This blog post is motivated by Ashish Kulkarni’s post, which is a response to Samrudha Surana’s substack entry, which in turn is a response to a question I had posed at the recently concluded HET conference organized at Azim Premji University, Bengaluru. And perhaps the process of reading and writing for this post will motivate me enough to get back to systematic blogging.
According to the Oxford Dictionary, ‘natural’ means “not made or caused by humans”. Viewed this way, there is nothing natural about markets or governments. Both have been created/designed by humans. Consequently, the prices set in markets and the prices set by governments are in no way natural. Yet, marginalist economists (and adherents of the Austrian school) suggest that there is something natural or spontaneous about the prices that emerge in markets vis-à-vis those that are set or administered by governments. This is the mainstream view—propagated via introductory textbooks.
This post critically engages with James Buchanan’s 1964 article ‘What Should Economists Do?’ published in the Southern Economic Journal as this forms the basis of the posts by Samrudha and Ashish. The critical appraisal of Buchanan’s article is restricted to his misunderstanding of Adam Smith.
Buchanan’s misunderstanding of Smith
In the very first page of his article, Buchanan calls our attention “to a much-neglected principle enunciated by Adam Smith” (p. 213). The “principle which gives rise to the division of labor” is, quoting Smith, “the propensity to truck, barter, and exchange one thing for another”. And that its significance “has been overlooked in most of the exegetical treatments of Smith’s work.”
Buchanan wants economics to be “the theory of markets” and not the “theory of resource allocation” (p. 214). As he writes,
Later in the essay, there is an inaccurate reference to Smith’s invisible hand (p. 217; see my moneycontrol article on Smith here). What Buchanan perhaps ignores or is unaware of is that Smith’s economics is one that emphasizes production, economic growth and development. Contrast Buchanan’s definition of economics provided above with that of Smith.
And to make sense of economic development, a theory of price is essential (for an elaborate account, see Section 2 of my chapter in The Anthem Companion to David Ricardo—available here).
In the tradition of Petty, Cantillon and Quesnay, Smith distinguishes between “natural prices” and “market prices”. In Cantillon, the corresponding terms are “intrinsic value” and “market prices”. It is important to keep in mind that both “natural prices” and “market prices” are theoretical in nature, with the former at a higher level of abstraction than the latter. If market prices were empirical in nature, there would not be a single market price but a spectrum of prices that vary according to the nature and quality of the commodity as well as the time and location of the market.
Be it the market or the government, both have been created and designed by humans and will continue to be re-created and re-designed. This, Buchanan recognizes. As he writes, “A market becomes competitive, and competitive rules come to be established as institutions emerge to place limits on individual behavior patterns” (p. 218; emphases in the original). For him, the market is “the institutional embodiment of the voluntary exchange processes that are entered into by individuals in their several capacities. This is all that there is to it” (p. 219). This is where Buchanan goes astray.
I ask: how voluntary is the process of exchange under capitalism? How voluntary is the process of exchange under patriarchy? How voluntary is the process of exchange under the caste system? Smith is very cognizant of the fact that employers have more power than workers in capitalist societies. Smith is aware that big corporations (with/without support from the government) have more power than small entrepreneurs. Buchanan is unable to view power as a structural feature of our economic system—unlike Smith. One reason for the inability could be his adherence to an extreme version of methodological individualism.
To conclude, the spaces wherein exchanges are truly voluntary for all parties, I think, are very less. Household? Firm? Village? City? International trade?
Political economy, in the work of Adam Smith, recognizes social classes and social power. And it is this recognition that will enable us to design better markets and governments. And this means better designs for pricing commodities, determining wages, setting interest rates, improving employment levels, and recharging our environment.