Bush Channeling Adam Smith?

Columnist Thomas Bray of the Detroit News states that GWB has been far more Smithian than Keynesian, and 'tis the reason for the continual, gradual economic growth of the past couple years.

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The Adam Smith I've read had

The Adam Smith I've read had no problems with government intervention in the economy, unde the right circumstances. Keynes is very near Adam Smith in thought, much more so than any other new "free market" theorist I've read. To give an example of what I'm talking about, Adam Smith made a brilliant and persuasive argument that the government should legally cap interest rates at a fraction above the average market rate. It makes sense (I'll explain if you want) but it also demonstrates that Smith was no Dogmatic anti-statist.

matt

Wouldn't that make you a

Wouldn't that make you a minarchist?

The Adam Smith I’ve read

The Adam Smith I’ve read had no problems with government intervention in the economy, unde the right circumstances.

That seems an empty statement, as I imagine most economists feel similarly. Indeed, I'm an anarchist, and that's my stance as well. The debate is -- of course -- over what constitutes the "right circumstances."

However, Bush has been

However, Bush has been reported as supporting the teaching of Keynes' Intelligent Design theories in schools, along with Smith's invisible hand, so that students can make their own informed choices between the alternative theories.

To give an example of what

To give an example of what I’m talking about, Adam Smith made a brilliant and persuasive argument that the government should legally cap interest rates at a fraction above the average market rate.

Indeed? I'd like to see that, if you can dig up a reference.

Fixing interest rates at a

Fixing interest rates at a little above prime creates a loan shark market. Which one is better, skeevy-yet-visible companies or dangerous and violent criminals? Either way, the end result is the same, that the people who shouldn’t get loans do get loans.

I'm not so sure about that. I think you could get a level of enforcment that would drive loan sharks to instead become business partners and share in the risks. This used to be the definition of usury- not lending at a high rate, but rather lending without sharing in the risks of the prject. My guess is that if you enforced such a law the macroeconomic effect would be overwhelmingly positive.

No. It could very well be

No. It could very well be that the set of "right circumstances" is an empty one.

But this is all vastly simplifying a complex argument.

Just because he got the

Just because he got the great ideas right doesn’t mean he is definitive.
okay, great who said he was?

Likewise, Smith lived in a time when money markets were both poorly understood (even by the people making a living at it) and relatively undeveloped. Smith also lived before the marginal/subjectivist revolutions in Economics.

many people consider him a pre-capititalist theorist, in fact. What this has to do with anything I posted I'm not sure.

Thus, I have little compunction waving my hands at Smith’s proposals for monetary policy while still saying he was a great economist.

good for you, selectively quote him all you like... but just don't pretend your thinking somehow falls in line with his. I think I'm the one who's questioning the use of Smith's honorable name to fluff up certain leaders and/or policies.

Matt

It could also mean that

It could also mean that while there are some circumstances that intervention improves, as a whole giving government the power to do so is a net negative.

Correct.

Correct.

Brandon- The citation is

Brandon-
The citation is Wealth of Nations, book II, chapter 4. He says "In country such as great britain where money is lent to... private people at 4 1/2 (percent), the present legal rate, 5 percent, is perhaps as proper as any.

The argument is a macroeconomic one,that if you allowed high interest rates a substantial portion of the monwy would go to "prodigals and projectors" who'd be willing to accept high interest rates because they're confident of their crazy schemes. "A great part of capitall in this country would thus be kept out of the hands which were most likely to make profiatble and advantageous use of it, and thrown into those who are most likely to waste and destroy it. When the legal rate is fixed a little above the market rate, sober people are usually preferred..."

(a bit here to scott)
It's quite a good argument I think, and through it we can see that SMith thinks there are times for government intervention in the economy. Of course "under the right circumstances" (as everyone from the most radical statist, to the biggest anti-state anarchist can agree) but I suppose more to the point, he felt that there were right circumstances and that they cropped up in an area as major as legislating interest rates.

