Source: Ideas and Institutions Issue #33
Analysis
A Moral Philosopher of the Market Economy: Three Centuries of Adam Smith
In Process and Reality, based on a lecture series delivered in 1927–28, Alfred North Whitehead writes, “The safest general characterization of the European philosophical tradition is that it consists of a series of footnotes to Plato….I allude to the wealth of general ideas scattered through them. His personal endowments, his wide opportunities for experience at a great period of civilization, his inheritance of an intellectual tradition not yet stiffened by excessive systematization, have made his writings an inexhaustible mine of suggestion.”
It would not be much of an exaggeration to make a similar statement about the importance of Adam Smith for the study of political economy and economics. Smith’s intellectual acumen, applied to observations of social and economic life at a time of major changes well before the ideological debates around those changes became systematized, makes his writings a treasure trove of ideas and suggestions. June 5 marked three centuries since his birth.
Smith wrote two masterpieces: The Theory of Moral Sentiments (TMS) and The Wealth of Nations (WN). Published in 1759, TMS is a work of moral philosophy and social psychology, and WN, which was published in 1776, is a work on political economy and economics.
WN is mainly about improving material well-being through consensual, self-interested transactions in competitive markets. TMS is mostly about how social interactions can build on our innate empathy to achieve moral improvements. So, the primary concern of both these works is how individual lives can be improved through economic and social interactions, and a secondary concern is how social, political, and economic processes interact to bring about structural changes.
Consider how, in TMS, Smith builds up his arguments from a conception of the natural empathy that exists in human beings.
The first sentence of TMS conveys his basic premise: “How selfish soever man may be supposed, there are evidently some principles in his nature, which interest him in the fortune of others, and render their happiness necessary to him, though he derives nothing from it except the pleasure of seeing it.” He calls this principle “sympathy,” but its meaning is similar to that we now assign to the word “empathy.” Smith shows how this empathetic capacity also makes us expect others to empathize with us as we observe their responses to our emotions. So, we like the views of those who agree with us and share our emotions, and we feel unhappy when someone disagrees with our actions and views and does not share our emotions.
Smith argues that such entanglement also brings about a regulative function. It can trigger a sociopsychological process wherein we observe others’ responses to our emotions and modulate our actions and emotions accordingly. Sometimes, we increase their intensity and decrease it at other times to take them closer to what an “impartial spectator” observing our situation would approve of. This can create socially beneficial morality, which Smith explains as follows: “To feel much for others and little for ourselves, that to restrain our selfish, and to indulge our benevolent affections, constitutes the perfection of human nature; and can alone produce among mankind that harmony of sentiments and passions in which consists their whole grace and propriety.”
In a highly insightful discussion on the psychological foundations of economic pursuits, Smith points out an asymmetry in our empathetic capacity: “It is because mankind are disposed to sympathize more entirely with our joy than with our sorrow, that we make parade of our riches, and conceal our poverty.” So, while wealth may not give us as much joy as we expected through the objects it can buy, there is a payoff in terms of the excessive admiration (and envy) it invokes among others. Since this fuels the competitive economic activity that can lead to economic growth, it can create benefits for those who are employed in the fulfillment of these pursuits. In Part IV of TMS, Smith invokes the famous idea of an “invisible hand” to show how the pursuit of wealth by the rich can benefit others even though they did not intend to generate such benefits. He writes, “They are led by an invisible hand to make nearly the same distribution of the necessaries of life, which would have been made, had the earth been divided into equal portions among all its inhabitants, and thus without intending it, without knowing it, advance the interest of the society, and afford means to the multiplication of the species.”
Smith discusses how we need to develop general rules based on which we can reward socially beneficial actions and punish harmful actions committed intentionally, but he also shows how our conscience plays a regulative role in our morality. However, he writes, “The word conscience does not immediately denote any moral faculty by which we approve or disapprove.” So, conscience needs the development of moral content upon which it can act. Smith observes that we can develop this moral content, which takes the form of general rules that inform our actions. This process is again based on our empathetic capacity—we can understand the effects of our actions and those of others and use this material to develop rules for appropriate actions. These rules allow us to make decisions without having to think deeply each time we are faced with a situation.
These ideas on empathy are spread over the first four chapters of TMS. This theory that sees human beings’ natural empathy as creating a potentiality that can be transformed into actual morality was a major breakthrough. Interestingly, though, Smith does not seem to consider even some of the limitations of this empathetic capacity—for instance, its tendency to overestimate the joys of others—to be necessarily harmful because they can lead to beneficial outcomes for the society. These limitations can be transformed into advantages.
Compared to TMS, WN is a very different work, but it also draws substantially on this basic insight that human pursuits, though motivated by strange, even illusion-laden conceptions of self-interest, can still generate benefits for the society. There is, in Smith’s view, a natural tendency among humans to transact with others in self-interest, and as long as the transaction is based on mutual consent, both sides will benefit.
