Why everything you think you know about Adam Smith is wrong

Well, hold on. We may think Smith laid the foundations for Thatcherism and Reaganomics, but according to one of Scotland’s most celebrated economists we couldn’t be more wrong.

Smith’s thoughts have been hijacked. Professor Ronnie MacDonald spent much of 2023 – significantly the 300th anniversary of Smith’s birth –uncovering the truth about Scotland’s greatest economic thinker. Who better?

MacDonald was, after all, the Adam Smith Professor of Political Economy at Glasgow University, one of Scottish academia’s most prestigious posts.

MacDonald’s findings, which completely recast almost everything we’ve been told about Smith, are about to be published in a landmark work from Cambridge University.

The National Institute Economic Review is presenting his investigations in a special issue called Smith @ 300.

MacDonald’s paper, running to almost 40 pages of painstaking research, is entitled “Adam Smith and the Neo-Liberal Paradigm: On the essential nature of trust, and rebalancing capital”. For non-economists, it sounds a daunting title, but break it down and you’ll discover a game-changing reassessment of one of history’s greatest minds.

Essentially, Smith’s work was corrupted by “neoliberal” free marketers in the 1970s. For neoliberal, think of Margaret Thatcher and Ronald Reagan’s essential policies: unfettered capitalism, where the market knows best and regulation is stripped to a minimum. Profit comes first.

Neoliberalism has led to real pain for society, MacDonald believes, boosting inequality, shattering trust in politics and capitalism, and leading to today’s broken global economy.

If Adam Smith’s original teachings had been followed, we wouldn’t be in this mess.

MacDonald is no radical. Anyone trying to pin claims of revolutionary zeal on him will struggle. MacDonald has been consistently ranked among the world’s top 1% of economists.

He has held posts at the International Monetary Fund, advised the World Bank and UK Audit Office, and acted as a consultant to the European Commission and European Central Bank.

He held the Adam Smith chair as Professor of Macroeconomics for 12 years and has just shifted into semi-retirement, although he’s still attached to Glasgow University.

His study of Smith is one of the crowning achievements of his career. He is currently considering turning it into a book.

Professor Ronnie Macdonald

Morality

MacDonald sat down with The Herald on Sunday for a lengthy discussion about what Smith really believed. “It’s important to remember that above all Smith was a moral and ethical philosopher,” he says. “That’s crucial as ethics have been taken out of economics.”

Smith maintained that all human life should be underpinned by the following virtues: courage, temperance, justice, prudence and benevolence – with temperance meaning “self-control” and prudence meaning “self-interest”.

However, to balance self-interest, MacDonald explains, Smith developed “a theory of empathy for others”.

Yet after Smith’s death in 1790, “that line of morality basically came to an end very quickly, the rot set in right after he died”. John Stuart Mill, the Victorian economist and philosopher, developed a school of thought which “moved away from an economy centred on ethics”. Mill came up with the theory of “Homo economicus” – economic man – where humans are defined by their “desire to possess wealth”.

MacDonald explains that while Smith accepted that humans are motivated by self-interest, he also believed that economies should be “tempered by moral sentiments, like consideration for others, self-control, the wish to see justice in society and what you could call ‘Christian love’ – love of others and self-sacrifice”.

There is debate about Smith’s own faith. He appears to have been an agnostic or “deist”, meaning he believed in God but not any particular religion. “He believed that for the market to work properly these moral virtues must be in place.”

MacDonald says that today “the market is separate from society” – meaning it operates by its own values, not the values of, for example, the British people.

“Smith believed the market should be embedded in society, and should reflect society’s values.”

The political ideologues who ushered in neoliberalism in the 1970s and 1980s often quoted Smith, referring to ideas of his such as the market’s “invisible hand”.

The invisible hand is used as a metaphor for the belief that markets can do no wrong, that markets will always reach the right decision.

