Critically examine the contributions of Adam Smith and John Keynes

8 August 2016

Essay topic: ‘critically examine the contributions of adam smith and john keynes to the study of the political economy and describe their contribution to current management practice. ’ introduction the names adam smith and john maynard keynes are considered to be two of the biggest influences of economics to date. Their contributions to the workings of society are unable to be quantified and although they have lived their lives, their work has seen the western world shape into what it is today. In this essay i pick out key parts of their work and critically discuss their influences on the inner workings of the world and society.

Ealth of nations smith’s magnum opus an inquiry into the nature and causes of the wealth of nations, gained immediate success and the first edition sold out after only six months. Shortly after, the wealth of nations was translated into italian, french, german and many other languages. The book contains two major features; firstly, it provides a detailed examination of the mechanisms of the economy. Secondly, it details policy recommendations in favour of laissez-­? Faire trade, that is, trade that is free ofgovernment restrictions. Shortly after the release of the wealth of nations, what are described today as western economies stopped economic stagnation dead in its tracks and the rate of growth of these nations increased at a dramatic rate. (see appendix 1. 1) this movement was then dubbed ‘the beginning of the industrial revolution. ’ (skousen, 2007) through smith’s study of the political economy he created the field of study that is known today as economics. He claimed that the purpose of economics was to “first, enable the people to supply a plentiful revenue for themselves and, second, to endow the state with sufficient revenue

Critically examine the contributions of Adam Smith and John Keynes Essay Example

To provide public services. ” (pettinger et al. 2012) it was to fulfill these purposes that he wrote a wealth of nations. The first fundamental theorem of welfare economics in his world wide accredited book, a wealth of nations, smith was in support of putting a stop to mercantilism in favour laissez-­? Faire trade. Skousen argues, “mercantilism was antigrowth and shortsighted” (skousen 2007, p. 10) and only “[benefited] the producers and monopolists. ” smith proposed that the key to economic prosperity is via ‘natural liberty. ’ this natural liberty involved the free movement of labour, capital, money and goods. He believed in the

Natural workings of the market and that they should be left alone by government. Smith (1776 [1993], p. 423) wrote ‘by pursuing his own self interest, every individual is lead by an invisible hand to promote the public interest. ” this invisible hand theory went on to be known as the first fundamental theorem of welfare economics. Smith explains his invisible hand theory via highlighting the relevance of mutual dependence via a simplistic statement; “it is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their self-­? Interest. ” (smith 1776 [1993], p. 22) smith

Aimed to provide growth and that is part of the purpose of the first fundamental theorem of welfare, to increase prosperity through growth. Smiths ‘invisible hand’ framework could only be achieved through a capitalist state and a competitive market base. Raphael (1985, p. 46) wrote, “this process is most successful when left to the play of natural forces, [smiths] analysis leads him to urge governments to let well alone. ” given a non-­? Barrier entry to a genuinely competitive market, high profits will encourage new entrants, driving profits down. Analogously, low profits or losses will discourage entrants and perhaps cause current

Participants to leave the market, driving profit back up. The result is that through natural market forces, an equilibrium quantity and price for a commodity is naturally set by the market. Note that this new price and quantity is optimally efficient. As brilliant as smith was the perfectly competitive market structure did contain it’s flaws and could never truly occur in the workings of society. He was not naive in this fact and wrote that “people of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public in some contrivance to rise prices. ” (smith 1776

[1993], p. 232) even in this day and age capitalist governments will sometimes force a barrier to enter to some form of the market, a current example is the delivery of mail in the us, which is restricted and can only be carried out by the usps (united states postal service). Although a perfectly competitive market is impossible to truly achieve, there exists non-­? Perfect competitive markets for which smith’s first fundamental theory of welfare economics still applies. The division of labour smith believed that economic growth was dependent on the division of labour. As the scale of the division of labour was restricted to the size

Of the market base, it would follow transitive logic that continual economic growth required an ever growing market base. This division of labour had dire consequences to workers who had to complete mind numbing and repetitive tasks in their daily work. Smith claimed that the labourer “has no occasion to exert his understanding… and generally becomes as stupid and ignorant as it is possible for a human creature to become. ” (smith 1776 [1993], p. 782) this effect of the division of labour became known as ‘alienation. ’ emile durkheim argued, “the increasing division of labour has enormous implications for the structure of society.” (pettinger 2012, p. 100) the division of labour that smith refers to is considered an ‘abnormal’ form of the division of labour to durkheim. In the division of labour in society, durkheim argues, “there [is] no necessary correlation between increased division of labour and decreasing solidarity” (pettinger 2012, p. 101) if anything, the structures of the division of labour could be reworked to increase solidarity and use interdependence as a positive influence in the workforce. The key to providing solidarity is through the range of skills and capabilities in the working group of civilization. This is supported by durkheim, “the

