Paul A. London: Understanding Adam Smith and John Maynard Keynes

Failure to solve the unemployment problem cost Democrats the 2010 election. Fifteen million Americans are out of work. Nine million more are involuntarily working part time. Many with jobs also feel threatened. Voters don’t understand why jobs are scarce so they vote against those they believe are in power. Under similar circumstances they voted against the first George Bush in 1992, Clinton and the Democrats in 1994, and Republicans who had supported George W. Bush in 2008. They want jobs and they don’t know what policies — tax and spending reductions or spending to create jobs more directly — will get them what they want so they keep changing horses.

So what do economists say would reduce unemployment? In truth economists paid little attention to unemployment as a distinct problem until the 1930s. Adam Smith, the wonderfully insightful father of free market economics was focused on how to expand the economic pie. He was a brilliant observer of how economies work, so much so that America’s Founders were his disciples. His aim like theirs was to liberate the energies of entrepreneurial people to create wealth. The immediate problem though was monopolies not unemployment. Smith’s political goal, therefore, was to get the British parliament to stand up to government-sponsored monopolies that in the 18th century kept competitors out of many areas and stifled growth. My copy of The Wealth of Nations is 900 pages long and has an additional 67 page index. There are no mentions of joblessness as a distinct problem in all those pages.

Smith’s insights needed important tweaks by the 1930s because unemployment had emerged as a political issue and voters demanded action. John Maynard Keynes is the economist who suggested how unemployment could be attacked. A recent three volume biography of Keynes makes clear that he believed in markets as much as Smith did. He recommended, for example, that the British government use market prices not rationing to allocate scarce resources as World War II approached. During the Depression of the 1930s, however, the millions of jobless were a crucial political problem. Keynes argued that waiting for private investors to create jobs as conservatives said Smith would have done could lead to the overthrow of Great Britain’s free institutions.

Conservatives were arguing in the 1930s, as they still do in 2010, that cutting taxes and reducing government outlays would create jobs in the “long run.” Keynes famously responded that “in the long run we are all dead.” He saw the Nazis in Germany and the Communists in Russia using government to create jobs, and he was afraid that these political systems that he abhorred would take hold in England if its government insisted on waiting for the “long run” solution to work.

The insights of Smith and Keynes are central to today’s debate between the parties. Smith is still right that economic progress depends on liberating the energies of entrepreneurs so that they can create wealth. It is completely consistent to agree with Smith about the benefits of competitive markets and to support Keynes’ tweak of it. The tweak says that tax and spending cuts will not create jobs quickly enough to satisfy voters. The argument that they will is an ancient folk remedy unsupported by the observation and knowledge of economic history that makes Smith so brilliant. Government has to pump money into competitive markets to get investment going again. That’s what stimulus is. Tax and spending cuts are like bleeding George Washington to cure him of a cold. The folk remedy dressed up as medical expertise killed the great man while attempting to save him.

From The Huffington Post