The financial crash of 2008 did serious injury to conventional economic wisdom. Not only was the judgement of expert forecasters questioned, so too was the widely held view that free markets had the capacity to self-correct. Market fundamentalism had prevailed for 30 years, albeit in various iterations and distinctive policy permutations: the ballooning deficits of Reaganism, the fiscal austerity of Thatcherism, the Clintonite-Blairite Third Way. However, the crash raised major doubts about the timeless truths of neoclassical economics. Why did an emergency intervention necessitate a turn to Keynesian injections of cash into the economy? And what sort of rationality underpinned longer-term quantitative easing and, in the case of a few central banks, negative interest rates? The (more politically radical) generation that came of age in the aftermath of the crash began to ask whether the mathematical modelling of neoclassical economics properly reflected the complexities of the real world. Were self-regulating markets no more than a mirage?
Further disillusionment soon followed. Far from borders withering away due to the seemingly unstoppable momentum towards globalisation, instead we have seen a return to fortress economies. In the United States, Trumponomic protectionism entailed the abandonment of traditional Republican principles, and the Covid pandemic, compounded now by the invasion of Ukraine, exacerbated trends towards nationalistic forms of political economy. A long-standing insistence on cost being the bottom line has given way – quickly and unexpectedly – to the strategic importance of energy sources and supply chain resilience.
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Market orthodoxies faced further challenges from other directions, including environmentalist approaches and “happiness” economics, which insists that well-being is not a simple function of GDP. The turmoil of the past decade has thrown into doubt the universal applicability of economics as a science for all seasons. The technical aspects of the discipline are, it transpires, not so easily divorced from changing historical contexts and wider ethical issues.
The contours and contents of economics are in flux and under interrogation. Yet, strangely, one element in the old credo that remains unquestioned is the assumption that Adam Smith, the discipline’s presiding icon, was himself a market fundamentalist and has always been regarded as such. As the American academic Glory M Liu shows in a fascinating tour of American economic theory and debate from the late 18th century to the present, Smith’s reputation was never fixed or enduringly settled. We are most familiar with the depiction of Smith, by Milton Friedman and the Chicago school of free-market economists in the second half of the 20th century, as an apostle of laissez-faire prescriptions and a minimalist state. However, this “Chicago Smith” was only the latest in a long series of caricatures, which accentuated certain features of Smith’s work at the expense of others.
It is more than a coincidence that Smith’s The Wealth of Nations – which among other things charted the problem of Britain’s increasingly vexed relationship with its American colonies – appeared in 1776, the year of the Declaration of Independence. But it is emblematic, Liu shows, of the deep, inextricable link between Smith’s legacy and the history of US capitalism. Liu shows how generations of Americans appropriated, recycled and refashioned The Wealth of Nations and its author, becoming “captive to the very idea of an Adam Smith that they invented”.
So fertile in invention were American economists that Liu identifies two distinct portrayals of Smith by the economists associated with the University of Chicago during the 20th century. Friedman’s Smith, she argues, was a cruder, more “populist” version of the Smith to be found in the first wave of Chicago economics. This earlier version, whose most notable proponents were Jacob Viner and the Austrian émigré Friedrich von Hayek (who became a professor at Chicago in 1950), proved sensitive to the nuances in Smith’s thought.
Viner acknowledged tensions within Smith’s work and his Smith was far from a one-dimensional laissez-faire absolutist. Hayek, too, repudiated an overly rationalist reading of Smith, emphasising instead his undogmatic diffidence and sceptical awareness of the limits of human knowledge. To be sure, the Viner-Hayek Smith was a champion of laissez-faire, but in this conception of free-market economics the innumerable individual transactions of the market served as a cautious corrective to schemes of supposed social betterment founded upon human presumption.
By contrast, Friedman and his Nobel Prize-winning colleague George Stigler advanced a more decisive and “streamlined” interpretation of Smith, marked by “strident market advocacy”. At the bicentennial of The Wealth of Nations in 1976, Stigler boasted that Smith was “alive and well and living in Chicago”.
But Stigler’s version was a travesty not only of the man himself, but of the earlier Chicago Smith. Whereas Hayek saw the market as a balm against arrogant rationalism, Friedman and Stigler stressed instead the very rationality of the profit motive. At the core of Smith’s work Stigler perceived “the granite of self-interest”, and he paid less attention to the range and understated subtlety of Smith’s psychological insights. Similarly, Friedman made a fetish of Smith’s expression “the invisible hand”, something barely noticed by earlier commentators and a phrase that only appeared three times in Smith’s entire oeuvre.
Was Smith’s invocation of the invisible hand – a metaphor for the unseen forces that shape the free market – any more than a throwaway remark, and one possibly drenched in irony? This slender basis notwithstanding, the invisible hand became a central feature of American economic analysis during the second half of the 20th century, reified into a theory of spontaneous order. Liu holds the second wave of Chicago economics responsible for the cartoonishly reductive impression of Smith as the unequivocal cheerleader for free enterprise that prevails in American culture. Significantly, Friedman’s television series of 1980, Free to Choose, brought this bold, primary-coloured version of Smithian economics to a broader public.
