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.

The natural rate in pure exchange, intertemporal models

One more clarification on the previous discussion about the natural rate in Austrian models. In his reply,  Mr. Rallo suggests (in Spanish) that I confused the natural rate that can be derived from a barter economy with the one derived from intertemporal equilibrium model. So let's start by clarifying that barter refers to whether there is money or not, while the notion of intertemporal equilibrium is associated to the nature of equilibrium, whether it is short-term or long-term.  You can have an intertemporal model of equilibrium with barter as several Arrow-Debreu models actually are.

Traditional notions of equilibrium, like the classical authors had, are not intertemporal, but several of those were based on barter ideas. Equilibrium in classical economics is a tendency associated to the process of competition that leads to a uniform rate of profit. Some authors had the real (meaning non-monetary) rate of profit govern the system and also the rate of interest, like Ricardo, while others like Tooke suggested that the rate of interest governed the rate of profit, and arguably there are elements in Marx analysis that suggest the possibility of an independent rate of interest.*

The notion of intertemporal equilibrium is relatively new and was developed by Hayek, Hicks, Lindahl, and Myrdal (see Milgate here; subscription required)  in the 1920s and 1930s, before it become common after the capital debates on the basis of the Arrow-Debreu model. Intertemporal models do not require the notion of a uniform rate of profit, and some authors have suggested that as such they are not open to the capital critique. Because they do not require a uniform rate of profit these models are short-term.

So the relevant point is the notion of equilibrium and not whether it is a barter or credit system [additionally that would bring about the way money is introduced in the economy, as mere toke for exchange, or as a unit of account in which agents want to accumulate, but that is a different issue]. Mind you, one might think that Mr. Rallo is suggesting that in a short-term model (with no tendency ot a uniform rate of profit) there is no need in marginalist models for a natural rate of interest (although we'll see that's not his point).

Yet, the point made by Garegnani and Petri is that in an intertemporal model with disaggregated means of production (capital goods), it is still necessary for the equilibration of aggregate investment to full employment savings, and that requires a measure of the quantity of capital, and that means, and by necessity a rate of interest. That rate of interest that equilibrates savings and investment is a natural rate.

Mr. Rallo seems to believe that there is a difference between a situation in which there are "lenders (savers) lending at 5% for a year, and investors that demand 5% for 30 years" (or in Spanish "ahorradores que prestan al 5% a 1 año e inversores que piden prestado al 5% a 30 años"), which would be different if both lenders and borrowers had the same time period in mind, but different rates.
Again, this involves not the intertemporal nature of the model, but the term structure of interest rates.

So taking away the adjustment for risk associated to the longer-term that financial capital would be tied to investment, in the neoclassical theory arbitrage should still work. So presumably the rate would be more than 5% for the 30 year loan. This has nothing to do with the necessity in Austrian theory, as in any type of marginalist model, of a quantity of capital and a natural rate of interest. Neither barter nor the term structure of the rate of interest (or the more relevant discussion of the short-term nature of intertemporal models) relieves the marginalist (and Austrian) theories from a need for a natural rate of interest.

The only consistent way to get rid of the notion, is to abandon the marginalist approach, and like Sraffa assume that one distributive variable, in his case the monetary rate of interest, is given exogenously. Savings then is adjusted to investment by the multiplier process (i.e. Keynes and Kalecki's Principle of Effective Demand).

* Panico (1980, p. 269 here; subscription required) argues that: "Marx's analysis of the factors determining the rate of interest, he rejected any attempt to explain the determination of the average rate of interest on the basis of'laws of necessity'. He proposed instead, to investigate it by means of qualitative description, of those economic, conventional and institutional factors that, from time to time, affect this variable." So while its clear that Marx thought that the rate of profit determined the rate of interest, it is also reasonable to argue that there are contradictory propositions that suggest a determination of the normal rate of interest that is independent from the rate of profit.

PS: Thanks to Franklin Serrano for pointing my mistake on Quesnay (deleted; yes there is money in the Tableau as there is in Marx's simple reproduction system, derived from Quesnay) and the causality in Marx. Also, forgot the link to Milgate's paper, which is now in place.

Say's Law Keynesians

In the 1990s Fernando Henrique Cardoso, the one time sociologist and dependency theory author, turned politician and president of Brazil said that people should forget about what he had written in the past (on dependency theory). Something similar could be said about the economists at Catholic University in Rio de Janeiro, who were the main economic advisors to Cardoso during his presidency.* They seem to have forgotten what they wrote in the past.

An interesting case of the switcheroo from heterodox to mainstream is Edward Amadeo (Labor Minister during the Cardoso administration, even though he had connections to the Worker's Party up to the early 1990s), author of a very good book on Keynes (Keynes' Principle of Effective Demand), based on his dissertation at Harvard supervised by Murray Milgate and co-supervised by Lance Taylor (who was at MIT at that time), with a preface by Vicky Chick. The book is still the best interpretation of Keynes' General Theory, and its relation with the Treatise on Money.

