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.
The metaphor of guns and butter is used in macro 101 to convey the tradeoffs a nation and it's economy must make. More spent on national defense means less available to spend on consumer goods at home.
There is also strong and plentiful evidence of a strong positive correlation between education and health. Correlation is not causation, you say. Well, here's a good article by a team of first rate researchers that includes one of our best economists/econometricians, James J. Heckman (Nobel laureate, 2000) credibly identifying causal links. Understand, this relationship is not occasionally observed, it is always observed and it is observed across nations as far as I can tell. And, yes, it is observed after all the obvious possible confounders are controlled.
So if one were genuinely interested in reining in health care costs, one would not support cutting education funding. In fact, one might attempt to expand it, since it would not only help to rein in health care costs over time, it would increase productivity, which would help to grow the economy out of debt.
Two much desired fiscal objectives achieved with one policy instrument.
I will also point out that if one were sincerely concerned about our children and their children,
one would not cut education funding for all of the above reasons.
Now, about not extending unemployment benefits. The issue of unemployment benefits is not only an economic issue, it's an ethical issue for crying out loud. But let's just look at the economics of it. This is probably not a good time to contract the economy further by cutting unemployment benefits. So in lieu of actual jobs creation (which seems to be stalled, still, because of all that money that for all we know is still being creatively destroyed by the finance casino), wouldn't it make sense not to withdraw dollars that are helping the jobless to weather the downturn AND that are stimulating what little demand there is?
Unemployment benefits have the added benefit that they are the right thing to do. Unless of course you live in a world where it's OK to bail out investment banks and insurance companies with no real penalties for the guys who created the need for a bailout, but helping workers who are unemployed largely because of the antics of those crazy bankers, traders, raters, and insurers causes you to lie awake nights worrying about throwing good money after bad. Oh, would that it had occurred to you to worry about this earlier in the game.
We do not need people who hawk deficit reduction strategies with the style and substance of a carny barker. We need deficit falconers. Sensible, informed people. Not just policy makers and politicians, but the electorate, too. We are going to have to spend some money to get out of this hole. How we spend it will matter immensely both for us in the near term and for our children and grandchildren. Worrying about things that haven't happened (like inflation) and reducing debt by cutting the very things that in the long-run are our ticket out of this is as crazy and short-sighted as selling mortgages to people who have no hope of repaying them and buying complex securities composed of those mortgages under the assumption that if you can't see the risk, it must not be there.
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.
I have been thinking about income inequality. I've been thinking about it because if the final version of the finance reform bill now awaiting reconciliation does not effectively rein in speculation and unfettered and seemingly unbounded short-term individual self interest (aka greed), income inequality in the US (which is already quite high) is likely to become even greater.
If finance reform does not dampen unfettered and seemingly unbounded short-term individual self-interest we can look forward to even more financial capital being siphoned off to feed the casino that passes for finance these days. It will not recycle back into the economy where it could fuel innovation, competition, and the day-to-day provision of goods and services that creates jobs and from which we all benefit. In addition, continuing periodic crisis will almost certainly necessitate additional future transfers of taxpayer money to support the financial sector's addiction to gambling. The crises and the transfers widen the income gap. Depending on how resolution is ultimately structured and financed, taxpayers could still remain unwilling enablers to a highly dysfunctional financial system.
So I got to thinking. Are there additional ways to rein in unfettered, seemingly unbounded short-term individual self-interest?
What if there are two kinds of people in the world? One experiences diminishing marginal utility of income just as we are all taught in Econ 101. The other, let's call him Gyges, experiences constant or even rising marginal utility of income. Because each additional dollar of income yields the same or more utility, the second type of person is drawn to high-risk, high-payoff "games." In the extreme and particularly as the downside diminishes because someone else underwrites the losses or because the speculation is with someone else's money, Gyges over time is enabled to behave like an addict in the advanced stages of addiction, seeking higher and higher highs (payoffs), taking on higher and higher risks with other people's money.
