A little economic history: Adam Smith advocated competitive markets, not “free” markets

This is the second post in a series about political economy.

I begin with an intriguing historical observation that pertains to present electoral politics: the guy who convinced Franklin D. Roosevelt to engage in public spending was a wealthy Mormon businessman. His name was Marriner Eccles, and he chaired the Federal Reserve Board from 1934 to 1948.

Why does this matter? In today’s American politics, advocates of deregulated capitalism are arguing that the only ‘alternative’ is socialism. Such a flawed and false dichotomy is only possible in a world of public debate where almost all history and most economic theory is ignored or forgotten.

So a little history. I have been reading the 1992 edition of Robert Heilbroner’s The worldly philosophers (first edition was 1953, but he kept revising). On page 275, Heilbroner interrupts his biography of John Maynard Keynes to point out that the Roosevelt administration was already implementing the policies Keynes advocates in General theory of employment, interest, and money (1936). Heilbroner’s does not clearly explain how and why the Roosevelt administration adopted an interventionist policy. But since the financial panic of 2007, a number of leading economists have taken a closer look at the past, including Robert Reich.  In Aftershock (2010), Reich begins with a description of how and why Eccles pushes Roosevelt to “prime the economic pump” through public borrowing and spending. In 2010, Reich’s observation that a wealthy Mormon businessman pushed Roosevelt towards economic interventionism was an interesting historical observation. Today, it lends some sharp perspective to present politics.

History matters. Especially the history of political-economic thought and rhetoric. In the last post, I pointed out that government intervention seems to correlate with long-run economic growth, and with sustained national wealth. But that is an empirical, generic set of observations. The following posts provide some key concepts for understanding how government intervention can promote and sustain national economic growth. However it is not a one-size-fits-all formula; so far as I can tell there is no single solution for economic recovery from the 2007-2008 debt and finance crisis. “Government intervention” is not one solution. That term covers every public intervention into economic activity, ranging from local NIMBY activists opposing a housing development, all the way up to Federal Reserve management of interest rates and the money supply. Which public-policy interventions into the economy can promote growth? The simplistic conservative answer is ‘none,’ and contemporary political rhetoric obscures many of the nuances of political-economic theory.

To clear away some of this fog it is worth looking back at the history of economic policies, but also the ideas that frame both policies and current rhetoric. In this post I am only going to explore the distinction between “free” markets and competitive markets.

Argument #1: Competitive markets, not “free” markets.

Adam Smith is often cited as the patron saint of “free” markets (and everything else must be socialism!!). First clarification: what conservatives mean by “free” markets today is deregulation. We have done a pretty good job of dismantling regulations back to the era of the robber-barons of the 1890s, all under the supposed blessing of Saint Smith. But Adam Smith argued for competitive markets, not deregulated markets. Smith did argue for freedom: the freedom of commoners to engage in private, peer-to-peer contracts. He argued that the aristocracy and royalty should liberate the commoners to use their common sense to ‘truck and barter’ as they saw fit. That liberation was why John Stuart Mill called himself a Liberal in the 1840s and 1850s; for Mill, that meant promoting private enterprise, lowering taxes and customs-duties. But for both Smith and Mill, such a system would not work unless the government did two things:

a) protect private property and private contracts with a public system of police and courts.
b) make sure that markets remained competitive, not monopolistic.

In fact Smith’s metaphor of the “Invisible Hand” was an argument for competitive markets, and against monopolistic domination. Smith argued that production and trade did not need Royal/Aristocratic direct control because two forces in the market tend to counterbalance each other:
a) the greed of the producer, who will try to get the maximum profit from production, and
b) the willingness of the buyer to go to other producers offering a lower price.
So the “Invisible Hand” is not at all mystical. Nor is it a justification for letting an unregulated market run. Rather, it is an argument that two factors—greed and competition—work as feedback mechanisms against each other to yield the best production at the optimal price. In such a competitive market, prices tend to be driven down to virtually zero profits; producers will sell to buyers at the break-even point. At such low prices, buyers are willing to buy more; so a lot is produced (Heilbroner 1992:57).

Example of competitive market: basic clothing. Cloth used to be super-expensive, before mechanical spinning, weaving, and knitting. Compared to the 1700s and before, modern households spend a teeny fraction of their wealth on clothing today. Why? Because the the production and trade in clothing (aside from fancy brands) is super-competitive, and production is massive.

Example of less-competitive market: smart-phones. These are incredibly useful items, so demand is extremely high. But there are very few producers in this market. RIM (Blackberry) and Palm seem to be dropping out. In terms of operating systems, it is mostly Apple and Android (Google); even Microsoft is dropping off (though they might come back in this market; Lord knows they are trying). In terms of hardware, there is Apple, Samsung, and then HTC. At the second-tier of less-known smartphone-makers it may be highly competitive, but at the top, there are only two and they charge excessive prices for their hardware.

Even less-competitive? Oil companies and banks. The U.S. has allowed gross consolidation of firms in these two sectors, so that very, very few are left. Let’s set aside details for the moment about multiple gas stations and prices at the pump, etc., and look at a simple relationship: very few oil companies left in the market. Massive profits to those oil companies. That is monopolism. It is not rocket science. And it might be a “free” market in conservative terms, but it is definitely not Smith’s idea of a competitive market.

Examples of least-competitive markets? Narcotics and human trafficking are often cited as prime examples of unregulated markets (i.e. Alex Marshall, 2000). However as a planner, I am interested in whole urban, regional, and even national economies. And the best example I can think of at the moment is Somalia. You want a place where ‘the government is so small it could be drowned in a bathtub?’ Try Mogadishu. It was the capital, but Somalia has not had an effective national government since the early 1990s. As perhaps the supreme example to the U.S. Republican ideal of ‘small government,’ what is the resulting aggregate wealth of the nation of Somalia? Well, neither the World Bank nor the IMF will list Somalia in their rankings, because the numbers are so uncertain. However the CIA lists Somalia as 191st out of 194 countries. Yeah! Deregulate! The University of Pennsylvania lists Somalia at 181 out of 185 countries, with an estimated GDP/capita of $547 per year. Interestingly, a country with quite valuable exports lists at the very bottom of all four estimates: the Democratic Republic of Congo, with its oil and rare-earth minerals, is a place where the U.S.-supported dictator Mobutu Sese Seko became a billionaire. Estimated per GDP/capita is somewhere between $300 and $400 per year (in purchasing power parity terms) for the Congolese. Minimal government in the DRC? Absolutely. Valuable resources? Some of the best in the world. If we ask Smith’s question about the nature and causes of the wealth (or lack thereof) of this nation, compared to nations with far poorer natural resources like Denmark, Singapore, Finland, and South Korea, you have to work pretty hard to deny the possibility that strong regulatory regimes might have something to do with aggregate wealth-generation.

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