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History of Economic Doctrines
Session 7
The “Liberal” Tradition: Classical Economics II
If you laid all the economists in the country end to end,
they’d never reach a conclusion.
George Bernard Shaw
Issue: Economics contains many
different schools of thought. How do we ascertain reality?
The parable of the blind men and the elephant: A number of blind men were asked
to describe an elephant after each had inspected the beast. Every blind man who felt a
different part f the elephant [leaf
= ear | trunk = firehose | leg = tree trunk | tail = rope | torso = wall |
tusk = spear | etc.] was
convinced of his correctness, and thought all the rest wrong.
Perspectives and “schools’
of thought” differ depending on what is perceived to be “correct.” Is any paradigm correct? Unlikely. Perhaps “pragmatism” is the
best approach to decisionmaking. The pragmatic
method is to try to identify the practical consequences of a theory. If it works, use the theory. If a theory
fails to perform as expected, try a different theory. And don’t expect one theory to be so
general that it explains everything. Moreover, there is no requirement of
logical consistency between the theories that are applicable to different
problems. For example, in physics, the stochastic logic underpinning Brownian
movements is inconsistent with the deterministic logic of Einstein’s
theory of relativity. A general theory that encompasses all phenomena may
be impossible, and the quest for such a general theory, doomed.
LIBERAL (Free-Market) ECONOMICS
1.
Began with Richard Cantillon (1680-1734), Francois
Quesnay (1694-1774), and Adam Smith (1723-1790). All rejected the “divine
right of kings” as an appropriate mechanism to govern economic
activity, favoring instead market solutions to economic problems.
2.
From the 18th Century through much of
the 19th, the liberal tradition was a view that government was a
necessary evil to be minimized, that monarchs had no special insights, and “liberals”
asserted that people left alone would be better off. – laissez nous faire.
3.
Classical “liberal economics” culminated
with the writings of John Stuart Mill in the late 19th century.
4.
Libertarian approach- free to do whatever people
choose in both civil actions and in the market.
5.
Today?-Liberal and conservative seem to have
flipped meanings. The stereotype is that liberals want more government
regulations and conservatives want greater freedom in the market place.
Curious factoid: Government has tended to be larger as a percentage of GDP
during Republican Administrations.
The Era of Adam Smith
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1.
Radical rejection of governmental primacy in directing
economic activity. Advocated freedom (“the invisible hand”) as
the best organizing principle.
2.
The real “Wealth
of Nations” [1776] is the ability to deliver goods and services
through competitive private industry and free trade.
3.
Contrary to mercantilism, money [gold] is just a
way of keeping track (echoing David Hume.}
4.
Absolute advantage: Smith argued that absolute
advantage was the basis of gains from free trade.
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Adam Smith 
(1723-1790)
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Smith, a lifetime bachelor; was
an eccentric professor of moral philosophy in Scotland. In his first major
book, The Theory of Moral Sentiments
[1758], Smith argued that people are motivated by self interest, and viewed
sympathy and our ability to identify with the plight of other people as the
primary constraints on our behavior..
He published the Wealth
of Nations in 1776 [the same year as American Declaration of Independence.] The Wealth of Nations draws heavily from rationality, the “rights
of man”, and other theories of the enlightenment and was an early
statement of ideas now considered “libertarian.”
Smith (echoing the ideas of David Hume and especially Richard
Cantillon, whose books Smith had read) attacked mercantilism, and advocated
freedom and competition as organizing principles. Smith believed that
society doesn’t need a king or a government to control economic
activity; we need to rely on the “invisible
hand” of the marketplace.
Smith believed that humans mimic successful patterns; in
doing so they are lead as if by the “invisible hand” for the
social good.
Smith opposed monopoly. [Feudal kings often granted
rights of monopoly to their cronies. For example, in 1600, Elizabeth I
granted the East India Company exclusive right to import Indian goods into
England, and the exclusive right to export English goods to India.]
Invisible Hand
Every economic system except capitalism relies on the
inherent goodness and selflessness of the people who are “in charge.”
Capitalism does not. Essentially, if there were more competition, society
would do much better through the invisible hand than through, e.g.,
government. [Ex: A butcher does not provide meat to just
feed other people; he provides it to serve his self interest. Thus, he is led by the invisible hand to
provide meat which, in turn, helps serve the common good.]
Division of Labor
Smith viewed the division of labor [originally discussed
by the ancient Greek, Xenophon] as crucial in increasing production. [Ex:
Pin Factory: More efficient to have people specialized to do one step: heat up the metal, roll it into a long
wire, cut it into links, join the big piece to the small, sharpen, take the
pin and put it into paper, and sell it, than having one person doing it
from beginning to end.]
Wage Structures
Smith said that wages are determined by factors such as
intelligence and skill, and he also addressed the affect on wages of how
unpleasant or dangerous the work is, and the likelihood of having a job and
succeeding in it. [Consider construction workers and actors, for example.]
Conventional Economics [per, e.g., Smith and Jevons]
Work=Pain
Consumption=Pleasure
People want to maximize pleasure and minimize pain
(falls in line with Epicurus and with Jeremy Bentham’s theory on
utility). However, even though the
person doing the risky/ obnoxious job might be a risk lover, hence, not
need to be paid a high amount to do the task and not need safety
precautions
Issue:
Safety Regulations: the government
(OSHA) often imposes safety regulations.
This in turn, reduces a person’s wage due to the added cost for
safety. Ultimately, society as a
whole is a loser because the cost of doing the job artificially goes up and
results in inefficiency.
Furthermore, we take away the freedom to contract as will which is
an important principle.
Entrepreneurs’ Motives: Aside on Standard
Assumptions and George Gilder
Economists usually assume that entrepreneurs are
motivated by profit alone, intending to increase their personal jollies
through consumption. [Higher income è
greater consumption.] However, George Gilder [Wealth and Poverty, 1980] asserts that the drive of the
entrepreneur isn’t necessarily mere profit, but also to change the
world … to give the world a gift.
Entrepreneurs [ex.: Thomas Edison or Bill Gates] produce things
because they want to change the world.
Money is a symbol, a badge of honor that illustrates society’s
appreciation for these gifts.
Gilder’s example from
history: One hundred fifty to three hundred years ago, Tlingit Indians of
the Pacific Northwest had a tradition called potlatch. This involved
the richest man throwing a party and giving away all of his
possessions. In turn, he would be
the poorest man, but first in line to receive at the next potlatch. Gilder views entrepreneurs
as frequently driven by a similar “potlatch” motive.
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