The Big Three in Economics OTHER ACADEMIC BOOKS BY MARK SKOUSEN The Structure of Production Economics on Trial Dissent on Keynes (editor) The Investor’s Bible: Mark Skousen’s Principles of Investment Puzzles and Paradoxes in Economics (co-authored with Kenna C. Taylor) Economic Logic The Power of Economic Thinking Vienna and Chicago, Friends or Foes? The Compleated Autobiography by Benjamin Franklin (editor and compiler) The Big Three in Economics Adam Smith Karl Marx and John Maynard Keynes Mark Skousen M.E.Sharpe Armonk, New York London, England Copyright 2007 by Mark Skousen All rights reserved. No part of this book may be reproduced in any form without written permission from the publisher, M.E. Sharpe, Inc., 80 Business Park Drive, Armonk, New York 10504. Library of Congress Cataloging-in-Publication Data Skousen, Mark. The big three in economics : Adam Smith, Karl Marx, and John Maynard Keynes / Mark Skousen. p. cm. Includes bibliographical references and index. ISBN-10: 0-7656-1694-7 (cloth : alk. paper) ISBN-13: 978-0-7656-1694-4 (cloth : alk. paper) 1. Economists—History. 2. Economics—Philosophy. 3. Economists—Biography. 4. Smith, Adam, 1723–1790. 5. Marx, Karl, 1818–1883. 6. Keynes, John Maynard, 1883–1946. I. Title. HB76.S58 2007 330.15092’2--dc22 2006020466 Printed in the United States of America The paper used in this publication meets the minimum requirements of American National Standard for Information Sciences Permanence of Paper for Printed Library Materials, ANSI Z 39.48-1984. ~ BM (c) 10 9 8 7 6 5 4 3 2 1 Dedicated to The Big Three in my life, My editor, my friend, and my wife, Jo Ann Skousen Contents Introduction ix Photos follow page 104 Chapter 1. Adam Smith Declares an Economic Revolution in 1776 3 Chapter 2. From Smith to Marx: The Rise and Fall of Classical Economics 46 Chapter 3. Karl Marx Leads a Revolt Against Capitalism 64 Chapter 4. From Marx to Keynes: Scientific Economics Comes of Age 105 Chapter 5. John Maynard Keynes: Capitalism Faces Its Greatest Challenge 133 Chapter 6. A Turning Point in Twentieth-Century Economics 163 Chapter 7. Conclusion: Has Adam Smith Triumphed Over Marx and Keynes? 191 Bibliography 219 Index 231 About the Author 243 vii Introduction During the past three centuries, three economists stand out as archetypes, symbols of three distinct approaches to economic philosophy. In the eighteenth century, Adam Smith, a student of the Scottish Enlighten- ment, expounded a “system of natural liberty” (what we might term a liberal democratic order consisting of an unfettered market and limited government), and elucidated how a nation flourishes and advances the standard of living of its citizens. In the nineteenth century, the German philosopher Karl Marx attracted and inspired workers and intellectuals who felt disenfranchised by industrial capitalism and sought radical so- lutions to inequality, alienation, and exploitation of the underprivileged. Finally, in the twentieth century, the British economist John Maynard Keynes sought to stabilize a crisis-prone market system through activist fiscal and monetary government policies. The Pendulum and the Totem Pole The stories and ideas of these Big Three economists are told in context of a larger history I have described in greater detail in The Making of Modern Economics. In the introduction to that work, I describe two possible approaches to writing about the lives and ideas of economists, what I term the spectral versus the hierarchal approach. The most popular method of analysis I describe as a pendulum, by which historians place each economist somewhere along a political spectrum, from extreme left to extreme right. Figure A illustrates the pendulum approach used in many economics textbooks. The Pendulum Approach to Competing Economic Theories Simple though it is, I see several problems with the spectral ap- proach. First, it treats Karl Marx and Adam Smith as coequals, that is, ix x INTRODUCTION Figure A The Pendulum Approach to Competing Economic Theories “extreme” in their positions and therefore equally bad. By implication, neither man’s position is sensible and must be rejected. The result is a pendulum-like swing between the two extremes, eventually coming to rest in the middle. Consequently, the moderate, middle-of-the- road position held by John Maynard Keynes appears to be the more balanced and ideal. But is his system the way to achieve growth and prosperity? Or is the middle of the road simply the path toward big government and a cumbersome welfare state? I suggest as an alternative the “hierarchal” approach. In Indian folklore, the higher one’s placement on the totem pole, the higher the rank of significance. Instead of comparing economists horizontally on a pendulum or spectrum, we might choose to rank them by height according to the same standard of achievement. Using this totem pole structure, I would