Since he was no pamphleteer looking only to win an argument, his thoughts are complex. He analyzes the workings of the market economy in a variety of ways. However, he clearly highlights the benefits of a well-functioning market economy and suggests that the market economy did not have unusually negative effects on morality. Both sets of arguments were important. If Smith had only pointed to the benefits in terms of efficiency gains due to market competition, it would not have been enough. This is because most of the prevailing views of the market economy were suspicious of the moral consequences of its expansion.
Smith explains how the market-based interdependence with strangers can be beneficial in a commercial society: “When the division of labour has been once thoroughly established, it is but a very small part of a man’s wants which the produce of his own labour can supply. He supplies the far greater part of them by exchanging that surplus part of the produce of his own labour, which is over and above his own consumption, for such parts of the produce of other men’s labour as he has occasion for. Every man thus lives by exchanging, or becomes in some measure a merchant, and the society itself grows to be what is properly a commercial society.” The market enables this coordination and cooperation among strangers who individually specialize in specific tasks and activities. As Smith notes, this specialization makes them efficient by allowing them to develop skills through repetition, saving them the time of moving from one task to another, and allowing the use of specialized machinery for each task that improves the efficiency of the person performing it.
Smith showed how the combination of trade and competition created the efficiency gains through the specialization we see in the modern economy. While trade had existed for a long time, it had typically been done through monopolies, and tariff restrictions or controls were often imposed when imports started competing with domestic production. Smith’s observation that trade is beneficial for both sides was a direct critique of the prominent mercantilist idea that a country had to limit imports from other countries. At its heart, mercantilism is about seeing money as the wealth of a nation, while Smith argued for seeing wealth in terms of economic productivity. So, while mercantilists advocated for curbing imports to prevent the outflow of money, Smith argued that money was just a medium of exchange meant to facilitate trade within a country and across borders. Smith’s argument for trade is mainly built on the benefits of specialization—the bigger the market, the better the efficiency gains.
In WN, Smith argues strongly against granting monopolies or imposing tariff protections or controls. Even for the more reasonable instruments, such as drawbacks, Smith warns about the possibilities of misuse. He extends this even to include the colonies, which were typically forced to trade only with the colonizing country. A key “self-interest” argument he makes against such restrictions is that they direct the colonizing country’s capital toward the colony when it could have been more efficiently used elsewhere.
Similarly, while domestic markets had existed for ages, some of them were marred by anticompetition forces such as guilds and trade associations. Since markets are, as Smith argued, mechanisms for efficient allocation of resources and for automatic coordination between different producers and consumers through the price information, any distortions could lead to inefficiency. So, Smith’s argument is that efficiency improvements require freeing up foreign trade while also removing barriers to competition within the domestic economy so that producers are exposed to local as well as foreign competition.
Coming to product markets, Smith considers the development of land for agriculture as the top priority. In his time, which was before the Industrial Revolution, food products were among the few products that were considered essential, and almost all manufacturing products were considered “conveniences and luxuries” (Smith even calls poultry a luxury). Since, as Smith argues, subsistence takes priority over convenience and luxury, agriculture should be given priority. Further, he argued, rightly for his time, that agriculture was the main source of surplus that could then be invested into manufacturing. Smith was, however, among the first to argue that manufacturing is productive. Further, he also saw value in services, even though he considered them unproductive. Most services in his time, except perhaps engineering, architecture, teaching, etc., did not produce anything durable. The durability of services outputs in domains such as entertainment has increased due to technological change, and new types of services such as information technology have emerged, which add value to many production processes.
Smith’s thinking on the sources of growth includes ideas that correspond to certain aspects of modern growth theories. In addition to the role played by trade, which Smith is traditionally associated with (Joel Mokyr calls this Smithian growth), he also emphasized, in a Solovian argument, how increasing capital investment (he uses the word “stock” for capital) boosts growth by raising labor productivity. Even though Smith wrote in a pre-Industrial Revolution world and therefore drew many examples from agriculture, his overall model of how factors of production—land, labor, and capital—come together for productive purposes was sound. He emphasized the importance of not just increasing participation in the labor force but also the role of skills in improving productivity.
Smith also highlights the role played by institutions. In a discussion on commerce in towns, he shows how commerce thrives when security and order are ensured. Book III of WN has an extensive discussion on public policies that affect economic productivity, with many examples of how policies hamper productivity. Smith argues against many types of government interventions in the economy that reduce competition to benefit a few but ultimately have a negative effect on efficiency and productivity. Book V of WN is mainly about the role of the government. Smith advocates for an essential role of the government in ensuring the defense of the country, the administration of justice within the country, ensuring supply of infrastructure (financed by toll, local taxes, or general taxes), and public education. He was obviously writing for his time, but the underlying theme of this discussion in Book V is the identification of functions that are most efficiently performed by the government.