If this were Uncle Ned, the guy who started out going to Atlantic City every weekend and ended up losing the house, his wife, Aunt Shirley, the cousins, his job, and his self-respect, we might be willing to pay for his rehab, but we sure wouldn't give him more money to take to Atlantic City. In fact, we might try to figure out how to reduce the payoffs of any of his bets. After all, if we're paying for his rehab, wouldn't it make sense to rake back some of his gains when he sneaks to the Jersey shore? The ultimate goal would be to shrink the actual increment in Uncle Ned's utility from that $1200 win at black jack to something like, say, $120, with us using the balance to pay the still outstanding bill from his rehab.
Remember when the marginal tax rate on the top income bracket in the US was 90%? Many of you won't. It outraged my businessman father although I'm pretty sure it never affected him. It used to outrage me, but now I find myself wondering. What if it dampened unfettered, seemingly unbounded, short-term individual self interest? What if the Gyges of the world are unable to resist the temptation to go for broke? What if they are drawn to jobs where payoffs are high (because of their non-diminishing marginal utility of income)? What if the majority of the people who populate the top income brackets are of the Gyges type, addicted to high payoffs, high risk; obscured by complex financial instruments; and enabled by an uncritical national narrative in which high income signals high productivity, high innovation, high contribution to the common wealth?
If this were the case, then progressively higher marginal tax rates serve more purpose than simply allowing those who have benefited most from the laws, markets, and other benefits of residing in the US to contribute equally in utility terms to the infrastructure and country that enabled their success. It serves to dampen the siphoning of financial capital away from productive enterprise and into non-productive unfettered, seemingly unbounded, short-term individual self-interest. It dampens the incentives to take high risks with other peoples' money for high payoffs to oneself. It internalizes the negative externalities associated with unproductive financial "innovation," thereby discouraging it.
Am I advocating a return to a 90% top marginal tax rate? I'm not sure. For one thing, my father will never speak to me again if I do. For another, some of the people in that bracket are not Gyges. The non-Gyges contribute to the economy. They are not vampire squids and should not be penalized.
The optimal tax rate for the top income bracket(s) will depend on at least two things: the proportion of Gyges-like people (or people engaged in Gyges-like activities) relative to productive people and the relative responsiveness of both groups to changes in the marginal tax rates.
Evidence suggests that increasing the top rates does not curtail productive activity as measured by growth in GDP. This would be expected if the non-Gyges of the world have diminishing marginal utility of income and progressively higher tax rates approximately reflect the utility they derive from the marginal dollar. The higher rates tax rates do not affect their productive output.
Unfortunately, the fact that there appears to have been less casino-like finance during the time that the top marginal tax rates were high does not prove that they acted as a restraint on casino-like finance. There were many other forces in place post-WW II that may also have served to constrain such behavior.
That such a tax structure appears not to affect productive output or growth and also appears to reduce income inequality seems to argue in its favor. That reductions in income inequality will tend to raise individual incentives among the less advantaged to invest in health and human capital, seems wholly consistent with the objectives of those who favor "personal accountability" as a means of achieving better population health, lower rates of growth in health costs, and higher educational attainment. Increases in such investment would also tend to narrow income inequalities over time by increasing the inter-generational transmission of better health and human capital.
Whatever the optimal top marginal tax rates are, I'm guessing that a top rate in the 30-40% range is probably too low, both as a brake on Gyges and as a utility-neutral way of financing a capitalist economy and the government that must provide, maintain, and update the infrastructure for it, that must regulate it and that must govern it in ways that encourage and enable all its citizens to flourish.
It's time to disable greed and to enable individual productivity, commercial competition and innovation, and long-term investment in commercial enterprise and in the health and human capital that supports it. This is how markets and economic growth benefit both current and future generations.
Panera Bakery has opened a non-profit pay-what-you-want shop in an upscale St. Louis suburb. This is surely a form of (voluntary) price discrimination, where everyone pays an amount that reflects the value to them of the marginal croissant or sandwich.
It almost certainly erodes both consumer and producer surplus, economists' measure of welfare obtained from competitive markets. If consumers consistently "cheat" in the amount they pay, it could be output reducing (assuming an upwardly sloping supply curve) or could alter the output mix.
