To Predict It Is Necessary to Know Your History

Dani Rodrik, Professor of Political Economy at Harvard University’s John F Kennedy School of Government, writes in the Business Standard (India) HERE:

“Those who predict capitalism's demise overlook its historical malleability.”

“Capitalism is in the throes of its most severe crisis in many decades. A combination of deep recession, global economic dislocations, and effective nationalization of large swathes of the financial sector in the world’s advanced economies has deeply unsettled the balance between markets and states. Where the new balance will be struck is anybody’s guess.

Those who predict capitalism’s demise have to contend with one important historical fact: capitalism has an almost unlimited capacity to reinvent itself. Indeed, its malleability is the reason it has overcome periodic crises over the centuries and outlived critics from Karl Marx on. The real question is not whether capitalism can survive — it can — but whether world leaders will demonstrate the leadership needed to take it to its next phase as we emerge from our current predicament.

Capitalism has no equal when it comes to unleashing the collective economic energies of human societies. That is why all prosperous societies are capitalistic in the broad sense of the term: they are organized around private property and allow markets to play a large role in allocating resources and determining economic rewards. The catch is that neither property rights nor markets can function on their own. They require other social institutions to support them.

So property rights rely on courts and legal enforcement, and markets depend on regulators to rein in abuse and fix market failures. At the political level, capitalism requires compensation and transfer mechanisms to render its outcomes acceptable. As the current crisis has demonstrated yet again, capitalism needs stabilizing arrangements such as a lender of last resort and counter-cyclical fiscal policy. In other words, capitalism is not self-creating, self-sustaining, self-regulating, or self-stabilizing.”

“The history of capitalism has been a process of learning and re-learning these lessons. Adam Smith’s idealized market society required little more than a “night-watchman state.” All that governments needed to do to ensure the division of labour was to enforce property rights, keep the peace, and collect a few taxes to pay for a limited range of public goods.”

“The share of public spending in national income rose rapidly in today’s industrialized countries, from below 10 per cent on average at the end of the nineteenth century to more than 20 per cent just before World War II. And, in the wake of WWII, most countries erected elaborate social-welfare states in which the public sector expanded to more than 40 per cent of national income on average.”
“The lesson is not that capitalism is dead. It is that we need to reinvent it for a new century in which the forces of economic globalization are much more powerful than before. Just as Smith’s minimal capitalism was transformed into Keynes’ mixed economy, we need to contemplate a transition from the national version of the mixed economy to its global counterpart.”

This means imagining a better balance between markets and their supporting institutions at the global level. Sometimes, this will require extending institutions outward from nation states and strengthening global governance. At other times, it will mean preventing markets from expanding beyond the reach of institutions that must remain national. The right approach will differ across country groupings and among issue areas.

Designing the next capitalism will not be easy. But we do have history on our side: capitalism’s saving grace is that it is almost infinitely malleable.”

Comment
Dani Rodrik is an excellent economist and thoughtful commentator, and I have considered his contributions to international debate as constructive. I have to make some fairly basic points about his post in the Business Standard (you should read his article in full by following the link).

He starts off well, even prophetically: “Those who predict capitalism's demise overlook its historical malleability”, which is well worth many current commentators reading and thinking about, who, jumping the gun, predict the imminent demise of all forms of capitalism, much of it in the form of the State-Capitalism most of us live in.

Those who approach such a prospect with joyful hope are going to be disappointed.
As I was disappointed to read Dani’s paragraph:

‘Adam Smith’s idealized market society required little more than a “night-watchman state.” All that governments needed to do to ensure the division of labour was to enforce property rights, keep the peace, and collect a few taxes to pay for a limited range of public goods.’

This is a crude caricature of Adam Smith’s observations about the commercial society he lived in, and what he proposed for it as it increased the annual output of the ‘necessaries, conveniences, and amusements of life’ and, not forgetting, as it ‘spread opulence’ towards the labouring poor. His time-scales somewhat longer than a politician’s electoral horizon – even longer than a dictator’s life expectancy.

