|
|
By Dr Tim Evans, on 27 June 11
A couple of weeks ago in the offices of the Adam Smith Institute, I addressed more than twenty of China’s most senior economic thinkers while they visited London. All were members of China’s Development Research Centre (DRC) – the leading think tank of Communist Party’s Central Committee and the State Council.
At their request, I touched on the history of the UK’s free market think tanks, the importance of maintaining independence and how, in the Anglo-sphere, such organisations are often funded by a diverse array of non-governmental sources including individuals, foundations and enterprises.
I also talked about money, banking, accountancy rules, the sovereign debt crisis and I even briefly managed to touch on the issue of gold. Everyone smiled when we mused over the fact that the Chinese state represents 32 percent of GDP while the UK government is heading towards 52 percent.
However, the real fun started when we moved to the questions and answers section. Very quickly, a hand went up in the front row and through the translator a gentleman on my right asked “have you ever heard of the Austrian School of Economics?” I smiled, paused, said “yes”, explained why, and we all moved forward.
Later, the leader of the delegation said that while Adam Smith had been translated in to high Chinese at the beginning of the twentieth century, the Communist Party had had it more accessibly translated thirty years ago – in the early 1980s.
Now, reflecting on all of this after the event, I was reminded of something a friend at Liberty Fund had said to me concerning the launch of The Online Library of Liberty in the middle of the last decade. Within two days of the library going live its South East Asian server out of Australia crashed. Under investigation it turned that it had been due to the number of students in China trying to download J.S. Mill’s On Liberty.
I have no idea how many people in China are reading the classical liberal ideas of Adam Smith and J.S. Mill or are in any way familiar with the greats of the Austrian School of Economics. But this is a question to which I wish I had an answer.
By Prof Peter J. Boettke, on 4 May 11
Previously published in Global Policy, Volume 2, Issue 2, May 2011
London School of Economics and Political Science.
Peter J. Boettke and Christopher J. Coyne
Abstract
Writing over 230 years ago, Adam Smith noted the ‘juggling trick’ whereby governments hide the extent of their public debt through ‘pretend payments’. As the fiscal crises around the world illustrate, this juggling trick has run its course. This article explores the relevance of Smith’s juggling trick in the context of dominant fiscal and monetary policies. It is argued that government spending intended to maintain stability, avoid deflation and stimulate the economy leads to significant increases in the public debt. This public debt is sustainable for a period of time and can be serviced through ‘pretend payments’ such as subsequent borrowing or the printing of money. However, at some point borrowing is no longer a feasible option as the state’s creditworthiness erodes. The only recourse is the monetarization of the debt which is also unsustainable due to the threat of hyperinflation.
Policy Implications
- The fear of deflation on the part of policy makers has led to an inflationary bias which neglects or underestimates the costs of inflation.
- The debt–inflation theory of economic crises must be considered as a viable alternative to the standard debt–deflation theory of economic crises.
- In order to curtail the tendency of using the tools of monetary and fiscal policy to concentrate benefits and disperse costs, policy institutions must effectively tie the rulers’ hands.
- After centuries of only fleeting success at curtailing the deficit, debt and debasement cycle of public policy, we may have to consider seriously the possibility that the only way successfully to constrain the state is to eliminate from its purview the task of monetary policy.
Writing in 1776, Adam Smith noted the following regarding public debt:
When national debts have once been accumulated to a certain degree, there is scarce, I believe, a single instance of their having been fairly and completely paid. … publick bankruptcy has been disguised under the appearance of a pretend payment. … When it becomes necessary for a state to declare itself bankrupt, in the same manner as when it becomes necessary for an individual to do so, a fair, open, and avowed bankruptcy is always the measure which is both least dishonorable to the debtor, and least hurtful to the creditor. The honour of a state is surely very poorly provided for, when in order to cover the disgrace of real bankruptcy, it has recourse to a juggling trick of this kind … Almost all states, however, ancient as well as modern, when reduced to this necessity, have upon some occasions, played this very juggling trick
(Smith, 1776, pp. 929–930).
The implications of Smith’s logic regarding public debt have come to fruition as evidenced by the violent situation in the streets of Athens, the situation facing the PIIGS (Portugal, Italy, Ireland, Greece and Spain) and the pending fiscal crisis facing US states such as California, Illinois and New Jersey. In each of these instances, the current predicament did not arise over the past year or two, but rather was the result of decades of public policy decisions resulting in fiscal imbalance. While pretend payments and the juggling of finances were able to hide the underlying realities for decades, the bill has now come due.
Over 230 years after Smith wrote The Wealth of Nations, the Great Recession has again brought debates about the public debt, and the role of government more broadly, to the forefront. The purpose of this article is to explore the relevance of Smith’s ‘juggling trick’ in the context of the dominant fiscal and monetary policies. Our central argument can be stated as follows: government spending intended to maintain stability, avoid deflation and stimulate the economy leads to significant increases in the public debt. This public debt is sustainable for a period of time and can be serviced through ‘pretend payments’ such as subsequent borrowing or the printing of money. However, at some point borrowing is no longer a feasible option as the state’s credit- worthiness erodes. This implies that the ultimate result of Smith’s juggling trick is the monetarization of the debt in order for the state to avoid bankruptcy. This too, however, is an unsustainable policy due to the threat of hyperinflation which has ravaging effects as evidenced by Russia and Germany in the early 20th century.
We proceed as follows. The next section shows how the current debates over public debt mirror the debate that took place during the 1930s between John Maynard Keynes and F. A. Hayek. We also highlight how concerns over the debt–deflation spiral emerged as part of this debate and continue to drive policy today. Section 2 discusses the mechanisms underpinning the debt–inflation cycle. We contend that the focus on deflation leads to an inflation-biased policy which neglects the cost of inflation and the logic of democratic politics that Smith highlighted in the opening quote. Section 3 lays out the dilemma we face. On the one hand we have theories indicating that active fiscal and monetary policies are necessary for recovery and growth. At the same time, we have public choice theories which indicate that increased public debt is ultimately unsustainable. Section 4 concludes with the lessons learned.
