Rediscovering Adam Smith: 5 Questions for Biographer Nicholas Phillipson | Britannica Blog Adam Smith is revered as the father of modern economics and admired as one of the principal figures of the Scottish Enlightenment. That said, he is more admired than read these days; snippets from his Wealth of Nations are the fare of undergraduate economics and political science courses, but his other works are scarcely mentioned. Britannica contributing editor Gregory McNamee sat down with biographer Nicholas Phillipson, author of the recently published Adam Smith: An Enlightened Life, to find out why.
21st Century Regress Sometimes it seems like the world is going to hell and there's absolutely nothing a girl economist can do about it.
What Exactly Are We Crowding Out? The current economic downturn isn't a random draw of a black ball from an urn containing white balls and black balls. There's no sampling distribution. Very specific policies and actions landed us here. Now we must decide not only what policies need to be put in place to prevent it happening again, but also what policies would best drive us out of the ditch faster and sustainably.
I Wish It Were Only Butter We should be giving up some butter if we must. We should not give up education or health investment (or infrastructure or the environment (hello, BP). They may be the only legacies of any value that we pass on to our children and grandchildren.
Rational Health Investment? The obvious "market solution" is to improve the long run return on investments in health among the disadvantaged through meaningful and effective publicly funded education. The obvious short run "market solution" is to reduce the costs of investment and the shadow price of health for the disadvantaged by providing health insurance cover and reduced out-of-pocket costs.
The Socrates Parameter To the extent that our limbic systems respond to such engineering by over-riding the judgment of our frontal lobe and to the extent that our frontal lobe is deprived of the information it requires to make a rationally self-interested judgment, we are not only pigs and fools, we are slaves.
The Economic Rewards of Virtue If individual virtue tempers our "piggy" desires and conditions our choices to something that is both individually and socially better, then the economic rewards of virtue as embodied in and promoted by societal norms and institutions are far greater than we have ever suspected. As economists, we would do well to recognize this when we teach U max.
The Market for Morals Markets then are places where more is exchanged than goods and services, labor and product, credit, and interest. They are places where we also develop the personal virtues of temperance and prudence and the social virtues of benevolence and justice. When they function well, they produce trust, loyalty, and sympathy among those who trade there.
Post-Modern Applied Economics: It’s the Error Term, Stupid Maxine believes it’s time to refocus attention and discussion on the error term. It is often where much of the action is in our models. It is where unexpectedly catastrophic events dwell resulting in fat tails. It is where our animal spirits manifest and cause us to do the right thing or the wrong thing or the thing everyone else is doing rather than the self-interested, fully-informed rational thing. It is where God and miracles and chance dwell.
Short-term Private Payoffs, Long-term Social Costs The real health reform discussion, the one we should be having, is “What must we do to create a health system that is both efficient and fair?” The answer will almost certainly include relegating the private sector to markets where market forces or regulation are effective at aligning short-term private incentives and goals with long-term societal interests. If such markets are scarce or non-existent in health, then the private health sector will be of limited value.
This was sent to me by a friend. Many of you may already have seen it. The sound is too low for speakers. Headphones will remedy this. The lecture itself is excellent. Sen provides a more accurate account of Adam Smith's notion of self-interest than is commonly found in political and economic discourse. There are also excellent descriptions of the public good aspects of health and the environment. I highly recommend it.
Commenter Peter Kurze offered the following comment in reply to my blog on The Rules of the Game. It is very similar to my own
thoughts on this topic. For this reason, I am featuring Peter’s comment as a
“guest” blog in order to highlight it. Thank you, Peter, for a thoughtful and thought provoking comment.
A couple of weeks ago in reaction to this post
over at Baseline Scenario I started this:
When I read stuff like this I can't help but
think that it will never be enough to hem this game in with regulation. We
need, to take a figurative phrase and apply it literally, a game changer. The
game itself is wrong. These guys don't need to worry about blocking whatever
regulatory scheme is proposed, all they need are a couple of little pinholes
and regulation is a party balloon.
I keep coming back to something Wayne Gretzky
said, “A good hockey player plays where the puck is. A great hockey player
plays where the puck is going to be.” I have no idea (and the regulators are
pretty much in the same boat) what kind of schemes these guys will come up with
to game the system, but I know what they are after, and for me, when all of the
pluses and minuses have been tabulated, I would be willing to deny it to them
by fiat. Let's just put a cap on income.
This is admittedly a draconian solution, and I
am not even sure I like it much, but I like the simplicity of it. I like the
idea of creating counter incentives, as opposed to rewards, for market
distorting activity. I know there are lots of legitimate exceptions, but I do
not see in general that at the high end of the income distribution curve there
is that much meritocracy. If that is true, and I'm not entirely sure that it
is, the question is, does the harm done to the exceptions outweigh the benefit
to society of putting an effective end to this culture of malfeasance.
