Book review - Adam Smith by Jonathan Conlin (Reaktion Books, 2016)

One of the unintended consequences of the 2008 financial crisis has been to bring what until then had been a backwater of academic research, financial history, into a mainstream topic of the reading public. So it will pique readers’ interest that Jonathan Conlin in Adam Smith (Reaktion Books, 2016, £11.99) covers an intriguing episode from the life of the great economist when he was working on The Wealth of Nations. In 1772, Smith witnessed the collapse of a major Scottish financial institution, Ayr Bank, and since one of the bank’s principal shareholders was Smith’s principal patron, the Duke of Buccleuch, its demise affected him in more ways than one.

In 1769, when Ayr Bank opened doors, Scotland was booming. Investing in Edinburgh’s New Town seemed a one-way bet and substantial sums were raised for property there and for infrastructure in the region. When the managers Ayr Bank came to grief they did much as have bankers before and since, namely by kidding themselves that loans could not sour and even if they did, savers were unlikely to care enough to pull their deposits., David Hume wrote to his economist friend after Ayr Bank collapsed, “we are here in a very melancholy situation … Do these Events any-wise affect your Theory?”

Smith in Wealth of Nations had two points to make.

The first was banks ought to lend to create real value in an economy and help build highways rather than highways through the air.  Such common sense advice was in keeping with conventional thinking. But there was another comment Smith offered, regarding the imprudence of depositors, that evinces Smith had an intuitive understanding of the psychology of risk where he was well ahead of his time.

This is what Adam Smith had to say about depositors whose mind-set conduced to financial crashes:  “The house is crazy, says a weary traveller to himself, and will not stand very long; but it is a chance if it falls to-night, and I will venture, therefore, to sleep in it to-night.” Depositors, in other words, share some of the blame for a collapse in market confidence because they are not as vigilant as they ought to be.

Just how perspicuous is this insight we can see from debates over the benefits of deposit insurance, today unquestioned as an indispensable prop of financial market stability. But less thought is given that once monitoring bank solvency becomes a regulator’s job, this not only adds to cost of regulation but also tempts reckless depositors to act as free-riders to the system.  

In Jonathan Conlin’s biography, Smith’s reaction to Ayr Bank’s default is only one of many incidents in the life of Adam Smith that are sets against his works. As Conlin shows, it is often Smith’s asides and throwaway observations with which his Theory of Moral Sentiments and Wealth of Nations abound that illustrate his almost limitless capacity to prod readers into looking at things from an unexpected angle; for more of this see my full review of Adam Smith.

Well, why not slash corporation tax to 10%?

Given that we are all economically literate around here we know that corporations do not bear the economic burden of corporation tax. It's just a convenient fiction that they do, the reality is that the tax hits the wallets of investors in the company being taxed and all the workers in the economy which has the tax. Similarly, given that we are all economically literate, we know that capital income should be taxed rather more lightly than labour income, if it should be taxed at all.

So, this seems like a very good idea:

Britain could slash corporation tax to 10 percent if the European Union refuses to agree a post-Brexit free trade deal or blocks UK-based banks from accessing its market, the Sunday Times reported, citing an unidentified source.

The newspaper said the idea of halving the headline rate from 20 percent had been put forward by Prime Minister Theresa May's advisers amid growing fears other EU member states will take a hard line in Brexit negotiations.

The tax cut would be used to try and persuade the EU to grant "passporting" rights for financial services firms to continue operating across the EU, the newspaper said, in a sign of the likely animosity of the upcoming divorce talks.

But why is this being kept in reserve just in case we want to be dastardly to the French? Or the threat of not doing is being used as a persuasion for the Germans to maintain their own access to our fine banking services? 

This is simply a good idea in and of itself and one we should implement right away.

Could we make all politicians personally liable?

Could we, should we, think about importing a political practice from Thailand? We have the long reigning monarch after all, even if their practice of military coups is something we gave up centuries ago. For they've decided that a Prime Minister who oversaw a piece of monumental stupidity should be personally liable for some of the damages.

Yes, obviously, there's more than just a tad of political score settling here but the idea still has merits:

Former Thai Prime Minister Yingluck Shinawatra on Friday said the junta that overthrew her government had ordered her to pay nearly $1 billion in civil damages over a botched rice-subsidy program.