In an ideal world, the value of the lost consumer surplus would exactly balance the lost producer surplus for the units provided at below marginal cost "prices." In other words, the amount paid by those who value the product more at the margin will in effect be transferred to those who value the product less at the margin (at least as revealed by the price they pay). In this case, level and mix of output should be the same as in a competitive market (I think).
I can think of several reasons why someone might offer a low price: 1) they can't afford to pay more, but would benefit nutritionally and psychologically by more than or at least as much as the price they can afford to offer; 2) they can afford more, but do not value the sandwich enough to pay a higher price; or 3) they can afford to pay more, their valuation of the sandwich is high (say above marginal cost), but they prefer to cheat and pay less than their actual valuation of the sandwich.
Assuming the store can stay in business without altering product mix or output, will there be a welfare loss or a welfare gain? How will the mix of 1's, 2's, and 3's affect your answer? How might social norms or an inner moral compass affect the outcome of this experiment? Is there any way to "police" cheaters while maintaining the spirit of the experiment? Under what conditions is this pricing mechanism Pareto efficient?
They rigged bids on auctions for so-called guaranteed
investment contracts, known as GICs, according to a Justice
Department list that was filed in U.S. District Court in
Manhattan on March 24 and then put under seal. Those contracts
hold tens of billions of taxpayer money.
In October, CDR was charged with criminal conspiracy and
fraud, along with Chief Executive Officer David Rubin, 48,
vice president Evan Zarefsky
and Wolmark. They pleaded not
guilty. Rubin, who was also charged with making fraudulent
bank transactions, faces as much as $3 million in fines and
more than 30 years in jail if convicted.Rubin declined to comment in a telephone call.
“Mr. Rubin doesn’t think that CDR broke the law in any
of these transactions,” said Laura Hoguet,
his attorney in
Daniel Zelenko, a lawyer for Zarefsky in New York, said
he was confident his client will prevail at trial.“The government continues to show that it simply doesn’t
understand how this market operated,” Zelenko said in an e-
Self-interest, unfettered by ethics, virtue or sunlight, is a wondrous thing indeed. A marvelous source of fraud
innovation. I wonder how we can blame this on Fannie, Freddie, or the government?
I can't wait to see how the viaticals market plays out...."well, yes, we were killing people before their time, but you just don't understand how this market works...." (Hat tip to rjs.)
If you read nothing else today, read this from Venkatachalam
Shunmugam, Chief Economist, Multi Commodity Exchange of India Ltd., Mumbai, writing at VOXEU on dark pools and flash trading.
"Markets are essential support institutions for the economic evolution of
humankind. Can policymakers afford to allow the creation and
continuation of mechanisms that can – at any time – destroy these
institutions and make the public turn against the wisdom of capitalism?"
Short answer: No.
Efficient markets, indeed. Efficient at what though? That's the question.
Several years ago I had a student whose day job was running
a large clinic. He was enrolled in a Masters of Public Health program, taking
my course on ethics and economics at a business school as an elective. He once told me that one of
the most important things he learned from studying economics and public health
was that the health production process begins before people walk through his
clinic doors (often his emergency department door). (By health production, he meant the process, the combination and amounts of inputs such as medical care provided by his clinic and individual's own choices about what and how much to eat, how much to exercise, that ultimately produce a given level of health for an individual.) Why was that such an important
revelation for him?
Let’s start at what could be regarded as “the beginning," at least in economics.
A key feature of the new framework was the conceptualization of health as something that is produced by individuals and households by combining market inputs, such as nutrition, tobacco, alcohol, and medical care, and non-market inputs, such as own time spent in exercise, information gathering/education, child care, and leisure/relaxation. Another feature of the model is a stock of health capital that depreciates over the life cycle, but that individuals and households can invest in through preventive inputs (again market goods, such as healthy foods, preventive medical care, and non-market own-time spent in, say, exercise). Such investment can add to the stock of health in future states of the world thereby slowing the rate of depreciation, at least over some range of the life cycle. (After all, in the long run, we are all dead.) Inputs such as tobacco (and alcohol at higher consumption levels) have negative marginal product thereby increasing the rate of depreciation and lowering the stock of health capital in future states of the world.