Matt, Smith, though the

Matt,

Smith, though the godfather of Economics, was the first in a long line. Just because he got the great ideas right doesn't mean he is definitive. Newton did the Calculus and had gravitation, etc, but his theory was incomplete (as Einstein and others found out). Doesn't mean he wasn't great, but if you use newtonian physics to try and fly to the moon or further out, you're going to have some nasty surprises (especially the faster and further you go).

Likewise, Smith lived in a time when money markets were both poorly understood (even by the people making a living at it) and relatively undeveloped. Smith also lived before the marginal/subjectivist revolutions in Economics.

Thus, I have little compunction waving my hands at Smith's proposals for monetary policy while still saying he was a great economist.

Matt, fixing interest rates

Matt, fixing interest rates at just a little above market invites loan sharks. Which is worse, visible-yet skeevy people loaining money to those who shouldn't be taking on debt or hidden and dangerous loan sharks doing it?

Matt, Fixing interest rates

Matt,

Fixing interest rates at a little above prime creates a loan shark market. Which one is better, skeevy-yet-visible companies or dangerous and violent criminals? Either way, the end result is the same, that the people who shouldn't get loans do get loans.

This argument assumes that

This argument assumes that lenders are incompetent to gauge risk, and that they lend out money only to those who are willing to pay the highest interest rates. But in reality, credit markets simply don’t work this way. Those who can convince lenders that they can and will repay a loan will find it easy to obtain credit at a low rate, while those who pose a greater risk, either because of personal responsibility or because of the risk inherent in a venture, will find it more difficult to obtain credit even at much higher rates.

for one thing, I'd argue that you're largely dealing with uncertainty and not risk. Lending someone money for a business probably has more to do with business potential than his/her past history of paying. It's also worth noting that as a result of current laws, the assessment of risk is done in a way that's problematic exactly as Smith was pointing out. Suppose you have a 597 credit score but 6 million in assets as collateral for a 200,000 dollar loan- are you "risky"? Not really, because the bank knows it won't lose money if you fail to pay, but it knows it'll stand to make a killing if you do. This is why lenders like Countrywide home loans have risen to national prominence without seriously competing with A list lenders like WaMu- Countrywide's never had a 30 yr fixed rate lower than WaMu's, but it makes a killing at the Subprime market, favoring prodigals and projectors.

With a cap on interest rates, entrepreneurs would find it difficult to raise capital for these ventures. The likely result of such a regulation would be a substitution away from debt funding towards equity funding. If there were no equity or black markets, capital would be funneled into safe but inefficient enterprises, stifling innovation and slowing the rate of growth.

not neccesarily, but you'd force banks to share in the risk of the loan by assessing the risks involved with the guarantee they'd be paid back. People with "risky" ventures would have no problem if they had great credit, and people with poor credit should find it easy to obtain a loan on a sober and rational investment. Why should a loan be guaranteed to be paid back, regardless of the outcome of the venture? There's no good reason- the lender should share in the risk of the venture and analyze risk as such.

The fundamental fallacy in this argument is the paternalistic one: the assumption that the government knows best how you and I should conduct our own business.

this is an impovirished micro response to a serious micro approach. There's no reason to assume that banks should have some inalienable right to charge whatever interest rate they want, so if we as citizens believe that there's some macro advantage to be had by instituting a law restricting the bank's behavior. The government would be us, because you can damn well bet that politicians aren't about enact a law like this. It'd take such a remarkable movement of the populace to affect this change that "the government" would never be doing it; we would.

I have not read Smith in context to know for sure, but assuming your interpretation is accurate, it is neither brilliant nor persuasive. It is not much different in kind than the economically illiterate arguments for price controls aimed at preventing price gouging during times of crises. It commits the same fallacy of ignoring incentives and focusing only on what is seen, not what is unseen.