1. Back to the future
In the 1930s, the main macroeconomic debate in economic theory and policy centered around the question of who was right, Keynes or Hayek? In the wake of the Great Depression, Keynes argued that unless action was taken to stimulate aggregate demand the economy would sink further into an abyss of unemployment and lackluster economic growth. In contrast, Hayek argued that fiscal irresponsibility threatened the recovery and long-term economic health of the economy. The key to recovery and growth, according to Hayek, was private investment.
Keynes won the day in the 1930s, but in the 1970s that same debate resurfaced with a more ambiguous resolution, and since 2008 the debate has returned with a vengeance at a variety of levels. The current debate mimics the earlier one in that there is intense academic dispute about the causes of the Great Recession, as well as the best way forward. Further, as during the 1930s, the debate is also being played out in newspapers and magazines, as well as in vigorous political dialogue between conservative and liberal politicians on both sides of the Atlantic. Perhaps nothing illustrates more how the current debate mirrors that of the 1930s than the comparison of the writings in the pages of the major newspapers (see Boettke et al., 2010).
On 17 October 1932, D. H. Macgregor, A. C. Pigou, J. M. Keynes, Walter Layton, Arthur Salter and J. C. Stamp (Macgregor et al., 1932) published a letter in the Times of London noting that private spending was one of the primary causes for the continuation and severity of the Great Depression. They argued that immediate government action was necessary to counteract the fall in aggregate demand. Two days later, T. E. Gregory, F. A. von Hayek, Arnold Plant and Lionel Robbins (Gregory et al., 1932) responded in the same paper arguing that private investment was necessary to recovery and growth.
Eighty years later, a similar debate took place. On 14 February 2010, a group of economists led by Timothy Besley published a letter in the Sunday Times arguing for a credible fiscal plan to create confidence in the robustness of the UK system (Besley et al., 2010). Only by reducing the structural budget deficit, the authors argued, could the confidence of private investors be maintained. Four days later, a group of economists led by Lord Skidelsky, Keynes’ biographer, published a letter in the Financial Times arguing that the immediate concern should not be reducing the deficit, but instead ensuring robust growth through public spending (Skidelsky et al., 2010).
As the comparison of these two exchanges illustrates, the high stakes in the 1930s regarding government policy still exist decades later. However, the debate cannot be adequately understood in broad brush strokes of free market versus government intervention, or even in terms of the effectiveness of fiscal policy or monetary policy. It is much more subtle than that, even as it does turn ultimately on the question of the self-correcting capacity of the market economy. To understand the debate, one has to recognize the classic position carved out in the 1930s by Irving Fisher (1933). Fisher argued that a debt–deflationary spiral can sink an economy into a great depression unless the appropriate policies are performed to prevent the downward spiral of economic activity. Deflation, in other words, must be avoided by the monetary authorities, even at significant cost.
This preoccupation with avoiding deflation necessarily leads to an inflation-biased monetary policy. The ‘chief source of the existing inflationary bias’, Hayek wrote, ‘is the general belief that deflation … is so much more to be feared that, in order to keep on the safe side, a persistent error in the direction of inflation is preferable’ (Hayek, 1960, p. 330). The practical problem in monetary policy under this set of assumptions results in a situation where because ‘we do not know how to keep price completely stable and can achieve stability only by correcting any small movement in either direction, the determination to avoid deflation at any cost must result in cumulative inflation’ (Hayek, 1960, p. 330).
There are at least two major policy issues with the preoccupation with deflation. First, a positive case for declining price levels can be made since deflation, if it reflects generalized productivity gains that result from technological innovation in an economy, is good, not bad (see Selgin, 1997). It is complicated, if not impossible, to sort out as a matter of public policy good deflation from bad deflation. As a result, we are back again to the situation of cumulative inflation stressed by Hayek. Second, the self-reversing of the economic errors caused by inflation can be interpreted as a collapse in spending and a corresponding decline in economic activity as resources are reallocated, and thus those who fear deflation will call for a re-inflation to forestall the debt–deflation downward spiral. Hayek argues that the problem politically is that moderate inflation will be viewed pleasantly and will be revealed to be costly only in the future, whereas deflation is immediately observable and painful. Expediency in politics will reinforce the push for inflation, whereas politics by principle would demand permitting market adjustment and the reallocation of resources however painful in the short run (see Hayek, 1973, pp. 55–71).
The concern of deflation, and the neglect of inflation, have continued to the present day as evidenced by a recent speech by Federal Reserve Chairman Ben Bernanke (2010) in which he noted:
the FOMC [Federal Open Market Committee] will strongly resist deviations from price stability in the downward direction. Falling into deflation is not a significant risk for the United States at this time, but that is true in part because the public understands that the Federal Reserve will be vigilant and proactive in addressing significant further disinflation.
Recognizing Fisher’s concern for the debt–deflationary spiral is crucial because while the debate between Keynes and Hayek focused largely on fiscal policy, the fear of deflation shifted focus to monetary policy. The combined result was, and continues to be, a policy characterized by a proactive Keynesian case for fiscal policy to stimulate growth, and a proactive monetarist (and proto-monetarist) policy to avoid deflation. This, however, puts us in the very situation raised by Smith in The Wealth of Nations. How do we avoid the natural tendency of politicians and policy makers to engage in the juggling trick that hides the true costs of these proactive fiscal and monetary policies through increased borrowing and the monetarization of debt which can ultimately destroy an economy?
2. The public debt–inflation cycle
Smith’s recognition of the juggling trick regarding public debt is especially prescient because it correctly recognized the incentives facing elected officials well before the public choice revolution of the 1960s. This focus on basic incentives was lost with the Keynesian revolution. As Zingales (2009a) notes, ‘Keynes studied the relation between macroeconomic aggregates, without any consideration for the underlying incentives that lead to the formation of these aggregates. By contrast, modern economics base all their analysis on incentives’. This is a crucial point because fiscal and monetary policy is not designed in a vacuum. Instead, we must consider the incentives at two levels. First, we must understand the incentives facing policy makers when they design policy. Second, we must consider the incentives created by those policies. Let us consider each of these incentives in turn.