However, that’s cherry-picking of the worst order, MacDonald feels. “Smith only mentioned the invisible hand once,” says MacDonald, in his most famous book The Wealth Of Nations. Whereas Smith talks of the need for “moral virtue” in markets repeatedly.

Even then, Smith’s reference to the invisible hand doesn’t imply that the market is godlike. Smith was very forthright about the inherence of “market failures” – meaning that markets don’t get everything right, and often get matters very wrong.

“A good example,” says MacDonald, “is pollution and its effects on global warming.” Lack of regulation – allowing the invisible hand to do its unfettered work – saw markets fail to deal with the consequences of their actions on the environment.

Thatcher

NEOLIBERALS oppose market regulation. “Smith is very clear that you need regulation – that’s been lost in modern neoliberal policies, initially pursued by Thatcher and Reagan.

“Their idea was to deregulate markets. But Smith said if you go down that line you’ll end up paying a heavy price. In terms of his view of the importance of morality guiding the invisible hand, it’s all been forgotten.”

For proof of this corruption of Smith, note that Britain’s most influential neoliberal think tank is called the Adam Smith Institute.

It promotes a free market agenda and laid the intellectual ground for Thatcher’s privatisation policies.

The American economist Milton Friedman was the principle thinker behind neoliberalism. Friedman and others “emphasised the few comments Smith made about humans working for their own self-interest and put to one side all the other ethics he discussed”.

Smith warned about what’s called “the principal-agent problem” – what we would now describe as the separation between chief executives and the companies they run.

Executives, as recent events have shown, can attempt to maximise share prices and their own bonuses and salaries at the cost of laying off workers, trashing the environment, and gouging consumers over prices.

Smith knew that “the people running private companies don’t have the same care as those running family-owned companies”, and that can have hugely detrimental effects on workers and the wider society.

“Smith effectively said if you don’t address this issue you could really ruin your economy. Friedman argued that the sole function of directors was to maximise profits. That’s become a key element of neoliberalism.”

Friedman used Smith to claim that individuals should simply pursue their own interests. This selective reading made Smith synonymous with libertarian free-market capitalism. It’s a cruel twist of fate for a man who championed regulation and what could even be described as “caring capitalism”.

Friedman even claimed Smith was “a radical and revolutionary in his time – just as those of us who preach laissez-faire [free market economics] are in our time”.

Capitalism in action

Trust

SMITH, says MacDonald, thought such a position was “the key source of many of society’s ills, and leads to the corruption of moral values”. The dominance of neoliberalism, says MacDonald, has – as Smith feared – “caused inequality, degradation of the environment, and the loss of trust in capitalism and democracy”.

Smith wanted to see capitalism spread wealth throughout society, whereas so much of today’s market is centred on “rent-seeking”, says MacDonald, with investors simply accumulating money from assets, rather than creating jobs and products. Smith would have supported “stakeholder capitalism”, where the economy benefits employees and consumers as well as business.

“Friedman categorically stated that he was in Smith’s tradition of liberalism,” says MacDonald. “That’s simply not true.”

Ideologues like Friedman “completely ignore more than half of Smith’s work. They compress his work down to one idea: self-interest. But he said self-interest must be tempered by other virtues.”

MacDonald says there’s an analogy here with the way organised religion cherry-picks the Bible. “It’s like saying ‘let’s just focus on the Old Testament and forget the New Testament’.” Most neoliberals concentrate on The Wealth Of Nations, and ignore Smith’s other works like The Theory of Moral Sentiments. “You’ve got to take everything he wrote together,” says MacDonald. The Wealth Of Nations allows neoliberals to claim Smith backed “profit above principle”, despite his other works discussing how business should be benevolent and has a duty to wider society.

In its broadest context, neoliberalism, says MacDonald, “is about putting yourself before others”. That’s a complete “corruption” of Smith’s thinking and his call for “self-control, justice and love”.

Neoliberalism “built an entire edifice” on Smith that doesn’t accord with his writings. “That corruption has had stark consequences for the world we live in.”

