent development strategy.

This is where I would place the emphasis somewhat differently. The historical success of the Italian City States, Netherlands, Britain, and later the United States rested not simply on trade protection and some degree of what today is called industrial policy. It depended on the construction of a fiscal and monetary architecture based on the so-called Military-Fiscal State. Taxation, public debt, public banks, central banking, infrastructure, where central elements of the Military-Fiscal, and Fiscal-Naval, state. These institutions made sustained developmental policy possible. Trump revives the rhetoric of mercantilism while neglecting the other elements that successful countries actually used. I discussed why Trump's protectionism would not birng back manufacturing jobs here.

Kurz’s discussion also raises an old notion about Smith’s “Physiocratic prejudice.” Following a line of interpretation originating with Piero Sraffa, Kurz argues that Smith continued to give agriculture and “corn” a privileged position within his analytical system, even though Smith explicitly rejected the Physiocratic doctrine that agriculture alone was productive. On an analytical level, there is no doubt that Professor Kurz is correct and that the foundation of the Smithian growth model is Physiocratic. 

Kurz's argument is subtler than simply saying Smith believed only agriculture was productive. Instead, Kurz reconstructs Smith's analytical system in Sraffian terms and argues that Smith distinguishes "necessaries" (corn) from luxuries. Corn is treated as the only genuine basic commodity, because every production process ultimately requires workers' subsistence. Manufacturing therefore cannot become the independent engine of cumulative growth. Consequently Smith retains what Sraffa calls a "Physiocratic prejudice." Notice that Kurz's criticism concerns the architecture of Smith's growth theory, not Smith's explicit statements about productive labor.

Tony Aspromourgos provides a counterpoint, with a more direct textual reading of Smith. Textually, Smith clearly regarded manufacturing, transportation, and commerce as contributors to the social surplus. Aspromourgos stresses that Smith rejected the Physiocratic view outright: "The capital error of this system ... seems to lie in its representing the class of artificers, manufacturers and merchants, as altogether barren and unproductive." He notes that Smith systematically repudiates the Physiocratic limitation of productive labor to agriculture in Book IV of WN. This reflects the difference between a historical-institutional reading of Smith's aims and the theoretical basis of his model.

Ronald Meek, in a classic paper, suggests another way of looking at the issue. Smith was not primarily constructing a timeless model of production in the manner of Ricardo or Sraffa. His central concern was historical development, in particular the movement from hunting to pastoral, agricultural, and commercial society, and the corresponding transformation of property, law, government, and social classes. Agriculture may therefore be historically central without being the only analytically productive sector.

This has implications for the interpretation of Alexander Hamilton, and Hamiltonian protectionism, often defended as the first in a long line of American protectionists, an American School, as Michael Hudson has called it.* Hamilton’s Report on Manufactures should not be read as a theoretical rejection of Smith. Hamilton relied on distinctly Smithian mechanisms, the division of labor, the extent of markets, the vent for surplus that created demand for agricultural output. His disagreement concerned the policies appropriate to a new, agrarian republic rather than the underlying theory.

Hamilton did not believe that the policy appropriate to an already industrial and financially developed Britain could simply be transferred to the United States. Public credit, a national bank, taxation, and the encouragement of manufacturing were historically specific applications of political economy to American conditions. In that sense, Hamilton was not a mercantilist in Smith’s pejorative meaning. He was a Smithian developmental statesman.

Paradoxically, Jefferson’s agrarian ideal was closer to the Physiocratic privileging of agriculture, while Hamilton’s emphasis on manufacturing, urbanization, finance, and the division of labor was closer to the dynamic elements of Smith’s commercial society. Kurz’s lecture therefore provides an excellent starting point for recovering a Smith who was neither a free-market ideologue nor an opponent of developmental statecraft.

* On the American School or Political Economy Tradition see my substack post here. 

The Wealth of Nations at 250! Misunderstood icon of free markets

Today, March 9th, marks the 250th anniversary of the publication of The Wealth of Nations (WN) in 1776. Adam Smith may also be one of the most misunderstood thinkers in the history of economics. Smith is not the father of modern economics, neither of capitalism, a term he never used.