Sole cause then determining how labour is divided up is the diversity of abilities. ” (durkheim, 1893 [1997] p. 313) a range of abilities is thus key to fight the effects of alienation. It is of belief that smith was aware of this well before durkheim wrote the division of labour in society. While smith was a true believer in the free and open market, he was no pure libertarian. He acknowledged the government’s role in society for purposes such as law, national defence and public works and education. In a wealth of nations he distinguished education in terms of its purpose specifically to stamp out alienation when he wrote in favor

Of “universal public education to counter the alienating and mentally degrading effects of specialization (division of labour) under capitalism. ” (smith 1776 [1993], p. 734 – 735) through further education, the ‘diversity of abilities’ discussed earlier can be enhanced, which results in turn, to a decrease in alienation. Spending vs. Saving and government persuasion. Smith explores the contrast of spending and saving in a wealth of nations. He is fearful of excessive spending and argues that it “can lead to insufficient capital for growth or the existing numbers of productive labour. ” (raphael 1985) it is important to note here

That the spending that smith refers to is non-­? Inclusive of spending in investment, it refers to consumption only. Smith delves into why we spend and argues, “the principle, which prompts to expense, is the passion for present enjoyment. ” (smith 1776 [1993], p. 341) smith also explores the idea that people save in order to increase their standing of living and implies that saving, to a certain extent, is a natural part of human nature; “the principle which prompts us to save, is the desire of bettering our condition, a desire which… comes with us from the womb, and never leaves us until we go into the grave” (smith 1776 [1993] P. 341). Whilst smith implies it is a natural instinct to save, the government’s reserve bank actually plays a role in creating incentives to spend or save. They are able to do this through monetary policy. The effect on providing an incentive to spend or save may or may not be a direct consequence of the implementation of monetary and fiscal policy. For example, an economies reserve bank can use monetary policy in order to increase or restrict the supply of money, thus affecting the cash rate and in turn affecting ones incentive to spend or save. Rationally speaking, if the cash rate and in turn the interest rate available for

Savings is high, one is more inclined to save their money. This goes analogously for a low cash rate, which provides incentives to spend, as the opportunity cost of spending money is less. Low interest rates also provide incentive to borrow and invest in capital. While the intention was not to completely discredit smith, as this use of monetary policy came about well after his time, it appears that the desire which ‘comes with us from the womb’ to save can in fact be intentionally or unintentionally influenced by the government. The biggest threat to capitalism – karl marx in the century following that of the life of adam smith,

Came the biggest threat to his workings, karl marx. Skousen highlights the comparison between marx and smith, “smith argued that the individuals pursuit of self interest would lead to an outcome beneficial to all, where as marx argued that the pursuit of self interest would lead to anarchy, crisis and the dissolution of the private property based system itself. ” (skousen 2007, p. 66) marx was a firm believer in the communist state. He believed that the capitalist system only benefited the rich and took advantage of the poor. When comparing economies of varying economic freedom, it can be found that the higher degree of freedom in

The economy, the higher the countries per capita gdp (see appendix 1. 2). Note that per capita gdp is a common measure of the standard of living. Furthermore when comparing the percentage of the whole us population with basic utilities such as water, electricity as well as basic needs such as refrigeration and a household toilet, with the us population that were considered to be ‘poor’ with the same utilities and basic needs, the numbers are undeniably in favor of capitalism (see appendix 1. 3). For example the whole of the us population with flush toilets went from 15% in 1900 to 99% of the population who were considered poor. In

Conclusion, “free economies are richer. ” (skousen year, p. 31) this goes onto support capitalism and smith’s first fundamental theorem of welfare economics. Smith argued “both rich and poor benefit from a liberal economic system” (skousen year, p. 34) and that “universal opulence… extends itself to the lowest ranks of the people. (smith 1776, p. 11) it is clear that the poor also benefit from a capitalist state and whilst marx is still considered a genius by many, some of his views were, in fact quite extreme. Capitalism takes another hit – john maynard keynes to the rescue adam smiths lassez-­? Faire market framework falls under