The logic of Smith’s ‘juggling trick’ insight was based on the basic incentives facing elected officials. Government can raise revenue in three ways: taxation, debt and inflation. To maintain popularity, governmental leaders prefer not to raise explicit taxes, so the preferred method of revenue generation is to borrow and then pay debts back with debased currency (an implicit tax). The democratic bias is to concentrate the benefits of public policy on well-organized and well-informed voters in the short run, and disperse the costs of public policy on the ill-organized and uninformed masses in the long run. The least informed and organized interest group at any point of time is future generations. Hence, the natural proclivity for the ruling regime is to run deficits that result in accumulated public debt, which is paid off with debasement. Throughout history this governmental habit of deficit, debt and debasement is what has brought down regimes and with that sometimes civilizations (see Groseclose, 1961, pp. 57–76; Rothbard, 1990 [1963], pp. 63–64).
It is this logic that has historically underpinned calls for an independent central bank, and various constraints on the policy discretion of both the treasury and the central bank. Ideally, rules must be designed to prevent policy cooperation ⁄ collusion between the fiscal and monetary policy makers precisely because we know the history of the political temptations to be seduced by the opportunity to engage in the juggling trick that Smith so long ago identified.
However, the problem goes beyond the incentives facing policy makers. The process of engaging in Smith’s juggling trick also creates perverse incentives in the private arena as proactive fiscal and monetary policies have led to increased efforts on the part of private actors to influence these policies for their personal gain. This raises the return to lobbying and rent-seeking activities relative to productive entrepreneurial activities, which are necessary not only for immediate recovery, but for long-term growth.
This interplay between the incentives facing policy makers and private businesspeople has resulted in a ‘vicious circle’ of favouritism and a lack of trust in financial and political institutions by citizens (see Zingales, 2009b). Politicians are intertwined with private markets as the logic of special interests discussed above (see Smith et al., forthcoming). At the same time, politicians seek to signal to citizens that they are independent of private interests. They do so by adopting strong policies against those private interests in the wake of crisis – increased regulation, threatened and actual taxes and fines, etc. This attempt to send a strong signal, however, has the unintended effect of creating an uncertain environment for subsequent investment which further exacerbates the fundamental problem of encouraging private investment for recovery and growth.
3. Misdiagnosing the sickness and cure
We are faced with a dilemma. On the one hand, the dominant theories of economic crises indicate that government must play a proactive role in getting the economy out of the depressed state of affairs. Active fiscal policy must be used to stimulate aggregate demand while active monetary policy must be used to avoid a deflationary spiral. However, we also have public choice theories dating back to Adam Smith which indicate that these very government actions are unsustainable and economically destructive.
The trends seem to support the Smith ⁄ public choice line of reasoning. In Capitalism and Freedom, Milton Friedman (1962, p. 75) pointed out that the primary justification of the expansion of public expenditure since the Second World War has been the ‘supposed necessity for government spending to eliminate unemployment’; an idea, Friedman goes on to argue, that has been thoroughly discredited by theory and practice. But, as he points out, ‘The idea may be accepted by none, but the government programs undertaken in its name, like some of those intended to prime the pump, are still with us and indeed account for ever-growing government expenditures’ (Friedman, 1962, p. 76). Close to 20 years later, Friedman noted that little had changed from when he first made those observations. ‘The repeated failure of well-intentioned programs is not an accident. It is not simply the result of mistakes of execution. The failure is deeply rooted in the use of bad means to achieve good objectives.’ But in spite of the overwhelming record of failure, these programs continue to expand. ‘Failures are attributed to the miserliness of Congress in appropriating funds, and so are met with a cry for still bigger programs’ (Friedman and Friedman, 1980, pp. 87–88).
Further, in the 25-plus years since those words were written little has changed in the day-to-day operation of politics, though Friedman was successful in transforming the rhetoric in the direction of market-economics language. At best, the growth of government was slowed, but it is important to stress that neither the Reagan nor Thatcher administrations reversed the trend line, and in the subsequent years even that slowing of the growth of government was reversed, especially after the 11 September 2001 terrorist attacks and the ensuing military conflicts and enhanced domestic security measures.
It is important to stress this because one of the great mythologies is that the Great Recession is evidence of the failure of unregulated capitalism. A similar mythology arose concerning the Great Depression. As Friedman and Friedman summed it up:
The depression convinced the public that capitalism was defective; the war, that centralized government was efficient. Both conclusions were false. The depression was produced by a failure of government, not of private enterprise. As to the war, it is one thing for government to exercise great control temporarily for a single overriding purpose shared by almost all citizens and for which almost all citizens are willing to make heavy sacrifices; it is a very different thing for government to control the economy permanently to promote a vaguely defined ‘public interest’ shaped by the enormously varied and diverse objectives of its citizens (Friedman and Friedman, 1980, pp. 85–86).
Failing to distinguish between unregulated capitalism and state-led capitalism, or mercantilism, has two negative consequences. The first is that it runs the risk of misdiagnosing the problem. If failures are attributed to capitalism when they are in fact the result of distortions caused by fiscal and monetary policies, this will lead to an incorrect diagnosis of the actual problem. The second, and related, consequence is that it runs the risk of misdiagnosing the solution. If, in fact, the cause of downturns is distortions caused by past fiscal and monetary solutions, then it is incorrect to assume that these same policies are the solution to the very problem they caused.