In modern discussions Smith is often portrayed as a precursor of contemporary economics, something like an early version of the Arrow-Debreu model of competitive equilibrium. I remember Sam Bowles suggesting that (he actually said something to the effect that Smith, Marx and Arrow, all said the same thing) at a talk at the University of Utah. In that interpretation, Smith supposedly discovered that self-interested individuals interacting through markets generate optimal outcomes, the infamous “invisible hand.”

Many books, including most classics on the topic suggest that interpretation. For example, yesterday WAPO had an op-ed (actually two; the other was much less problematic) by Jesse Norman, who will be publishing a book titled, you guessed, Adam Smith: Father of Economics. He correctly notes that the: "250th anniversary is not a moment for hagiography. It is an opportunity to recover a way of thinking that is directly relevant, indeed urgent, to the economic, social and political challenges we face today." He goes on to analyze essentially the question of tariffs with modern economic notions. Note that back in the 1790s, just after Smith passed, Alexander Hamilton, using Smithian ideas and method achieved very different policy conclusions.*

These readings of Smith as a father of modern economics and a champion of free market capitalism tells us far more about modern neoclassical economics than about Smith himself. The conceptual universe of modern economics is fundamentally different from that of classical political economy, the tradition to which Smith belonged.

Smith should be understood as part of a broader intellectual tradition that begins not with him but with William Petty, and continues through Cantillon, the Physiocrats, Ricardo, and ultimately Marx, what later came to be called the surplus approach. This tradition was concerned with the material conditions for the reproduction of society, the generation of surplus, and the process of accumulation.

In that framework, economics was not primarily about individual choice or utility maximization. It was about the reproduction of society. Seen in this light, Smith’s analysis was fundamentally about social conflict and the distribution of income, not about harmonious equilibrium among optimizing individuals. The core problem of political economy was explaining how societies generated and distributed the surplus that allowed accumulation and growth.

Another common myth is that Adam Smith founded economics. In reality, Smith was the great systematizer of a body of ideas of the surplus approach. Political economy emerged gradually during the Scientific Revolution and the early modern period. Petty, Cantillon, and the Physiocrats had already developed crucial insights about value, production, and economic reproduction before Smith wrote the WN. Smith’s real contribution was to organize these insights into a coherent framework and to place them at the center of his critique of the mercantilist system he saw as dominant. His book certainly helped establish political economy as a distinct intellectual discipline.

Nor was Smith the theorist of capitalism in the modern sense. The term itself was not part of his vocabulary. Smith spoke instead of commercial society, a stage in historical development characterized by the expansion of markets, manufacturing, and exchange.** He was certainly against the mercantile system, and believed that Physiocracy had incorrectly limited the creation of wealth to agriculture. But his defense of the system of natural liberty was not a defense of free markets in the modern sense.

Modern defenders of free markets often claim Smith as their intellectual ancestor. But the relationship between the liberalism of classical authors (not classical liberalism, which brings another series of confusions) and neoliberalism is far more complicated. Smith’s defense of laissez-faire was largely a reaction against the mercantilist system and the remnants of feudal regulation that constrained economic activity in the eighteenth century. The liberalism of Smith and Ricardo was historically progressive; it aimed to dismantle the privileges of the Ancien Régime and promote economic development.

Neoliberalism, by contrast, emerged in the twentieth century as a reaction against the Keynesian and welfare-state reforms of the New Deal era. Its central objective has been to limit the ability of democratic governments to regulate markets or redistribute income. In that sense, neoliberalism is better understood as a revival of what Marx called “vulgar economics”, rather than a continuation of the classical tradition.

