Major Schools of Economic Theory

The word "economics" is derived from oikonomikos, which means skilled in household management. Although the word is very old, the discipline of economics as we understand it today is a relatively recent development. Modern economic thought emerged in the 17th and 18th centuries as the western world began its transformation from an agrarian to an industrial society.

Despite the enormous differences between then and now, the economic problems with which society struggles remain the same:

* How do we decide what to produce with our limited resources?
* How do we ensure stable prices and full employment of our resources?
* How do we provide a rising standard of living both for ourselves and for future generations?

Progress in economic thought toward answers to these questions tends to take discrete steps rather than to evolve smoothly over time. A new school of ideas suddenly emerges as changes in the economy yield fresh insights and make existing doctrines obsolete. The new school eventually becomes the consensus view, to be pushed aside by the next wave of new ideas.

This process continues today and its motivating force remains the same as that three centuries ago: to understand the economy so that we may use it wisely to achieve society's goals.

Mercantilists

Mercantilism was the economic philosophy adopted by merchants and statesmen during the 16th and 17th centuries. Mercantilists believed that a nation's wealth came primarily from the accumulation of gold and silver. Nations without mines could obtain gold and silver only by selling more goods than they bought from abroad. Accordingly, the leaders of those nations intervened extensively in the market, imposing tariffs on foreign goods to restrict import trade, and granting subsidies to improve export prospects for domestic goods. Mercantilism represented the elevation of commercial interests to the level of national policy.

Physiocrats

Physiocrats, a group of 18th century French philosophers, developed the idea of the economy as a circular flow of income and output. They opposed the Mercantilist policy of promoting trade at the expense of agriculture because they believed that agriculture was the sole source of wealth in an economy. As a reaction against the Mercantilists' copious trade regulations, the Physiocrats advocated a policy of laissez-faire, which called for minimal government interference in the economy.

Classical School

The Classical School of economic theory began with the publication in 1776 of Adam Smith's monumental work, The Wealth of Nations.

The book identified land, labor, and capital as the three factors of production and the major contributors to a nation's wealth. In Smith's view, the ideal economy is a self-regulating market system that automatically satisfies the economic needs of the populace.

He described the market mechanism as an "invisible hand" that leads all individuals, in pursuit of their own self-interests, to produce the greatest benefit for society as a whole. Smith incorporated some of the Physiocrats' ideas, including laissez-faire, into his own economic theories, but rejected the idea that only agriculture was productive.

While Adam Smith emphasized the production of income, David Ricardo focused on the distribution of income among landowners, workers, and capitalists. Ricardo saw a conflict between landowners on the one hand and labor and capital on the other. He posited that the growth of population and capital, pressing against a fixed supply of land, pushes up rents and holds down wages and profits.

Thomas Robert Malthus used the idea of diminishing returns to explain low living standards. Population, he argued, tended to increase geometrically, outstripping the production of food, which increased arithmetically. The force of a rapidly growing population against a limited amount of land meant diminishing returns to labor. The result, he claimed, was chronically low wages, which prevented the standard of living for most of the population from rising above the subsistence level.

Malthus also questioned the automatic tendency of a market economy to produce full employment. He blamed unemployment upon the economy's tendency to limit its spending by saving too much, a theme that lay forgotten until John Maynard Keynes revived it in the 1930s.

Coming at the end of the Classical tradition, John Stuart Mill parted company with the earlier classical economists on the inevitability of the distribution of income produced by the market system. Mill pointed to a distinct difference between the market's two roles: allocation of resources and distribution of income. The market might be efficient in allocating resources but not in distributing income, he wrote, making it necessary for society to intervene.

Marginalist School

Classical economists theorized that prices are determined by the costs of production. Marginalist economists emphasized that prices also depend upon the level of demand, which in turn depends upon the amount of consumer satisfaction provided by individual goods and services.

Marginalists provided modern macroeconomics with the basic analytic tools of demand and supply, consumer utility, and a mathematical framework for using those tools. Marginalists also showed that in a free market economy, the factors of production -- land, labor, and capital -- receive returns equal to their contributions to production. This principle was sometimes used to justify the existing distribution of income: that people earned exactly what they or their property contributed to production.

Marxist School

The Marxist School challenged the foundations of Classical theory. Writing during the mid-19th century, Karl Marx saw capitalism as an evolutionary phase in economic development. He believed that capitalism would ultimately destroy itself and be succeeded by a world without private property.