There is reason to believe that both types of misdiagnosis are at work in the current crisis. Zingales (2009a) notes that Keynesian policies have not only failed to avoid the current crisis but instead were a contributing factor to its onset. He writes that ‘The Keynesian desire to manage aggregate demand, ignoring the long-run costs, pushed Alan Greenspan and Ben Bernanke to keep interest rates extremely low in 2002, fuelling excessive consumption by the household sector and excessive risk-taking by the financial sector’ (Zingales, 2009a). Similarly, Taylor (2009) has documented how easy monetary policy combined with government programs that unintentionally shifted the incentives for risk taking caused and prolonged the current crisis. Finally, Rajan (2010) highlights how the role of loose monetary policy and the political push for easy housing credit contributed to the current crisis.
Prior to the onset of the crisis, economists too quickly identified the lack of macroeconomic volatility with the perfection of central banking, rather than seeing policies in terms of Smith’s juggling trick whereby fiscal and monetary policies paper over (literally) the efforts by market forces to correct for the misleading signals of the previous period of manipulation of money and credit in the economy. The Fed ‘getting off track’, to borrow Taylor’s (2009) apt phrase, was due to efforts to keep the previous misguided set of economic activities afloat rather than permitting the necessary adjustment to economic reality by market participants.
To the extent that Zingales, Taylor and Rajan are correct that past fiscal and monetary policies were a factor in causing the current situation, what confidence do we have that those same policies can now solve the existing predicament they helped to create? Further, to the extent that these policies are successful, they will only be so in the short run as they are just a continuation of the juggling trick. As the debt crises around the world illustrate, while payment can be delayed, eventually the bill becomes due.
4. Lessons learned
What have we learned from the Great Recession? We would like to highlight three lessons which we hope will be the subject of subsequent debate and discussion.
First, the debt–inflation theory of economic crises must be considered as a viable alternative to replace the debt–deflation theory of economic crises. Under the debt–deflation theory policy makers interpret every downturn in economic activity as a potential deflation, and therefore counteract it with easy monetary policy. When this happens market corrections will be cut short, and the previous boom is recreated through the manipulation of money and credit.
Ludwig von Mises (1966 [1949]) and F. A. Hayek (1979) were early expositors of an expectation-based macro-economics arguing that efforts to offset economic downturns through monetary policy enter a dangerous game of expectations and anticipated inflation. As Hayek argued, ‘We now have a tiger by the tail: How long can this inflation continue? If the tiger [of inflation] is freed, he will eat us up; yet if he runs faster and faster while we desperately hold on, we are still finished!’(Hayek, 1979, p. 110, emphasis added) It is this theory of the ‘crack-up boom’ (see Mises, 1966 [1949], pp. 426–428) that very well may be what we have seen manifesting itself in reality with the onset of the Great Recession in 2008. If this is accurate then the policy steps taken to date have merely reinforced, rather than ameliorated, the problem as a market correction to previous malinvestments has been turned into a global crisis by the very steps taken to prevent the market correction from occurring.
Second, to curtail the tendency of using the tools of monetary and fiscal policy to concentrate benefits and disperse costs, policy institutions must effectively tie rulers’ hands to eliminate the possibility of engaging in the juggling trick that Smith warned against. The importance of establishing credible and binding constraints on monetary authorities and government spending is by no means a new idea. However, modern history has demonstrated the elusiveness of the quest to establish binding and credible constraints on monetary and fiscal authorities.
This has important implications because the relevant question is not if constraints should be established, but instead whether binding constraints can be established within the existing institutional framework. If that institutional framework is vulnerable to the inevitable errors committed by policy makers – either innocent or malevolent – then the problem is not in the framework, it is the framework. Milton Friedman (1962, pp. 50–51) recognized this possibility when he wrote:
Any system which gives so much power and so much discretion to a few men that mistakes – excusable or not – can have such far reaching effects is a bad system. It is a bad system to believers in freedom just because it gives a few men such power without any effective check by the body politic – that is the key political argument against an ‘independent’ central bank. But it is a bad system even to those who set security higher than freedom. Mistakes, excusable or not, cannot be avoided in a system which disperses responsibility yet gives a few men great power, and which thereby makes important policy actions highly dependent on accidents of personality. This is the key technical argument against an ‘independent’ bank. To paraphrase Clemenceau, money is much too serious a matter to be left to the Central Bankers.
Similarly, Buchanan and Wagner are pessimistic of the ability to restrain the state from engaging in juggling tricks leading them to conclude that, ‘politically, Keynesianism may represent a substantial disease, one that can, over the long run, prove fatal for a functioning democracy’ (Buchanan and Wagner, 1977, p. 56, emphasis added).
This leads to our third and final lesson. After centuries of only fleeting success at curtailing the deficit, debt and debasement cycle of public policy, we may have to consider seriously the possibility that the only way successfully to constrain the state is to eliminate from its purview the task of monetary policy. Rather than a centralized and government monopoly control of the money supply, perhaps more decentralized and competitive institutional arrangements might have to be relied upon. Of course, what is required is the attention of economists to examine such institutional arrangements in depth and with all their critical attention. What cannot continue is the standard practice of looking at central banking theory and practice as if they were to be done by fully informed agents who act only in the public interest. Instead, a robust theory of the institutions of the monetary framework must be developed.
References
- Bernanke, B. S. (2010) ‘The Economic Outlook and Monetary Policy’. Speech at the Federal Reserve Bank of Kansas City Economic Symposium, Jackson Hole, Wyoming, 27 August. Available from: http://federalreserve.gov/newsevents/speech/bernanke20100827a.htm [Accessed 22 February 2011].
- Besley, T., Davies, H., Goodhart, C., Marcet, A., Pissarides, C., Quah, D. et al. (2010) ‘UK Economy Cries Out for Credible Rescue Plan’, Sunday Times, 14 February, p. 26.
- Boettke, P. J., Smith, D. and Snow, N. (2010) ‘Been There Done That: Political Economy of Déjà vu’, mimeo.
- Buchanan, J. M. and Wagner, R. E. (1977) Democracy in Deficit: The Political Legacy of Lord Keynes. New York: Academic Press.
