Free Liberal

Coordinating towards higher values

Happy Belated! Remembering Adam Smith and John Maynard Keynes One Week After Their Shared Birthday

by , Doctoral student, American University Department of Economics

June 5th is a big birthday in economics, shared by the two giants Adam Smith and John Maynard Keynes.

Although their interests and approach to economics differed in many ways, the two are ranked together in the highest echelons of economic science for good reason. To a large extent (and admittedly simplifying the contributions of many other great economists) Smith and Keynes provide bookends to an interlude in economics where one simple fact was often forgotten: we as a society do not sit comfortably and automatically on a production possibilities frontier.

Our economic fortunes are not pinned down to a particular point by exogenous parameters such as our natural resources or the size of our population.

Adam Smith destroyed the poor arguments of British protectionists by discussing how the division of labor and mutually beneficial exchange could make us wealthier with the same inputs. We do not live in a zero-sum world and we can creatively recombine the resources we have to improve our situation. Smith was one of the first economists to consider the prospect of increasing returns, or the idea that positive feedback loops associated with specialization and the division of labor would allow us to be more productive as the extent of our production increased.

After Smith, the Ricardians and the classical economists slipped the discipline into a world of diminishing returns, where productivity eroded and the economy marched toward the staleness of a steady state. In certain applications, diminishing returns were an appropriate analytic choice, but the success of this Ricardian picture was to a large extent due to the fact that it was mathematically tractable, and not because it was necessarily realistic. Themes of increasing returns, innovation, and spillovers from specialization were underemphasized (although thankfully the gains from trade and the rejection of a zero-sum viewpoint were still maintained as a theme in classical economics).

There were innovations in this Ricardian interlude, the marginal revolution being the chief among them. While Leon Walras made important contributions in this respect, his general equilibrium system continued the tradition of a perfectly calibrated, balanced systems where general gluts were inconceivable. At the Walrasian auction block, everything was sold and everyone was employed.

Enter John Maynard Keynes

Keynes revived the tradition of Smith in a subtle way. Smith studied the economy as it really existed and uncovered the key to rapid economic growth and innovation beyond a stable production possibilities frontier. Smith, in other words, provided the optimistic alternative to the Ricardian vision. Keynes worked and wrote during harder economic times, and so his principal interest was in filling in the other side of the equation. Keynes explained how the stability of the Ricardian system was an illusion, and how the complex emergent system of Smith could discoordinate and collapse at regular intervals. The key was the relationship between money, the interest rate, and investment levels.

The economics of Ricardo, Walras, and the other classics was both Panglossian and stagnant. Smithian economics dispells the stagnation of the classics, while Keynesian economics unravels the Panglossian myth. It is therefore fitting that two of the greatest economists we have and two of the greatest champions of liberalism share a birthday.



Note: We don’t know Adam Smith’s actual birth date, but his birth is commemorated on June 5th, the date of his baptism.

About

Daniel is a doctoral student in American University’s Department of Economics and a research associate at Urban Institute. His blog is Facts and Other Stubborn Things