The standard argument against highly progressive
tax schemes is that it destroys the incentive to work hard. I really cannot buy
this argument. In the first place, if 500K isn't enough to get you up out of
bed in the morning and doing your best, you are either a.) not motivated by
money at all, b.) so jaded I don't want you anywhere near the finances of my
nation, or c.) enough past it that it is time you focused on your begonias. But
more importantly I don't believe that people who are passionate about
accomplishing some worthwhile goal are going to be dissuaded by the fact that
the financial upside is not infinite. If your goal is the acquisition of money
for its own sake, without actually producing something of value, then it would
be much more of a disincentive, and personally I'm just fine with that.
It's not even that I would object to a few
people making an inordinately large fortune playing these kinds of games if the
net effect was to accomplish something vital that is consistent with the
concept of the general welfare. Instead though, what we have is a system that
by its very nature poisons and distorts the ethos of the larger society. The
term investment has for most become synonymous with speculation and ethical
behavior in business has been redefined as just avoiding prison.
I'm not sure I'd be willing to stand by [the
above] in a technical sense, but I wanted to throw it out there to stir the
pot. Perhaps put another way it makes more sense. Would you be willing to forgo
the possibility of ever becoming an oligarch in exchange for a guarantee to
live in a world freed from oligarchy?
Maxine here: As I’ve said before, Peter, you really
should start a blog. I could not have said any of this better and doubt I could
have said it as well. Thank you.
I've been thinking about "the rules of the game." Consider this from a recent ProPublicaarticle by Jesse Eisinger and Jake Bernstein on Magnetar, the hedge
fund that took short positions on CDOs it helped create and that it appears also
helped to fail (thereby realizing large gains from its short positions):
what we've learned, there was nothing illegal in what Magnetar did; it was playing by the rules in place at the
time. And the hedge fund didn't cause the housing bubble or the financial
crisis. But the Magnetar Trade does illustrate the perverse incentives and
reckless behavior that characterized the last days of the boom.
“The rules in place,” I said to myself. “What does this remind me of?” And then I remembered:
is one and only one social responsibility of business—to use its resources and
engage in activities designed to increase its profits so long as it stays
within the rules of the game, which is to say, engages in open and free
competition without deception and fraud.
Friedman, Capitalism and Freedom, Ch VIII
Clearly, if the ProPublica article is accurate, Magnetar scores high on
“deception and fraud.” The problem is, as the article notes, perverse private
incentives led to suboptimal social outcomes yet no laws were broken. Magnetar was playing by the rules of the game while betting against the American dream.
Friedman had great confidence that the rule of
law was sufficient in combination with competitive market forces and a modicum
of self-interest to assure individual virtue, societal cohesion, and economic
growth. That confidence resulted in a role for government limited mainly to determining and enforcing the rules of the game:
existence of a free market does not of course eliminate the need for
government. On the contrary, government is essential both as a forum for
determining the "rules of the game" and as an umpire to interpret and
enforce the rules decided on. What the market does is to reduce greatly the
range of issues that must be decided through political means, and thereby to
minimize the extent to which government need participate directly in the game.
The characteristic feature of action through political channels is that it
tends to require or enforce substantial conformity. The great advantage of the
market, on the other hand, is that it permits wide diversity. It is, in
political terms, a system of proportional representation. Each man can vote, as
it were, for the color of tie he wants and get it; he does not have to see what
color-the majority wants and then, if he is in the minority, submit.
Fortunately, each woman can also vote for the color of scarf she wants. Unfortunately, at present, representation in both markets
and the political system appears to be proportional to corporate size and
income. And we, the economically and politically less powerful majority, are being asked to
disregard that last little tremor in the financial sector so that the “wide
diversity” of financial “innovation” can continue to misdirect capital, both
financial and human, to where it will evaporate when the next bubble or Ponzi
Magnetar and the challenges of financial regulation remind me of the early challenges in US food and drug
regulation. You can read about them in Philip J. Hilts book, Protecting
America's Health, in the chapter titled “Capitalism in Crisis.”