- Fisher, I. (1933) ‘The Debt–Deflation Theory of Great Depressions’, Econometrica, 1 (4), pp. 337–357.
- Friedman, M. (1962) Capitalism and Freedom. Chicago, IL: University of Chicago Press.
- Friedman, M. and Friedman, R. (1980) Free to Choose. New York: Harcourt Brace.
- Gregory, T. E., Hayek, F. A., Plant, A. and Robbins, L. (1932) ‘Spending and Saving: Public Works from Rates’, Times of London, 19 October, p. 10.
- Groseclose, E. (1961) Money and Man. New York: Frederick Ungar.
- Hayek, F. A. (1960) The Constitution of Liberty. Chicago, IL: University
of Chicago Press.
- Hayek, F. A. (1973) Law, Legislation and Liberty, Volume 1: Rules and
Order. Chicago, IL: University of Chicago Press.
- Hayek, F. A. (1979) A Tiger by the Tail: The Keynesian Legacy of Inflation. San Francisco, CA: The CATO Institute.
- Macgregor, D. H., Pigou, A. C., Keynes, J. M., Layton, W., Salter, A. and Stamp, J. C. (1932) ‘Private spending: Money for Productive Investment’, Times of London, 17 October, p. 13.
- Mises, L. von (1966 [1949]) Human Action: A Treatise on Economics.
Chicago, IL: Henry Regnery.
- Rajan, R. (2010) Fault Lines: How Hidden Fractures Still Threaten the
World Economy. Princeton, NJ: Princeton University Press.
- Rothbard, M. (1990 [1963]) What has Government Done to Our
Money. Auburn: The Ludwig von Mises Institute.
- Selgin, G. (1997) Less than Zero: The Case for a Falling Price Level in a Growing Economy. London: Institute of Economic Affairs.
- Skidelsky, L. et al. (2010) ‘Letter: First priority must be to Restore Robust Growth’, Financial Times, 18 February. Available from: http://www.ft.com/cms/s/0/84b12d80-1cdd-11df-8d8e-00144feab49a.html#axzz18g54gh6Y [Accessed 22 February 2011].
- Smith, A. (1776) An Inquiry into the Nature and Causes of the Wealth
of Nations, Volume II. Indianapolis, IN: Liberty Fund.
- Smith, A., Wagner, R. E. and Yandle, B. (forthcoming) ‘A Theory of Entangled Political Economy, with Application to TARP and NRA’, Public Choice.
- Taylor, J. (2009) Getting Off Track: How Government Actions and
Interventions Caused, Prolonged, and Worsened the Financial
Crisis. Stanford, CA: Hoover Institution Press.
- Zingales, L. (2009a) ‘Keynesian Principles’, Economist Debates
[online]. Available from: http://www.economist.com/debate/days/view/280#con_statement_anchor [Accessed 22 February 2011].
- Zingales, L. (2009b) ‘Capitalism after the Crisis’, National Affairs, Fall (1), pp. 22–35.
Author Information
- Peter J. Boettke, Department of Economics, George Mason University, Fairfax, Virginia.
- Christopher J. Coyne, Department of Economics, George Mason University, Fairfax, Virginia.
By Mark Skousen, on 9 March 11
Today is the anniversary of the publication of Adam Smith’s most famous work, ”The Wealth of Nations” (March 9, 1776).
To celebrate this important day, I’ve written an article for FEE on Dan Klein’s discovery about the “deliberate centrality” of the invisible hand in Smith’s work, and what it all means. It will appear in print in the June issue of “The Freeman.”
For some time now, there’s been a controversy brewing about Adam Smith’s famous metaphor of the free market, “the invisible hand.” Critics point out that it is used only once in each of Smith’s two major works, “The Theory of Moral Sentiments” (1759) and “The Wealth of Nations” (1776). Therefore, they conclude, this much touted symbol of free-market capitalism was in reality a marginal concept to Smith.
But now Daniel B. Klein (GMU) has made a fascinating discovery: the invisible hand is physically located in the dead center of the middle of both books. Prof. Klein argues for deliberate centrality by Adam Smith — that the invisible hand doctrine of “the system of natural liberty” was central to his work. Adam Smith has finally revealed his (invisible) hand!
On a personal note, March 9 is also the pub date of ”The Making of Modern Economics” (March 9, 2001). It is not a coincidence. Adam Smith is the heroic figure of the book. It is now in its 2nd edition. Last year it won the Choice Book Award for Outstanding Academic Title. The book is available in hardback, paperback, Kindle, and audio book — and translated into five languages.
I’m happy to announce that Prof. Klein has accepted my invitation to participate in a debate at this year’s FreedomFest (July 14-16, Las Vegas), on the subject: “Libertarian, Conservative, or Radical Egalitarian: Will the Real Adam Smith Please Stand Up?” I hope you will join us for this annual event.
By Toby Baxendale, on 7 June 10
We are pleased to republish here an excellent article by Dr. Richard Ebeling, Professor of Economics at Northwood University. The article originally appeared in Freedom Daily (June 1996), published by the Future of Freedom Foundation, Fairfax, Virginia.
Adam Smith’s Wealth of Nations is justly considered one of the intellectual fountainheads of economic liberty. With a brilliant combination of logic and historical example, Smith demonstrated, like few others had up to his day, that governmental controls, regulations, and restrictions on economic freedom were the fundamental causes of extensive poverty, misuse of resources, and pervasive political corruption. He declared that what England — and indeed any country — needed, if it desired increased prosperity for all, wise use of its resources, and greater justice in human relationships, was a “system of natural liberty.”
Under such a system, Smith argued,
Every man, as long as he does not violate the laws of justice, is left perfectly free to pursue his own interest his own way, and to bring both his industry and capital into competition with those of any other man, or order of men . . . The sovereign is completely discharged from a duty . . . of which no human wisdom or knowledge could ever be sufficient; the duty of superintending the industry of private people, and of directing it towards employments most suitable to the interest of society.
