Happy Birthday Smith and Keynes

Jonathan reminds me that it is John Maynard Keynes and Adam Smith's joint birthday today! The two are ranked together in the highest echelons of economic science for good reason. To a large extent (and admittedly simplifying many other great economists) they provide bookends to an interlude in economics where one simply fact was often forgotten: we do not sit comfortably and automatically on a production possibilities frontier. Smith destroyed the poor arguments of British protectionists by discussing how the division of labor and mutually beneficial exchange could make us more wealthy with the same inputs. After Smith, the Ricardians and the classical economists slipped the discipline into a world of diminishing returns - not because it was necessarily realistic, but for the sake of tractability. Themes of increasing returns, innovation, and spillovers from specialization were underemphasized (although thankfully the gains from trade were still maintained as a theme in classical economics). There were innovations in this Ricardian interlude - the marginal revolution being the chief among them. And while Walras made important contributions in this respect, his general equilibrium system continued the tradition of a perfectly calibrated, balanced systems where general gluts were inconceivable. At the Walrasian auction block, everything was sold and everyone was employed. Keynes revived the tradition of Smith in a subtle way. Smith studied the economy as it really existed and uncovered the key to rapid economic growth and innovation beyond a production possibilities frontier. Keynes filled in the other side of the equation and explained how the complex emergent system of Smith could discoordinate and collapse at regular intervals. The key was the relationship between money, the interest rate, and investment levels. The economics of Ricardo, Walras, and the classics was both Panglossian and stagnant. Smithian economics dispells the stagnation of the classics, while Keynesian economics unravels the Panglossian myth.

It is fitting that two of the greatest economists we have and two of the greatest champions of liberalism share a birthday.