21st January 2017
Was Adam Smith a socialist? #3 – Are high profits a sign that a country is going to ruin?
The proponent of the view that Adam Smith’s system did not permit inequality in the first place cited the following comment from Smith to “prove” his point: that profits are “always highest in the countries which are going fastest to ruin.”
Apparently, this indicates he was against high profits. And hence a socialist. This idea is also related to Keynes’s view about the declining marginal efficiency of capital.
There is some merit in this view.
We know that poor societies will tend to have a lower rate of financial savings (instead, animals, and particularly children, are used as a means of saving) and will tend to consume all output.
In such a society, only those investments become profitable that allow higher rates of profit to be generated and hence enable the payment of higher rates of interest which are necessary to borrow money for investment.
Further, in such developing societies, with highly underdeveloped and incomplete markets, there are many more opportunities for profit than the opportunities available in well developed countries. However, these profitable opportunities are associated with greater risk, so not many people are willing to invest in developing societies.
This is where Schumpeter comes in. Innovation and competition are the main long term drivers of profit. With every commercial innovative breakthrough, there are immediate profit opportunities but unless the government institutionalises monopolistic power, the market will always wear down the profit margin.
Two forces are at work in relation to innovation:
(a) the technical frontier gets harder to breach and the “bang” for each new innovation potentially gets relatively smaller than the bang from the previous big innovation. For instance, the internet is a much smaller innovation (relatively speaking) than the discovery of electricity; and
(b) more research takes place and knowledge is generated at an exponential pace, as a society becomes more developed.
The empirical question is – which of these two forces “wins” at a particular point in time.
Thus, it is simply untrue to assert that profits are “always highest in the countries which are going fastest to ruin”. The question is – what’s the level of associated risk, the level of innovation, the depth of markets.
It is unclear whether Adam Smith fully understood the concept of profit.
Once again, I would like to reminder readers that Smith was a founder of economics. He has been superceded on numerous things by other analysis.
Everyone who reads Smith should use his BROADER understandings as a starting point, and thereafter read more – much more (i.e. many other authors); in order to understand the market.
I think I’ll now move on to other issues. The idea that Smith was somehow against inequality – even if true – is related (at best) to some of his erroneous understandings. We must look at the TRUTH that lies in his work and not focus on things on which he has been superceded.