[Note: This post originally appeared on thomasmalaby.com]
Feb 10, 2009
There is no shortage of opinion, much of it from folks more knowledgeable than I, about how we might make sense of the recent financial catastrophe. Still, I continue to be struck by the way in which a recollection of Adam Smith is apt. By this I mean Adam Smith in his actual writings, not in his mythicized persona – Smith seems to share with Charles Darwin the indignity of massive and sustained misunderstandings of his core ideas. This makes it all the more remarkable that, for us today, Smiths vision of the market 230 years ago was so clear that he can help us understand even its recent, science fiction-like, turn.
As I see it, many of the central lessons of The Wealth of Nations are about a tempering of enthusiasm for market forces. At every turn, Smith is ready to specify what the market cannot do. It cannot answer the demands of infrastructure, for example, or education. I suspect he would have agreed with the phrase that occured to me after Katrina: The invisible hand doesnt rebuild levees.
One of his least often noted but bedrock critical claims about the market is about the relationship between laborers and employers. Smith recognized that laborers are unique among commodities in the way they bid for the price of their own labor. The upshot of this is that, as soon as laborers are competing with each other for jobs, and thereby given a choice between no job and a job for a pittance, they will take the pittance. This can easily leave them working for wages below subsistence level.
So Smith concludes from this that the only broad market condition that stands a chance of improving the workers condition is an expanding market. If the market expands in space rapidly enough, finding more people to participate in buying and selling, then demand can be high enough for workers to be scarce, and for the rising tide indeed to raise all boats. But Smith notes that should the market stop expanding, or contract, things turn very bad for the worker, very quickly.
This is an old economic lesson, of course. And I am sure that it could be picked apart in particulars – it is, after all, a very broad way of talking about things. But what I want to consider for a moment is this notion of expansion in space, and wonder what happens when the market, effectively, runs out of space.
If a significant cause of the recent catastrophe was the ease of credit – many formerly unable to buy homes led to purchase them, most famously, but let us not forget the proliferation of consumer credit in the form of credit cards – then suddenly the so-called prosperity of the last fifteen years or so makes sense in Smiths terms, as long as were willing to shift from thinking about expanding in the dimension of space to that of time.
Consider what credit is – it is effectively an agreement that a future you will actually purchase the item at hand. So in a way the expansion of credit (helped along by a proliferation of financial instruments and related technology) fulfilled, temporarily, exactly what Smith would have predicted. It expanded the market not in space, but forward in time, and the number of available consumers continued to grow. We expanded our market in the fourth dimension.
But of course, it could not be sustained. The bets we made with our future selves were overly hopeful, themselves grounded upon the promise of more of the same paper-thin prosperity. We were not actually finding new markets (which in the long run is a losing proposition in any case) – we were finding ways to sell to us, but in another time.
And it all came crashing down, back to the present.