Grossman's model sees humans as demanding health, not medical care per se. Medical care is demanded as input to health production. Health is demanded and produced for the utility it provides as a consumption good in the current time period (because it translates into more healthy days, presumably higher wage income from the productivity gains, and feeling better). However (and this is what was innovative about the Grossman model), health is also demanded as an investment good, that is, a good that if invested in would yield more healthy days over the life cycle. More future healthy days yield utility through the extra earnings that are realized from them. As number of healthy days rises and as the wage rate rises, returns to investment also rise, leading to more investment in health (holding all else constant).
The Grossman model wasn't just theoretically elegant. It also explained a lot of observed human health-related behavior. It could account for why individuals with higher rates of time preference were less likely to demand preventive care as a hedge against future (unhealthy) states. It predicted that such individuals would be more responsive to changes in current prices, such as can be achieved by a "sin tax" on tobacco or alcohol, than to new information about future health consequences of consumption of such goods. It predicted that individuals with lower rates of time preference would be more responsive to information about the (future) bad effects of current consumption of goods such as tobacco and alcohol. These effects have been confirmed empirically (see for example here.) The model also predicted that more efficient producers of health (usually the more highly educated) face a lower "shadow price" for health, therefore demanding more of it. (The shadow price can be thought of as the money and time that individuals have to spend in producing an increment in health.) The model also predicted a wide range of wage rate effects on both investment decisions and on the substitution of market goods for own time in the production of own and child health.
What can we learn from this? Well, one thing is that medical care is one input among many to improving our own health now and in the future. Moreover, it may not be the most important input. However, when needed, if delivered too late or not in the right amount, it is likely to have severe negative consequences for the individual. It is necessary, if not sufficient.
It also means that rational economic actors may differ in the amount of health they choose to produce or to invest in. But the reasons for this do not translate readily into "personal accountability." The Grossman model suggests that economic actors who are less efficient at producing health face a higher shadow price. All else equal, they will rationally demand less health. The model suggests that individuals with lower wage rates and life expectancies will face a lower return on investment in own health and will rationally reduce investment in that health. The model suggests that individuals with higher rates of time preference, i.e., they discount future health states at a higher rate, will invest less in achieving those states.
Is it a "free choice" when the (shadow) price of health, the subjective discount rate, and the ROI that condition the choice are determined in large part by a circumstance of birth, early home environment, and even the culture and context into which they live? What does it mean to hold individuals personally accountable for making the rational choice not to invest as much in current or future health as someone judges they should, given the price they face, the discount rate they have inherited, and
the ROI they're likely to realize? If they are rationally not purchasing health insurance should we force them to? Are we, in effect, requiring them to be irrationally exuberant? To produce more health and to invest more in future health than their price, time preference, or the ROI would warrant?
Or do we have an obligation as a society and a community, to counter these "market forces" that are so obviously harmful to less educated, less advantaged individuals and to society? Do we "nudge" them to be irrationally exuberant about their own life and health prospects? Do we demand that they over consume and over invest in their own health and penalize them when they rationally opt not to? Or do we offer them more education, greater future opportunity, the potential
for a higher wage and a longer life to increase the ROI and reduce their discount rate? Do we subsidize health insurance and provide lower co-pays and deductibles to reduce their shadow price of health? These are the ways to create the proper incentives for disadvantaged and less educated individuals to invest in their own and their children's health.
If health reform is repealed, if the electorate continues to hear simplistic, but emotionally engaging rhetoric, about personal accountability, free choice, and so-called "rational behavior," one day we will have created an even more unequal society.
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.
That these policies are likely to produce a less unequal society and a more educated electorate is pure benefit to a democracy that favors, benefits from, and rewards commercial and individual endeavor.
Here's Abrams, Professor Emeritus, History, UC Berkeley:
Every time I see or hear the phrase “free market,” I have mixed feelings
– a mix of anger and exasperation. Why? Because there is no such
thing as a “free market;” there has never been any such thing, and never
will be. What’s more: it is hard to believe that those otherwise
intelligent people who prattle about “the free market” don’t know that.
So it is easy to conclude that those who do use the phrase are simply
monumental cynics or are suffering from an acute case of cognitive
Here's me: Or they have much to gain personally and politically by perpetuating the myth?