In this system of natural liberty, the government, in Adam Smith’s view, would be limited to three functions: protection of the citizenry from foreign aggression; the protection of the citizenry from domestic robbery and murder, along with a judicial system to administer justice; and the provision of a number of limited public works that Smith believed might not be profitable for private citizens to provide but which might have a wider usefulness for the society.
In spite of the eloquence and rigor with which Adam Smith demonstrated the harm and futility of the mercantilist forms of planning and regulation in his day, he despaired that economic freedom would never be triumphant. “To expect, indeed, that the freedom of trade should ever be entirely restored to Great Britain,” he said, “is as absurd as to expect that an Oceana or Utopia should ever be established in it. Not only the prejudices of the public, but what is much more unconquerable, the private interests of many individuals irresistibly oppose it.”
Wartime Regulations and the Emergence of the Free Trade Movement
The several decades following Adam Smith’s death in 1790 seemed to bear out his pessimism. While under the prime ministership of William Pitt in the 1780s, Great Britain moved in directions that were consistent with the types of trade policies advocated by Smith; they were reversed in the 1790s with the advent of the wars fought between Great Britain and France. New protectionist trade barriers were imposed in the name of the war effort. Britain and France both tried to enforce naval blockades against each other. Only a pervasive network of smuggling throughout Europe prevented many from going without food or clothing. As Francis W. Hirst explained in his book From Adam Smith to Philip Snowden: A History of Free Trade (1925), “When peace came in 1815 it found Great Britain exhausted by twenty-two years of war and Protection.”
However, instead of reversing the controls and regulations, the British Parliament passed the Corn Laws of 1815, which were meant to assure a protected market for British agricultural interests. No foreign wheat could be imported into the British Isles unless the domestic price reached an exorbitantly high level. This condemned the low-income industrial workers of British towns and cities to a meager and expensive diet. The trade barriers also acted as a restraint on the development of the emerging British manufacturing industries.
In 1820, a group of British industrialists issued a Merchant’s Petition declaring that they were “against every restrictive regulation of trade, not essential to the revenue, against all duties merely protective from foreign competition.” In 1830, Sir Henry Parnell, a longtime chairman of the finance committee of the House of Commons, published a book entitled, On Financial Reform. In it, he declared:
If once men were allowed to take their own way, they would very soon, to the great advantage of society, undeceive the world of the error of restricting trade, and show that the passage of merchandise from one state to another ought to be as free as air and water. Every country should be as a general and common fair for the sale of goods, and the individual and nation that makes the best commodity should find the greatest advantage.
In 1836, the Anti-Corn Law Association was formed in London, which in 1839 was renamed the Anti-Corn Law League in Manchester. For the next seven years, under the masterful and powerful leadership of Richard Cobden and John Bright, the league fought unstintingly for the repeal of the Corn Laws and for the establishment of total free trade in the British Empire.
Throughout the cities, towns, and villages of Great Britain, Anti-Corn Law League chapters were opened. Hundreds of thousands of dollars in voluntary donations were collected to fund rallies, meetings, public lectures, and debates. The league organized a vast publishing campaign of books, monographs, and pamphlets advocating the repeal of all protectionist restrictions and the freeing of all trade and commerce from government control.
The Case for Unilateral Free Trade and the Goal of Peace
From the beginning, in making his case for free trade, Richard Cobden saw the breaking down of trade barriers as a powerful avenue for depoliticizing human relationships. By privatizing all market transactions between individuals of different countries, he said, free trade would assist in removing many of the causes of war. “As little intercourse as possible between Governments,” Cobden declared, “as much connection as possible between the nations of the world.” To emphasize this, the slogan of the Anti-Corn Law League became “Free Trade, Peace and Good-Will Among Nations.”
Furthermore, Cobden and the Anti-Corn Law League made the case for unilateral free trade. “We came to the conclusion that the less we attempted to persuade foreigners to adopt our trade principles, the better,” Cobden explained in later years, “for we discovered so much suspicion of the motives of England, that it was lending an argument to the protectionists abroad to incite the popular feeling against the free-traders . . . To take away this pretense, we avowed our total indifference whether other nations became free-traders or not; but we should abolish Protection for our own selves, and leave other countries to take whatever course they liked best.”
In 1841, Sir Robert Peel became prime minister, determined to maintain the Corn Laws as a cornerstone of British foreign economic policy. But through one of those ironies of history, the man appointed to lead the defense of protectionism ended up advocating and overseeing the abolition of protectionism in Great Britain.
Over the next several years, Peel’s government lowered and, in some cases, eliminated many of the trade restrictions on manufacturing and industrial goods, but he would not reduce the trade barriers on agriculture. Under the unrelenting arguments of the free traders, Peel finally admitted, in 1843, during a debate in the House of Commons, “I am bound to say that it is our interest to buy cheap, whether other countries will buy cheap or no.” In 1845, of the 813 commodities on the import tariff restriction list, 430 were placed on the free-trade list. But, still, Peel was unwilling to give way on the Corn Laws.
The Rains Came and the Trade Barriers Finally Fell
In the fall of 1845, the worst rains in living memory hit the British Isles, and the domestic food crops were devastated. Food supplies declined, bread prices rose dramatically, and the potato harvest was destroyed in Ireland, threatening mass starvation. Young boys could be heard in the cities saying, “I be protected and I be starving.” Daniel O’Connell led demonstrations in Ireland, in which a cannon would be dragged through the streets to which was attached a sign saying, “Free trade or this.”
In November 1845, the leaders of both the Tory and Whig parties came out for repeal of the Corn Laws. In January 1846, Robert Peel told the House of Commons that the Corn Laws would be abolished. On February 27, the resolution was approved, and the Corn Importation Bill left the House of Commons on May 16, after passing on the third reading. The Duke of Wellington speedily ushered the bill through the House of Lords, and free trade became the law of the land in Great Britain on June 25, 1846.