An advocate of a labor theory of value, Marx believed that all production belongs to labor because workers produce all value within society. He believed that the market system allows capitalists, the owners of machinery and factories, to exploit workers by denying them a fair share of what they produce. Marx predicted that capitalism would produce growing misery for workers as competition for profit led capitalists to adopt labor-saving machinery, creating a "reserve army of the unemployed" who would eventually rise up and seize the means of production.

Institutionalist School

Institutionalist economists regard individual economic behavior as part of a larger social pattern influenced by current ways of living and modes of thought. They rejected the narrow Classical view that people are primarily motivated by economic self-interest. Opposing the laissez-faire attitude towards government's role in the economy, the Institutionalists called for government controls and social reform to bring about a more equal distribution of income.

Keynesian School

Reacting to the severity of the worldwide depression, John Maynard Keynes in 1936 broke from the Classical tradition with the publication of the General Theory of Employment, Interest, and Money. The Classical view assumed that in a recession, wages and prices would decline to restore full employment. Keynes held that the opposite was true. Falling prices and wages, by depressing people's incomes, would prevent a revival of spending. He insisted that direct government intervention was necessary to increase total spending.

Keynes' arguments proved the modern rationale for the use of government spending and taxing to stabilize the economy. Government would spend and decrease taxes when private spending was insufficient and threatened a recession; it would reduce spending and increase taxes when private spending was too great and threatened inflation. His analytic framework, focusing on the factors that determine total spending, remains the core of modern macroeconomic analysis.


Summary

Economic theories are constantly changing. Keynesian theory, with its emphasis on activist government policies to promote high employment, dominated economic policymaking in the early post-war period. But, starting in the late 1960s, troubling inflation and lagging productivity prodded economists to look for new solutions. From this search, new theories emerged:

Monetarism updates the Quantity Theory, the basis for macroeconomic analysis before Keynes. It reemphasizes the critical role of monetary growth in determining inflation.

Rational Expectations Theory provides a contemporary rationale for the pre-Keynesian tradition of limited government involvement in the economy. It argues that the market's ability to anticipate government policy actions limits their effectiveness.

Supply-side Economics recalls the Classical School's concern with economic growth as a fundamental prerequisite for improving society's material well-being. It emphasizes the need for incentives to save and invest if the nation's economy is to grow.

These theories and others will be debated and tested. Some will be accepted, some modified, and others rejected as we search to answer these basic economic questions: How do we decide what to produce with our limited resources? How do we ensure stable prices and full employment of resources? How do we provide a rising standard of living both for now and the future?

The information in this publication was taken from The World of Economics, a unique exhibition on economics and the U.S. economy located in the lobbies of the Federal Reserve Bank of San Francisco and its Los Angeles Branch.

The greatest threat to the U.S. economy is not creeping socialism. It's creeping subsidism

In the October 26, 2009 Salon article "The tax breaks that ate America," Michael Lind argues "the greatest threat to the U.S. economy is not creeping socialism. It's creeping subsidism."

Here's the latest bold new idea for reconciling the costs of national defense with the need to avoid adding to federal deficits or raising taxes. A bipartisan coalition of "New Democrats" and moderate Republicans has proposed buying weapons for the U.S. military through the IRS rather than the Pentagon. Here's how it would work. Instead of being paid to deliver planes, missiles and tanks, defense contractors would receive "weapon supply tax credits" (WSTC). The defense contractors would be able to reduce the taxes they owed the federal government by the prices of the weapons they delivered. Because the tax credit would be refundable, if the prices exceeded a firm's annual tax liability, the IRS would send a check to the firm in the amount of the difference. In this way, the federal government could finance a massive military buildup -- and because tax credits aren't counted as part of the federal budget, for official purposes the cost of the buildup would be zero!

I had you going there for a minute, didn't I? The "weapons supply tax credit" is a joke. It was proposed some years ago by the late David Bradford, a Princeton economist who worked in the Ford and George H.W. Bush administrations. Bradford's purpose was to ridicule the growing reliance of Congresses and presidents on tax credits and other so-called tax expenditures as an alternative to ordinary spending programs funded by ordinary taxes.

The weapons supply tax credit is no crazier than the major tax expenditures that shape -- no, make that disfigure -- the political economy of early 21st century America. Instead of raising taxes to pay for universal healthcare, as many other nations do, the federal government grants a $250 billion a year tax break to employers to give them an incentive to buy healthcare for their employees. Hey, that approach really worked out well, didn't it?