Addendum: BTW, I wouldn't go so far as to say "there's no such thing as a "free market;" there has never been any such thing, and never will be." What I would go so far as to say is that "free market" is used way too much in contexts where markets have clearly failed, which leads to confusion among media types and to sustained ideological distortions among the electorate. The confusion and distortions have negative consequences for us all.
Ezra Klein gives us James Galbraith weighing in from the mews on deficit hawkery. Here are some excerpts that seem particularly relevant to the current situation:
EK: What are the policy implications of this view [that government's spending creates the bank's demand for bonds, because
they want a higher return on the money that the government is putting
into the economy]?
JG: It says that we should be focusing on real
problems and not fake ones. We have serious problems. Unemployment is at
10 percent. if we got busy and worked out things for the unemployed to
do, we'd be much better off. And we can certainly afford it. We have an
impending energy crisis and a climate crisis. We could spend a
generation fixing those problems in a way that would rebuild our
country, too. On the tax side, what you want to do is reverse the burden
on working people. Since the beginning of the crisis, I've supported a
payroll tax holiday so everyone gets an increase in their after-tax
earnings so they can pay down their mortgages, which would be a good
thing. You also want to encourage rich people to recycle their money,
which is why I support the estate tax, which has accounted for an
enormous number of our great universities and nonprofits and
philanthropic organizations. That's one difference between us and
EK: That does it for my questions, I think.
JG: I have one more answer, though! Since the
1790s, how often has the federal government not run a deficit? Six short
periods, all leading to recession. Why? Because the government needs to
run a deficit, it's the only way to inject financial resources into the
economy. If you're not running a deficit, it's draining the pockets of
the private sector. I was at a meeting in Cambridge last month where the
managing director of the IMF said he was against deficits but in favor
of saving, but they're exactly the same thing! A government deficit
means more money in private pockets.
The way people suggest they can cut spending without cutting activity
is completely fallacious. This is appalling in Europe right now. The
Greeks are being asked to cut 10 percent from spending in a few years.
And the assumption is that this won't affect GDP. But of course it will!
It will cut at least 10 percent! And so they won't have the tax
collections to fund the new lower level of spending. Spain was forced to
make the same announcement yesterday. So the Eurozone is going down the
On the other hand, look at Japan. They've had enormous deficits ever
since the crash in 1988. What's been the interest rate on government
bonds ever since? It's zero! They've had no problem funding themselves.
The best asset to own in Japan is cash, because the price level is
falling. It gets you 4 percent return. The idea that funding
difficulties are driven by deficits is an argument backed by a very
powerful metaphor, but not much in the way of fact, theory or current
Thanks to Nick Krafft for pointing me to this. Why the mindless devotion to reducing deficits when unemployment is at 10%? billy blog nails it, I think. Everyone understands that if they do this with their own personal finances, they are grasshoppers not ants, spendthrifts, profligate ne'er-do-wells. And so they would be (although I can't help but wish that this wave of temperance had o'ertaken households, say, 6 or 7 years ago and with regard to their own and the government's deficits). But individuals are not governments, they are households. And even households would and do run deficits to tide them over a temporary downturn.
Here's Paul Krugman on whether the US is so profligate that we're Greece. He thinks not. He's right that the US must rein in health care costs, but we should also rein in investment banks and stop creating unfettered moral hazard. Reining in bankers seems way more important and immediate to me than reining in health care costs. After all, as Galbraith points out, when we're spending 30% of GDP and everyone else is spending 12%, "we can always buy Paris and all the doctors and move all our elderly there."
I wonder if we could sell them our investment bankers? Give them our investment bankers? Pay them to take our investment bankers?
global glass onion Everything macro: the Fed, QE, debt & deficits, FX & and macro issues; banks, banksters & congress critters; the main street economy, including CRE, foreclosures, unemployment, state budgets and health care issues; &global issues, including the Chinese economy, world trade, energy and the environment, and peak oil.
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.
Patience-Please Good blog for dog and horse lovers, creative writing lovers, music lovers, art lovers, and people who just want a quiet corner of the web where they can curl up for a good story, a good laugh, or a good cry.