Perhaps no concept has been more abused than Smith’s invisible hand. In modern economics it is often interpreted as a general theorem about markets producing optimal outcomes. But in Smith’s text the metaphor appears in a very specific context: merchants preferring domestic investment for reasons of security, which incidentally supports domestic employment. That is a far cry from the sweeping claim that all self-interested behavior leads to socially optimal results.***

Smith was also deeply skeptical of concentrated economic power. His famous warning that “people of the same trade seldom meet together… but the conversation ends in a conspiracy against the public” reflects a profound concern with monopoly and collusion. Competition, not the invisible hand, was the mechanism that restrained self-interest. He was anti-monopoly, not anti-state. In fact, he was for taxes to fund public education, a radical proposition back then (and now if you believe libertarian views that education is not a public good).

If you want to understand more about Smith ideas I recommend Tony Aspromourgos' The Science of Wealth: Adam Smith and the framing of political economy. For a book that puts in perspective how the legacy of Smith evolved in the 19th century read  After Adam Smith: A Century of Transformation in Politics and Political Economy by Murray Milgate and Shannon Stimson.

* On the distortions on Smith's views within the American context see my comments on  Glory M. Liu's book Adam Smith's America: How a Scottish Philosopher Became An Icon of American Capitalism. 

** On Smith's views on history and the four stages of development see the classic paper by Ronald Meek.

*** On that see the revised entry on the Invisible Hand by Tony Aspromourgos for the New Palgrave Dictionary of Economics.

PS: He also did not build up on the ideas of Ibn Khaldun, who, in turn, cannot be seen as a precursor of classical political economy or of Smith. On that see this post.

 

What's the deal with The Smiths

 

 

With friends like this...

This is NOT a review of the Smiths (the band), and neither of (or at least not a full one) of Glory M. Liu's (relatively) new book Adam Smith's America: How a Scottish Philosopher Became An Icon of American Capitalism. For a proper review go read Kim Phillips-Fein's one. In a sense, the book remind me of Bernard Shaw's famous saying that UK and the US were two countries divided by the same language. Here the gap is between fields, and there are two gaps, one within economics, modern mainstream economics and old classical political economy. Liu is a political scientist by training, and what she takes as economists views, including the understanding of the history of the discipline, are fundamentally from a mainstream perspective.

The phrase by Sraffa, that I have cited before fully applies here. He said:

"The classical economists said things which were perfectly true, even according to our standards of truth: they expressed them very clearly, in terse and unambiguous language, as is proved by the fact that they perfectly understood each other. We don’t understand a word of what they said: has their language been lost? Obviously not, as the English of Adam Smith is what people talk today in this country. What has happened then?" [Sraffa, Nov. 1927, D3-12-4, front page, 14]

In particular, the continuity in what has been aptly referred to as the surplus approach from William Petty to Smith, and the well documented trajectory from the ideas of Petty to Cantillon, to Quesnay, and then to Smith is lost in her relatively thin discussion of political economy aspects of Smith. The book by Tony Aspromourgos, On the Origins of Classical Economics: Distribution and value from William Petty to Adam Smith, is required reading on this subject. Smith clearly builds upon the core of the surplus approach, as developed by Petty-Cantillon-Quesnay, in particular on the question of the notion that manufacturing activities are productive. That is certainly an important aspect associated to the disputes between agrarian and industrial views of society.

But while there are differences in their views with respect to what might be termed the model of development (agrarian vs manufacturing), there is clear analytical continuity between Smith and the Physiocrats. They are all concerned with the material reproduction of society, in which the surplus (and, hence, profits and distribution) is a residual, and wages are at the level of the socially and institutionally determined (not merely physiologically) by the needs of survival of the working class. Smith saw distribution as conflictive. That's an analytical point that cannot be dismissed, and is not discussed in Liu's book at all.

This matters to some extent, because the general argument in Liu's book -- which is for the most part correct, that Smith ideas have been used by different groups to promote agendas that were not originally part of Smith's arguments, and that he was a complex author with more depth than often transpires in these several versions of reinvented Smiths (hence, the Smiths) -- misses the actual point of the original Smith. In her view, the nuance is provided by the fact that Smith was a moral philosopher and that in his other major work (and in his Lectures on Jurisprudence, based on students notes, and published posthumously), The Theory of Moral Sentiments (TMS), a Smith different from the one of The Wealth of Nations (WN) appears. Smith cannot be seen as a defender of selfish behavior, since he is clearly critical on TMS (the so-called Das Adam Smith Problem, about which Liu makes more than one should), neither an unqualified supporter of unregulated capitalism, since he qualified it, including in the WN (for example, with his approval of the Navigation Acts; I would add of the Bank of England). That's fine, but displays a limited understanding of the relation of Smith's and the surplus approach with modern economics.

