Friday, May 7, 2010

Reassessing Adam Smith

Much has been written about this. Adding to the literature are these two recent essays, by Amartya Sen and Stephen LeRoy, which tries to reassess the legacy and modern interpretation of Adam Smith in light of the spectacular financial market failures of the past two years.

Sen revisits the debate that Wealth of Nations cannot be read in isolation but has to be necessarily read with Smith's first book, The Theory of Moral Sentiments,

"Since the ideas presented in The Wealth of Nations have been interpreted largely without reference to the framework already developed in Moral Sentiments (on which Smith draws substantially in the later book), the typical understanding of The Wealth of Nations has been constrained, to the detriment of economics as a subject. The neglect applies, among other issues, to the appreciation of the demands of rationality, the need for re­cognising the plurality of human motivations, the connections between ethics and economics, and the codependent rather than free-standing role of institutions in general, and free markets in particular, in the functioning of the economy."

Far from beinng a fanatic laissez faire advocate, Smith acknolwedged the strong possibility of market failures

"The spirited attempt to see Smith as an advocate of pure capitalism, with complete reliance on the market mechanism guided by pure profit motive, is altogether misconceived. Smith never used the term "capitalism"... Smith was convinced of the necessity of a well-functioning market economy, but not of its sufficiency... He rejected market-excluding interventions, but not market-including interventions aimed at doing those important things that the market may leave undone...

He defended such public services as free education and poverty relief, while demanding greater freedom for the in­digent who receives support than the rather punitive Poor Laws of his day permitted... in dealing with regulations that restrain the markets... he gives a formula of disarming simplicity: "When the regulation, therefore, is in favour of the workmen, it is always just and equitable; but it is sometimes otherwise when in favour of the masters"...

He emphasised the class-related neglect of human talents through the lack of education and the unimaginative nature of the work that many members of the working classes are forced to do by economic circumstances. Class divisions, Smith argued, reflect this inequality of opportunity, rather than indicating differences of inborn talents and abilities..."

Stephen LeRoy examines the issue of the appropriate balance between the dynamics of the market and government intervention in the context of the debate about the causes of the recent financial market crisis. Instead of faulting the government for misconceived interference (as claimed by the free-marketers) or government's failure to place checks on destructive market practices and market failures (as claimed by opponents), he advocates identifying "specific problems in the financial system and introducing regulatory changes that address these clearly defined weaknesses, such as executive compensation practices that encourage excessive risk-taking".

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