Home > finance, rant > Adam Smith made me buy a Kindle

Adam Smith made me buy a Kindle

August 6, 2011

When I was pregnant with my third son, and working at D.E. Shaw, I got really into reading Adam Smith’s seminal work “Wealth of Nations” on the subway rides to and from work. Once the baby came, though, the problem was that the book is huge, like 1,200 pages, and impossible to read while breastfeeding. In my frustration, and to combat baby brain-rot, I bought a Kindle to continue my reading through many many exhausting hours those first few months. Totally worth it, an investment in my sanity.

This post got me remembering my personal experience with Adam Smith. Adam Smith has really gotten a bum rap. He is generally known for inventing the concept of the invisible hand, which is the idea that, as long as each person is working as hard as they can to personally profit from their labor, the overall economy will benefit from that self-interest. However, it’s often used is as an excuse for why regulations are unnecessary, because somehow, the feeling goes, the invisible hand is all we need. To tell you the truth, I don’t even remember seeing that in his book. Maybe it was there, and maybe I was getting barfed on during that page, but he definitely didn’t focus on it. He had other fascinating points though which he did reiterate.

Here’s why Wealth of Nations is so amazing. First, Smith really is incredibly good at explaining how markets work and, considering that he was inventing a field as he was writing, did so extremely well (although at times the book can be a bit repetitive, probably because he never invented notation- he just rewrote out entire phrase whenever he wanted to refer to an idea). The most basic goal of the book is to explain that it makes more sense to trade between countries so that things that are relatively cheaper to make or produce in Country A can be traded for things that are easier for Country B to make, and to generalize that to “between towns” or “between people”.

The examples he uses are really interesting, and include various layered considerations such as whether the goods are easily stored. For example, he maintains that cotton and wools should absolutely have free trade, since there is a clear advantage to having the appropriate climate for the growth of the plants, as well as the long storage. By contrast, he talks about the price of meat in England versus Argentina, being non-storable, and mentions that the price of a cow in Argentina is equal to the tip you need to give a village boy to go catch a cow (I’m paraphrasing because it was almost three years ago).

Another fascinating aspect of the book is that, since he wrote it in the 1770’s, economic conditions were really different, and he talks at length of the peasant classes in various countries. One of the most striking descriptions comes when he describes how much healthier the Irish peasants were compared to the Scottish peasants, because they ate potatoes, whereas the Scots ate oatmeal. It took me a few minutes to realize that he meant, that they only ate oatmeal. And he was saying that you could tell, by the way the 20 year olds still had teeth in Ireland, how much better a staple potatoes are than oatmeal.

He also talks about the various economies of South America and Europe and it sounds like they were doing better than Great Britain, especially Holland, which was a huge trading country back then. It’s fascinating just to understand, at the level of the average person, the peasants and the merchants, how incredibly different the world was then, something you don’t get as good a look at reading history books (at least the history books I’ve read).

Adam Smith was certainly pro-business, in the sense that he wanted a functioning and efficient system to work for all of the people in the world. However, he was well aware of the natural tendencies of people in power to abuse that power. He speaks at length against monopolies, which he thinks are a natural tendency, and claims that regulations to prevent such things are absolutely necessary.

He also talks at length about currencies and bank notes and the concept of borrowing money to be paid later. He is a proponent of usury laws- he doesn’t think it’s fair to entrap people into debt that they can’t repay (and back then I believe the consequences for unpaid debt were pretty severe). He also goes into incredible detail in describing the way Scotland went through a credit crisis, caused by a lending bubble, where people were cycling through various banks with different loans, borrowing more money to repay other debts, and which spiraled into a huge mess which caused the banking system to collapse. The Bank of England itself defaulted as well in one of his other historical accounts of lending bubbles.

One really interesting point he made about the credit crises he talks about is that, in those days, if you had money, which were called bank notes, then if you wanted to use them in another country you’d have to exchange them for gold when you left the country, and then you’d have to exchange the gold back into bank notes when you entered the next country. He claims that this system actually limited the scope of the credit crisis from going beyond the shores of Scotland; he used a kind of conservation of money argument, wherein he considered promised money, i.e. bank notes, to be only probabilistically worth something . Of course there are many parallels to be made to our current credit crisis, but that part about containing the crisis inside a country really makes me think about how much China has lent to the United States.

Adam Smith had one huge blind spot, which was the way he talked about slaves. It was a long time ago and times were different but it’s really hard to read those passages where he talks condescendingly about how naturally lazy slaves are, although he also mentions how little motivation they have. It’s totally brutal, but then again if you read the 1911 Encyclopedia Britannica you will find much the same kind of thing and worse.

Categories: finance, rant
  1. August 6, 2011 at 8:52 pm

    Adam Smith does have a bum rap.

    He mentions the invisible hands two times in all of his written works and on The Wealth of Nations he only makes a very passing mention to it and it is a very nuanced mention.

    I haven’t read all of the Wealth of Nation, but I think that saying that Smith was pro business is something of a mistake. He did advocate free markets but only on conditions of total equality because that would imply that everybody would gain. So I think that a more description would be that he was pro-people, pro-equality and that he saw that markets under certain conditions would help people get better lives for themselves.
    He was a man of classical liberalism and everything that would infringe upon the freedom of people would simply be abhorring to him.

    I also remember he being very harsh on the treatment of indigenous people all over the world by the British

    Ps: This is a very nice blog on Adam Smith and the author of the blog also written the best book on Adam Smith that’s out there: http://adamsmithslostlegacy.blogspot.com/

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  2. Carolyn Stonewell
    August 7, 2011 at 8:06 pm

    Smith’s view on the ability of markets to self-regulate is also often misrepresented. In an essay by John Meadowcroft called “Greed and the Market” from a book of essays called _Greed_ edited by Alex Brassey and Stephen Barber, Meadowcroft tries to clarify Smith’s views:

    “Smith believed that in a market economy it was in each individuals self-interest to establish a reputation for trustworthiness and probity because others were unlikely to enter into contracts with people who had a reputation for underhand dealing. As a consequence, even individuals who desired only their own personal advancement were led to behave in what was at least a morally tolerable fashion. The freedom to exit from relationships with those who proved undeserving of trust and to enter into new relationships with those who appeared more virtuous acted to drive up the general standard of human contact in the same way that the forces of competition improved the standard of goods and services.”

    Meadowcroft goes on to say that Smith saw eighteenth century commerce as repeated transactions between trades people who at least knew something about one another. Smith was less sure that people could trust exchanges in the marketplace when they happened infrequently or were annonymous. Meadowcroft quotes Smith: “Where people seldom deal with one another, we find that they are somewhat disposed to cheat, because they can gain more by a smart trick than they can lose by the injury which it does to their character.”

    Meadowcroft concludes that Smith’s “view questions the ability of markets to self-regulate when exchanges are not repeated and is reflected in the analysis of information asymmetries by contemporary economists who have argued that lack of trust among participants in non-repeated exchanges may be an example of ‘market failure’” (Smith, _Lectures on Jurisprudence_, 538-39).

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