Botched is not quite the concise description we want here - insane folly is perhaps closer. The plan was to pay Thai farmers 50% above the world price for their rice, store it, then make a profit by selling as exports the now more expensive rice. This did not work as a quick glance at the EU's history of wine lakes and butter mountains would have shown.

It was political genius, that's true, given that it secured the votes of the 40% of Thais who are rice farmers, but an economic hallucination consistent with the very finest psychotic drugs. Production increased both inside and outside Thailand, the export markets substituted over to other producers, smuggling into Thailand took place and by the end the plan was reportedly swallowing 4% of GDP.

That's cheap votes if it's other peoples' money, expensive if its your own. And thus the idea of making all politicians so personally liable. £400 million here on a troubled families programme, £20 billion there on a nuclear power station and £169 a MWatt for tidal power and pretty soon you're talking about real money.

Some would say that this would mean politicians never did anything, paralysed as they would be by the fear that it might go wrong. This is not a bug in the plan, King Log was a rather better ruler than King Stork,  it's rather the point of it....

Voluntary economic transactions between consenting adults to be made illegal

Not that it's actually that unusual for people to try to usurp the law to ban voluntary economic transactions. There're all too many people out there who believe that others should not be allowed to do as they wish and who will use the might of the State to prevent them doing so. This does not make prison time for being an efficient ticket distributor the correct answer:

Touts who use computer software to buy concert tickets for resale at inflated prices could face a prison term, under proposals to be considered by the government.

The proposal was made as Theresa May, the prime minister, said she was looking at ways to address the use of ticket-resale websites by professional touts at the expense of fans.

This simply is not the correct answer.

The market clearing price is the market clearing price and it always will be. Those supply and demand curves really do intersect. And trying to put a price cap on the supply only makes whatever it is more expensive for the consumer. Either there is the intervention of resellers, in a relatively inefficient market, or the cost of gaining access to the tickets becomes something else, time spent in queues for example, also less efficient. As we know, the best method of rationing anything is by price.

If it is true that the current supply leads to a price being "too high" according to whatever metric you want to use then there are only two potential answers. One is to reduce demand - by, perhaps, doing worse gigs. This might not be an entirely desirable answer of course. The other is to increase supply so that prices do come down - because again those supply and demand curves do intersect. Play larger gigs, play gigs more often.

That prices will vary according to those two, supply and demand, is not some optional extra it's one of the laws of our universe, at least a universe which has humans like us in it. Up to 51 weeks in prison doesn't change that fundamental fact of our existence.

This is a terrible idea, a bad suggestion for the law.

It is always true that small companies produce the employment growth

The House of Commons library has compiled figures to show that it is small, not large, companies that produce employment growth in the economy. This should not be news to anyone although sadly it is. For it is small companies which provide almost all of the forward impetus of the economy. This is true everywhere and always:

Small firms have created ten times more jobs than the big businesses who are lobbying to keep Britain inside the EU's single market, an MP revealed last night.

Tory backbencher Charlie Elphicke said the figures – compiled by the independent House of Commons library - nailed the CBI's 'single market lies'.

The pro-EU business group argues it is vital for the economy that the UK stays inside the tariff-free single market.

...

The figures show small and medium-sized enterprises (SMEs) have created 3.4 million new jobs in the private sector in the past 15 years.

Big businesses have created 323,000 over the same period, according to a new analysis of the Government's Business Population Estimates 2015.

This is true not just of employment. It is also true of innovation - as in the old joke that science proceeds one funeral at a time. The economy advances, productivity increases, one bankruptcy at a time.

New technologies are created, new technologies are adopted, largely through firm exit from the market and firm entry to it. Thus the entire system itself advances not through those large companies continuing to exist, but by their death from the competition bubbling up underneath them.

This is not a point specific to Brexit or the EU argument of course, but it is relevant to it. It's the entire and whole reason why we want a lightly regulated economy. Regulation aids incumbents as they are the people with the size and heft to be able to deal with the overhead of said regulation. It is only via a low regulation environment that we leave the room for the small companies to pop up into and so drive that economy forward to the ever greater enrichment of us all.

The relevance of the EU or Brexit to this being that we do all believe that we can transform the EU into a low regulation economy, right?

Right?

Christmas reading list 2025

Christmas seems to start early these days, so here's our contribution.  We sometimes publish a list of books we suggest people might lay in stock to read over Christmas, or to give to friends.  Here's our list for Christmas 2025.

