Saturday, October 15, 2011

Smith on Effective Demand

"The quantity of every commodity which human industry can either purchase or produce, naturally regulates itself in every country according to the effectual demand, or according to the demand of those who are willing to pay the whole rent, labour, and profits which must be paid in order to prepare and bring it to market."

Wealth of Nations, IV.i.12


  1. An interesting quote.

    One can see how Say's law is derivable from this (in fact, a form of Say's law is already there in the quote really), if one believes that all money from factor payments from production is actually spent.

  2. It sounds like Smith is respectful of both sides of supply and demand.

    Also, Daniel Kuehn, have you arrived at the parts in Smith's "The Wealth of Nations" where the great Scotsman talks about a central bank being essential to neutralizing the effects of "prodigals and projectors"?

    The reason I ask is because Michael Emmett Brady's been claiming that with regard to financial speculation, both Dr. Smith and Baron Keynes converge quite closely. He has constructed a supportable case in this working paper, which compares and contrasts Keynes, Smith, and Bentham.

  3. LK -
    re: "if one believes that all money from factor payments from production is actually spent."

    And he does say this elsewhere... or something close to it - I'm criticizing him for it in an essay right now.

    Blue Aurora -
    I think I know what you're talking about, and yes. Ya Smith is rich for people interested in financial regulation. I wrote an earlier post about Smith and Stiglitz, and I believe this "prodigals and projectors" line comes up in that passage, but I could be misremembering.

  4. >re: "if one believes that all money from >factor payments from production is actually >spent."

    And he does say this elsewhere... or something close to it

    Possibly Smith says it here?:

    What is annually saved is as regularly consumed as what is annually spent, and nearly in the same time too; but it is consumed by a different set of people. That portion of his revenue which a rich man annually spends is, in most cases consumed by idle guests, and menial servants, who leave nothing behind them in return for their consumption. That portion which he annually saves, as for the sake of the profit it is immediately employed as a capital, is consumed in the same manner, and nearly in the same time too, but by a different set of people, by labourers, manufacturers, and artificers, who re-produce with a profit the value of their annual consumption. His revenue, we shall suppose, is paid him in money. Had he spent the whole, the food, clothing, and lodging, which the whole could have purchased, would have been distributed among the former set of people. By saving a part of it, as that part is for the sake of the profit immediately employed as a capital either by himself or by some other person, the food, clothing, and lodging, which may be purchased with it, are necessarily reserved for the latter. The consumption is the same, but the consumers are different” (Adam Smith, 1811. An Inquiry into the Nature and Causes of the Wealth of Nations [11 edn; vol. 1], Oliver D. Cooke, Hartford. p. 240).

    More here:

  5. Daniel Kuehn: Indeed, Smith hated what we would call in modern day terms, "the speculators". But does anything in your reading of The Wealth of Nations support Brady's case that Keynes and Smith hold similar positions on curtailing financial speculation?

  6. Blue,

    I have a quote here:

    'A great part of the capital of the country would thus be kept out of the hands which were most likely to make a profitable and advantageous use of it, and thrown into the those which were most likely to waste and destroy it. Where the legal rate of interest, on the contrary, is fixed but a very little above the lowest market rate, sober people are universally preferred as borrowers to prodigals and projectors.'

    He seems to dislike projectors and would prefer money to be lent to 'sober people' who create jobs.

  7. I don't see how Smith's argument for usury law can be taken directly as an argument against speculation.

    Though, inevitably, I don't agree with LK's post on Say's law, it's a great post and a great source of information.

  8. I agree with Current. Presumably speculators form some portion of the prodigals he was concerned about, but there doesn't seem to be an argument against speculation. I think Smith's usury argument can be pretty effectively read as an anticipation of Stiglitz's credit rationing model. It hits almost all the points that Stiglitz hits, and I think it carries all of the implications of Stiglitz's model. In other words, it is what Smith presents it as: one of the few good arguments out there against usury. I don't think it carries many implications for anything else - and that includes speculation.

  9. According to Amartya Sen's introduction to the Penguin Classics edition of "The Theory of Moral Sentiments" (of which I own a copy), the term "projector" in the 18th century English essentially is the same as the term "speculator".

    I have not read Joseph Stiglitz's credit rationing paper, but I will point out that Stiglitz criticises speculators to this day.

    According to Smith, the "prodigals and projectors" of his day raised interest rates to exorbitant levels, and raised the level of risk taking. This goes on to form bubbles and massive losses. While a credit rationing model interpretation does hold water, I'm quite sure that Brady's case that Keynes and Smith converge on financial speculation somewhat supportable.

  10. So let me clarify - that speculators can be underhanded, destabilizing, and simply bad for the economy is something I agree with. One of the big concerns that Stiglitz has about asymmetric information in credit markets is precisely the sort of people like speculators who are not only willing to take huge risks on bets about the future - but who take these risks without their creditors knowing that that's what they're borrowing money for. This is all a major problem for Stiglitz certainly, and I think also for Smith.

    What I'm arguing (and I can't say if I speak for Current here) is that one need not be reckless and information need not be asymmetric for speculation to occur. So speculation as a market activity is not coterminous with the sort of "projectors" criticized here. I don't think Smith or Stiglitz want to shut down futures markets, for example. It's a specific sort of speculator they are concerned about - not the activity of speculation.

    Keynes can be thrown in with this. He has lots of concerns about speculation in the stock market. But in the Tract on Monetary Reform he talked about the immaturity of futures markets as one of the chief causes of the underdevelopment of many economies. So he's clearly not against speculation per se.

  11. So you and I converge together somewhat. It's when Smith's "projectors" speculate so much to the extent that it overtakes proper enterprise that causes things to be destabilizing, resulting in what we would call in the 21st century a "Minsky moment". Keynes does say something like what I said in his magnum opus.

    Would you then say that Brady's case is somewhat supportable, then?

  12. re: "Would you then say that Brady's case is somewhat supportable, then?"

    I still don't feel like I entirely grasp Brady, but he seems to have a good sense of Keynes on these things, and I personally think there's a lot of similarities between Smith and Keynes - so I would say yes.

  13. I see. If you don't mind me asking, what is it that you don't quite get about Brady's work? On a side note, have you seen any of his reviews on

  14. My point is similar to Daniels....

    You may be right that Smith is against speculation, but if he is then why doesn't he propose laws against speculation? Attacking debt markets in order to get at speculation looks too indirect to me.

  15. @Current: If my memory serves me correct, Smith's advocacy of usury laws would have the effect of at least taming speculation whilst not totally destroying free enterprise, hence the "sober people" he refers to.

  16. That may have been what Smith meant, but it seem to me that whether your a sober person or not has nothing to do with if you engage in speculation or not.


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