Siege again, this time not by man, but by the great depression of the 1930’s. “in the middle of the great depression, the best and the brightest intellectuals embraced marxism, but not keynes. ” (skousen 2007, p. 157) while keynes was attempting to write his own theory into the frameworks of the economy, the general theory of employment, interest and money, he unintentionally saves the faith in the open market at the time. John maynard keynes did not have faith in the ability of the free and open market to correct itself and knew that it was inherently unstable, but nor was he a believer in the communist state backed by marx. (skousen 2007) keynes solution to the mass unemployment of the 1930’s (in some nations more than 25%) was simple, yet not thought of by any other great mind at the time who were all turning to marx. Keynes argued that, “mass unemployment had a single cause, inadequate demand, and an easy solution, expansionary fiscal policy. ” (krugman 2006) this expansionary fiscal policy involved mass amounts of government spending; keynes argued that the nature of the spending was unimportant, as long as consumption was occurring. The proposal was that this major increase in spending would increase aggregate demand and put faith back into the consumer and

Producer. Keynes proposal worked, unemployment was on the decline and gdp per capita was on the increase again (growth). However, the cost of returning to the road of prosperity is quite high. Let me turn the attention to the more recent significant disaster of the political economy, the global financial crisis. Without going into to detail of the causes of this catastrophe, the basic result was the same, gdp was decreasing with unemployment on the rise. Political figures of the time turned back to the analysis of keynes and implemented what he had proposed back in the 1930’s. That was to increase public spending. Different nations

Implemented public spending in different ways, for example australia’s government endorsed the use of a stimulus package, which was simply just giving out lump sum payments in order to increase consumption. It could be argued that this is one of the more effective schemes in putting the economy back on it’s feet while in turmoil. Why? Because australia was one of the few western countries to avoid a recession as a result of the gfc. Note that the big powerhouse that is the us could not even achieve this. In order for an economy to return to economic growth in desperate times like the great depression of the 1930’s and the gfc in the

Early 21st century, government spending must be increased. However, this comes at a grave cost. In order for governments to achieve this high level of spending it must run large budget deficits, that, depending on the severity of the economic state at the time, may take decades to return to a budget surplus. This means that governments will have to cut back spending, increase revenue (through taxes) or a combination of the two until it can finally return to producing a budget surplus. Coming back to keynes in comparison with smith and marx, keynes did not believe in capitalism in its greatest form, he argued that it was unstable. This

Is evident from the economic history of the 20th and 21st century. Nor did he believe in the harshness of the communist state. He saw the need for government intervention and he was caught somewhere in between the two. While not intending to re-­? Work the classical model that was a wealth of nations, keynes to a certain extent did just that. Most western societies today that see larger gdp per capita and strong rates of growth are capitalist nations, that have a government influence on trade and are able to control levels of inflation, the interest rate and level of unemployment to some degree. Conclusion in conclusion, the works

Of adam smith and john maynard keynes have played a dramatic role into the development of the western world since the late 1700’s. Adam smiths first fundamental theorem of welfare economics was able to single handedly pull the western world out of decades of economic stagnation and return society to growth. John keynes was able to save the capitalist economy, on more than one occasion and even after his death. His contributions to the study of the political economy are considered fundamental to the way the political economy conducts it’s monetary and fiscal policy today. It is interesting to think had we not had smith’s a wealth of

Nations and we were only left with marx as a leading political thinker how different the world may have turned out. References durkheim, e. (1893/1997) the division of labour in society, new york: free press. Hall, p. (1989) the political power of economic ideas: keynesian across nations (princeton, nj: princeton university press) krugman, p. (2006) introduction into the general theory of employment, interest and money, viewed 20/05/2013 pk archive. Marx, k. & engels, f. (1848/1967) the communist manifesto, london: penguin. Pettinger, r, hague, r, harrop, m, bratton, j, sawchuck, p, forshow, c, callinan, m, corbett, m, mellahi, k,

Morrell, k, wood, g, noon, m, blyton, p, boxall, p, purcell, j, burns, p, linstead, s, fulop, l, lilley, s & morrison, j. (2012) introduction to management, palgrave macmillan: china. Raphael, d. (1985) adam smith, (oxford and new york: oxford university press) skidelsky, r. (2009) keynes: the return of the master (london and new york: penguin) skousen, m. (2007) the big three in economics: adam smith, karl marx and john maynard keynes, new york: m. E. Sharpe. Smith, a. (1776) [1993 edn] an inquiry into the nature and causes of the wealth of nations, ed. K. Sutherland (oxford and new york: oxford university press) appendix figure 1. 3

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