These arguments on the sources of growth can be read in an integrated manner: private capital investments are encouraged by improvements in institutions and an adequate supply of public infrastructure, and in the context of competition from domestic and foreign producers, these investments enable the use of other factors of production toward the most efficient and productive purposes.
Smith’s thoughts on the consequences of the market economy were more nuanced and multifaceted than he is often given credit for. While he famously explained the efficiency gains created by the specialization that was necessitated by market competition, he also saw how it could create a problem of meaning for the workers. In Book V of WN, he writes, “The man whose whole life is spent in performing a few simple operations, of which the effects too are, perhaps, always the same, or very nearly the same, has no occasion to exert his understanding, or to exercise his invention in finding out expedients for removing difficulties which never occur.” This is quite like the concern Marx expressed many years later in his idea of alienation. Smith’s suggestion to overcome this to some extent was to invest in education that exposes every human being to some learning and helps them develop.
From WN, it is quite clear that Smith is concerned about the welfare of the workers. Smith argues that economic growth is a necessary condition for improving the welfare of workers. For workers’ wages to rise, he argues, the incomes of the enterprises they work for must grow. If the economy does not grow and the incomes of the enterprises do not rise, it would be difficult to negotiate a wage rise because the owners of capital are in a stronger position in an economy that is not growing and therefore has fewer opportunities for workers. However, as he writes in Book I of WN, even though economic prosperity is essential for the workers’ wages to rise, workers are often not in a position to understand this fact and to propose the policies that might improve such prosperity that can enable a wage rise. Further, he observes that, given the way policy was made during his time, the workers’ views rarely mattered.
Smith is also quite clear-eyed about the disproportionate power that owners of capital can come to have in the policymaking process. After showing why landowners and workers are often unwilling or unable to influence policies, he shows how the owners of capital have the ability and the incentive to do so. He argues that their interest may not always be aligned with the society’s interest. In a discussion containing the essential insight on “creative destruction” that Schumpeter wrote about many years later, he shows how a vibrant economy encourages more capital investment, which means more competition that can put pressure on profits of those who invested earlier. So, owners of capital often advocate for expanding the markets while reducing the competition. Smith writes: “The proposal of any new law or regulation of commerce which comes from this order, ought always to be listened to with great precaution, and ought never to be adopted till after having been long and carefully examined, not only with the most scrupulous, but with the most suspicious attention.” In a similar refrain, Smith writes about how people of a trade or profession often conspire to keep their incomes high at the cost of the public. He writes: “People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.”
Essentially, Smith seems to be arguing that a well-functioning market economy requires policies to be made in public interest through a process that is not held hostage to any class. This requires a certain level of independence, transparency, and objectivity in the policymaking process, which many good governments in recent decades have accepted.
In his wonderful introduction to the Penguin Classics edition of TMS, Amartya Sen writes, “Smith’s focus is on actual realizations (not just on institutions and arrangements), and on comparisons rather than on transcendence. The primary concentration in the Smithian approach is on questions such as ‘how would justice be advanced?’ rather than on, as in Rawlsian theory, ‘what would be perfectly just institutions?’” This is a crucial distinction in the different ways in which people think about justice. Since Smith began his work from the observation of social and economic interactions, he could see how they could be made more beneficial—sometimes gradually, sometimes quickly. Such a reconstructive approach that builds normative proposals based on observation of practices is something that all interested in political economy can learn from Smith.
This kind of methodological learning is particularly important when it comes to Smith because he always emphasized a specific historical understanding of political economy. For instance, his narrative in WN about how the feudal lords’ rising expenditure on luxury may have weakened them and created grounds for the development of the rule of law, which helped give birth to modern liberty, is offered specifically in the context of the Europe of his time. People working in a specific political economy would do well to learn from the way Smith pursued his inquiries rather than relying on ideological readings of his work. Such readings offer attractive but ultimately hollow prescriptions.
—By Suyash Rai
Review
Does Land Pooling Lead to Concentration in Land Ownership? The South Korean Experience
As I have written earlier, the enactment of the new land acquisition law in 2013 has heralded a significant change in how land is being acquired for urban development in India. While land acquisition was the predominant instrument prior to 2013, there has been a slow shift toward more consensual and market-based mechanisms such as land pooling since then.
This has been driven by the fact that the 2013 land acquisition law provides for significantly higher compensation for acquisition, making it fiscally much more expensive for urban development agencies. Land pooling, on the other hand, relies on financial contributions by landowners themselves. Urban amenities and infrastructure can therefore be provided by urban development agencies at a much cheaper cost.
