Domestic / Federal

The Adam Smith Economist: The Public Policy Economist

An argument that modern public policy should take a leaf out of Adam Smith’s book.

The increased influence of mathematics in economics has led to modern economics becoming a field dominated by abstract theoretical discussion, not public policy.  But economics is not a field which should merely describe, in an abstract way, social interaction.

Smith, Keynes and Friedman, arguably the three greatest economists of all time, did not become famous for their abstract theory.  Rather, it was their application of economic theory to current society and their strident debate on public policy issues.

Take for instance Smith’s works, which are essentially constructive critiques on government.  Not only does he explain why the mercantilist and monopolist government policy of the 1700s worked against the general welfare of society, but he explained what government should be doing instead.

Part of the reason why modern economics has veered into a theoretical abstraction, distancing itself from mainstream public policy discussion, is because modern economists fail to read the works of the masters. Unfortunately, a simple glance at the central tenets of the theories of the masters is not enough.

Adam Smith for example: Arguably the founder of modern economics.  The Chicago School claim him as one of their own, the inspiration for homo economicus. Some even claim his writing became the basis of not only classical economic thought, but that of the neo-classical as well.  On the death of Keynes, the New York Times wrote that one would have to go back to Smith to find an economist of higher standing.

Yet most modern economists will not have read the Wealth of Nations cover to cover, and nearly all students would be guilty of going to Wikipedia for a summary.

Most modern thinkers, both the economist and the layman, would know that the inventor of the invisible hand is Adam Smith, and that he firmly established the concept of self-interest as the basis for modern economics – economic interaction as the interdependence of individuals.

Most who understand this principle would know that it is derived from his work: An Inquiry into the Nature and Causes of the Wealth of Nations.  Even fewer would realise that the phrase ‘invisible hand’ is mentioned only once his magnus opus, and only three times in the entire body of his works.

And even fewer would realise that the modern understanding of the invisible hand bears little resemblance to Adam Smith’s explicit use of the phrase in the Wealth of Nations.  The modern invisible hand, derived from the quintessential butcher, baker, brewer example, is that the uncoordinated interaction of agents in a market, will produce the best outcome.  Or, as Milton Friedman said, it shows ‘cooperation, without coercion’.

Yet, Smith’s only explicit reference to the invisible hand in the Wealth of Nations is contained in an explanation of why mans preference to invest domestically, rather than internationally, unintentionally benefits the domestic society.

“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.”

These excerpts, which form the bread and butter of most economists’ understanding of Adam Smith, provide a preliminary outline of his ideas.  But it is impossible to understand the central argument of his work, without delving into the actual book itself.  His importance as an economist is not because of his multitude of individual theories explaining human interaction and the market, but because of his avid discussion of the public policy issues facing 1700s Europe.

Even today, Smith’s public policy sheds some significant light on policy issues.  A greater understanding of Smith could enhance modern public policy discussions, particularly on the role of the market and the state.  In an era of increasing size of government, and a blur between what should be operated by government and what should be operated by the private sector, Smith’s work provides some valid perspectives.

When debating whether governments should undertake a certain task or program, as a society we often fail to apply a clear set of criteria to ask whether or not it is appropriate for government to undertake that activity.  This is unlike any business or individual.

When a business decides to take on a venture, or undertake an activity – it does it with a set of principles, ultimately profit maximization.  When an individual performs an action they do so with the guidance of attempting to maximize their satisfaction, subject to certain constraints including their income and their moral code.

But too often when government undertakes a venture, its reasoning is borne out of community discontent (or discontent from a particular pressure group), rather than a set of objectively applicable criteria.  There should be clearly delineated roles for government which can be objectively applied.

Perhaps, the simplicity of Adam Smith’s express theory on government should be considered.  Smith saw three roles for government deemed necessary to create the structure upon which the market can operate.

Defence; to protect domestic markets from foreign aggression.

Justice; to protect private property rights.

Public institutions and works; the establishment of institutions which private individuals, or small groups of private individuals cannot provide.

If government was to operate on these three broad principles, there would be absolutely no issue with whether a government should, or should not undertake an activity.  With clearly delineated criteria, policy makers can easily assess whether a particular program falls within any of these sectors.

Take for instance rubbish collection and Adam Smith’s categories.  Local councils still insist on undertaking this task, yet it could be efficiently completed by private contractors. There is no justification for government involvement under any three of Adam Smith’s broad categories.  Therefore, local government should not undertake this activity.

Take the NBN for example.  Whether the federal government should undertake this activity would depend on whether private individuals or groups of private individuals could not provide the service.  Thus the question becomes, does it fit within Adam Smith’s third criteria of public institutions.

Whether the NBN is a valid public institution is open to debate, which I will not attempt to resolve.  But an investigation can be undertaken to assess whether or not private individuals can undertake this activity.  If the answer is yes, then the NBN is not a necessary activity of government, and vice versa.

It may be debated as to whether Smith’s three categories are appropriate.  But Smith’s methodology in deciding on whether an activity should or should not be adopted by government should be practised by modern governments.  Imagine if each political party set out a broad agenda, a set of values, on which they should then base each of their decisions.  Rather than presenting to the electorate a mismatch of policies, some of which conform to their basic party principles, others of which don’t.  The curse of modern politics is the failure to present policy which reflects a broad, or directing, principle, or set of principles.

It is also appropriate to consider Smith’s discussion of public education.  He was a supporter of public education because he was of the view it would improve government by ensuring that the people were knowledgeable enough to keep their representatives accountable.

At the time of Smith’s writing, government policy in England actively supported monopolies because the merchant class (think: British East India Company) had convinced the public and the legislators that it was in the community’s best interests.  Smith believed that a better educated society could resist the pressures of the monopolising capitalist.

A perfect modern example of where patently incorrect political party policy is having a devastating effect on public opinion due to the public’s (and even media’s) lack of comprehension is Tony Abbott’s rhetoric on the carbon tax.  No, this is not about whether or not climate change is real, or whether we should take action.

Rather, it is Tony Abbott’s contention that a carbon tax, accompanied by income supplements to low income earners, will not change carbon emissions.  This is clearly wrong.  Why? Because a relative price change in goods (low emitting v high emitting) will encourage persons to substitute to the cheaper good (the low emitting good) because of the substitution effect caused by a price change.  This will still occur even in the presence of an income supplement.  It is a common case of compensating variations – Google this to realise how wrong Abbott is.  With greater education, as Smith suggests, it is likely that the public would be able to resist such blatant spin, like this.

Smith’s ideas, and his methodology, are a perfect example of how economics theory should be interrelated with public policy discussion.  Recent tension between policy makers and economists in the resource rent and carbon pricing debates could have been easily solved if economists had become more active in advocating their public policy.  As economics is the study of the interdependence of human interaction, it is economists who should be at the forefront of public policy discussions.  It is time for modern economists to head back to the works of the masters such as Smith, whose work demonstrates, not only a discussion of theoretical economics but, an acute analysis of public policy issues to realise that they should have a crucial, and very public, role in policy debate.


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