"Why I Became a Conservative" by Owen Jones.

In this story of his journey, Owen tells how he came to see Marxism as an ideology imposed by intellectuals on the working class, and against their interests and aspirations.  By contrast, he came to realize that Conservatism, working with the grain of human nature, gives working people the chance to improve their lives.

"On My Ownio - the last of Labour" by Ben Bradshaw.

This rather sad autobiography chronicles how it feels to be the last Labour MP.  Ben sketches the history of the once great party from its origins in working men's associations, to its final demise in the streets of Islington.  As Westminster's solitary Labour MP, Ben tells how it feels to have no-one to second his motions, and to have to sit on the cross benches after a distinguished career in opposition.

"The Body Count" published by HM Statistical Office.

This shocking book catalogues the death toll brought about by NGOs through their campaigns against genetic modification, nuclear power, fracking, global free trade, and by their campaign for biofuels. The authors count up the millions of children who could have been saved from starvation by GMO crops and cheap food and energy, plus those whose sight could have been saved by GMO golden rice.  It is a shocking catalogue of the havoc the NGOs wreaked until their funding began to dry up four years ago as people withdrew their support.

"Bought and Sold for English Gold" by Elaine McLintock.

Here at last is the gripping story of how Scotland's fifth referendum on independence since 2014 went down by an even bigger margin than the fourth.  It's a blow by blow account of the increasingly bitter campaign that saw the Scots decide to remain within the developed world's fastest growing economy rather than heed the siren calls to a proud and romantic, if impoverished, independence. 

"We Kept the Peace" by Herman von Rompuy.

Five years after the dissolution of the European Union, one of its stalwart old time enthusiasts asks for it to be remembered fondly for the good it did.  Herman claims it prevented a third war between France and Germany, and that although it finally expired in a quagmire of bureaucracy and mutual recrimination, it should be remembered for its earlier achievement as Europe's Nobel prize-winning peacekeeper.

Unconventional thinking does not mean we should stop thinking

It's entirely true that at times we need to be a little unconventional in our thinking. Possibly even prioritise some out of the box conceptualisations as an urgency to set the ball rolling. But unconventional thinking is not the same as asking us to stop thinking.

At which point gurning from stage left is Andrew Simms, he formerly of the not economics frankly groupuscule:

Conventional thinking will not solve the climate crisis

Andrew Simms

Choosing the best possible future means considering radical scenarios that align energy use and industry with climate action

OK, many of us don't share his obsession with the amount of plant food in the atmosphere. But it is always worth examining someone's logic within the structure of their own beliefs. So, what is it that we are urged to do?

Rarely considered but important variables come from new economics, including the shorter working week, the share economy, shifts in corporate ownership and governance, and intelligent but deliberate measures for economic localisation. Compare these to the “stumble on”, or business as usual scenario, in which we give up control of our future to a permanently destabilised climate change, but also assess seriously the consequences of the argument for planned so-called “de-growth” of the economy.

That is not thinking rather than unconventional thinking. For all of these were examined, in detail, a quarter century back. It was considered in the Special Report on Emissions Scenarios, the economic models upon which the entire IPCC process is built. Absolutely every meeting, treaty, gabfest and report since then has been working on the basic logic of that examination.

The results of that examination being most interesting. The most obvious of which is that, even within that obsession with plant food, if we reduce carbon emissions then we're done. There is no other problem in this area. The other seriously interesting result being that economic localisation makes the problem, such as it is, worse, not better. 

Approximately speaking we have four models, families of models. A, in which we're capitalist free marketeers and B in which we do the Swedish socially democratic cha cha cha. 1 in which we're doing the globalisation waltz and 2 in which we revert to economic localisation. A1 and B1 are markedly better in terms of living standards and also the size of the climate problem than A2 and B2. Better as in the problem is smaller.

The reason is obvious - more trade will produce a higher living standard with the same resource use, or the same living standard with lower resource use, than less trade will. Because the process of trade is producing where resource use is least.

Which leaves us where we came in. Unconventional thinking is undoubtedly necessary at times. But this is not a synonym for not thinking. As with Simms and his idea here that the solution to climate change is economic localisation, the very thing we've known for 25 years which makes the climate change problem worse.

