Economics – From Smith to Keynes

History of Economics

Adam Smith

Adam Smith (1723-1790) was a Scottish moral philosopher and economist. An empiricist, and one of the key figures of the Scottish enlightenment; Smith is often cited as the ‘father of modern economics’.

Smith’s great work, The Wealth of Nations, uses examples of real people (case studies) and thinks he has found the universal law of human behaviour based on these. He thought he had figured out why some countries are richer than others, and the answer is the free market; if you allow free market it will boost economy.

He was a major proponent of laissez faire economics: minimising the role of government intervention and taxation in the free markets, and the idea that supply and demand is guided by an ‘invisible hand’. His philosophies reflect the basic concept behind his economic theory; that each person, by looking out for him or herself, inadvertently helps to create the best outcome for all.

Merchants sell products that people want to buy, in the hope of making money; if they are successful and meet the needs of consumer, they will be financially rewarded. They do this for their own interest, not to serve some greater benefit to the economy, but they are also providing products that people want. Smith argued that this kind of system creates wealth for the whole nation, when the citizens are working productively to better their financial situation.

Basically refuted by modernism – the world is not a machine.

J M Keynes

John Maynard Keynes (1883-1946) was a British economist who’s ideas were influential on modern macroeconomics, and have affected the economics the economics policies of governments. Keynes was a modernist, influenced by the social changes of the 1920s-30s, and spearheaded a revolution in economic theory which overturned previously held neo-classical ideas.

His work on economics bears some of the hallmarks of modernism: rejection of classicism and empiricism, move towards subjectivism.

Idea of the phenomenal and noumenal (Kant) is fundamental to modernist thinking, and Keynes is the first to apply this to economics.

Keynes systematically analyses the fallacy that each person acting for their own benefit in a free society will stimulate economic growth – rarely the case. Doing what is good for you is not always beneficial to others, it’s rare that this happens, often it is actually detrimental. He refuted the neo-classical ideas (purported by Smith) that free markets would, in the short/medium-term at least, automatically provide full employment as long as workers were flexible in their profession and wage demands. Keynes posited that instead, aggregate demand drove the level of economic activity; so a decrease in demand would mean a decrease in employment.

In Keynesian economics, state intervention is sometimes necessary to moderate the “boom and bust” cycle of the economy. Keynes supported the use of fiscal and monetary measures to balance adverse effects of depressions and recessions; an idea which was adopted by most Western governments after the outbreak of World War Two, along with his other theories of economic policy.

David Ricardo 

David Ricardo (1772-1823) was a British neo-classical economist, almost a romantic. Ricardo devised the labour theory of value (contrasts Smith and the physiocrats).

Smith tries to answer question of why some commodities are as expensive as they are, where does an items value come from? Smith says it is simply supply and demand. Ricardo says this is not true, he introduces “labour power”: a second-hand car is so cheap because of the labour power that’s embedded in it – anything that’s expensive requires human labour, any kind of personal service requiring labour is expensive  i.e. Going to the dentist.

But with many commodities there is a gap between the exchange value and the labour value. The most profitable commodities are the things with a high exchange value and a low labour value.

General points

Unemployment is impossible in classical economics (Smith’s view); only through Marx and Keynes that unemployment can be understood – in Smith’s system, people who lose their jobs are instantly employed elsewhere. They will go off and get a job in another field if necessary, or even find a job that pays the same or better. This is because nobody naturally wants to starve to death.

It’s a paradox because there are examples – i.e. The Great Depression – where this does not happen.

Ricardo and Marx refute this. People will not react rationally. People will cling to the job/trade/location they know; people will not simply uproot and leave their home for a new job.

Marx and alienation: your true nature is taken from you, because you don’t possess what you’ve made. A factory worker earning minimum wage cannot afford the product they have made. That is what causes unemployment. A crisis of over-production and under consumption. Jobs are destroyed by mass production and mechanisation.

Keynes’ answer is to get unemployed people to dig holes and fill them in again. Better an unemployed person is doing this than nothing. He argues that Smith is wrong; people will not find jobs automatically, the hidden hand of the market will not come in.

He argues that nothing is better for solving unemployment than war. Keynes liked Hitler’s economic politics, though not so much his racial politics.

In Keynes’ ‘general theory’, he posits that money is not important. Aristotle thought value was contained in money (gold) in the same way he thought virtue/vice was contained in people, and that gravity was contained in heavy objects. Keynes says this idea that money holds value is wrong.

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