reformulate the diagram according to Figure B. The Totem Pole of Economics I have chosen a ranking system consistent with the opinions of most economists. A large majority of economists and historians of economic thought consider Adam Smith the greatest of the Big Three. His model of competitive markets constitutes the “first fundamental theorem of welfare economics,” what George Stigler called the “crown jewel” of economics, the “most important substantive proposition in all of economics” (Stigler 1976, 1201). Next on the list is John Maynard Keynes. Despite substantial criticism of the Keynesian model, it continues to endure as a mac- roeconomic model in institutional analysis and policy matters. As a defender of bourgeois values, Keynes supported individual liberty, but on a larger scale, he thought that macroeconomic intervention is INTRODUCTION xi Figure B The Totem Pole Approach: The Ranking of Three Economists (Smith, Keynes, and Marx) According to Economic Freedom and Growth essential to stabilize the economy, a view still held by many econo- mists today. The third man on the totem pole is Karl Marx. Although his endorse- ment of centrally planned command economies at both the micro and macro level has been largely discredited, Marxist interpretations of class conflict and economic crisis still draw the attention of sociolo- gists, historians, and economists.1 The story of modern economics can be told through the eyes of the Big Three. I have added vital transitional chapters between the three biographies to complete the story. As you will see, it is a cunning plot that has many unexpected twists and turns. Let us begin. 1. Those radical economists who take issue with my ranking of Marx as “low man” on the totem pole may take comfort in the argument made by some experts in Indian folklore who claim that the figure on the bottom may in fact be the founder or most significant chief in the history of the tribe. The Big Three in Economics 1 Adam Smith Declares an Economic Revolution in 1776 Adam Smith was a radical and a revolutionary in his time—just as those of us who preach laissez faire are in our time. —Milton Friedman (1978, 7) The story of modern economics begins in 1776. Prior to this famous date, 6,000 years of recorded history had passed without a seminal work being published on the subject that dominated every waking hour of practically every human being: making a living. For millennia, from Roman times through the Dark Ages and the Renaissance, humans struggled to survive by the sweat of their brow, often only eking out a bare existence. They were constantly guarding against premature death, disease, famine, war, and subsistence wages. Only a fortunate few—primarily rulers and aristocrats—lived leisurely lives, and even those were crude by modern standards. For the common man, little changed over the centuries. Real per capita wages were virtually the same, year after year, decade after decade. During this 3 4 THE BIG THREE IN ECONOMICS age, when the average life span was a mere forty years, the English writer Thomas Hobbes rightly called the life of man “solitary, poor, nasty, brutish, and short” (1996 [1651], 84). 1776, a Prophetic Year Then came 1776, when hope and rising expectations were extended to the common workingman for the first time. It was a period known as the Enlightenment, which the French called l’age des lumieres. For the first time in history, workers looked forward to obtaining a basic minimum of food, shelter, and clothing. Even tea, previously a luxury, had become a common beverage. The signing of America’s Declaration of Independence on July 4 was one of several significant events of 1776. Influenced by John Locke, Thomas Jefferson proclaimed “life, liberty, and the pursuit of happiness” to be inalienable rights, thus establishing the legal frame- work for a struggling nation that would eventually become the great- est economic powerhouse on earth, and providing the constitutional foundation of liberty that was to be imitated around the world. A Monumental Book Appears Four months earlier, an equally monumental work had been published across the Atlantic in England. On March 9, 1776, the London printers William Strahan and Thomas Cadell released a 1,000–page, two-volume work entitled An Inquiry into the Nature and Causes of the Wealth of Na- tions. It was a fat book with a long title destined to have gargantuan global impact. The author was Dr. Adam Smith, a quiet, absent-minded professor who taught “moral philosophy” at the University of Glasgow. The Wealth of Nations was the intellectual shot heard around the world. Adam Smith, a leader in the Scottish Enlightenment, had put on paper a universal formula for prosperity and financial independence that would, over the course of the next century, revolutionize the way citizens and leaders thought about and practiced economics and trade.