Smith is misread by modern economics NOT because he was not an unqualified defender of unmitigated, unregulated, laissez-faire capitalism (which he wasn't), but because theoretically his economic system did not imply that markets produced optimal outcomes. His defense of laissez-faire and of commercial societies was not based on the allocative efficiency of markets (neither then intervention could be supported as a way to preclude inefficiencies), but simply as needed break with the remnants of feudal institutions that hampered the process of accumulation. As Marx noted in his The Poverty of Philosophy (Works, vol. 6: 176): "The Classics, like Adam Smith and Ricardo, represent a bourgeoisie which, while still struggling with the relics of feudal society, works only to purge economic relations of feudal taints, to increase the productive forces and to give a new upsurge to industry and commerce."

Of course, to sort this out one has to get into the theory of value.* The labor theory of value (LTV) (in an early and rude state of society) meant that the long term (natural) prices were determined by the relative amounts of labor, and supply and demand only determined short term market prices. This theory implied that profits were determined as a residual, for a given level of output and with real wages given, for historical and institutional circumstances, at the level of subsistence. The implication is that the theory did not imply the full utilization of labor, and that distribution is conflictive. So Smith's policy defense of laissez-faire was not based, like modern neoclassical versions (in particular the Chicago School that Liu's discusses in more detail, including Stigler, pictured above), on markets producing the optimal allocation of resources, including the full utilization of labor.

It is clear that Smith is not a forerunner of Marx, something that the latter understood. Marx shared an analytical framework with the classical authors, but rejected their a-historical categories. He argued that:

"Economists like Adam Smith and Ricardo, who are the historians of this epoch, have no other mission than that of showing how wealth is acquired in bourgeois production relations, of formulating these relations into categories, into laws, and of showing how superior these laws, these categories, are for the production of wealth to the laws and categories of feudal society." (Ibid.).

But it is also clear that the theoretical foundations of his policy views was very different than those that were built from the developments of the Marginalist Revolution, and closer, in fact, to Marx's own analytical framework. On that Milgate and Stimson (2009), in their very useful After Adam Smith, are also clear. They say:

"Indeed, if the contemporary economic case for liberty is ultimately made in terms of the language of the market, which if left unimpeded by the state is capable of solving a static problem of allocating a fixed supply of resources, then we have moved well beyond these eighteenth-century thinkers such as Smith. In this sense it might be reasonable to ask whether what we understand today as free market theory—against which a modern form of nationalist- led trade policies might be said to operate—is different in important ways from the eighteenth-century political economy from which it is said to have originated. It might also be well to ask just how that transformation of the conceptual framework of political economy and its relationship to politics that came about after Smith took shape" (2009: 32).

Without an understanding of the changes in political economics (and its transition to economics) after Adam Smith, one is left with the puzzle noted by Sraffa almost a century ago.

* On the reasons for the need for a theory of value go here. For more on the limits and problems of the LTV see this and this.

PS: I should note that Liu tells the story of Stigler's T-Shirt that read Adam Smith Best Friend (Nathan Rosenberg's paper on that here). Back when, my PhD students in Utah, did a T-Shirt on my suggestion that there should be an alternative to Stigler's one. The Heterodox Students Association (HESA) T-Shirt read: I read Adam Smith and Understood it. Enough said. Old post on that. A recurring theme around here.