The free market case for hard Brexit doesn't add up

Ryan Bourne is a great guy, but I think he’s wrong about ‘hard Brexit’ being desirable, as opposed to the ‘open Brexit’ alternative. By ‘open Brexit’ (aka ‘soft Brexit’) I mean leaving the customs union but staying in the Single Market or getting a trade deal that is very similar in practice. His recent City AM piece makes strong claims about this without, I think, sufficient evidence to back them up.

First off, he contrasts a European Commission report, which concluded that the Internal Market has added 2.1% to the GDPs of EU member states, with a pre-referendum Treasury report, which suggested that we would suffer permanent losses of up to 6 percent of GDP if we were to leave the Single Market and Customs Union.

Ryan suggests that there is a contradiction here, but these estimates are looking at different things: the Commission’s study only looks at the gains from the post-1992 integrations that took place (the Single Market proper), not the gains from pre-1992 economic liberalisations the then-European Economic Community brought on. 

So it doesn’t make much sense to compare this with the scenario the Treasury modelled of the UK leaving the Single Market altogether, which obviously includes all the GDP-boosting reforms that took place before 1992 as well. So Ryan isn’t comparing like with like here – and that explains why the Treasury study seems much worse than the European Commission study. If they’d been looking at the same question, it’s quite possible that they’d have agreed entirely.

So Ryan’s point doesn’t add up, but maybe the Treasury’s model is wrong for other reasons. I’m sceptical of economic models at the best of times. But the ‘gravity’ model of trade, so-named because it assumes that countries’ size and proximity is an important predictor of how much trade can profitably take place between them, is a very robust one. It makes predictions that are very reliable – indeed John van Reenen, who is a very good and pro-markets economist, has described it as "the most reliable empirical relationship in international economics". As empiricists we should be careful about dismissing it.

This approach also compares favourably to Patrick Minford’s models of the GDP gains from unilateral free trade, because Minford makes several very unrealistic assumptions. These include the premise that distance does not affect ease of trading (so it’s literally just as easy for British firms or consumers to buy goods from Mongolia as it is to buy them from Ireland or France) and that the quality of items is the same in every country in the world. 

Let me give an example: socks may cost £3/pair in the UK, and 30p/pair in Mongolia. Minford’s approach assumes that the only reason we don’t all buy and wear 30p/pair Mongolian socks is tariffs, and that by abolishing tariffs we could all save £2.70 per pair of socks. This is probably not true, because (a) those 30p socks might be made out of polyester rather than cotton and hence actually be inferior as a product to the socks we wear here, and (b) the cost of transporting socks from Mongolia to Britain is probably higher than zero. I am sympathetic to the idea of unilateral free trade, but people like Ryan and Minford have an over-optimistic idea about how much better off it can make us.

With this in mind, the budget payments to the EU, while annoying, are probably not the biggest issue on the table. If those budget payments net out to 0.5% of GDP but our GDP shrinks by between 2% (let alone 6%) by leaving the Single Market, we’re not exactly better off keeping them. Shrugging off 2.1% of GDP (the low-range estimate Ryan cites) is not sensible, to my mind – since it’s a permanent loss it means that over time, it’s like shrugging off a year’s worth of income.

I’m surprised also to see Ryan, and so many other free marketeers, say things like “The depreciation of the pound already vastly outweighs any adverse tariff effect on exporters to the EU”. I suspect Adam Smith and Milton Friedman would have been too: both realised that exports are things you give up to get imports, and depreciation in a currency’s value really just means you’re getting less for what you’re giving up than you used to. 

This might still be good for exporters, but it effectively means that importers (that is, consumers) are losing out to help them. It is puzzling to see this argument in a free market case for a hard Brexit.

When Ryan refers to the opportunities open to the City from leaving, there's just no plausible market of a meaningful size anywhere in the world that we can gain share of if we lose regulatory access to EU27. Ryan’s point about not listening too much to established firms is well taken, but we have to weigh against that the fact that most people not involved in finance don’t know all that much about passporting, equivalence and so on. We shouldn’t simply ignore the people that do because they might be looking to keep rivals out, and I suspect if they were saying things in favour of a hard Brexit Ryan would be less sceptical about their motives.