I think it takes into account incentives, very much so. I should mention also that it's not just my interpretation but Jeremy Bentham wrote a response to Smith on this very subject called "in defense of usury", and so you can have it on his authority.

But this is true only if a substantial portion of those with money to lend are high risk preferrers and don’t mind betting their capital on crazy schemes, for the potential high rate of return, despite the significant possibility that the debtor will default on the loan and not be able to pay back the principle.

no, but rather that they'd do so given a significant level of assets and a guarantee that the borrower will not be able to default. If a borrower has assets (so you are guaranteed a return) and the interest rate is so high that youstand to make a killing, you have a large incentive to make this loan. In fact, you'd prefer this loan in some scenarios to a low interest rate, low risk loan. In fact it's been said that the assessment of risk has less to do with default than it has to with profit- you weigh two borrowers against each other by assessing which one will pay you back for longer, since if they default you only get your money back and not your next few years of profitable interest.

Collateral may reduce this risk of loss somewhat, but there are still high transaction costs associated with enforcing contracts this way. Why should we assume that a substantial portion of those with money to lend prefer this sort of arrangement over less risky, more conservative arrangements?

yes but those are all accounted for in the transaction. Surely lenders don't prefer foreclosure, but big deal- they take what they can get. Because of heavy profit incentive to make more money on the interest rate. There are also mitigating factors like PMI, a type of insurance that the borrower is required to pay on a home loan if the loan is thought to be risky at all.

Further, there is a need for long-shot projects. One could reasonably argue that many of the greatest advances in technology, especially within the last century or so, have been a result of just such long-shot opportunities, where conventional wisdom dictated beforehand that these were precisely the same crazy schemes that investors should be prohibited from funding.

This is actually just a myth- these loans are far too risky to ever be covered by a private bank. That's why the US government steps in and handles it- covering the development costs for computers and then handing the profitable finished product off for private profit. It's also the case that the investment needn't be crazy, of course. The issue is the overlap where a reckless borrower who's "not rate sensitive" (in the bank sales lingo) is preferred to a sober borrower looking for the right interest rate. It's a reason why, for instance, Mortgage Brokers are so widely dispised- it's the working out of the simple principle that, in many cases, we prefer buyers who are willing to accept high interest rates because it's more profitable this way.

For some reason I’m reminded if the oft-repeated leftwing notion that we need to have a huge welfare state with a generous safety net precisely to encourage risk-taking on the part of entrepreneurs who wouldn’t do what they do if they didn’t have the government tit to fall back on. I wonder how many lefties who make this claim realize this is just another
argument for corporate welfare.

Ive never heard this argument before, but it's not too bad. It could be an argument for corporate welfare, but I don't think so. I think it's an argument for continuing state funding but ensuring that public profits from what they've invested in, which is fine with me.

I need not mention, but will anyway, that this justification for the welfare state is incompatible with the lefty demand that interest rates be capped to prevent foolish risk-taking.

I'm not sure that this is a lefty demand- I've actually never heard it made aside from Smith. I also don't think it's incompatible because the two propsals handle two different sides of the incentives equation.

It's also probably worth mentioning that the micro economic rebuttal to Smith's argument (most notably expressed by Sharpe) is not theoretically valid.

Matt

IS PRESIDENT BUSH A

IS PRESIDENT BUSH A SMITHIAN?
Lynne Kiesling Detroit News columnist Thomas Bray argued so on Sunday. In fact, his argument is more along the lines of his being more Smithian than Keynesian (as is Doug Allen's at Catallarchy, from whom I got the link: President...

The fundamental fallacy in

The fundamental fallacy in this argument is the paternalistic one: the assumption that the government knows best how you and I should conduct our own business.

Yup. And it's the same paternalism that drives "consumer advocates" [sic] to want to ban payday lending and other non-traditional check cashing services, as Reason's Michael Lynch has written about here and here.