Economics without Gaps: on Ibn Khaldun and non-Western traditions in the history of ideas

Ibn Khaldun, Arab scholar

A piece* from a few years ago, has again become somewhat popular and it has been making the rounds. It suggests that the Arab scholar Ibn Khaldun developed the ideas of classical political economics in the late XIV century, about half a millennia before Adam Smith, often seen as the father of classical economics, and of modern economics. Some would suggest that Khaldun was the real father of economics (or stepfather in the first essay on top). To a great extent, the discussion of the role of non-western scholars tries to show that an Eurocentric bias has dominated the history of economic thought. This discussion goes hand in hand with the notion that the Rise of the West and the so-called Great Divergence are relatively recent phenomena.

There are many elements in that assessment that are correct. Schumpeter's massive History of Economic Analysis does mention Khaldun in passing on his discussion of historical sociology, but he also argues that between the ideas of classical antiquity and scholastic thinking there was a great gap.** In his words: "So far as our subject is concerned we may safely leap over 500 years to the epoch of St. Thomas Aquinas (1225–74), whose Summa Theologica is in the history of thought what the south-western spire of the Cathedral of Chartres is in the history of architecture." There is little recognition of the role of Arab scholars in maintaining and expanding the knowledge of classical antiquity in almost all fields. And in the field that eventually would be associated with political economy, Khaldun's Muqaddimah, or Introduction (or Prolegomena), does indeed provide significant progress over the work of classical antiquity.

His work essentially deals with the cyclical rise and fall of caliphates, and analyzes the material conditions for these historical circumstances. Robert Irwin in his intellectual biography of Khaldun, reminds us that: “Arnold Toynbee, who produced a twelve-volume study of the rise and fall of civilizations, described Ibn Khaldun’s theoretical treatise on history, the Muqaddima, as 'undoubtedly the greatest work of its kind that has ever been created by any mind in any time or place'.”

However, while all of that is correct, and should lead to a more encompassing understanding of the role of non-western economic thinking, it is also important to bear in mind what was the contribution of Ibn Khaldun, how it fits in the history of ideas, and also in what sense classical political economy authors have an original theoretical framework. That tradition, it is worth noticing starts really with Sir William Petty, not Smith, as noted by whom I would suggest is the first serious historian of economic ideas, Karl Marx, in his Theories of Surplus Value. Furthermore, it is important to be careful and avoid the normal confusion of seeing Adam Smith as the father of modern, meaning marginalist (or neoclassical), economics. As a general principle, I would also be critical of the notion that the history of economic ideas is the repository of old versions of modern economic theory, that have to be deciphered and understood in modern guise. It was exactly this kind of thinking that led many marginalists, like Alfred Marshall, to suggest that they were expanding on the ideas of classical authors like David Ricardo, when in fact they were subverting them.***

I would suggest that there are two important differences between Ibn Khaldun and the Anglo-French tradition of the surplus approach, associated with the Petty-Cantillon-Quesnay-Smith-Ricardo (and I would add Marx; on the first three that form the basis for the work of the surplus approach see this chapter by Tony Aspromourgos) line of evolution. First, while Khaldun is interested in the cyclical rise and fall of civilizations, associated to the sedentary, urban, mercantile caliphates bordered by nomadic, desert populations, Smith developed at the same time and independently from Turgot (on that see Ronald Meek), a linear four stage theory of economic development, from hunting (and gathering), to pastoral, then agricultural, and finally commercial societies, which is the term he used for societies like the England of the time, were manufacturing activities and financial relations were significantly developed. These ideas would lead to Marx's materialist conception of history based on the notion of modes of production, evolving from ancient slavery and feudalism to capitalism.

It seems that while a perception that, what we now call, the social sciences are historical in nature was clearly in Khaldun's writings, the conception of history, and the scope of the analysis was different than the one in Smith. The reason is not only related to the fact that Khaldun was writing in the Middle Ages, before the rise of capitalism, but also, and more importantly it seems, Khaldun was looking at the specific circumstances of Arab societies, even if there were universal lessons in his analysis. The evolution from hunter-gathering to agriculture and to manufacturing are more universal. Further, Marx's conception of modes of production emphasizes the method and the social relations of production by which surplus is extracted from workers. Command and coercion in the context of slave and feudal societies, and market relations in the case of capitalism.

