Adam Smith III: What Controls the Economy?

 

The Small Country simulation (above) looks very much like a Random Walk and cannot be identified without estimation (see the System Matrix below). The System Theoretic definition of a Small Country is one that has no State Variables. The difference between a Small Country and a Random Wak model is that the Small Cpuntry models is stable (see below).

Notes

Adam Smith Controller

Adam Smith Small Country System Matrix

Adam Smith II: The Small Country

Neoclassical Economic Growth models seem to be designed to explain growth in large, industrialized countries with large populations, urban labor forces, modern capital stocks and advanced technologies. But, large countries are not the only states in the World System and my question is whether Economic Growth theory adequately explains the development of these countries. The answer is: it doesn't!

We have to go back to the Classical economists to find models that are more appropriate.

Notes

• Small State a generic term for a small country, that has limited land, population, or resources. The term "small state" is similar to the term microstate or ministate, a sovereign state having a very small population or land area, usually both. However, the meanings of "state" and "very small" are not well-defined in international law. Two important definitions for a small state are World Bank, which defines small state as those with less than 1.5 million people, which is about 40-50 countries, and the U.N. Forum on Small States which has higher threshold and includes about 100 countries, most of which are under 5 million people.
• Khalid Saeed (2005)  Classical Economics on Limits to Growth Develops System Dynamics models for the Classical Economics: Adam Smith, David Ricardo, Thomas Robert Malthus, Karl Marx and Joseph Schumpeter searching for the Limits-to-Growth in each model. I have used the output of these models as the basis for my State Space (SS) Dynamic Component Models (DCM) of the Classical Economists. I have based all my models on the Kaya Identity.
• Benjamin Higgins (1968) Economic Development develops models of the Classical Economics on which Saeed based his models.
• Joseph Schumpeter (1942) Capitalism, Socialism and Democracy 
• Cole et. al., (1973) Models of Doom: A Critique of the Limits to Growth 

State-Space Theoretical Dynamic Component Models

• Smith Growth Model
• Smith Controller Model
• Smith Small Country Model
• Ricardo Cyclical Model
• Malthusian Model 
• The Leibenstein Malthusian Model
• Schumpeter Model Creative Destruction.
• Marx Steady State Model
• Marx Collapse Model 
• Marx Cyclical Model
• The Leibenstein Expanded Model
• The Leibenstein Controller
• Forrester's World1 Model (NeoMalthusian) The Original Limits-to-Growth Model.
• IPCC Scenario Models
• Kaya Growth State Space Model

 