Matt, I have not read Smith

Matt,

I have not read Smith in context to know for sure, but assuming your interpretation is accurate, it is neither brilliant nor persuasive. It is not much different in kind than the economically illiterate arguments for price controls aimed at preventing price gouging during times of crises. It commits the same fallacy of ignoring incentives and focusing only on what is seen, not what is unseen.

You say that "if you allowed high interest rates a substantial portion of the money would go to 'prodigals and projectors' who’d be willing to accept high interest rates because they’re confident of their crazy schemes."

But this is true only if a substantial portion of those with money to lend are high risk preferrers and don't mind betting their capital on crazy schemes, for the potential high rate of return, despite the significant possibility that the debtor will default on the loan and not be able to pay back the principle. Collateral may reduce this risk of loss somewhat, but there are still high transaction costs associated with enforcing contracts this way. Why should we assume that a substantial portion of those with money to lend prefer this sort of arrangement over less risky, more conservative arrangements?

Further, there is a need for long-shot projects. One could reasonably argue that many of the greatest advances in technology, especially within the last century or so, have been a result of just such long-shot opportunities, where conventional wisdom dictated beforehand that these were precisely the same crazy schemes that investors should be prohibited from funding.

For some reason I'm reminded if the oft-repeated leftwing notion that we need to have a huge welfare state with a generous safety net precisely to encourage risk-taking on the part of entrepreneurs who wouldn't do what they do if they didn't have the government tit to fall back on. I wonder how many lefties who make this claim realize this is just another
argument for corporate welfare. I need not mention, but will anyway, that this justification for the welfare state is incompatible with the lefty demand that interest rates be capped to prevent foolish risk-taking.

That's a very young adam

That's a very young adam smith you cited there.

Little else is requisite to

Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism but peace, easy taxes, and a tolerable administration of justice: all the rest being brought about by the natural course of things. - Adam Smith, Lecture in 1755

0 for 3.

- Josh

The argument is a

The argument is a macroeconomic one,that if you allowed high interest rates a substantial portion of the monwy would go to “prodigals and projectors” who’d be willing to accept high interest rates because they’re confident of their crazy schemes.

This argument assumes that lenders are incompetent to gauge risk, and that they lend out money only to those who are willing to pay the highest interest rates. But in reality, credit markets simply don't work this way. Those who can convince lenders that they can and will repay a loan will find it easy to obtain credit at a low rate, while those who pose a greater risk, either because of personal responsibility or because of the risk inherent in a venture, will find it more difficult to obtain credit even at much higher rates.

Furthermore, if the expected payoff is high enough, high-risk ventures can make economic sense, both for the participants and for society at large. With a cap on interest rates, entrepreneurs would find it difficult to raise capital for these ventures. The likely result of such a regulation would be a substitution away from debt funding towards equity funding. If there were no equity or black markets, capital would be funneled into safe but inefficient enterprises, stifling innovation and slowing the rate of growth.

The fundamental fallacy in this argument is the paternalistic one: the assumption that the government knows best how you and I should conduct our own business.

Matt, Like Micha, I think it

Matt,

Like Micha, I think it focuses entirely on what's seen and ignores what's not seen.

Brandon,

This argument assumes that lenders are incompetent to gauge risk, and that they lend out money only to those who are willing to pay the highest interest rates. But in reality, credit markets simply don’t work this way. Those who can convince lenders that they can and will repay a loan will find it easy to obtain credit at a low rate, while those who pose a greater risk, either because of personal responsibility or because of the risk inherent in a venture, will find it more difficult to obtain credit even at much higher rates.

I don't think that's entirely true. Read Something Awful's Comedy Goldmine from last week. There are a lot of stories of renting to people who they knew would default on payments, and I don't doubt it happens. But, they're charging such a high interest rate that often enough they could get their money back and get the item back to rent out again. Even I as the most staunch free market advocate will admit that it's entirely predatory and skeevy, but hey, these people that this stuff is being lent to are adults who are responsible for their own choices.