Smith on Laissez-Faire, Markets and Morals

Edward A. Fallone writes in the Marquette University Law School Faculty Blog
HERE

“As R. Kent Newmyer succinctly summarized it, in his book “John Marshall and the Heroic Age of the Supreme Court,” Marshall understood the rights of property ownership to include an individual’s right “to acquire property and deploy it creatively as he saw fit and to enjoy its fruits without hindrance.” (Newmyer p. 264) But this does not mean that Marshall embraced Adam Smith’s theory of completely free markets, where private business enterprises act completely free from government regulation. First of all, not even Adam Smith advocated for markets that were sealed off from all government regulation. Second of all, while the Framers of the Constitution were aware of Adam Smith, there is little evidence that Smith’s economic theories influenced the Constitution.”

Comment
Adam Smith did not have a “theory of completely free markets” – he did not subscribe to the laissez-faire views of some of the French Physiocrats and did not use the phrase at all. All of the beliefs that he did have such a theory are attributions from the 19th century; at best they were careless exaggerations that missed the nuances of Smith’s political economy; at worst they were the self-interested preferences of merchants and manufacturers in the industrialization of Britain (see: The Economist, the parliamentary spokesmen for mill owners, The Anti-Corn Law League, the Manchester School, J. S. Mill, and non-readers of Wealth Of Nations).

The whole tenor of Wealth Of Nations was about how unfree markets were in 18th century Britain, characterised by the deliberate actions of ‘merchants and manufacturers’ and of mercantile policies favoured by legislators and those special interests that influenced them.

In proposing that these interventions in markets should be swept away, Smith carefully acknowledged that markets should be operated under the rule of law and under the moral guidance of participants.

To ensure compliance, Smith indicated that regulations may be necessary on a case-by-case basis (example: banking, assaying, indicating the quality of certain manufacturers; buildings posing fire risks; and public cleanliness and safety). It was also essential that government intervene in the procurement of certain public works to facilitate commerce and certain public institutions to facilitate education, healthy minds and treatment of obnoxious diseases.

Edward A. Fallone’s assessment is correct broadly.

[NB: Edward Fallone, Associate Professor at Marquette, carries the following in his faculty biography:

“When I was a law student, my Corporate Law professor treated the study of insider trading, hostile takeovers and corporate crimes as the dry recitation of legal rules to be memorized. My approach to teaching is different. I teach these cases as human tragedies (and sometimes comedies) involving greed, betrayal and corruption. In my view, the law in this area serves the classic end of all laws: to protect ourselves from our own worst impulses.”

This about as close to a genuine moral ‘Smithian’ approach to people in markets as you can get.]

A Student Who Reads Smith for Himself

Dan Hirschman writes “A (Budding) Sociologist’s Commonplace Book” Blog HERE:

"Adam Smith on Systemic Risk, ca. 1776

Adam Smith is sometimes heralded as the foundational thinker of laissez faire economics. As many people have written before, Smith was not a doctrinaire proponent of laissez faire, but rather took a pragmatic approach that started with the principle of promoting natural liberty to the extent possible, but recognized times when government must encroach on that liberty to promote everyone’s welfare.
Smith’s chapter on Money (book 2, ch. 2) in The Wealth of Nations provides an excellent example. Smith has a lengthy discussion of bank notes and other forms of paper money as supplements to hard currency. Smith generally favors such notes, especially in relatively large denominations for use in transactions between businessmen or banks themselves. Smith worries about small denominations of paper money because such small denominations are much more likely to be accepted at first, even when issued by someone of questionable credit, and then end up going unpaid and causing lots of bankruptcies (Wealth 351-352). Smith concludes this discussion with a recommendation for government intervention":

"To restrain private people, it may be said, from receiving in payment the promissory notes of a banker, for any sum whether great or small, when they themselves are willing to receive them; or, to restrain a banker from issuing such notes, when all his neighbours are willing to accept of them, is manifest violation of that natural liberty which it is the proper business of law, not to infringe, but to support. Such regulations may, no doubt, be considered as in some respect a violation of natural liberty. But those exertions of natural liberty of a few individuals, which might endanger the security of the whole society, are, and ought to be, restrained by the laws of all governments; of the most free, as well as of the most despotical. The obligation of building party walls, in order to prevent the communication of fire, is a violation of natural liberty, exactly of the same kind with the regulations of the banking trade which are here proposed. (Wealth 353)"

"In other words, if your liberty could lead to a major negative consequence for many people who have no part in your actions, the government should step in to prevent such harm. Sounds like a pretty good justification for regulating derivatives and other financial instruments to me!”