The second difference is related to the notion of surplus, and the source of value. It is true that there was a notion of a surplus beyond what is needed for survival in Khaldun's work, and that it allowed in his view for crafts and division of labor, or specialization, as would be discussed by classical authors much later. And there was also a clear sense that labor was the source of value, and that a producer must cover the costs of production. Some have argued that one can see the labor theory of value (LTV) in Khaldun's writings. However, it is clear that the conception of profits and of prices in Khaldun was not in conformity with the LTV.

He argues in chapter 5 of the Muqaddimah that: "Commerce is a natural way of making profits. However, most of its practices and methods are tricky and designed to obtain the (profit) margin between purchase prices and sales prices. This surplus makes it possible to earn a profit." In other words, the surplus results from selling at a higher price than purchased in the process of exchange. Profits were not a residual obtained in the process of production for Khaldun, after the conditions for reproduction of society, in particular the subsistence of the labor force, was obtained. This is, of course, the whole point of classical political economy. The understanding of the objective, material conditions for the reproduction of society. Profits were obtained in the process of production, and that would allow to understand accumulation, since the surplus was the basis for economic growth. Accumulation and not the cyclical fluctuations of civilizations were at the center of classical political economy analysis, reflecting, perhaps, the dynamic nature of capitalist societies.

These differences suggest that Khaldun was, most likely, an important source for scholastic, and mercantilist/cameralist authors to which classical authors were to some extent responding in their own writings. Mercantilists authors also thought in terms of profits in the process of exchange, which was to some extent to be expected in pre-capitalist societies with a large mercantile sector. These were essentially agrarian societies, and the transformation of the structure of production was not yet significant.  Recognizing the role of Arab scholars in preserving the texts and the knowledge of ancient scholars, and their ability to move beyond the ancients is crucial for the proper understanding of the evolution of economic ideas. But it is important understand their actual contributions to avoid more confusion in the history of ideas.

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* In this piece it is suggested that the history of thought textbooks by Screpanti and Zamagni and by Roncaglia are mainstream texts, and put in the same category with Blaug's book. That is of course a misconception. The former differentiate between classical and marginalist traditions, and do not argue for the continuity, as Blaug does, and can be seen as clearly heterodox in nature.

** Spengler (1964) is the classic study on Khaldun by western historians of economic thought. Although his essay is careful about Khaldun's contribution it might give to much credence to the notion that the "economic literature of Islam can be traced to the Economics of Bryson", for the ancient Greek philosopher. 

** It is worth noticing that the piece cited at the beginning suggests that Khaldun is a precursor of Smith, presumably because of the division of labor, but without a distinction of productive and unproductive activities, but also of Alfred Marshall. We are told that Khaldun "analyzed markets which arise based on the division of labor and examined market forces in a simple didactic way which is very similar to the attitude of Alfred Marshall. The invention of supply and demand analysis wasn’t invented in the 19th century: the islamic scholar also described the relationship of demand and supply." Supply and demand forces were well-known before Khaldun. Marginalism suggested that long-term prices, what Smith called natural prices, were determined by those forces.

Das Adam Smith problem

A short lecture on Adam Smith's problem for a Principles class. This might be of more general interest, and perhaps something to watch during the quarantine. The book I used for the lectures on history of economic ideas was Heinz Kurz's Economic Thought: A Brief History, a book that I highly recommend. The discussion here is heavily influenced by Tony Aspromourgos' book The science of wealth: Adam Smith and the framing of political economy, another one you should read if you have the opportunity.

Tony Aspromourgos on Piketty, future of capitalism, growth & theory of distribution

By Tony Aspromourgos

From the abstract:

This essay reviews Thomas Piketty’s Capital in the Twenty-First Century (2014). The focus is upon the conceptual framework and theoretical interpretation of the empirical findings assembled in the book, rather than those empirical findings themselves (which are, in any case, broadly incontestable). The core theoretical logic of the distributional dynamics is explained and subjected to scrutiny with respect to the theory of distribution in particular, but also the theory of growth. 

Read rest here. For other posts on Piketty, see here, here, here, here, here, and here.