Friday 25 May 2012

If Obama is a socialist, so was Adam Smith

James Otteson, professor of philosophy and economics and author of learned books on Adam Smith and other weighty subjects recently wrote a short paean to capitalism - An Audacious Promise: The Moral Case for Capitalism. He begins by noting that "President Obama has oddly claimed that we’ve tried free-market capitalism, and it 'has never worked'." Yet by the criterion Otteson is using - criticising the sufficiency of free markets in any way - Otteson's own libertarian hero, Adam Smith, must also have been against capitalism.

Otteson's positive moral argument for capitalism has some agreeable parts. Yet his framing of the issue is rather peculiar. He begins with this quotation from an important speech on economic policy by President Obama.
"The market will take care of everything," they tell us…. But here’s the problem: it doesn’t work. It has never worked. It didn’t work when it was tried in the decade before the Great Depression. It’s not what led to the incredible postwar booms of the ’50s and ’60s. And it didn’t work when we tried it during the last decade. I mean, understand, it’s not as if we haven’t tried this theory. (Remarks by the President on the Economy in Osawatomie, Kansas, December 6, 2011)
Otteson interprets this as a rejection of capitalism. Yet what it actually appears to be is a rejection of the claim that "The market will take care of everything”. Is this the same thing as rejecting capitalism? Not according to Adam Smith, whom Otteson quotes effusively later in his essay. As I noted in a previous post, Smith was a 'true friend' of commerce, supporting the project because of its achievements and its even greater potential, but constructively critical about both the shortcomings of the mercantilist society he lived in and commerce in general. Smith was no naive ideologue for free markets and profits. First, he described political economy as "as a branch of the science of a statesman or legislator" (WN IV.I.1) not as the study of free markets in their natural state. Second, he made explicit recommendations about government interventions and regulations properly justified by the public interest.

As to interventions, while Smith's ‘laissez-faire economics' proposed taking government out of the business of micro-managing the economy, it also outlined a clear and extensive government responsibility for ensuring the conditions for a flourishing free and just economic system. That included organising (though not necessarily directly providing) public goods that private market actors did not have the necessary credibility, scale, profit-incentives, or long-term perspective to provide, including legal justice, universal education, transport infrastructure, and security. Smith did not believe that "The market will take care of everything".

Smith's regulatory proposals were directed at preventing systemic failures and some remain highly pertinent (certainly they are pertinent to the speech by Obama that Otteson so dislikes). For example, Smith proposed banking regulations which though “in some respect a violation of natural liberty” upon a few individuals were justified by the government’s duty to protect “the security of the whole society” (WN II.ii.94). And he argued for fixing the rate of interest at a relatively low level (just above the prime market rate) in order to prevent imprudent “prodigals” (sub-prime borrowers) and “projectors” (speculators with crazy South Sea Bubble type schemes) from getting access to credit and thus diverting it from prudent investment and putting the financial system at risk. That is, unlike present-day supporters of the Efficient Market Hypothesis (and his own contemporary, Jeremy Bentham), Smith saw prudence as an individual virtue, and thought markets were good at teaching it but unfit to substitute for it. He did not think the market was always right.

Reading Obama's speech in full, what do we find? Does he condemn capitalism and propose socialism? Hardly. Far from rejecting capitalism, Obama explicitly embraces it, and for much the same reasons Otteson does. He says that, 
the free market is the greatest force for economic progress in human history. It’s led to a prosperity and a standard of living unmatched by the rest of the world.
Most of Obama's speech is eminently conventional and indeed eminently Smithian (though of course Obama makes reference to democratic values that are absent from Smith). Obama talks a lot about improving capitalism by improving and enforcing systemic regulation and consumer rights and protections. And he talks about the US government's role in providing the conditions for a flourishing economy in a globalised world. Not by anti-capitalist protectionist measures that exclude competition, but by providing the public goods - like transportation and communications infrastructure, advanced training/education and equality of opportunity (otherwise known as meritocracy) - that would increase America's productivity and hence prosperity.

Let me turn now to Otteson's own paean to capitalism. Although he does a good job showing how it promotes prosperity, dignity and freedom - all of which are significant - his essay is missing something which is central to the thinking of both Smith and Obama: justice.

Otteson makes the trivial point that all individual voluntary transactions are mutually beneficial ("positive sum"). The point is trivial because it is true by definition from the account of utility that contemporary economists employ - it amounts to saying 'if people engage in a voluntary transaction it's because they want to'. It doesn't mean that both parties will necessarily be better off materially or financially as a result. Nor does it establish that this pareto optimality will obtain at the scale of an entire real market economy. A decentralised system of voluntary exchanges certainly has libertarian virtues, but it is a mistake to presume that it always has good outcomes. At the extreme, Amartya Sen has noted that famines that kill millions are quite compatible with functioning market systems, when the food purchasing power of a section of society suddenly collapses.

