Why do we have this type of economy?

There is little doubt that Adam Smith did as much for economic theory as anyone, but that does not mean that he and David Ricardo had found the best way to run an economy. For the Smith doctrine, markets are free and competitive, therefore what you get is proportional to your value, or at least your social contribution. It assumes that entry to the market place is effectively free and unconstrained, as is exiting, and further no single entry or exit will significantly perturb the market. The problem with this point of view is that it just does not apply in many areas. Smith based his analysis on an agricultural society, and in this the farmers have to sell whatever they grow, and his assumptions are valid. An additional farmer, or one who does not produce, makes little difference to the market. There are ups and downs. I can recall when I was young there was a potato glut, and farmers were taking potatoes and throwing them over a cliff. My father was at the bottom and picked up what he needed and set off to grow them for next season, his reason being if everyone else was getting out of potatoes, next season there would be a shortage. That happened, and prices went up by a factor of ten. Smith’s theory was working well, including the fact that some could see what would happen and make money from their foresight.

However, there is another side to the market: some find the best way to make money is not to be efficient, but to exercise power. With sufficient power, you can close out competitors, and with a monopoly, or failing that, a limited oligopoly, you can price how you like. The problem with Smith’s analysis is that the players respond differently to their rewards. Some spend and others save. The concept of saving, in the Smith analysis, is that the saver simply delays reward, while investment is made with the goal of forgoing present rewards with the view to get bigger rewards in the future. But suppose the purpose of saving is not to get rewards, but rather to gain economic power? With power, you also get inequality, because the purpose of power is to get your rewards by tithing those without sufficient power.

In a previous post (http://wp.me/p2IwTC-5n ) I constructed a simple game where 128 people started equally, and they could either spend or save. After as few as five rounds, where in each round there was a fifty-fifty choice of whether to spend or invest, one was clearly ahead of all the rest. Now, you might say, if someone is prepared to forego current pleasure, is it not fair that he ends up with more wealth in the end? That depends, in my opinion, on how he uses it. If the saving is merely spent on getting a bigger brighter object, then that is of no concern, but if he uses wealth to close down others’ opportunities, then that is not helpful.

The problem with the wealth is that when opportunities are rare, whoever gets in first and succeeds has a great start. There is no doubt that in the very early stages of a new technology, there are a number of failures as a very few become ascendant. The question then is, why do they become ascendant? In some cases it is because others fall by the wayside, in part because they were one-hit wonders, and as time passes, the hit that was is no longer a hit. But in other cases, it was because they were lucky, or had a slight edge at the right time and place. How much is due to power and influence? It may very well be that it has nothing to do with the best product. Thus I recall when desktop computers came into being, businesses all went with Microsoft. Why was that? First, Microsoft somehow came to a deal with IBM, which in principle had been leading in the handling of mainframe computers for some time. Why IBM gave Microsoft that position is one of the mysteries of life; presumably they did not foresee what would happen, because the opportunity was theirs for the taking. IBM gave businesses a feeling of “security”. Second, these businesses often had in-house computer “experts”, and these would recommend Microsoft, even if it were not the best. Why? Well, if they recommended Apple, say, the bosses could work out how to use it themselves, and the jobs of the “IT experts” were not necessary. Better to go with IBM, and keep their jobs because the procedures then were too opaque for the bosses, and the workers were not going to show them how to do what would make them unnecessary. There are a number of other businesses, such as telecoms, insurance, pharmaceuticals, banks, etc, that are essentially oligopolistic.

Pharmaceuticals are an interesting example, in that the relevant companies have supported extremely expensive testing regimes that ensure the barriers to anyone else entering are so high. With little competition, they price their drugs extremely highly, thus ensuring many ordinary people cannot afford them, and also, they tend to focus their research on chronic problems, or problems such as cancer, where any treatment has to be on-going for a long time. There is also the question of personal rewards. The large payments to the banksters who effectively brought the economy to its knees, and their firms to near collapse is hardly a sign of reward for value and efficiency.

So, the question is, are our economies run by means that are fundamentally efficient and fair, or are they based on exploitation? If the former, governments cannot do anything but mess them up; if the latter, then defeating entrenched power is necessary for fairness and shared prosperity. Assuming we want to be fair. Do we, or do we prefer to let greed win out, and ignore the [plight of those who did not win?

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11 thoughts on “Why do we have this type of economy?