And then there's America's biggest antipoverty program, the Earned Income Tax Credit (EITC). By means of the EITC, the federal government "tops up" the wages of full-time workers who are trapped in poverty. Needless to say, this is also a massive subsidy to employers who pay poverty wages to their workers, and to consumers who buy goods and services produced by poverty-wage workers. You'd think the more straightforward approach would be to ensure that anybody who works 40 hours a week doesn't need to rely on welfare, with entry-level public employment mopping up most remaining unemployment. You'd think.

Did I mention the home mortgage interest deduction? This costs the Treasury around $80 billion a year in lost tax revenue that must be paid for by other taxes if it is not to enlarge the deficit. This program, justified on the grounds that it promotes home ownership, in practice showers government subsidies chiefly on rich and upper-middle-class homeowners. Some countries like Canada that lack such a tax expenditure have higher rates of homeownership than the U.S.

The political scientist Christopher Howard calls the tax expenditure system the "hidden welfare state." It might just as well be called the Blob That Ate the Economy. If only non-business subsidies to individuals are counted, the IRS-administered subsidy sector costs around $800 billion a year. That's about 6 percent of U.S. GDP, or about a fifth of the total official expenditure of the federal, state and local governments combined.

To put that number into perspective, according to official figures the U.S. spends about 30 percent of its GDP on government at all levels -- well below the OECD average of around 36 percent and the EU average of about 39 percent. But add in the "dark matter" of tax expenditures, and federal-state-local spending goes up to around 36 percent of GDP -- close to the international average among developed countries and within range of European norms.

This is something that neither liberals nor conservatives are honest about. Liberals like to invoke official spending numbers to claim that the U.S. spends far less on social welfare purposes than other, similar industrial democracies. That implies that there is room for a massive expansion of federal spending on new purposes -- health, environment, education. But as Jacob Hacker has pointed out, when tax expenditures are factored in, U.S. welfare policies absorb far more of the U.S. economy already than many on the left want to admit. Though it is still short of the half of GDP taken by government in the Nordic democracies, the American public sector, when dark matter is included, is pretty close to Western European levels already.

But conservatives have no reason to gloat about the discovery of the tax-expenditure dark matter -- not if they believe their own rhetoric about free markets and free enterprise. The truth is that tax expenditures warp the market and corrupt private enterprise.

In a mixed economy like that of the U.S. from the Depression until the 1980s, there is a division of labor among well-defined sectors. The government provides public goods -- sometimes directly, as in the case of public K-12 education, and sometimes indirectly, through "state capitalism," by making loans to college students or paying contractors to build roads and bridges. The private sector provides most other goods, from apples to Apples. A limited nonprofit sector made up of universities, hospitals and museums rounds out the mixed economy.

In the new "subsidist" economy that both parties have created in recent decades, the distinctions among public, private and nonprofit sectors are broken down. Government becomes unlimited in ends at the same time that it becomes rigidly limited in means. The means are always the same -- a tax credit that conservatives can describe to their constituents as a "tax cut" and that liberals can describe to their constituents as a spending program. But the ends are unlimited.

Does the annoying nanny-state left want to replace French fries with asparagus spears? Then call for an individual tax credit to encourage healthy eating, and label it a "nudge" in the manner of Richard Thaler and Cass Sunstein. Does the big-government right want to expand healthcare without paying for it? Then call for a tax credit for "medical savings accounts."

Conservatives make little effort to reconcile their libertarian, anti-statist rhetoric with their defense of old subsidies and their call for new ones. For example, they claim to believe that private schools, competing in the market, can deliver better outcomes than public schools. Do they therefore demand for-profit schools that, if they fail, declare bankruptcy and go out of business like stores in a shopping mall? No. They call for government vouchers for private schools. What do government vouchers, paid for by taxpayers, have to do with the "free market" and "free enterprise" and "the private sector"?

Vouchers are also the basis of most conservative healthcare plans. Ironically, the idea of "voucher socialism" as a proposal dates back to certain groups on the left in the early 20th century. Today's "right" consists largely of voucher socialists and apologists for tax breaks for large corporations, banks and insurance companies. To judge by their actions, rather than by their words, most conservatives appear to believe that private enterprise is so congenitally deformed and feeble that it will expire of its own debility unless it is given constant intravenous injections of direct and indirect taxpayer subsidies.