Ryan doesn’t make the point here, but he has elsewhere, that there are lots of successful countries that are outside the Single Market like Japan and Canada, so why not Britain? Well, yes. But to get there would mean liquidating a lot of what we’re good at and, over time, the UK economy developing entirely different comparative advantages. Think of it like someone who has to re-skill after their old skilled job ceases to exist. It’s do-able, but the transition can be painful and costly. And there's no guarantee we'll be as rich as we were before. (By the way, maybe Canada would be richer if it was in the Single Market – they're certainly keen to get an extensive trade deal with the EU passed.)

Finally, I am somewhat annoyed by free marketeers describing the Single Market as a ‘single regulatory zone’ or similar. Yes, it involved harmonising some regulations. But mostly it relies on mutual recognition of other countries’ rules, and that harmonisation is overall a restraint on interventionist national governments. It also, obviously, makes trade substantially easier across borders. Governments like to protect domestic firms with regulations, not just tariffs, and the Single Market goes some way to preventing that. Just because it involves regulation does not make it automatically anti-market: if the alternative is more domestic regulation, and I think generally it is, the Single Market is the liberal option.

I strongly dislike many of the regulations that the EU passes. I don't like rules that stop kettles from boiling 'too fast'. But I think it's noteworthy that people criticising the Single Market focus on these annoying but relatively trivial regulations, because in terms of the big regulations that actually matter I don't think it does too badly. Outside the Single Market, even if we do scrap stupid laws about straight bananas and kettle heating times, I fear that we'll get much worse laws that cap energy prices and part-nationalise industries – many of which would be illegal in the Single Market.

My own view is that Brexit can and quite possibly will be a success but it depends on us being smart about it. I think many Brexiteers object most of all to symbolic aspects of the EU – the flags, the passports, the irritating and stupid lightbulb and kettle regulations – and we will probably end up with something that in practice is ‘soft Brexit’ but looks like and is sold by the government as ‘hard Brexit’, and ditches most of those symbols that they really hate. It may, in effect, be the EEA Option. That would get us out, and do it without turning Brexit into something that makes us poorer.

Once more into the breach on Brexit and trade

The Cabinet has been told that Brexit will be bad for trade, very bad. The problem here is that the sources of this information are the same scaremongering reports that were passed around before the referendum, those reports that were part of Project Fear. And the current precis of them doesn't include the most important part of the Treasury report, which is the mechanism by which trade makes us richer in the medium to long term.

The Cabinet is thus being feed information that is not entirely and wholly true: 

Cabinet ministers have been given detailed warnings that the UK pulling out of the EU customs union could lead to a 4.5% fall in GDP by 2030 and the clogging up of trade through Britain’s ports.

The predictions were contained in a paper circulated at a meeting of Theresa May’s special Brexit cabinet committee, which concluded that ministers were not yet prepared to decide whether the UK should withdraw from the EU’s free trade bloc.

The 4.5% cut is the average prediction made in three studies that were carried out before Britain’s EU referendum, in a move that could anger Brexit supporting MPs who believe that the old estimates are out of date.

To get to this result people are just doing sums. Exports are positive in GDP, imports negative, add up what you think the volumes of them will be and there's your answer.

But the Treasury report itself was very clear that this is not the medium nor long run effect of trade. Rather, there, the real effect is upon the productivity of domestic producers.

It's only the top 10 to 15% of companies, or producers, in any economy who partake in international trade. Why ship mediocre goods half way around the world when there're plenty of local mediocrities to be dealing with? Imports thus represent competition from the most efficient producers in the world - being exposed to such competition means that local producers either buck up their own productivity or they go bust.

Imports thus boost local productivity - and as Paul Krugman has said, productivity isn't everything but in the long run it's pretty much everything. Increased productivity is the very thing that makes us richer.

The sums being done in these reports do not take account of this effect. They are, essentially, doing sums not economics.

When we do economics, and take account of this effect, then we get to Patrick Minford's result. Assume that our exports face the usual WTO barriers. But that we offer unilateral free trade on imports to us. This exposes the British economy to that productivity enhancing competition from the best of the whole world's producers, not just those from the rather sclerotic economies of mainland Europe. The net result is a 3% addition to British GDP in this timescale, rather a far cry from the 4.5% contraction given here.

Which leaves us with a rather important point. The effect of Brexit upon trade and thus GDP is an economic question. We should therefore be doing economics in trying to answer it, not just sums.