  1. Why This Economy?
    Before we answer this question asked by Ian Miller (a scientist) an even deeper question beckons: what is this economy? Paradoxically that answer is not clear. As a faithful Anglo-Saxon, Ian Miller evokes Adam Smith and Ricardo, who are famous British economists.

    Adam Smith is viewed as the first temple of economics, inventor of the free market. And that is the first set of deep mistakes. First, there was never any free market, ever since there are tribes, and they are governed. Even a government of pirates has laws. Which its market obeys.

    Second, Adam Smith was actually a student. All right, we all are, but some of us do like Einstein, and get “their” main ideas somewhere else. They are not the ultimate creators. Ultimate creators are the ones worth pondering: their reasons are always deeper and more interesting than that of their parrots.

    Adam Smith went to France, and learned from the physiocrats. The most prominent physiocrats were towering personalities. One, Turgot, became France’s Prime Minister (under Louis XVI), another was king Louis XV’s surgeon (so economy was a love of his, as it was with the philosopher who named and founded economics, Xenophon. Lovers tend to think better than those paid to think correct thoughts).

    What was the idea of physiocracy? Let’s quote a blog of The Economist:

    “IF YOU asked twenty well-educated souls to identify a physiocrat, only a couple could help you out. Writers like A.R.J. Turgot, the Marquis de Condorcet and Francois Quesnay are not household names, unlike Adam Smith or David Ricardo. But they are important. According to one late-19th century historian, the physiocrats (who called themselves the “économistes”) created “the first strictly scientific system of economics”.
    Physiocracy was a theory of wealth. The physiocrats, led by Quesnay, believed that the wealth of nations was derived solely from the value of agriculture. Quesnay’s understanding of value-added was rather primitive—he could not see, for example, how manufacturing could create wealth. Farmers, on the other hand, could. As Karl Marx explains in “Das Kapital”, “the Physiocrats insist that only agricultural labour is productive, since that alone, they say, yields a surplus-value”.
    The physiocrats are most commonly known for these simplistic economic ideas. But this was not their most important contribution to economic thought. Rather, it was the physiocrats’ methodological approach to economics that was revolutionary.
    Before physiocracy, economics was not a very scientific discipline. As we discussed in a previous blog post, mercantilist thinkers sometimes assumed that amassing gold was the best economic strategy. Economic efficiency was a pretty alien idea.
    But Quesnay was a scientist (for most of his life, he was a medical doctor). And he wanted to apply the scientific principles of medicine to the study of wealth. The “Tableau Economique”, which shows in a single page how an entire economy functions, is Quesnay’s most famous contribution.”

    Clearly as Quesnay was France’s top doctor, he could not possibly believe that there was no added value in science and medicine. Quite the opposite. So that physiocrats believed in agriculture alone is a parody.

    Quesnay,an immensely respected figure, showed that the economy was something to be respected, analysed and understood—much like a human body. It could not simply be moulded by the will of a monarch (or government).

    This was a hugely important step forward. The Comte de Mirabeau, the main leader in the first few months of the Revolution, before an untimely death at age 40, considered Quesnay’s Tableau to be one of the world’s three great discoveries—equalled only by the invention of printing and the discovery of money. As The Economist says:

    “Familiar notions of contemporary liberal economics derive from Quesnay’s scientific approach. The physiocrats, like many other thinkers of the eighteenth century, subscribed to the idea of a “natural order”. They showed that unchanging laws governed all economic processes. Consequently, it is generally thought that the physiocrats were opposed to government intervention. The dead hand of the state would only corrupt the natural evolution of the economy. Jacob Viner, the Canadian economist, referred to the physiocrats as one of the “pioneer systematic exponents” of laissez-faire (alongside Adam Smith).”
    Well, sorry The Economist: Adam Smith was the student.

    Why is the preceding important? First it destroys the Anglo-Saxon hubris that the Anglo-Saxon culture invented economic theory, and succeeded because of it (whereas the proper application of gunnery has more to do with it).

    More importantly, the Physiocrats incarnated a revolt against the preceding economic practice, MERCANTILISM.

    Mercantilism, was practiced deliberately, as early as 1500 by the two most powerful states, France and Spain (sorry, Oh Anglo-Saxon nationalists). In mercantilism, there is a collusion of the state with the private companies. In a way, the most extreme case of mercantilism was the Corsairs, when a state (France, England, the USA) would give “Lettres de Marque” to “privateers” to go attack the enemy and profit from it.