Defeating the Blob may require an alliance of both ends against the middle. When it comes to the subsidy sector, we have a four-party system. Neoliberal New Democrats, like the majority of personnel in the Clinton and Obama administrations, have preferred tax credits to honest spending programs, so they can claim to be in favor of limiting the size of government. Centrist Republicans like tax expenditures for the same reason. The opponents of the ever-expanding subsidy state are found among social democrats on the left and libertarians on the right. Social democrats would prefer direct government spending for public purposes rather than subsidies to rent-seeking middlemen bribed into doing things that the public sector does in better-governed countries. Libertarians -- at least the ones who don't care about being players in the Republican Party -- oppose corporate welfare in the name of the free market.

Social democrats and reasonable libertarians might consider uniting in a grand alliance against the bloated subsidy sector. As a rule, public goods should be provided by the government and private goods by the private sector, with a small contribution from a modest nonprofit sector. Most of the 6 percent or so of GDP that is now converted into the dark matter of tax expenditures needs to be divided between a restored public sector and a restored private sector -- with a rebuilt border between them. The principled left and the principled right can argue about where the border between the public sector and the private sector should be. But at least they can agree that there should be a border, and that the no man's land of the subsidy sector needs to be erased from the map.

Two Recent Books about Ayn Rand

The October 22, 2009 Economist article "Capitalism's martyred hero: The life and views of Ayn Rand" reviews two recent books about Ayn Rand, saying "most intellectuals don’t have much time for Ayn Rand with her `glare that could wilt a cactus.´ But her uncompromising views are still worshipped by many."

Ayn Rand and the World She Made. By Anne Heller. Nan A. Talese; 592 pages.

Goddess of the Market: Ayn Rand and the American Right. By Jennifer Burns. Oxford University Press; 384 pages.

FOR all its faults socialism is manifestly superior to capitalism in one area: the making of myths. Capitalists can never equal the emotional appeal of socialism’s martyred heroes. Ayn Rand, however, is a conspicuous exception to this rule. She has been given short shrift by the intellectual establishment. Literary critics bemoan her cardboard characters and tabloid style. Political theorists dismiss her as a shallow thinker whose appeal is restricted to adolescents. But such disdain has done nothing to damage her popular appeal.

Rand’s books have enjoyed impressive sales since her death in 1982. But America’s shift to the left—the Democratic takeover of Congress in 2006 and Barack Obama’s election two years later—has put her back at the heart of the political debate. Conservative protesters carry posters asking “Who is John Galt?”, referring to one of Rand’s heroes. Conservative polemicists suggest that Mr Obama, by stepping in to rescue the banks and industrial behemoths such as General Motors, is ushering in the collectivist dystopia that Rand gave warning against. Sales of “The Fountainhead” and “Atlas Shrugged” have surged. Rumours swirl that a film based on “Atlas Shrugged” is in the works.


So the publication of these two books could not have been better timed. Anne Heller is more informative on Rand’s early years in Russia. Jennifer Burns is better versed in conservative thought. Both are well worth reading, partly because Rand’s life was so extraordinary and partly because the questions that she raised about the proper power of government are just as urgent now as they ever were.

Rand was the single most uncompromising critic of the collectivist tide that swept across the capitalist world in the wake of the Depression. For her, government was nothing more than licensed robbery and altruism just an excuse for power-grabbing. Intellectuals and bureaucrats might pose as champions of the people against the powerful. But in reality they were empire builders who were motivated by a noxious mixture of envy and greed. Rand’s heroes were a different breed: the businessmen and entrepreneurs who felt the future in their bones and would not rest until they had brought it to life.

This might sound like libertarian boilerplate: Nietzsche repackaged for the Chamber of Commerce crowd. But three things gave her work its hypnotic power. The first was her background as a Russian Jew—she was born Alisa Rosenbaum—who witnessed the revolution and its aftermath at first hand. This filled her with contempt for the Communist fellow-travellers she encountered in Washington and Hollywood, and sensitised her to the similarities between the New Deal and central planning. The second was the absolutism of her vision. Confronted by an almost uniformly hostile elite, she went out of her way to pick a fight with a possible ally, Friedrich Hayek, dismissing his “The Road to Serfdom” as pure poison because he conceded there might be a limited role for the state.

