Smith, Marx, and Keynes: Understanding the Big Ideas of Economic Theory

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1 Smith, Marx, and Keynes: Understanding the Big Ideas of Economic Theory 2009 James L. Smith

2 The Ideas of Adam Smith Adam Smith ( ) was a Scottish Philosopher and economist who published The Wealth of Nations (1776), a book that laid the foundation for an intellectual defense of the free market capitalist system. 1. Human beings are creatures of self-interest. 2. Due to self-interest, each individual pursues work that satisfies the demands of the marketplace. Individuals are controlled by an invisible hand that guides them according to their talents to fulfill the needs and desires of society. In a free market system each individual is free to choose the place, the amount, and the kind of work that most satisfies individual needs and desires. 3. Competition is a natural result of self-interest. When human beings pursue selfinterest they compete with each other. Competition is a natural result of a free market system. 4. Competition creates a market system that is self-regulating. Competition keeps the prices, the quantity, and the quality of products at a level satisfactory to the marketplace. 5. When the market system is left alone society will continually improve. The natural result of a free market system is the creation of new products and services at a better quality and price. 6. Government intervention destroys the marketʼs natural ability to regulate itself. The economic system is self-regulating when it is left free of government intervention. 7. The formation of monopolies destroys competition. Without competition the market cannot operate in the best interest of society. 8. There are three laws governing economic decisions: a. Self-Interest: In order to satisfy personal needs and desires individuals are motivated to perform the necessary takes for which society is willing to pay. b. Competition: Selfish motives are controlled by competition. Business owners will lose their businesses if they overcharge or produce unsatisfactory products. Business owners will lose workers if they pay wages that are too low. c. Accumulation: Capitalists accumulate profits that can be invested in the production of more and better products. All of society therefore benefits from the profits of the capitalists. 9. The labor theory of value holds that the value of any product is determined primarily by the cost of the labor it takes to produce the product. 1

3 The Ideas of Karl Marx Karl Marx ( ) was a German philosopher who published Das Kapital (1867), a book that described capitalism as an unworkable system doomed to failure. 1. Karl Marx identified Three Laws of History: a. Economic Determinism: Economic conditions determine the character of all institutions. b. Dialectical Materialism: Economic classes struggle against each other and produce changes in history. c. Inevitability of Communism: The working classes will eventually overthrow the capitalists and produce a classless society. 2. In a capitalist system work does not belong to the worker. Capitalists control employment, and the worker is at the mercy of the capitalist. Workers therefore live under conditions that do not allow them to refuse work; they are in a situation of forced labor. 3. Capitalists profit from paying workers subsistence wages. Capitalists will never threaten their own profits by providing workers with higher wages. 4. Capitalists profit from the destruction of competition. With the destruction of competition capitalists can more easily increase their profits. 5. Class conflict is inevitable in a capitalist system because capitalists work to protect capitalism while workers struggle to destroy capitalism. 6. Capitalism faces a continuing a cycle of overproduction and underconsumption that will result in the destruction of the capitalist system. a. A desire to sell more products motivates capitalists to hire more workers. b. The desire for more workers drives up wages. c. More workers at higher wages leads to a crisis of overproduction during which capitalists witness a decline in profits. d. A decline in profits causes capitalists to reduce labor costs. e. When labor costs are reduced society faces a crisis of underconsumption. During this crisis smaller businesses are taken over by larger businesses. The circle of capitalists narrows, and huge business organizations begin to dominate the economy. f. The crisis of underconsumption gives capitalists a desire to sell more products. The cycle starts over and continues until society experiences a final economic collapse in which capitalism will be abolished. Since workers outnumber capitalists, capitalism is destined for a revolution in which the workers abolish private property. g. Capitalism will be replaced by communism, an economic system defined by the abolition of private property. 2

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5 The Ideas of John Maynard Keynes John Maynard Keynes ( ) was an English economist who published The General Theory of Employment, Interest, and Money (1936), a book outlining a plan for full employment through a system of managed capitalism. 1. No system is safe that permits a wide gap between rich and poor. No system is safe that permits widespread unemployment. (Note: Adam Smith believed no society could be happy in which too many people were poor.) 2. Classical economists mistakenly claim that all depressions are temporary. In reality, an economy might remain in a depression. The health of an economy depends on the spending and investment that make an economy grow. Spending and investment are not automatic. 3. Capitalism has no villain. It does, however, suffer from a technical defect. Although investment is the key to economic prosperity, business owners and bankers are not always motivated to invest. During a depression, for example, capitalists have no incentive to invest because there is no market for their products. Capitalists should not be blamed for an unwillingness to invest when there is no market for products. 4. When private businesses have no incentive to invest, government should prime the pump. Pump priming means that government spends heavily on programs that stimulate economic activity. 5. Government should regulate consumer demand through taxation and interest rates. Lower taxes and lower interest rates stimulate demand. In turn, increased demand inspires business expansion and a subsequent increase in employment. 6. Government should be granted the power to stimulate economic activity in order that capitalism can be saved from its greatest threat unemployment. The primary goal of a managed capitalist system should be full employment. 7. The fundamental point of using government to manage the capitalist system is to conserve the capitalist system. Keynesian Management of a Capitalist Economy Recession Recovery Government Spending Taxation Interest Rates 4

6 Twentieth Century Developments Herbert Croly Herbert Croly ( ) was the author of The Promise of American Life (1909) and founder of The New Republic. His ideas helped defined a liberal approach to economics in the early twentieth century and influenced Teddy Roosevelt, Woodrow Wilson, Franklin Roosevelt, and Lyndon Johnson. 1. Government policy in the United States should combine the beliefs of Thomas Jefferson (equality) with the beliefs of Alexander Hamilton (government-protected liberty). 2. Government action is needed to create conditions where liberty can thrive by guaranteeing equal economic opportunity for all people. However, the equality of opportunity does not mean the equality of results. American democracy must offer a fair field of play and an abundant reward for success. 3. Jeffersonʼs idea of the minimal state will not work in modern times. The uneven distribution of wealth has created privileges that are contrary to the popular good. Social Darwinism and unrestrained liberty undermine political and social stability. 4. The United States constitution was made for the people, but some individuals have developed a permanent advantage over others. 5. The United States government should regulate the property rights of some to allow all to have a chance. Ronald Reagan Although Ronald Reagan ( ) was not an economic philosopher, the conservative movement associated with him brought together the various beliefs of those who criticized government policies under the New Freedom, the New Deal, and the Great Society. 1. Individuals should have few constraints on their economic liberty. Freedom and economic incentive unleash the genius that lies at the core of human progress. 2. Government planners and do-gooders working from a far-distant capitol should not think they can plan our lives for us better than we can plan them ourselves. Government is not the solution to our problem. Government is the problem. 3. Government does nothing as well or as economically as the private sector. 4. We should shrink the size of government through tax cuts and budget reductions. 5. Public policy should be based on Judeo-Christian values. We are a nation under God, and God intended for us to be free. God is engaged and directing human affairs. His counsel should be sought and executed. 5

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