    Mercantilism was the main economic organization of the greatest European States, and of the USA, for many centuries. It was a roaring success.

    When the US made most of the world its empire, after the Nazi spearheaded rout of the European empires, the US naturally embraced the “Free Market”. That allowed the USA to undermine the European companies which served said empires. But that was then. Been there, done that. This is now.

    Guess what? Now the European Union defends mostly the “Free Markets”, like a bleating sheep it is, following Quesnay and his pet Adam Smith. Whereas the USA and China, mixing “defense” and giant oligopolies, are fully mercantilist. Guess who is winning? The bleating sheep, or those who make war?

    • Ouch! A faithful Anglo Saxon. Faithful???? I was not intending to going the history, and the reason for citing Smith was that just about everyone else does, and, paradoxically, the reason for citing Ricardo was that most people have not heard of him.

      As for Mercantilism, fancy omitting Holland. For its size, perhaps one of the greatest trading nations, and possibly the first to make a significant impact through stocks, including the stock bubble. (I think tulips came before the South Seas, but I may be wrong – if so, I apologise.)

      As for the success of the US, I would put it down to massive area that is largely flat, huge resources, and a major river system, but then, maybe once again i am wrong. However, my post was mainly intended to be about what is coming, not what was. Europe is not really a free market, in my view, because it is mainly controlled by the powerful, and that is more so than the US. I don’t think there is a free market, and I don’t think there should be one, but there are certainly huge questions as to what should be the restraints on markets.

      • No offense was meant. As you say, all quote Adam Smith, but Quesnay was more important.
        As you guessed, no doubt, this is the kernel of an essay of mine (I wrote it for you, but I will boost it a bit!) Right Holland was extremely mercantilist. A Dutch fleet would arrive somewhere with half a dozen boats, or more. However, Holland was mostly a creation of France (!), or more precisely, of the war between France and Spain. The original Franks were Dutch.
        Spain, a spawn of mercantilist France, was mercantilist. Portugal, even earlier also was, and probably the most mercantilist power which ever was. Mercantilist comes from power, and provides with power: contemplate Brazil

  2. Hello Patrice, No offence taken. I suppose “Anglo-Saxon” struck – the original Millers came from Wick, and there were few Saxons or Angles at the top of Scotland 🙂

    Yes, Spain was particularly successful, and probably would have been more so if it had not been at war so frequently. I am not sure what you mean about Brazil – from what i have seen of it, it was something of a mess – in the chaotic sense. I look forward to seeing what you write.

    • I meant Portuguese mercantilism was so strong that it defeated the feeble attempt at colonization of Brazil by the French. Portugal, for centuries, was determined to make a huge impact, worldwide. Portugal had only one million people, 5% of France… Systematic mercantilism at the highest level of the state, made the difference.

      To be a victim of “Anglo-Saxon” thinking, one does not need to have “Anglo-Saxon” genetics. Most French thinkers are contaminated by “Anglo-Saxon” thinking, complete, from attributing the Theory of Relativity to Einstein, instead of Poincare’, to physiocratic economics to the student and parrot Adam Smith…

  3. Ian, great essay. I would add the problem of inequality in wealth and income, each economic system causes, even if based on ideological dogma of equality, as the Soviet system was. Most of the economical systems, be it mercantilism, communism, feudalism need deep collaboration between the government (king), and the economic elites. This collaboration by its nature creates those who are close to the political leadership and those who are not and discriminated. The close elites gained certain kind of monopoly, supported by the power of government. While the feudalism had chosen the chosen economic leaders from among the aristocrats, the mercantile system among successful merchants, military leaders, entrepreneurs, adventures. The communist system gave
    The capitalistic systemis less ch

  4. Sorry slipped away. Continue….
    The communist system kept the monopoly in the hands of the governing body itself. All this systems were very inflexible as to resource division and social and economic mobility, even if mercantilism was more flexible than the rest. So the economic inequality was built in, in the system itself.
    The capitalistic market driven system as compared to the other systems mentioned above opened itself to the most skilled and in principle the government’s task should be support for smooth free competition environment. But this system has its faults too. If the system exists uninterrupted for more than a generation, socially the economic and political elites create a network of mutual collaborators, and disrupt the lassaiz faire system of competition, and again the inequality grows to unacceptable levels. This is the stage we are heading too in Europe and the US. Usually it this stage ends with war or revolution.

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