Dani uses the well-worn phrase, “night-watchman state” in association with the name of Adam Smith, as if the two go together in an eternal association. Strange! Given that the “night-watchman state” was uttered first by Ferdinand Lassalle, the fire-brand, 19th-century State Socialism, when he was mocking the laissez-faire politicians of the right for fiddling for penny profits in business and ignoring (what was obvious to socialists like Lassalle and his ilk) the far greater power and authority that would come from gaining controlling the State. No piddling capitalist ever controlled as much wealth and command over resources of the most petter politician!

But Adam Smith’s ideas were not limited by visions of a “night-watchman state”.

Writing in the mid-18th century, Smith’s agenda for government was already extensive, and promised by inevitable osmosis a far from insignificant state employing ‘night watchmen’.

At the time, defence was already a major expense of government; it did not diminish in the coming century, with its global reach of the Royal Navy and a military reach to match.

The growth of the expense of justice was already threatening to reach beyond the relatively passive bounds of local magistrates, especially as the list of capital crimes grew inexorably beyond the capacity of jails and ship’s hulks to hold those not hanged, so much so that the expense of founding a new colony in New South Wales was undertaken in 1788.

Smith’s agenda for public works and public institutions that ‘facilitated commerce’ was so extensive that it would take near on a hundred years to build and improve the necessary roads, canals, harbours and bridges, and by then whole new projects were added to the rising financial powers of municipal governance from the industrial ‘revolution’.

In education, universal provision across the 60,000 parishes of ‘little schools’ on the Scottish model, required 60,000 school buildings, teaching staffs, libraries and furniture, plus their annual maintenance, paid for partly by the state and by parents. He even had a scheme for gymnasia for exercises and crude martial fitness.

Significantly, Smith also alluded to primitive health measures in Wealth Of Nations, worthy of the government’s ‘most serious attention’ to prevent the spread of ‘leprosy or any other loathsome and offensive disease’. It would start there and expand when dealing with other health issues considered to be ‘so great a publick evil’. (WN V.i.f.60: pp 787-88)

Similarly, policies to meet the ‘police’ obligations of Britain’s towns implied considerable municipal expenditures (and taxes) to meet the needs for night lighting, pavements, disposal of soil and rubbish, and the maintenance of law and order.

True, the total expenditure required in Adam Smith’s Britain was relatively small alongside the total expenditure that would be required in the continental United States by the time of Ferdinand Lassalle (1870s). But it was much, much more than a ‘night watchman state’.

Dani claims that Smith believed: “All that governments needed to do to ensure the division of labour was to enforce property rights, keep the peace, and collect a few taxes to pay for a limited range of public goods.”

This is journalism, echoing the 1755 paper of Smith's, but is not a proper audit of Smith's ideas by a leading economist.

I suspect that Adam Smith and ‘division of labour’ go together in the minds of Dani’s readers, but with industrialisation, the division of labour in the pin factory had been superseded by the much more significant increasing division of labour of the kind alluded to by Adam Smith in his example of the day labourer’s ‘woollen coat’ and the long and complex supply chain required to produce this simple item. (WN I.i.11: pp 22-24)

The implications of this less well-known example of Smith’s insight (how few read on past the pin factory?) has been reactivated following the ‘re-discovery’ of Allyn Young’s 1928 article, ‘Increasing returns Increasing Returns and Economic Progress’, (Economic Journal, vol. 38. 1928: pp: 527-42).

Dani anticipates that “Designing the next capitalism will not be easy”. But if the ‘next capitalism' is down to ‘human design’, I must express scepticism as to its practicality. Capitalism was not designed, though futile attempts at socialism were ‘designed’, but unfortunately did not work out for those who had to endure the experiments.

Societies can legislate for this or that form of parts of their economies; sometimes they work, and last for a while, voluntarily; most often they don’t.

Social evolution is not about design, it’s about experimenting, sometimes intentionally, sometimes unintentionally. It has ever been thus. That is why history if littered with social experiments – the pyramids, the ‘hanging gardens' of Babylon, the Great Wall of China, the Scottish clans, the French majesties, ancient Greece and Rome, the hordes of Genghis Khan, Mahomet’s promises, the Czar’s empire, and the anonymous stone-tool makers of pre-history.

Globalism does not make co-ordinated design any easier, or local initiatives more difficult.

At root, when all else is failing, the Smithian urges to ‘self-betterment’, the ‘propensity to truck, barter, and exchange’ to ‘avoid toil and trouble’, will assert themselves, no matter what else is happening, somewhere among some people, humanity will start over.