Among other things Amadeo shows that the conventional view which assumes that Keynes moved from an interpretation of the system with flexible prices and fixed quantities in the Treatise to one of fixed prices and flexible quantities in The General Theory (GT), as interpreted by Leijonhufvud for example (see his classic On Keynesian Economics and the Economics of Keynes), is incompatible with a careful reading of chapter 19 of the GT (Amadeo, 1989, p. 4).

Further, Amadeo correctly points out that the transition from the Treatise to the GT involves a change from a dynamic theory of the trade cycle in historical time to an equilibrium theory of the level of output, one in which the flexibility of prices does not guarantee full employment. And obviously the level of activity is determined by demand. Amadeo also wrote a few papers on what we would now call the Kaleckian models of growth (see here; subscription required).

That is why is interesting to read a recent paper by Amadeo (in Portuguese here; originally published in O Globo). He says that Cardoso's agenda, which would have been carried by Serra (defeated presidential candidate in 2002), would have:

"redoubled the emphasis on education, promoted savings, done the labor reform, flattened the tax structure, promoted global integration, invested in infrastructure and modernized the public administration."

Note that the emphasis is on supply-side policies (with the exception of investment in infrastructure, which was actually accelerated during the Lula administration so-called PAC). And yes he suggests that savings would have lead presumably to investment and growth in a typical Solow model result, meaning Say's Law.

One could go on and discuss the other incompatibilities with almost all his previous work (not sure if he wrote something theoretical in a neoclassical perspective), for example the defense of labor reform (meaning lower wages) to promote growth and employment (the opposite of what the GT says). Or the silliness of suggesting at this point that more liberalization (global integration) along the lines of the Washington Consensus would really work. Or the fact, that he seems to believe that fiscal adjustment is necessary now in Brazil and that this would be compatible with higher growth (contractionary expansions).

But the remarkable thing is at the end of the day the complete 180 degree change in theoretical perspective, with no justification of what made him change his mind. I assume that in his case we can paraphrase Keynes and suggest that when proven correct, he changes his mind.

* Other economists close to Cardoso, like Serra from the more radical Unicamp, also moved to the right, favoring privatization and fiscal adjustment, but arguably abandoned academic economics long ago, being like Cardoso politicians. Finally, some economists from the Fundação Getúlio Vargas from São Paulo, like Bresser Pereira, remained more heterodox, and defend now something called New Developmenatlism. I'll leave comments on that for another post.

In the long run we are NOT all dead

Niall Ferguson has apologized for his offensive suggestion that Keynes' phrase on being dead in the long run was somehow related to his sexuality or the fact that he was childless (more here and here). Good for him. Note, however, that in that famous phrase from the Tract on Monetary Reform, from 1923, Keynes was still very much a conventional Marshallian author who thought that full employment would reassert itself, and that the Quantity Theory of Money (QTM) worked pretty well. In fact, it is often said that the Tract was Milton Friedman's favorite among all of Keynes' books.

The full quote says:

"But this long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again."

The point of the quote is that in the long run everything would be fine, since markets do get to full employment, and so, even without intervention, deflation and inflation do its magic, but the process is too long and painful, so it would be more reasonable to act in the short run. This was typical of the Cambridge version of Marginalism, which was very much in favor of government intervention to deal with market imperfections in the short run. This is true of Marshal and Pigou, as well as Robertson, and certainly Keynes, before the General Theory. Note that this does not mean, as most people think, that one should only be concerned with the short run. The point is that action in the short run facilitates the road towards the fully adjusted equilibrium in the long run.

This was still essentially Keynes' view by 1930, when he published the Treatise on Money, a book that is at heart Wicksellian [so at least he got rid of the QTM in this book], and that suggests that unemployment results from a monetary rate of interest that is too high with respect to the natural rate, in practice as a result from the Gold Standard rules, which Keynes wanted to abandon. [This precedes the modern views that the Gold Standard caused the Depression, by the way, as say defended by Barry Eichengreen]. This was a cyclical crisis that could be solved by reducing the monetary rate of interest, and in the short run employment programs, something Keynes defended in Can Lloyd George Do It?

The point of the General Theory (GT) is that there is no natural rate of interest, meaning that reducing the rate of interest would not bring investment to the full employment level of savings, and that the crisis was caused by lack of demand. The equilibrium between investment and savings was determined by variations in the level of output, and in the long run we are not self adjusted to full employment. Hence, the very logic of the phrase above is debunked by Keynes, when he became Keynesian, so to speak, and got rid of the old modes of thinking. Intervention is not needed because in the long run we are dead, but because the long run depends on the short run, and we tend to fluctuate around a sub-optimal position.

So in the long run we are NOT dead in the GT, in the absence of counter-cyclical policies we are all in deep trouble. Keynes was very much concerned about the possibility of capitalism to promote well being for all in the long run. In other words, not only is Ferguson wrong about the effects of Keynes' sexuality and lack of children on his economic reasoning, but he does not even get the point of the phrase.

PS: The best book to understand the theoretical changes in Keynes' views is still Edward Amadeo's  Keynes' Principle of Effective Demand, his PhD dissertation, supervised by Murray Milgate, and co-supervised by Lance Taylor, published with an intro by Vicky Chick.