But her most important attribute was her talent for myth-making. Rand perfected her literary art as a screenwriter in Hollywood. And she dealt in Hollywood-style dichotomies between good and evil, between white-hatted capitalists and black-hatted collectivists. Greys don’t interest me, she once said. “Atlas Shrugged” conjured up a world in which all creative businessmen had gone on strike, retreating to Galt’s Gulch in Colorado, and culminated in a dramatic court scene in which Galt detailed the evils of collectivism.

The woman behind these right-wing myths was exceedingly odd. She had “a glare that could wilt a cactus” according to a writer in Time, and wore a broach in the shape of a dollar sign. She was even odder to live with. Ms Burns points out that she obliged her long-suffering husband to wear a bell attached to his shoe so that she could hear him come and go. She all but obliged her leading acolyte, Nathaniel Branden, to meet her for sex twice a week, informing both her husband and Mrs Branden that the arrangement was rational. She picked fights with “frightened zombies”, as she called her fellow intellectuals, and yet was mortally offended when anybody dared to criticise her writing.

Ms Heller and Ms Burns both dwell on the contradictions of Rand and Randism. Rand was an uncompromising rationalist. But she was also the plaything of powerful emotions. She devoted her life to fighting collectivism. But she would not tolerate dissent among her followers—and even playfully called her inner-circle “the collective”. There was more than just a right kind of politics, one of her followers recalled. There was also a right kind of interior design, a right kind of dancing. She loathed communism. But many of her readers reacted to her writings in much the same way that leftists reacted to reading Marx.

Both authors point to the tragedy of her career even though her book sales turned her into a multimillionaire and a cultural icon. She lived to see laissez-faire triumph over collectivism and one of her leading acolytes, Alan Greenspan, appointed to the president’s Council of Economic Advisers. But nothing was ever good enough for her and she felt surrounded by traitors. Ms Heller is particularly informative on the way that the “collective” fell apart when she fell out with Branden.

Yet Rand’s appeal has been undimmed by either the vituperation of her critics or the peculiarity of her admirers. Her insight in “Atlas Shrugged”—that society cannot thrive unless it is willing to give freedom to its entrepreneurs and innovators—has proved to be prescient. Even if John Galt is under threat once again in the West, he is back in business in China and India.

The Real Unemployment Rate, a Broader Measure of Unemployment, Reaches 17%

In the October 19, 2009 Salon article "That sound you hear is the social fabric about to snap," Michael Lind says "the real unemployment rate is almost 20 percent. Here's what the federal government can do about the jobs crisis."

According to official statistics, the unemployment rate in the United States is now 9.8 percent. But those statistics understate the severity of the jobs crisis. The official statistics do not include the 875,000 Americans who have given up looking for work, even though they want jobs. When these "marginally attached" workers and part-time workers are added to the officially unemployed, the result, according to another, broader governement measure of unemployment known as "U-6," is shocking. The United States has an unemployment rate of 17 percent.

And even this may understate the depth of the problem. By adding the 3.4 million Americans who want a job but have not looked for one in over a year, businessman, philanthropist and Obama advisor Leo Hindery Jr. infers an actual unemployment rate of 18.8 percent. In other words, nearly one in five Americans is unemployed or underemployed.

The sound you hear is the sound of the social fabric in America rotting and beginning to snap. Thanks to the unemployment insurance system adopted during the New Deal years, and thanks in part to the stimulus that the Obama administration and Congress passed earlier in the year, we do not have hordes of out-of-work Americans standing in line at soup kitchens and riding the rails from town to town. Even so, the invisible decay of America's social order is just as real as the highly visible decay of abandoned McMansions in new developments that are turning into ghost towns across the continent.

Mass unemployment has yet to spawn a wave of crime or social unrest. But those possibilities cannot be dismissed. And the desperation is real, even if it is not signaled by desperate acts. The psychological toll of prolonged unemployment is devastating on individuals who have lost their roles as breadwinners or productive, self-reliant citizens. Employers prefer not to hire people who have been unemployed for long periods -- and laid-off workers today are spending an average of 26.2 weeks without jobs, the highest average since the Great Depression. And then there are the new graduates of high schools and colleges, a lost generation whose members may be crippled throughout their careers by the lack of opportunities in their youth.

The American political class, insulated by wealth and connections from the economic storm, has been slow to respond to this crisis. The Democratic majority in Washington has hoped that the stimulus would solve much of the problem. While waiting for its effects to manifest themselves, the Democrats have focused on long-term problems of structural reform -- healthcare, the environment, education. The Republican right has nothing to offer, except a contradictory message that both taxes and deficits should be drastically cut.

