18th January 2017
Was Adam Smith a socialist? #1
Smith’s capitalism demystified……
“People in a free market economy are to trade with, not rob, one another.”
– Smith didn’t preach / prescribe inequality as a precondition of wealth creation.
Smith is assumed to have accepted inequality as the necessary trade-off for a more prosperous economy. This is, in fact, the default assumption, which is wrong. The building blocks of Smith’s economic system do not allow concentration of wealth; the important point about Smith’s system is that it precluded steep inequalities not out of a normative concern with equality but by virtue of the design that aimed to maximize wealth. Once we put the building blocks of his system together, concentration of wealth simply cannot emerge.
In Smith, profits should be low and labour wages high, legislation in favor of the worker is “always just and equitable,” land should be distributed widely and evenly, inheritance laws should partition fortunes, taxation can be high if it is equitable, and the science of the legislator is necessary to thwart rentiers and manipulators. Political theorists and economists have highlighted some of these points, but the counterfactual “what would the distribution of wealth be if all the building blocks were ever in place?” has not been posed. Doing so encourages us to question why steep inequality is accepted as a fact, instead of a pathology that the market economy was not supposed to generate in the first place.
The key principles of Smith’s system work against the concentration of wealth-they also speak about the top issues in economic policy today: profits, taxes, and the minimum wage.
First, Smith thought high profits denoted economic pathology. The rate of profit, he said, was “always highest in the countries which are going fastest to ruin.” This pathology was not simply a symptom of mercantilism, but resulted from the incentives on the economic groups living by profit alone.
Unlike Ricardo, Smith believed that the interests of profit-seekers were structurally and thus “directly opposite to that of the great body of the people,” because “the rate of profit does not, like rent and wages, rise with the prosperity, and fall with the declension of the society. On the contrary, it is naturally low in rich, and high in poor countries” (with a few exceptions, especially new economies). Accordingly, when the economy is sound, wealth concentration should not occur. Only when profit-seekers have rigged the system through legislation do concentrations occur. Smith states that fortunes would, indeed, not be high and that in any case they were prone to dissipation. Such a system cannot generate steep inequality.
Wages, at the same time, should rise with increased wealth. On this basis, Smith defends adequate labor wages, which had to be at least sufficient to provide the “necessaries,” covering lodging, food and clothes, the latter tailored to middle-class comforts. This baseline appears minimal, yet it provides for more than is covered by the contemporary minimum wage. Moreover, high wage levels should occur naturally. Wages are only lowered artificially, through state intervention, because of the sophistry of merchants and manufacturers who are much more adroit in manipulating legislatures to pass laws in their favor. Moreover, employers enjoy a bargaining advantage over workers and can coerce them to accept worse terms, because they need individual workers less than individual workers need employment. Wages are not the simple product of supply and demand in Smith; bargaining asymmetries are key.
Taxation is perhaps the most contentious topic today, with prescriptions of punitive levels as the main instrument applied to reverse inequality. As such, it is seen as a distorting intervention in the market and a departure from “free market” principles. Smith did not prescribe punitive taxation, but what is missed is that he praised the British tax system though it imposed double per capita taxes than the French. Yet, “The people of France…are much more oppressed by taxes than the people of Great Britain.” Why? Because taxes were less equitably distributed, falling disproportionately on the poor.
A fair distribution of taxation was key to the soundness of the English economy in Smith. The rich, he claimed, should be taxed “something more than in proportion” to their wealth. “The inequality of the worst kind” was when taxes must “fall much heavier upon the poor than upon the rich.” The reasons were not moral. Bad taxes were simply bad economics.
Smith’s overarching point was this: taxes were bad only when they undermined the productive use of capital. But taxation should be used to discourage unproductive economic activities. Landlords, for instance, charged tenants large fines for lease renewals, rather than raise the monthly rent. This is usually “the expedient of a spend-thrift, who for a sum of ready money sells a future revenue of much greater value.” It is “hurtful to the landlord,” frequently to the tenant, but always to the community. So it should be taxed at a higher rate. A tax upon house–rents would also “in general fall heaviest upon the rich,” a welcome outcome, since rent was an unproductive expense; when high, it was simply a luxury. And when Smith advocated against a tax, it was for pragmatic reasons, as with taxing capital: capital holdings could never be verified and could always flee the country, so taxing them was counter-productive. But ground-rents should be taxable, as “Nothing can be more reasonable than that a fund which owes its existence to the good government of the state” should be taxed more than in proportion to its benefit.