Admittedly, Hilts appears to be no fan of capitalism, but the account he
provides was also reported by Cynthia Crossen in the Wall Street Journal on
October 3, 2005 (How Elixir Deaths Led US to Require Proof of New Drugs’
Safety). I note that the article appears no longer to be available from the WSJ,
but I have a pdf version of it downloaded at the time that agrees in substance
In Hilts’ book we learn that it was difficult to get food
and drug regulation in the US for a variety of reasons, most of which amounted
to variants of the reasons we are having trouble getting financial regulation
now. Like the more complex products of the finance sector, there was
considerable information asymmetry in food and drugs markets. Manufacturers
were not obligated to provide detailed information on contents, except the amount if any of alcohol, opium, cocaine, morphine, chloroform, marijuana, acetanalide, chloral hydrate and eucaine. (You can thank the Food and Drug Act of 1906 for saving us from unwittingly becoming a nation of addicts.) Manufacturers were not
obligated to test products for efficacy or safety. They could label tap water as mineral water and sell it as a cure for rheumatism. They could claim cures for
cancer or diabetes. Worse, they could put sugar in a drug marketed for treatment of
diabetes or morphine in a drug marketed as a cure for addiction with little fear of prosecution under existing law. As long as their
intent was to heal, there was little legal recourse if they killed people.They were playing by the rules of the game.
A confluence of jointly necessary, but individually insufficient,
events eventually provided us with better food and drugs regulation. One reason
I like the story is that an economist, Rexford G. Tugwell, figures prominently
and positively.Tugwell was part of
Franklin Roosevelt’s transition team in 1933, a professor of economics at
Columbia, who was second in command at the US Department of Agriculture. As an
economist, he knew that in the absence of full information, consumers could not
be relied on to make efficient choices and he knew that there was nothing in the
law or the prevailing social institutions that would compel drugs manufacturers
to reveal all the contents of their products, much less test them for safety or
efficacy. Nor would market forces make it happen. The preceding years had seen
multiple deaths from improper canning techniques, loss of eyesight from use of
aniline dyes in mascara, and pure and simple deceptions about ingredients in
foods and drugs. Despite these, manufacturers persisted in producing and selling
dangerous or useless products. When caught or when someone died, some simply changed the product
name and continued to produce it.
Over a period of about four years from 1933 to 1937, Tugwell
and Walter Campbell, head of the Food and Drug Administration (FDA), attempted
to move a bill through the US congress that would strengthen the regulatory
power of the FDA. In fact, one bill had already passed both houses of congress.
I quote from Hilts, p. 88:
one[bill] passed both houses of Congress, was agreed to by a conference
committee of the two houses, and was killed by a Republican maneuver in the
House of Representatives just before it could be sent for the president’s
signature. Representative Clarence Lea of California killed the bill; he was
close to fruit growers there, and they were incensed with the FDA’s attempts to
cut back on the chemicals used to preserve fruit in drying and shipping.
Sound familiar?Here’s Hilts again.
wrote that the bill would “Sovietize” drug sales in America and produce a
“virtual dictatorship over trade.
So how did we get an FDA that has some power to regulate?
Hilts tells us there were two critical elements: 1) a bill
was already present in Congress and 2) legislators and significant portions of
the public were paying attention when a crisis hit.
The crisis took the form of 107 deaths, most of them children,
from a drug, Elixir Sulfanilamide,
produced by the Massengill Company of Bristol, TN, in 1937. Massengill, in an
effort to respond to customer preferences, had tried to make a sweet liquid
version of the pill and powder form sulfanilamide that they already manufactured. So far, this seems like an example of the good that the market
can do.Sulfanilamide was a sulfa drug
used to treat strep throat and respiratory infections.
A sweeter, liquid version would be easier to administer to children. Market forces were working, just as Friedman predicted, to produce something more palatable to consumers. Good. Massengill’s head chemist determined that diethylene glycol (DEG),
which has a sweetish taste, would solvate the sulfa drug. DEG is poisonous to humans, which was apparently not known (at least to the head chemist) at that time. Massengill bottled the elixir without testing on humans and shipped 240 gallons in early September 1937. Bad.
October 11, the AMA had received an inquiry about the drug because six people
in Tulsa, OK, had died after taking it. By the end of November, 107 were dead,
not counting Massengill’s head chemist who committed suicide. FDA investigators
had recovered 90% of the original 240 gallon shipment within 4 weeks of the
first report of a problem.
The only law under which Massengill could be prosecuted was
that the drug had been mislabeled (substances labeled "elixirs" had to contain alcohol). Massengill was fined $26,000 (about
$240/death or, if I’ve done my arithmetic correctly, the equivalent to about
$4,000/death in 2010 dollars based on the St Louis Fed's
All Consumer CPI.)
wrote to the AMA that the deaths were regrettable, but “I have violated no
law.” Indeed, he had not. There was no law on the books that required his
company to test for efficacy or safety any of the products they sold and that
would be ingested by humans. Mr. Massengill and his company were playing by “the rules of
Representative Lea, under pressure from outraged consumers,
released the bill and Franklin Roosevelt signed the Food, Drug and Cosmetic Act
into law on June 15, 1938. It required manufacturers to demonstrate safety
prior to marketing and it codified a scientific approach to doing this. In the
long run, it proved a great boost to the drugs industry by sweeping
out the low price, low quality, low or negative marginal benefit chaff that
tends to dominate in unregulated markets where information is asymmetric. That
it led to other problems is a topic for another blog.