During the campaign, candidate Obama promised a jobs tax credit. That idea was left out of the stimulus, however. Democrats feared that employers would game the program while Republicans wanted broader tax cuts for business and individuals. Last spring, some administration officials said complacently that "employment is a lagging indicator" and that the jobs would return if we were patient enough. Now that unemployment is both worse than expected and more enduring, there is a growing recognition of the need to do something to address the sinkhole in the economic landscape into which so many individuals and communities are tumbling.

My colleagues and I at the New America Foundation's Economic Growth program have put together an expert round table featuring different proposals. Timothy J. Bartik of the W.E. Upjohn Institute for Employment Research proposes a New Jobs Tax Credit, like the one that candidate Obama favored, modeled on Carter-era precedents and an innovative state program in Minnesota. James K. Galbraith of the University of Texas proposes a major expansion of federal funding of state and local services, education, healthcare, infrastructure and energy investment. And L. Randall Wray of the University of Missouri-Kansas City proposes that the government act as employer of last resort, offering a job to anyone who wants one.

My guess is that Congress, if it does anything, will be attracted to tax credits for new jobs. In our taxophobic age, Congress always prefers tax credits to direct spending. But in the absence of demand for their goods and services, employers are not going to hire more workers, no matter what incentives are provided. For this reason, the optimal synthesis might be a combination of tax credits to lower the cost of hiring with sustained public investment in infrastructure and public services, where the government for the foreseeable future must replace the tapped-out consumer as the driver of demand in the U.S. economy for the next few years.

All of these policies would cost at least tens of billions in additional federal spending a year, for the next few years. But the costs must be kept in perspective. After the additions to the federal deficit and debt created by the stimulus and the bailouts of the banking sector, even ambitious jobs programs would add relatively little to America's long-term fiscal shortfall. And while the benefits could be estimated, the psychological and social benefits of putting Americans back to work, in terms of self-esteem and hope about the future, are literally incalculable.

Ronald Reagan was fond of saying, "Don't just do something, stand there." While this may sum up the approach of a certain kind of complacent, anti-government conservatism, the sentiment is not only politically suicidal but also unethical in a country where mass unemployment and mass foreclosures have littered the landscape with rotting houses and rotting lives. Like the New Deal Democrats, today's Democrats need to experiment ceaselessly, trying and abandoning programs until they find some that succeed in putting Americans back to work in a productive economy.

If we can bail out the employees of Wall Street, we can bail out the unemployed on Main Street. And we had better do so quickly, if we don't want that rotting sound to be followed by a sudden snap.

Heterodox Economic Thought

"There is much of the past that is in the present, so also there is much of the present that will be in the future."
-- John Kenneth Galbraith

John Maynard Keynes

"Keynes said some things that were new and some things that were true; unfortunately the things that were new weren't true, and the things that were true weren't new."
-- Frank Knight

Paul Samuelson

"To a person of analytic ability, perceptive enough to realize that mathematical equipment was a powerful sword in economics, the world of economics was his or her oyster in 1935."
-- Paul Samuelson

Austrian Economics

"Socialism is the road to serfdom."
-- Friedrich A. von Hayek

Thorstein Veblen

"Man is not simply a bundle of desires but rather a coherent structure of propensities and habits which seeks realisation and expression in an unfolding society."
-- Thorstein Veblen

Bruce Bartlett: A Conservative Who Favors Higher Taxes

Conservative David Frum interviews Bruce Bartlett on October 11, 2009. Highlights of the 53-minute video include:

A Conservative for Higher Taxes

Bruce’s new book, “The New American Economy” (07:16)
Where Obama went wrong on health care (07:06)
Bruce: Higher taxes are inevitable (04:16)
Why a carbon tax is far superior to cap and trade (05:21)
Bruce to GOP: Be more European! (09:54)
David: Obama’s economic policy is undermining his coalition (02:37)

Léon Walras

"If one wants to harvest quickly, one must plant carrots and salads; if one has the ambition to plant oaks, one must have the sense to tell onesef: my grandchildren will owe me this shade."
-- Léon Walras

Alfred Marshall

"Economic doctrine is not a body of concrete truth, but an engine for the discovery of concrete truth."
-- Alfred Marshall