In understanding the real achievement of capitalism we should look not to social mathematics (pareto optimality), but to Smith's analysis of the possibilities and forces unleashed in a market economy. As Otteson does note, the market provides the scope and incentives to individuals to find new and efficient ways to produce things to exchange with others. That's where the material prosperity - the wealth of nations - comes from.

Otteson simply dismisses the argument that this system of voluntary transactions can go along with the generation of extreme inequality by saying that under capitalism everyone will get richer and overcoming poverty is much more important than equality. But do we really have to make a choice between poverty and inequality? Don't the counter examples of contemporary N. Europe and Japan, or America in the 1960s, suggest the question is more nuanced?

Is it even true that inequality is always consistent with rising general prosperity? As Obama noted in his speech, the recent increases in income for the richest Americans coincided with a real income decline of 6% for most Americans over the last 10 years - the specific period he identified with trying to implement the theory that “The market will take care of everything”.

Nor, over the longer term and excluding this recession, has rising inequality been as great for US median and lower incomes as it has been for GDP (as this graph of pretax income from 1979-2007 shows). That is because in a real economy - not the toy model-economy Otteson is employing for this part of his essay - large inequalities of wealth lead to inequalities of political influence and opportunity over time (as real world economists like Joseph Stiglitz and Daron Acemoglu have pointed out).

Smith, too, was deeply concerned about how the economy distributed its surplus. First, because he analysed the wealth of a nation as the ability of its ordinary citizens to command goods to satisfy their wants i.e. not only the total wealth but also its distribution. Second, because he was deeply concerned about justice. In fact it was justice - not liberty - that Smith held to be sacred.
No society can surely be flourishing and happy, of which the far greater part of the members are poor and miserable. It is but equity, besides, that they who feed, cloath and lodge the whole body of the people, should have such a share of the produce of their own labour as to be themselves tolerably well fed, cloathed and lodged. (WN I.viii.36)
Smith famously understood justice in a strictly commutative way. He certainly did not think government should be in the business of 'redistributing' wealth between different groups in society. Yet Smith's concept of justice still had a lot of bite, and it is the foundation for his proposal of a ‘system of natural liberty’ characterised by a level playing field and commitment to fair play.

Smith's use of sporting metaphors for competition is apt because it introduces a concern that the rules of the game - the institutional arrangements that decide who should get what share of the gains of economic activity - should themselves be fair. If a country's economy creates great wealth but the share going to the workers versus the owners of capital is kept artificially low by unfair institutions (like restrictions on workers' ability to bargain, or rent generating monopolistic positions and privileges) that is a gross injustice. It redistributes wealth from one part of society to another which hasn't earned it (in other words, it functions like a tax, but without the political accountability of a real tax). And it thereby keeps the country less prosperous than it ought to be.

It is one thing to say that capitalism has accomplished much. It is another to say that it couldn't do even better. Smith spent most of The Wealth of Nations criticising the institutions of his contemporary commercial society and was far from optimistic that anything resembling his 'system of natural liberty' could ever be realised in the face of powerful vested private interests (e.g. on free trade). Ha-Joon Chang's book, Kicking Away the Ladder, for all its faults, does a good job of showing how right Smith was about that. Smith saw the establishment of a genuinely free and just commercial society as an ongoing ethical and political project that had to be continually struggled for. Not a machine that was ushered into being 200 years ago by the publication of his book that should be left to run by itself.

Otteson appears to agree: 
Capitalism is not perfect. But no system created by human beings is, or ever will be, perfect. The most we can hope for is continuing gradual improvement. To this end, we must honestly examine the prospects of the available systems of political economy.
Yet if this is so, what exactly is his complaint about Obama's economics? For Smith, as for us, a political commitment to the 'system of natural liberty'  does not imply simply accepting the existing institutional arrangements of our society without scrutiny. Are they competitive? Are they efficient? Are they sustainable? Are they fair? How do we make them better? It is exactly this kind of questioning that runs through Obama's speech. Not whether to drop free-market capitalism and try something else.

As Deirdre McCloskey, the libertarian but humanist economist and scholar who has clearly had a great influence on Otteson's thinking about capitalism, wrote in Bourgeois Virtues,
A democratic but cultured and creative capitalism is possible, and to our good. It needs to be worked on. You come, too.

Note: Amended slightly in light of Otteson's (first) comments, below