Angered by his surrender to the free traders, the protectionist Tories forced Robert Peel to resign from the prime ministership the very same day free trade was triumphant in Britain. In his final speech before stepping down, Peel declared that he hoped that whatever government was now formed, it would continue the “application of those principles which tend to establish a freer intercourse with other nations.” And he went on to say:
If other countries choose to buy in the dearest market, such an option on their part constitutes no reason why we should not be permitted to buy in the cheapest. I trust the Government . . . will not resume the policy which they and we have felt most inconvenient, namely, the haggling with foreign countries about reciprocal concessions, instead of taking the independent course which we believe conducive to our own interests. Let us trust to the influence of public opinion in other countries — let us trust that our example, with the proof of practical benefit we derive from it, will at no remote period insure the adoption of the principles on which we have acted, rather than defer indefinitely by delay equivalent concessions from other countries.
Within three years — by 1849 — not only were the Corn Laws gone, but also were the remaining Navigation Acts carried over from the 18th century that had required goods being imported into Britain to be carried on British ships. From then on, both goods and merchant vessels from any land could arrive in Great Britain “as free as air and water,” as Henry Parnell had wished it to be in 1830.
The Importance and the Lesson of the Free Trade Movement
On June 25, 1846 Great Britain became the first country in the world to institute a unilateral policy of free trade. For the rest of the 19th century — indeed, until the dark forces of collectivism enveloped Europe during World War I — the British Empire was open to the entire world for the free movement of men, money, and goods. Its economic success served as a bright, principled example to the rest of the globe, many of whose member countries followed the British lead in establishing, if not complete free trade, at least regimes of much greater freedom of trade and commerce.
The triumph of free trade in 1846 in Great Britain was one of the shining jewels in the crowning achievements of 19th-century classical liberalism. It represented more than just the opening of the door to material prosperity among an expanding group of nations of the world. It also heralded an epoch of greatly depoliticized relationships that, in fact, made international trade the private affairs of individuals and not concerns of the state.
The emergence of socialism and neo-mercantilism towards the end of the 19th century eventually brought about the end of the classical-liberal era and its epoch of free trade. Nevertheless, the victory of 1846 demonstrates that an uncompromising, principled belief in the freedom of man can triumph and change the course of human events.
Dr. Ebeling’s new book, Political Economy, Public Policy, and Monetary
Economics: Ludwig von Mises and the Austrian Tradition is now available through Routledge and Amazon.
By Toby Baxendale, on 8 March 10
The current debate about bankers’ bonuses is often seen as one of fairness pitted against the greed of those nasty capitalists,.
To me, bankers are lawfully working within the system – one that is rotten to the core. The banking system is the greatest of all examples of State corporate capitalism. We have a central bank that is State owned, we have a legal tender law that prevents competition in the provision of the production of money, and we have private sectors banks which are licensed by the State to be its agent when it wants to monetise its very own debts and create inflation at the expense of its citizens: people who have been prudent and thrifty as well as those on fixed income.
The State has one important central intention: to hide its prolific over spending. We have private sector banks that have legal privilege granted to them so they can use their depositors’ money to lend out many times over to entrepreneurs. They are the only type of business in the whole country permitted do this. All other commercial enterprises at all points in time need to keep their current creditors whole, otherwise they are insolvent. There is no requirement at all in this country for any bank to keep even one penny in reserves against their depositors’ funds. In fact, it has been a stated fact of law since 1811 in Carr V Carr that “his” deposited funds are not his, but are in fact the banks’.
This fractional reserve banking system we have can only work with a lender of last resort i.e. the State owned central bank with legal tender laws. This means that in partnership with the State, the State can monetise its debts (at the expense of you and me) and the banks can keep as little reserves as they can get away with to make a return on capital that you and I in the real capitalist private sector could never do. This encourages risk. Indeed with the banks now able to borrow at the taxpayers’ expense via the discount window (heavily subsidised short term central bank funding) and know there is a guarantee of a bail out should their gambles go wrong makes the state and the bankers two equal partners in a very unjust process.
The resulting situation is what I call ‘corporate capitalism’ (thoroughly amoral) as opposed to ‘capitalism’, which is totally moral. This needs some explaining, as I suspect worthy people are shooting arrows at the wrong target.
We know that the free market capitalist system is without doubt the most efficient creator and allocator of resources. Adam Smith taught us that “It is not from the benevolence of the butcher, the brewer, or the baker, that we can expect our dinner, but from their regard to their own interest” in his Wealth of Nations. Self interest or the profit motive drives man to create and to provide all the multiplicity of goods and services we have enjoyed and will enjoy.
Mises in his famous book Socialism, showed us that if Society was run by planners, the price system which allows resources to flow to their most desired uses would not function. Indeed it would impoverish anyone nation that tried it. If, say. the planner could not correctly witness all the competing bids and resource allocations for metals that were capable of being used in the construction of railroad tracks (that involves many companies competing for scarce resources) he would never know which metal would be the most cost effective to build his railroad. No one planner would be able to economically calculate, or indeed, no army of planners would be able to calculate and allocate all the resources of Society in the socialist economy better than the many millions of participants in the economy allocating resources via the price mechanism. The experiment in the Soviet bloc with socialism impoverished at least three generations and lead to wide scale death and a general shortage of life, and misery.
Hayek, in his very famous essay “The Use of Knowledge in Society” added to the critique of Mises by pointing out that absenting the price system would mean that the central planning officials would need to absorb the entire knowledge of all the people in society to effectively plan their needs. This was absurd and impossible.
All State planned schemes, from the provision of money to the provision of health and education – even in our cosy mixed economy – could be done better by an unhampered market. We are thus weary of all bloated government departments and officials who say they can do something better for us – they can’t.
The efficiency case for an unhampered market, or free market capitalism is clear and unchallengeable. The subjective actions of freely consenting adults in a capitalist system produce the most amount of goods in the most efficient way. But is there an objectively moral case for the capitalist system? I attempt to answer it in the remaining part of this Insight article.