Irving Fisher

"The value of the orchard depends upon the value of its crops: and in this dependence lurks implicitly the rate of interest itself."
-- Irving Fisher

William Stanley Jevons

"In commerce, bygones are for ever bygones; and we are always starting clear at each moment, judging the values of things with a view to future utility."
-- William Stanley Jevons

Karl Marx

"The fox knows many things, but the hedgehog knows one main thing."
-- Isaiah Berlin

John Stuart Mill

"Through Mill we see the philosophical conflicts underlying classical economics."
-- Todd G. Buchholz

Salon interviews the late Adam Smith

In the October 6, 2009 article "Salon interviews the late Adam Smith," Michael Lind uses quotations from Adam Smith to create a hypothetical interview in which "the 18th century's patron saint of free markets shares his surprising views about Barack Obama and the U.S. economy."

The remarks of Adam Smith are all quotations from his book "The Wealth of Nations," first published in 1776.

Our guest today is Adam Smith, a major figure of the Enlightenment who is widely considered to be the father of modern economic theory. He is a former professor at the University of Glasgow and the author of "The Theory of Moral Sentiments" (1759) and "An Inquiry into the Nature and Causes of the Wealth of Nations" (1776), his best-known book. Professor Smith joins us from Scotland.

Professor Smith, the Obama administration recently imposed tariffs on China, after companies and unions in the U.S. complained that the Chinese tire industry benefits from Chinese subsidies as well as an undervalued exchange rate. Most editorial pages and magazines in the prestige press denounced the tire tariffs as a threat to free trade. You are generally considered the patron saint of free trade. What is your view of the tariffs on Chinese tires?

The case in which it may sometimes be a matter of deliberation how far it is proper to continue the free importation of certain foreign goods is when some foreign nation restrains by high duties or prohibitions the importation of some of our manufactures into their country ... There may be good policy in retaliations of this kind, when there is a probability that they will procure the repeal of the high duties or prohibitions complained of. The recovery of a great foreign market will generally more than compensate the transitory inconveniency of paying dearer during a short time for some sorts of goods. To judge whether such retaliations are likely to produce such an effect does not, perhaps, belong so much to the science of a legislator, whose deliberations ought to be governed by general principles which are always the same, as to the skill of that insidious and crafty animal, vulgarly called a statesman or politician, whose councils are directed by the momentary fluctuations of affairs.

It will come as a great surprise to many people to learn that Adam Smith favors retaliatory tariffs in some cases. Would you make any other exceptions to the general rule of free trade?

There seem to be two cases in which it will generally be advantageous to lay some burden upon foreign [industry] for the encouragement of domestic industry. The first is when some particular sort of industry is necessary for the defence of the country ... The second case, in which it will generally be advantageous to lay some burden upon foreign [industry] for the encouragement of domestic industry is when some tax is imposed at home upon the produce of the latter. In this case, it seems reasonable that an equal tax should be imposed upon the like produce of the former. This would not give the monopoly of the home market to domestic industry, nor turn towards a particular employment a greater share of the stock and labour of the country than what would naturally go to it. It would only hinder any part of what would naturally go to it from being turned away by the tax into a less natural direction, and would leave the competition between foreign and domestic industry, after the tax, as nearly as possible upon the same footing as before it.

Interesting. Your second point brings to mind the argument that American exports are punished, because most countries in Europe and Asia impose a value-added or VAT tax on U.S. imports, and at the same time grant VAT rebates to products that they export -- penalizing American exports while subsidizing their own. Some argue that the adoption of a VAT in the U.S. could level the playing field.

It is often claimed that globalization is a force that cannot and should not be slowed down. And yet although you favor free trade in general, you argue that national economies should be opened up to foreign competition only slowly and carefully, in order to minimize economic and social disruption. Would you please explain your reasoning?

The undertaker of a great manufacture, who, by the home markets being suddenly laid open to the competition of foreigners, should be obliged to abandon his trade, would no doubt suffer very considerably. That part of his capital which had usually been employed in purchasing materials and in paying his workmen might, without much difficulty, perhaps, find another employment. But that part of it which was fixed in workhouses, and in the instruments of trade, could scarce be disposed of without considerable loss. The equitable regard, therefore, to his interest requires that changes of this kind should never be introduced suddenly, but slowly, gradually, and after a very long warning.