Comment
Dan Hirschman (now that’s a name to contemplate in economics) appears to be well informed on Adam Smith (see his earlier post on his Blog on Adam Smith and laissez faire via Jacob Viner’s 1926 seminal paper on the subject). This is probably because Dan Hirschman, as an ultra-keen, serious student takes the trouble to read Smith’s books for himself and not rely on “summaries” (A.K.A. epigonic inventions) from his tutors.

Have a look at his website and enjoy.

Adam Smith on Government Roles

By Dr Bharat Jhunjhunwala writing (22 November) in Organiser (HERE):

“Economy Watch - In defence of regulation of markets”

“This veneration of free markets was first propounded by famous economist Adam Smith about 200 years ago. He said that competition in a free market establishes public good as if an invisible hand was guiding the businessmen. There was no need to separately worry about public good. His logic was like this. Competition in the market pushes the businesses to produce goods at a lowest cost. This leads to cheap goods being made available to the people. For example, I had brought an electronic calculator from United States for my father in 1973 for 100 dollars or about Rs 1,000 at that time. Today, a much better calculator is available for Rs 50 because of the improvements brought about by competition. The slum-dwellers today have the pleasure of watching the TV and drinking cold water from the refrigerator because of the steep reduction in the price of these goods. Thus Adam Smith suggested that the government must not interfere in the market.”

Comment
Question to Dr Bharat Jhunjhunwala:

Exactly where does Adam Smith makes the statement: “that competition in a free market establishes public good as if an invisible hand was guiding the businessmen. There was no need to separately worry about public good?”

This is a paraphrase at best and a distortion of Adam Smith.

He never used the words “as if and invisible hand was guiding businessmen”. The addition of “as if” to his use of the metaphor of an invisible hand is fairly common among those who have not read Wealth Of Nations in general and the single paragraph in Book IV (chapter 2, paragraph 9: page 456) in which he uses the metaphor of ‘”an invisible hand”.

He most certainly never linked the metaphor to “competition” (which he discussed in Books I and II). He expressed reservations about leaving all decisions to “merchants and manufacturers” and such personages as bankers and their clients, especially where this “might endanger the security of the whole society” (WN II.ii.94: 324).

Nor did Adam Smith suggest such an extreme view “that the government must not interfere in the market”.

He saw a role for government, or public agencies, in stamping cloth and conducting assay tests on precious metals, to ensure that they been inspected for quality, that it should manage the currency and coinage, run the post office and general supervise markets and contract-making through an independent judiciary, and provide wholly or in part a national education system – and make a start on dealing on palliative care with “obnoxious diseases” like leprosy. All this, plus “facilitating commerce” by public works.

Smith on Banking Regulation

Dr Hugh Goodacre, a teaching fellow at University College London, writes to the Financial Times (10 November) HERE on the subject of the “arbiter’s” role of the ‘invisible hand’ as presented earlier by Michael Rossman, who “praised” the “invisible hand” as “the arbiter of success and failure”.

Hugh Goodacre disagrees, pointing out that Adam Smith “makes it clear “that for an economy to be guided by his ‘invisible hand’ is not a reality, but an ideal”.

Moreover, says Goodacre, “the Bank of England acts “not only as an ordinary bank, but as a great engine of state”, and, according to Smith, “the stability of the Bank of England is equal to that of the British government” and ‘is too big to fail”.

Comment
Apart from the usual myth and invention about the role of the “invisible hand”, Goodacre is surely right.

Smith considered it permissible to override the imperatives of “Natural Liberty”, especially in banking (I have quoted many times his insistence of regulation to stop low-value ‘promissory notes’ being issued by banks at WN II.ii.94: 324), so those who quote him as an authority against regulation where it is appropriate, as defined by Smith, mislead their readers.

[Incidentally, the Financial Times, adds this proviso to the above brief letter:

“Copyright The Financial Times Limited 2009. You may share using our article tools. Please don't cut articles from FT.com and redistribute by email or post to the web.” I am not sure why they are so draconian, though I am also sure my quotation meets the “fair use” criterion, but I am not sure that such necessary treatment portrays Michael Rossman's point of view adequately.]