The FDA story has always caused me to wonder: how does it
happen that US voters are sympathetic or neutral to corporate pleas for
protection from regulation that would benefit consumers? And why must children die or an economy fail before US voters are willing to apply sufficient pressure to lawmakers to obtain regulatory reform?
In the case of the FDA in the 1930s, consumers received very distorted news reporting because patent drugs advertising represented a large portion of newspaper revenues at that time. Hilts discusses the distortions that resulted from that conflict of private incentives and public interest. Modern news distortions may have less to do with advertising revenues and more to do with campaign contributions coupled to wholly-owned media outlets. The effect is much the same.
But I think it is more than that. I think voters are sympathetic, not to investment bankers, but to an idea. The idea results from uncritical
acceptance of a syllogistic fallacy derived from American beliefs that we now
take to be self-evident. Adam Smith may have said it first and best: “I have never known
much good done by those who affected to trade for the public good.” The modern variant is "government is the problem." The logical
fallacy is to conclude that, if true, it implies that those who affect to trade for
private good always and everywhere benefit the public “which was no part of
[their] intention;” that the pursuit of their own self-interested intention promotes the
interest of society “more effectually than when [they] really intend to promote
In my very humble opinion, both Smith and Friedman were
right only in very limited senses. Market forces will “reduce greatly the range of issues that must be decided through
political means, and thereby to minimize the extent to which government need
participate directly in the game.” But there are many markets where market
forces are dampened or non-existent and where private and public interests will
diverge without regulation. It seems to me that as we evolve and progress, new
and complex innovations and even the quantity and nature of information itself
have tended to obscure transactions thereby increasing the costs of and the need for determining and enforcing "the rules of the game." For
these reasons, I’m almost certain that Smith would view the financial sector as
more like the East India Company than like the butcher, brewer
or baker, at least in terms of the public benefits it is likely to yield
Contrary to Friedman, this is no “game.” In 1937, 107 (mostly
children) died because basic, common sense regulation was not in place. In
2009, millions in the US became unemployed and thereby lost both their main
source of income and their health insurance, many more lost value on their primary
asset, their home. All of this because the regulation that would have prevented it, the rules of the game, had
been dismantled over the last 30 years and what regulation remained was very weakly
Now (or soon) there will be a bill in Congress. A crisis has
occurred. People are paying attention (not always to the best sources of
information, but still paying attention). The rhetoric and tactics used by
investment bankers are remarkably similar to those used prior to the 1938
passage of the Food, Drug and Cosmetic Act. I know I could have written all of
this about Glass-Steagall, but I think it’s important to understand that this
happens over and over and over again in many different markets and about many
different issues that relate to the public good. The rhetoric seems never to
change: “sovietize,” "socialist," "socialism," "stifled innovation," "liberty," "freedom," "hurt America." It doesn’t
matter what the details are. It is a one-size fits all obstructive strategy
that protects the interests of business and power at the
expense of consumers, taxpayers, future generations, and the country as a whole. And it works nearly every time.
I fear that George Santayana was right and that we are
doomed to repeat the Great Depression over and over again because we appear to have forgotten the lessons it taught us. I fear that Milton
Friedman is right and that this is a “game” to some. I fear that Adam Smith is
right and that “as merchants their interest is directly opposite to [the
public] interest.” And I fear that misplaced tea bagger rage, unlike
misallocated capital, is more newsworthy, more interesting and more understandable
than CDOs and the ways in which Gyges
gains unearned power and wealth, hidden behind the opacity of complex
The rules of the game must be changed. They must be changed now. And they must be changed in ways that serve the public interest. Investment banks and bankers must be regulated.Leverage, transparency, size.I'm sure there is more. Toxic assets, toxic instruments, and toxic casino-like speculation are no different from toxic patent medicines. They harm us all.
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Rajiv Sethi Barnard College, Columbia U, and Santa Fe Institute economist Rajiv Sethi's thoughts on economics, finance, crime and identity...
VOXEU Research-based policy analysis and commentary from leading economists
OMB Blog Director of OMB, Peter Orszag, blogs on health reform and health costs with more credibility than almost anyone else.
Health Impact Assessment Blog Interesting because it attempts to conceptualize health production as an expanded process with many causal factors, not all of them the obvious ones like medical care, nutrition, exercise, etc.
Mike Lawlor's Economics & Health Reform Blog Maxine thinks that Mike is a near-perfect boy economist because of his background in both economics and philosophy. He is always thoughtful, balanced, and theoretically sound.
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