The minimum wage in the United States today is far below what it was a few decades ago, thanks to inflation. At the same time, in the last generation wages have stagnated while roughly half of the gains from economic growth have gone to a tiny number of rich Americans. Many conservative economists and business executives argue that companies cannot afford high wages for ordinary workers. Aren't high salaries and bonuses costs as well?

Our merchants and master manufacturers complain much of the bad effects of high wages in raising the price, and thereby lessening the sale of their goods both at home and abroad. They say nothing concerning the bad effects of high profits. They are silent with regard to the pernicious effects of their own gains. They complain only of those of other people.

One common theme of economic conservatives is that poor people in the U.S. are not really poor, compared to the truly destitute in developing countries. Many poor Americans own cars and television sets. Do you think that poverty should be measured in absolute, world-wide terms, or in relative terms, with reference to the living standards of particular societies?

By necessaries I understand not only the commodities which are indispensably necessary for the support of life, but whatever the customs of the country renders it indecent for creditable people, even the lowest order, to be without. A linen shirt, for example, is, strictly speaking, not a necessary of life. The Greeks and Romans lived, I suppose, very comfortably, though they had no linen. But in the present times, through the greater part of Europe, a creditable day-labourer would be ashamed to appear in public without a linen shirt, the want of which would be supposed to denote that disgraceful degree of poverty which, it is presumed, nobody can well fall into, without extreme bad conduct. Custom, in the same manner, has rendered leather shoes a necessary of life in England.

Many libertarians and conservatives argue that the only fair tax system would be a flat tax. In your opinion should the tax system be flat or progressive?

The necessaries of life occasion the great expense of the poor. They find it difficult to get food, and the greater part of their little revenue is spent in getting it. The luxuries and vanities of life occasion the principal expense of the rich, and a magnificent house embellishes and sets off to the best advantage all the other luxuries and vanities which they possess ... It is not very unreasonable that the rich should contribute to the public expense, not only in proportion to their revenue, but something more than in that proportion.

American labor activists and many liberals support the Employee Free Choice Act (EFCA), which would make it easier for workers to form unions. Many conservative economists argue that greater unionization would cripple the U.S., causing higher unemployment and rendering the U.S. economy less competitive. Do you agree?

We rarely hear, it has been said, of the combinations of masters, though frequently of those of workmen. But whoever imagines, upon this account, that masters rarely combine, is as ignorant of the world as of the subject. Masters are always and everywhere in a sort of tacit, but constant and uniform, combination, not to raise the wages of labour above their actual rate ... Masters, too, sometimes enter into particular combinations to sink the wages of labour even below this rate.

Speaking of combinations, here in the United States we are witnessing major lobbying campaigns by lenders to prevent Congress from creating a consumer credit protection agency and by health insurance companies that seek to defeat a public health insurance option. What do you think of organized lobbying by business interests?

People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.

During the 1980s, some followers of British Prime Minister Margaret Thatcher and American President Ronald Reagan wore neckties decorated by your profile. Thatcher said, "There is no such thing as society," and Reagan said, "Government is not the solution. Government is the problem." According to free-market conservatives, government should be run like a private-sector business and the noblest figures in society are business executives and entrepreneurs. Do you agree?

The violence and injustice of the rulers of mankind is an ancient evil, for which, I am afraid, the nature of human affairs can scarce admit of a remedy. But the mean rapacity, the monopolizing spirit of merchants and manufacturers, who neither are, nor ought to be, the rulers of mankind, though it cannot perhaps be corrected may very easily be prevented from disturbing the tranquility of anybody but themselves.

David Ricardo

"Ricardo's intellectual appeal then and now rested on his remarkable gifts for heroic abstractions."
-- Mark Blaug

Adam Smith

"Adam Smith occupies so central a place in the history of Political Economy that the prudent mariner hesitates to embark on so vast an ocean."
-- Alexander Gray

Scientific Attitude

"For it is remarkable that the inventors had none of that detached objectivity that goes by the name of 'scientific attitude.'"
-- William Letwin

The birth of economic analysis in the West

"The birth of economic analysis in the West was the result of a union of two elements in Hellenic thought. One of these was the ability to reason about social relationships in a generalized or abstract form. The second was reflection on living in a sophisticated economic environment created during an upsurge of export-led growth."
-- Barry Gordon

Where do we start?

"Where do we start?" asked the Red Queen.
"Start at the beginning," answered the Dodo.
-- Lewis Carroll

Human Undertakings

"The beginnings and endings of all human undertakings are untidy ..."
-- John Galsworthy