Adam Smith Opposes “Shock Therapy” for Developing and Transitioning Economies

Michael Giberson

“Get the prices right!” was the rallying cry of some economists in the aftermath of the break up of the Soviet Union. Don’t plan the transition, stop planning and let markets sort it out. Similar advice goes out to developing economies around the world. Don’t ease your way to liberalization, throw open the gates!

In a paper just published in The European Journal of the History of Economic Thought, Maria Pia Paganelli considers what advice Adam Smith might offer: “Economies in Transition and in Development: a Possible Warning from Adam Smith.” (Alternate link). Here is a hint, Smith wouldn’t focus on “getting the prices right.”

Paganelli writes (and I’m skipping a lot of good stuff to get directly to the Smithian advice, so do read the whole thing):

Smith offers one explicit policy prescription: avoid rent-seeking, if you can.

The legislature, were it possible that its deliberations could be always directed, not by the clamourous importunity of partial interests, but by an extensive view of the general good, ought upon this very account, perhaps, to be particularly careful neither to establish any new monopolies of this kind, nor to extend further those which are already established. Every such regulation introduces some degree of real disorder into the constitution of the state, which it will be difficult afterwards to cure without occasioning another disorder. (WN IV.ii.44: 471–2)

Smith’s advice sounds like some contemporary advice. Acemoglu (2008) claims, in fact, that:

Every policy intervention creates winners and losers. The winners not only gain economically, but also become politically powerful. These politically powerful groups can then become a barrier against further progress. This is well illustrated by the experience of import substitution, which supported nascent industrial groups in many developing economies. In most cases, the subsidized conglomerates were highly inefficient and became a formidable obstacle to further reform.

His advice: ‘Refrain from policies that will create new and potentially dangerous political constituencies’ (p. 5).

But how can it be possible to refrain? How can it be possible for the legislature to not be directed by ‘the clamourous importunity of partial interests’? Smith appeals to the legislator, claiming that he should not fall for the flattery of the self-interested merchants but should preserve the natural system of liberty out of reverence toward its beauty. But our civic spirit is generally weak (TMS IV.1.11). So how can it be strengthened? Additionally, if a ‘regular administration of justice’ is needed for commerce to flourish, how do we get this ‘justice of government’, which is so deeply missing in most transitioning and developing countries?

One can infer at least two suggestions from Smith’s work. One is to avoid situations that may generate rent-seeking opportunities, as we just saw. The other is to develop a strong sense of moral respect for rules, for institutions and for the public good. Both of these prescriptions collapse into only one: the gradual introduction of commerce. A gradual opening of the large wealth offered by international trade restrains rent-seeking opportunities and is likely to develop sound institutions and a strong moral sense that leads to respect for them. Smith indeed tells us that a just set of institutions and a public spirit do not come from any human wisdom, plan or design. They are not something that can be imposed from above or from the outside. They are something that comes, gradually, with commerce. Only commerce, when very gradually introduced, can ignite what no army or wisdom is able to start (WN III.iv.10: 418, WN V.i.g. 24–25: 803).

Smith claims indeed that it is from the gradual introduction of commerce that we generate both a strong set of institutions and the conditions that develop a strong moral sense, which would be fertile ground for prosperity.