However, instruments such as land acquisition and land pooling operate within specific contexts and may not necessarily lead to similar outcomes in all situations. While land pooling seems more equitable toward landowners on paper, the larger structure of the economy, developmental trajectory, and regulatory framework influence eventual outcomes significantly. This is the finding of an interesting paper by Klaas Kresse and Erwin van der Krabben, titled “Rapid urbanization, land pooling policies & the concentration of wealth” (2021). It provides an in-depth analysis of the impact of land pooling policies in South Korea during its period of rapid urbanization from 1962 to 1988.
The paper examines the hypothesis of whether land pooling as an instrument of urban development led to concentration in land ownership. At the end of its period of rapid urbanization, Korea’s land market became highly concentrated. Since South Korea went through two distinct phases of urbanization, during one of which land pooling was dominant, this enables the authors to clearly examine the causal link between land pooling and ownership concentration.
The authors report data to demonstrate that land pooling, also termed land “readjustment,” was the dominant land policy during much of this period of urbanization. It further divides the period of urbanization in South Korea into two phases and shows that the first phase, especially, was marked by land pooling. The authors find that, as the fiscal capacity of the state increased, the actors in the land market were able to “intensify the use of active land policies in the late stage of rapid urbanization.”
The study analyzes the influence of land pooling on ownership patterns in two stages. First, it tries to understand how specific patterns of government and market coordination can support land transactions that result in ownership concentration. Second, it analyzes public policy interventions “and [how] their side effects may support structural processes of land ownership concentration.” Land pooling is well suited to studying the effects of government and market coordination and the effects of policy interventions because, in theory, land pooling results in the pooled land reverting back to the original owners after the development work is complete. There should therefore be a minimal impact on ownership concentration in the absence of these effects.
As implemented in South Korea, land pooling was not entirely consensual. The decisions based on which zones of land were to be selected for readjustment were not completely voluntary, and the policy framework also made the participation of landowners in these zones compulsory. These decisions were left to the local government. The gains to be made from redeveloped land led to a prioritization of the scale and scope of land pooling projects. Local bodies therefore “prioritized the financial feasibility of land readjustment projects and tended to phase out large readjustment projects in order to let prices mature.”
According to Kresse and Krabben, this preference for small-scale, slow development led to land and housing scarcity even as new land was being developed. However, the fact that the gains from development were largely private “helped to fund urbanization with private investments.” The possibility of making profits from redevelopment, however, also encouraged speculation.
In addition, the fact that the risks to development were also privately shared created situations of financial distress and led to distress sales. The authors evidence absenteeism—20 percent of the resettlements were by the original landowners, and 60 percent of the resettlers were absentee landowners.
Active government interventions in the land market were limited. However, laws that affected land use affected the patterns of transactions. The authors note that laws on city planning and land use, zoning and building regulations, and urban containment policies restricted the supply of urban land. This caused urban land prices to increase rapidly and encouraged speculation.
In addition, government policies in agriculture and finance also had an impact on land ownership concentration. With respect to agriculture, Kresse and Krabben share the following findings:
The government interfered in agricultural markets and regulated the prices of agricultural goods, imported grain which weakened the prices of locally produced agricultural goods and limited the size of agricultural land holdings according to the land-to-the-tiller program.
This gradually made farming on a small scale uneconomic and caused small landholders to sell their landholdings and move to urban areas, creating greater demand pressure in cities.
The South Korean government also discouraged domestic credit unless it was backed by land or real estate ownership. This increased the threshold at which individuals could enter the land market and enabled existing landholders to acquire additional land. This facilitated “downward raiding,” or a process in which higher-income households buy out economically weaker households.
Based on these findings, the authors note that while land pooling/readjustment during South Korea’s phase of rapid urbanization led to dispossession and concentration, “the intrinsic institutional design of the policy has not been the driving force of this process.” Rather, the causes of dispossession and concentration originated in the government’s planning policies, including policies on land use, agriculture, finance, and national security.
In conclusion, the Kresse and Krabben study provides valuable insights into land pooling policies, government coordination, and land ownership concentration during the period of rapid urbanization in South Korea. The first key insight here is that outcomes such as the equitable distribution of ownership cannot be guaranteed by policy instruments such as land pooling unless such considerations are explicitly baked into the designs of policies.
Second, and more fundamentally, the study demonstrates how countries at a specific developmental stage face trade-offs between efficiency and equity. In South Korea, land pooling/readjustment delivered rapid urbanization within a couple of decades. The use of land pooling enabled the development of urban infrastructure at a low cost to government agencies and ensured that the gains from urban development accrued to private landholders rather than to the government. One consequence of this was a rapid increase in land prices and a concentration in land ownership. This stands in contrast to India, where large-scale land acquisition has led to dispossession but has also not led to the rapid provisioning of urban infrastructure.
In the final analysis, this paper provides many useful insights into the design of public policy instruments considering larger market forces and the intended and unintended consequences of government policies on the eventual outcomes.
—By Anirudh Burman