Adam Smith and Charles Darwin

The Sensuous Curmudgeon [SC] Blog (16 December) discusses “Adam Smith’s Invisible Hand and Charles Darwin’s Natural Selection” (HERE):

[First SC quotes part of ‘the invisible hand’ reference - ‘with paragraph breaks supplied’ by SC]:

“As every individual, therefore, endeavours as much as he can both to employ his capital in the support of domestic industry, and so to direct that industry that its produce may be of the greatest value; every individual necessarily labours to render the annual revenue of the society as great as he can. He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it.

By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.

Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good. It is an affectation, indeed, not very common among merchants, and very few words need be employed in dissuading them from it.”

[I have already quoted the fuller reference in my previous post. SC asks:]

“Where does Darwin’s theory of evolution fit into this?

It has often been remarked that the theory of evolution, according to which life on earth evolves without the guidance of a designer, is remarkably similar to the way a free-enterprise economy develops, with each enterprise doing its best to prosper, yet without the “benefit” of a centralized planner.

Was Charles Darwin influenced by Adam Smith? He was certainly aware of Smith’s work. Darwin mentioned Smith in Descent of Man, and provided a footnote to Smith’s Theory of Moral Sentiments. See: The Descent of Man. But that was in connection with Darwin’s discussion of emotions. It was his only mention of Smith, and he never used the expression “invisible hand.” We wish he had, as it would have been a useful metaphor for the misleading appearance of intentional design in nature.
Although it’s easy to make too much of this, we observe that throughout Origin of Species, Darwin uses the expression “economy of nature.” Additionally he has passages that literally suggest economic behavior, such as this in Chapter 4 - Natural Selection:

We leave you with the following tentative conclusions: (1) Darwin was a late product of the Scottish Enlightenment; (2) Darwin was influenced by Adam Smith’s ideas, far more than is apparent from his one mention of Smith; and (3) The theory of evolution is remarkably compatible with free enterprise economics, especially regarding the ‘invisible hand’.”

Comment
When I read Charles Darwin’s, The Descent of Man, and selection in relation to sex’, [1871] 1981, Princeton University Press, New Jersey, in 2003 (I was researching the pre-history of bargaining at the time), I marked the paragraph referring to Adam Smith in Part 1, chapter III, p 81 and footnote 17, because it discusses, if briefly, Darwin’s assessment of Smith’s views on ‘sympathy’ from chapter 1 of Moral Sentiments.

In distinction to Smith, Darwin concludes that ‘sympathy’ became an instinct (much like Francis Hutcheson, Smith’s tutor, asserted). This certainly establishes that Charles Darwin had read Moral Sentiments, or at least chapter 1.

First, SC includes the following sentence quoted above: “It was his [Charles Darwin’s] only mention of Smith, and he never used the expression “invisible hand.”

This is a strange statement from SC given that hardly anybody mentioned the ‘invisible hand’ metaphor in the 19th century. It did not have the significance given to it from mid-20th-century onwards. From this, I conclude that SC has not himself read Wealth Of Nations with its sole reference to the metaphor and acts on the modern popular myth that the metaphor had far greater significance than was accorded to it both by Adam Smith and by his 18th- and 19th- century readers.

Secondly, SC notes that evolution suggests that “life on earth evolves without the guidance of a designer” and is “remarkably similar to the way a free-enterprise economy develops, with each enterprise doing its best to prosper, yet without the ‘benefit’ of a centralized planner”. I agree with both statements.

However, SC seems to reverse his statement, that both evolution and the economy develops without ‘benefit of a centralized planner’, with his ‘tentative conclusion’ that “the theory of evolution is remarkably compatible with free enterprise economics, especially regarding the ‘invisible hand’ ” Yet the existence of ‘an invisible hand’ would suggest that these statements are contradictory.

If life evolved without ‘intentional design’, as I believe it did, and economies evolve ‘led by an invisible hand’ (which I consider nonsense and contrary to Smith’s treatment of markets, in which he never mentions an invisible hand) then it cannot be “a useful metaphor for the misleading appearance of intentional design in nature”.

Why do we need an invisible hand metaphor to deny ‘intentional design’ when how markets evolve and operate are themselves a clear example of the denial of such an assertion to begin with?