First Principles: Secular Argument
I Argue
One thing that distinguishes human beings from all other life forms is our ability to communicate with each other via talking. Only human beings can make a proposition. The question of what is just or unjust only arises because I can debate or argue this point with another person. To be able to argue my position I must be in control of my physical and mental self. I must own myself in order to be to be a human being. I have the total right to use all my physical and mental faculties to participate in life, otherwise I cannot even exist as a human being expressing an opinion. I do not know many people who would argue with this. If I did not own my own faculties I could not participate in life except under the command of who owned me. This also implies that just so much as I own myself, I do not own anyone else. It also follows that if I do something that violates another human being without their consent I violate their right to express their very humanness.
Thus, I deduce that by my very being , I own myself , I own my own property as me, I have a right not to be interfered with so long as I do not interfere with anyone else. It clearly follows that if I were to interfere with someone else’s property, they would not own it. This would deprive them of their own humanity, I suggest. This is a deduction from the axiom that to exist I need to argue. I come to this conclusion via the Haberrmasian axiom of interpersonal argument that has been so cleverly adapted by Hans Herman Hoppe in his book The Economics and Ethics of Private Property.
To argue against this you explicitly acknowledge control of your faculties, at the very least. Following Kant’s Golden Rule that a norm should be universal in its applicability should it be objectively valid, this proposition surely fulfils this requirement to be a totally objective axiomatic principle.
All ethical propositions, such as socialism, that say that you owe a duty to the State to provide for others, are violations of the very distinguishing thing that makes you a human being and not a rock or a colony of ants. To advocate any form or socialism, be it of the democratic variety, the communist variety, or indeed the mixed economy is to violate your very essence of being a human.
John Locke in his “Two Treatises of Government” spells out that property or, if you like all resources exist prior to any government. Man mixes his labour with what he finds and it is by right his. Government cannot ‘dispose of the estates of the subjects arbitrarily’. Locke left us with a conundrum called “Locke’s proviso.” This is where if a man mixes his labour to own something that was not owned before; he must always leave a “sufficient” amount for other human beings.
Jesus Huerta de Soto, one of the greatest living polymath Austrian School teachers in his essay “The Ethics of Capitalism” , shows us how possibly the other living giant of the Austrian School, Israel Kirzner in “Discovery, Capitalism, and Distributive Justice” has solved this proviso of Locke. And allows us to build the objective moral ethic of capitalism.
Socialist, social democrats and a large body of modern day liberals and conservatives have a distributive conception of justice that is about a top down approach of redistribution of scarce resources from those who do have to those who that have less, or nothing, or whose lobby groups has succeeded in extracting something from those that have. Kirzner shows us how as all human being are creative actor: they are always engaging in entrepreneurial activity to generate new goods and services. All human beings are alert to opportunity, some to a greater degree than others. The fruits of this alertness arises via their actions. This is universally so. To not act would not create these things. So he proposes an axiom that all human beings have a natural right to the fruits of their own entrepreneurial creativity. As these things are created out of nothing, it implies that the acting person has an undoubted right to the quiet and peaceful enjoyment of the fruits of his or her labour. If it did not exist before, it cannot be a negative to anyone else. So Locke’s proviso is overcome by the understanding of society as dynamic and spontaneous constantly evolving process with alert actors constantly creating new goods and services that they must have an unquestionable right to own.
De Soto coins the term ‘Dynamic Efficiency’ to describe this process. He also points out that the free market capitalist system – that we know is the most efficient system – is also the most just and in fact, these two concepts are indeed two sides of the same one coin. Any form of intervention is immoral as it impedes the creative capacity of individuals to express their creativity and create all the wide range of goods and services we have. It should be pointed out that top down provision of health, education, transport, industry etc is inefficient and hence unjust as it suppresses the creative activity of human beings. Absent the profit motive and you will get sub optimal results.
Do Soto points out that the last Pope, Pope John Paul II in his Centesimus Annus, which built on the earlier work of the Rerum Novarum of Pope Leo XIII, established the universal moral capitalist ethic by acknowledging the natural right (God given) to express your very creativity unhindered so long and you hinder no one else.
First Principle: Theological – God Endowed Rights
I Exist
Writing about the morality of capitalism in glowing positive terms as I have done above and setting it in the backdrop of universally applicable objective axioms is not as unfashionable as talking to any thinking person about God, but only just! Such is the secular society we live in; you are considered to be an ill informed mystic should you engage in “god bothering.” The See of Peter would naturally see this differently and I am very grateful for De Soto to direct me to the pro capitalist teachings of the Catholic Church.
Are the above self evident axioms that are universally applicable in all times and in all places to everybody there because we are human or are they there because they are God endowed?
I can ague both, but I favour self evident God endowed over self evident secular, although the latter can stand on its own legs. Why?
I wrote an article about the proof God three years ago for LewRockwell.com. In short, I take the Aristotelian inspired position that as I exist I know that other physical things exist. I know that each and every one of these physical things must have been caused by another physical thing. I know that nothing is infinite. If it was, I would not exist as for it to be infinite, it would occupy all time and space and I would not exist. As I exist, I know this cannot be the case. I know there is a beginning to the universe and that there are physical boundaries to the universe, therefore I know there cannot be an infinite series of physical causes and effects as there would be no boundary and no beginning. Therefore what caused the first physical thing must indeed be immaterial if it cannot be a physical cause. This immaterial thing is what I label as ‘God’. So I conclude God does exist and the only act I can attribute to God by a priori reasoning is that God created everything. As I like to exist I am very grateful for this and can only conclude that God has good intentions. If I do not like to exist, I can choose not to and commit suicide. God is therefore good for me and objectively good for all human beings. As God has created everything, he has endowed us with the ability to reason and engage in the formation of reasoned propositions, the latter which is undoubtedly a unique attribute to mankind the former quite possible unique to mankind, sets the foundation for the derivation of the rights of man and the very ethics of capitalism.
Further reading
|
|