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But long before these two contrasting celebrations of “Chicago Smith”, the philosopher’s legacy was much more hotly contested among US economists and policymakers. In particular, there was an influential view in the first half of the 19th century that, for Americans, following Smith’s free-trading prescriptions was a snare. Britain hadn’t become hegemonic on the basis of free trade. Quite the reverse: it had risen to economic dominance as a mercantilist power protected by its Navigation Acts, and only then had Smith’s critique of mercantilism followed in 1776.
A whole generation of early-19th-century American economists recognised that, far from Smith’s theories being timeless truths, economic policy should be aligned with the situation in which a country found itself. Smith’s American critics from this period included Daniel Raymond, Caleb Cushing and the German émigré Friedrich List, author of Outlines of American Political Economy (1827), who favoured a form of economic nationalism.
In policy terms the result of this anti-Smithian polemic was the “American System”, promoted most assiduously by the Whig politician Henry Clay, which involved nurturing infant industries and the proactive, federally supported development of transport, communications and infrastructure behind the security of a tariff wall. Having long since become an industrial leviathan, modern America now preaches the Smithian way – with perhaps unconscious hypocrisy – to emerging economies across the globe; but it is not how America itself became an economic powerhouse.
By 1850 Smith was in eclipse, The Wealth of Nations superseded in the US as a textbook by the French economist Jean-Baptiste Say and by another transatlantic import, John Stuart Mill’s Principles of Political Economy (1848). But if Northern protectionists regarded Adam Smith’s free-trade principles as “a curse upon America”, his ideas enjoyed a much warmer reception in the Southern slave states. For in the South the staple was cotton, which was traded in international markets. Ironically, free trade was valued most in the states with unfree labour.
This dichotomy persisted for decades after the American Civil War: it was the Democrats, compromisers straddling the North and the white South, who espoused free trade, while the Republican Party – the successor to Clay’s Whigs – combined commitments to free soil and free labour with protectionist economics. Donald Trump’s instinctive protectionism made him something of an outlier in the modern Republican tradition, but his position turns out to have deeper roots within the party’s late-19th-century history.
Liu’s book is more than an examination of the twists and turns in American economic debate, for it also raises profound questions about economics as a discipline and terrain of debate. Only in the 1820s did economics – or political economy, as it was called – emerge as a distinctive entity that amounted to more than a mere branch of statecraft. Where, then, does that leave Smith? The 18th-century Scot was not an “economist”, but a moral philosopher. Smith was acclaimed in his lifetime as the author of both The Wealth of Nations and The Theory of Moral Sentiments (1759), and the 18th-century conception of moral philosophy included not only ethics but what we would now recognise as the humanities and social sciences, including the study of politics and government.
The ambiguous relationship between economics and moral philosophy surfaces at various points in Liu’s book. Smith himself sought to separate moral philosophy from religion, but in 19th-century America some evangelical commentators regarded economic laws as divinely established, and economics as an offshoot of theology. Later in the century, Charles Dunbar at Harvard objected to the ethical dimension of economics, which appeared to subvert its scientific status. That battle seemed to have been won decisively in the subsequent development of economics as a value-free technical discipline. Nevertheless, Liu highlights more recent attempts by American neoconservatives such as Irving Kristol to explore the ethical dimensions of capitalism. Is capitalism simply a form of economic organisation, or is it more deeply interwoven with certain moral prerequisites, including prudence, temperance and responsibility?
Moreover, is it ever possible to draw clear lines of demarcation between politics and economics? Although, as Liu notes, Friedman and Stigler sought to draw a distinction between the “scientific rationality of markets” and politics as a “black box of irrationality”, matters are in practice more porous. Indeed, a neo-Smithian form of economic analysis pioneered by the Virginia school of James Buchanan and Gordon Tullock in the 1960s has unmasked government itself as a force which serves intrinsically to thwart the public good. Buchanan and Tullock’s public-choice economics reveals a “non-benign” invisible hand at work in the political realm, where politicians and bureaucrats follow their own individual and sectoral self-interest.
Behind Liu’s informative work on Adam Smith’s complicated American legacy lies a deeper conundrum. From time to time, commentators recognised that Smith’s work was out of date and old-fashioned, and needed to be supplemented by more recent forms of economic analysis. Yet why does an 18th-century Scot, who knew nothing of collateralised swap obligations or quantitative easing, remain so influential when many later, arguably more technically proficient, economists have slipped from view? Notwithstanding Smith’s clarity, coherence and accessibility, his stunning and enduring afterlife remains inexplicable: as mysterious as the invisible hand he so casually invoked.
Adam Smith’s America: How a Scottish Philosopher Became an Icon of American Capitalism
By Glory M Liu
Princeton University Press, 384pp, £28
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This article appears in the 02 Nov 2022 issue of the New Statesman, The Meaning of Rishi Sunak