Libertarians

ONE of the reasons that Smith backed regulation was due to how “asymmetrical” the market is, says MacDonald: in other words, billion-dollar tech giants with effective monopolies can pull the wool over the eyes of any consumer. “Smith was very much against monopoly. Today, there are monopolies all over the world.”

The neoliberal obsession with Smith’s mention of the invisible hand, has, MacDonald adds, “become a ‘broken hand’. The economy doesn’t operate efficiently”.

Neoliberalism “made extreme assumptions that everything is good about the market. That distorts Smith’s view. It’s a misreading. Smith never said that all markets, all the time, will operate perfectly due to this wonderful invisible hand. He heavily qualifies”. Markets will only achieve good outcomes with good regulation: that’s the essence of Smith’s thinking.

Why did neoliberals like Friedman corrupt Smith’s ideas? “There was a political agenda,” MacDonald says. “They’re certainly on the right, and generally libertarian. They wanted to sell a view that you don’t need government intervention.”

Hijacking Smith helped neoliberal thinkers “gain power”, he adds. What better way to back up your argument than to claim that one of the world’s greatest thinkers is on your side, even if they’re not.

Essentially, this paved the way for the banking crisis and resulting austerity. Those two events helped erode trust in both the economy and politics, paving the way for the rise of populism and authoritarianism.

“For Smith, trust in government was crucial,” says MacDonald. “Governments had to be seen as incorruptible, as that engenders trust within society. Trust in neoliberal societies like ours is currently broken.”

MacDonald’s critique of neoliberalism is scathing. “The norms of the market aren’t driven by our norms or the values of society. Many of our problems come from the failure to recognise what Smith was saying, and the corruption of his work. We live in a society where ethics and morality are unfortunately determined by markets and corporations.”

Smith’s writings are “simply contrary to the neoliberal paradigm”. He would have been appalled, MacDonald says, by “the accumulation of wealth on the scale we see in the world today” by figures like Elon Musk. Smith certainly cared about “generating wealth” but he also cared about “how we deal with inequality. He favoured government legislation to help the poor”.

MacDonald adds: “He said the primary interest of government should be ensuring that there’s proper distribution of wealth, that if we’re doing well we can’t simply look at others and think ‘he’s not, but I don’t care’ – which is the ethos today.”

Smith began what’s known as “the labour theory of value”, MacDonald explains, which says that the cost of goods should be determined by the labour of workers.

That’s basically as far from neoliberalism as you can get before you hit Karl Marx.

Smith used the price of corn, MacDonald says, to discuss the value of labour as it allowed him to “use the needs of the working class as his metric”.

That doesn’t mean Smith didn’t “see the importance of capital accumulation”, he just saw the needs of workers as equally important. “In the neoliberal model, that’s ignored.”

For MacDonald, the Friedman ethos “led to climate change”, as it advocated corporations doing as they please regardless of the consequences for society.

So, what would Smith make of how his work was used by neoliberal thinkers?

“He’d be horrified at how he’s been corrupted, horrified that the only virtue people look at today is self-interest,” says MacDonald. “That would be anathema to him.”

Heads of delegations assembled at Lancaster House, London, on the second day of the seven-nation London Economic Summit. * (L-R) West German Chancellor Helmut Kohl, Italy's Premier Benito Craxi, Japan's Prime Minister Yasuhiro Nakasone, America's

Inequality

AND what would he make of our economy? “He’d be horrified by that too – certainly by the huge inequalities that have arisen. He wouldn’t see that as consistent with a stable, well-functioning economy. He’d be horrified at what the corporation has become. He’d be horrified that the issues he saw in his own day haven’t been addressed.”

The towering irony is that if Smith were alive today, as a proponent of regulated capitalism, he’d probably get dismissed by the self-same commentators who claim to idolise him as a Marxist.

