Sunday, December 13, 2009

Adam Smith and Regulation

I’ve been reading The Wealth of Nations recently, I was rather interested in understanding what Adam Smith actually had to say, given the extent to which his views on economics are championed by conservatives. The most striking conclusion I have taken from his writing is that if his views were better known by conservatives and by liberals he would be reviled by the former and a champion of the later. For large numbers of people the passion with which the hold opinions of various philosophers, Smith prominent amongst them, is equaled only by their ignorance of the actual opinions of those philosophers. The absurdity of our discourse today is driven in no small part by this dichotomy.

For example, it is widely held among conservatives that the idea of market economics is totally at odds with any government regulations. Smith, it is clear, does not agree. He expressly recommends that government regulate the maximum interest that may be charged.

The legal rate, it is to be observed, though it ought to be somewhat above, ought not be much above the lowest market rate. If the legal rate of interest in Great Britain, for example, was fixed so high as eight or ten percent, the greater part of the money which was to be lent, would be lent to prodigals and projectors, who alone would be willing to give this high interest.

Adam Smith, The Wealth of Nations, Book II, Chapter 4

Adam Smith, at least, was no uniform opponent to regulation.

I note also, that this recommendation for government regulation is specifically to have the government enforce more sound management of money on the part of the citizens. That is, what is recommended here is a form of paternalism. Limits on the rate of interest are imposed on citizens to enforce parsimony with no other service provided in exchange.

The kinds of regulation recommended by modern liberal policy, on the other hand, can be defended, I believe, on grounds of exchange. That is to say that the regulation is imposed solely on the basis of the regulated accept the regulations in return for some other service provided by the state. For example, the restrictions on risk taken by large financial institutions are imposed on those institutions that have been incorporated under the laws of the United States. That condition of being incorporated provides an insurance policy for the managers and shareholders of those institutions on the loses that they may incur should the institution fail. This limitation of liability is an extremely valuable service.

To whatever extent regulations imposed by government to advance some general moral well-being are allowed, and Smith certainly considered them acceptable, it is even more acceptable when they are part of a mutual exchange.

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