The very discipline of economics, MacDonald feels, has become unmoored from Smith’s thinking. It’s become increasingly mathematical, and shorn of interest in issues like “virtue”. MacDonald even speculates that if Smith were alive today, given how the study of economics operates, “he might not have been able to produce the work he did”.

Smith came to his opinions “by being in society, by living and working in Glasgow, and observing how merchants acted, and how politicians behaved – and the corruptibility of merchants and politicians”. The study of economics should reorientate itself towards this more philosophical, rather than coldly scientific approach, to how markets work. It was only in semi-retirement that MacDonald could adopt the same style as Smith and explore the morality behind modern economics rather than just the brutal arithmetic.

“We’ve got to move back to the tenets of Smith,” he says. “But whether that can happen is very debatable.”

In principle, MacDonald believes, the crisis in capitalism caused by neoliberalism can be addressed. But it “would require state intervention on the modern corporation in a way governments haven’t been prepared to do. The state has allowed corporations to follow the Friedmanite rule despite all the consequences we see flowing from that”.

Corporations won’t change voluntarily, MacDonald says, and governments show no desire to “break from this Friedmanite doctrine”. Such a break would be “very difficult, however, in today’s global economy”.

Any individual nation which tried to reform neoliberalism, as Smith intended, would fail unless America followed suit. And that’s not going to happen “even under the Democrats”, says MacDonald. “So we’ll probably limp along until it’s too late.”

Violence

THAT sounds chilling – what does he mean? “Inequality is frightening,” MacDonald says. “It presents an existential threat on a par with pandemics and war. You could have a complete breakdown in society eventually if this isn’t addressed.”

Does he mean rioting and political violence? “Exactly,” MacDonald replies. If that happened, supply chains could collapse, creating a feedback loop of more economic chaos, poverty and rage.

“I’m not sure how far from that prospect we are, but clearly there are huge inequalities in all countries which follow these neoliberal policies.”

MacDonald fears the rise of the far right. “We’re seeing that trend already,” he says, as authoritarian and extremist leaders increasingly win elections.

Neoliberalism created “a vicious circle in the breakdown of trust. People don’t trust politicians, governments or markets. That’s a dangerous scenario. Politicians thought globalisation was a cure for everything – it turned out to be the reverse”.

So is neoliberalism like the proverbial thorn in the lion’s paw? If we take it out, we can fix everything? “Yes, in a way, but that thorn is now a spear and it’s affecting more than the paw. It’s to the bone. It’s going to be difficult to take it out.”

Can capitalism and democracy survive? “Hopefully,” he says, but MacDonald believes that today “liberal democracy is now at an end”, certainly in Britain.

As Smith was a classical liberal, there’s nothing truly liberal left in our democracy when it comes to the economy. “That’s largely due to the role of the corporation. Smith wanted the values of society to drive the market, now it’s the norms of those who control the market which are being pushed on society.”

MacDonald even feels that Britain is currently in the grip of a form of “state capitalism”, where the government has “ceded control of the economy to the corporation. The truly liberal part of democracy has gone”.

He adds: “From a classically liberal position like Smith’s, it was crucial for the state to act for the greater good when necessary.

“Today, the greater good is being undermined by the corporation. We forget that in classical liberalism there’s an important role for the state and for regulation if the liberty of an overall society is being undermined, as it is by the behaviour today of modern corporations.”

MacDonald makes clear that he isn’t attacking capitalism. He supports capitalism. What he’s saying is that if regulated properly capitalism can be a force for good. We’re just doing it all wrong. “That’s what Smith would be saying too,” he adds.

“He believed that capitalism could only work if it was underpinned by ethics.”

If Smith were alive today, he’d immediately rein in the power of corporations, MacDonald adds. “And he’d be very clear that the model of markets we now have – this neoliberal model – is completely wrong, completely at variance with his thinking and with reality.

“He’d want people to recognise that all markets need regulation, that they don’t work by the invisible hand always bringing optimum solutions. Smith recognised market failure, these neoliberal guys don’t.”