Wikipedia Links

• Adam Smith  (1723 – 1790) was a Scottish economist and philosopher who was a pioneer in the field of political economy and key figure during the Scottish Enlightenment. Seen by many as the "father of economics", or the "father of capitalism", he is primarily known for two classic works: The Theory of Moral Sentiments (1759) and An Inquiry into the Nature and Causes of the Wealth of Nations (1776).
• The Invisible Hand a metaphor inspired by the Scottish economist and moral philosopher Adam Smith that describes the incentives which free markets sometimes create for self-interested people to accidentally act in the public interest, even when this is not something they intend. Smith originally mentioned the term in two specific, but different, economic examples. It is used once in his Theory of Moral Sentiments when discussing a hypothetical example of wealth being concentrated in the hands of one person, who wastes his wealth, but thereby employs others. More famously, it is also used once in his Wealth of Nations, when arguing that governments do not normally need to force international traders to invest in their own home country. In both cases, Adam Smith speaks of an invisible hand, never of the invisible hand.
• Classical Economics a school of thought in political economy that flourished primarily in Britain in the late 18th and early-to-mid 19th century. It includes both the Smithian and Ricardian schools. Its main thinkers are held to be Adam Smith, Jean-Baptiste Say, David Ricardo, Thomas Robert Malthus, and John Stuart Mill. These economists produced a theory of market economies as largely self-regulating systems, governed by natural laws of production and exchange (famously captured by Adam Smith's metaphor of the invisible hand).
• Market Economy an economic system in which decisions regarding investment, production, and commerce (the distribution of goods and services) are guided by price signals resulting from the forces of supply and demand. A key characteristic of a market economy is the presence of factor markets, which play a major role in allocating capital and other factors of production such as labor and land.
• Benjamin Higgins  a Canadian development economists especially, noted for his work in and on Indonesia during the 1950s. Perhaps his greatest practical achievement was his role in producing Indonesia's first Five-Year Plan (1956–60). ,And his most influential academic achievement was his textbook Economic Development, one of the earliest in the field.
• David Ricardo (18 April 1772 – 11 September 1823) was a British economist and politician. He is recognized as one of the most influential classical economists, alongside figures such as Thomas Malthus, Adam Smith and James Mill.
• Thomas Robert Malthus  (1766 – 1834) was an English economist, Christian priest, and scholar influential in the fields of political economy and demography.
• Karl Marx (1818 – 1883) was a German philosopher, social and political theorist, journalist, and revolutionary socialist. He developed the theory of historical materialism, analyzing societal structure and change, particularly class struggle under capitalism, and predicting the system's ultimate replacement by communism. Marx co-authored The Communist Manifesto (1848) with Friedrich Engels, and undertook a critique of classical political economy in his magnum opus, Das Kapital (1867–1894).
• Joseph Schumpeter (1883 – 1950) was an Austrian political economist. He served briefly as Finance Minister of Austria in 1919. In 1932, he emigrated to the United States to become a professor at Harvard University, where he remained until the end of his career, and in 1939 obtained American citizenship.
• Neoclassical Economics an approach to economics in which the production, consumption, and valuation (pricing) of goods and services are observed as driven by the supply and demand model. According to this line of thought, the value of a good or service is determined through a hypothetical maximization of utility by income-constrained individuals and of profits by firms facing production costs and employing available information and factors of production. This approach has often been justified by appealing to rational choice theory.
• World-Systems Theory  multidisciplinary approach to world history and social change which emphasizes the world-system (and not nation states) as the primary (but not exclusive) unit of social analysis. World-systems theorists argue that their theory explains the rise and fall of states, income inequality, social unrest, and imperialism.
• Limits-to-Growth a 1972 report that discussed the possibility of exponential economic and population growth with a finite supply of resources, studied by computer simulation. The study used the World3 computer model to simulate the consequence of interactions between the Earth and human systems.
• Unified Growth Theory forces operating in the distant past have shaped the growth process and determined the differential timing of transitions from stagnation to growth across the globe. For most of human history, technological progress expanded population size but had little effect on living standards. As technological progress gradually gathered momentum, through the mutually reinforcing interaction between population growth, adaptation, and innovation, the increasing importance of human capital in coping with a rapidly changing technological environment prompted parents to prioritize child quality over quantity, triggering the onset of the demographic transition. The decline in fertility freed the growth process from the counterbalancing effects of population growth and, along with advancements in knowledge and education, laid the foundation for sustained economic expansion and modern prosperity.
• The DICE Model  The Dynamic Integrated Climate-Economy model, referred to as the DICE model or Dice model, is a neoclassical integrated assessment model developed by 2018 Nobel Laureate William Nordhaus that integrates in the neoclassical economics, carbon cycle, climate science, and estimated impacts allowing the weighing of subjectively guessed costs and subjectively guessed benefits of taking steps to slow climate change. Nordhaus also developed the RICE model (Regional Integrated Climate-Economy model), a variant of the DICE model that was updated and developed alongside the DICE model. Researchers who collaborated with Nordhaus to develop the model include David Popp, Zili Yang, and Joseph Boyer. The DICE model is one of the three main integrated assessment models used by the United States Environmental Protection Agency, and it provides estimates intermediate between the other two models.

Adam Smith Random Walk

Adam Smith Small Country Model

Adam Smith Controller

Why Bother Developing Simple Causal Models of Economic Systems?

This Page is UNDER CONSTRUCTION.

 

Why Bother Reading the Classics?

  

The Classical Economists, Adam Smith (1723-1790), Thomas Robert Malthus (1766-1834), David Ricardo (1772-1823) and Karl Marx (1818-1883), collectively wrote in the 18th and 19th Centuries. All their works are currently in the public domain and available on line (see below). Neoclassical Economics supposedly made their works obsolete and you hear little about the Classics if you take a course in ECON 101. Still, there is a sinking feeling in the Economics profession that We Need Better Economic Models. What might the Classics have to offer? Briefly:

• The Steady State Economy Modern economics assumes that growth can continue forever without limit. The Classics, on the other hand assumed that eventually growth would reach a steady state. For Marx, this was the Communist Society, which he described only general terms. There is evidence that current economies (here) are reaching a steady state and that it will not be a utopia.
• Economic Depressions and Business Cycles In Modern economics, cycles and long-waves are not supposed to happen. The market is supposed to adjust any imbalances in supply and demand and regulate the economy. The Classics assumed that booms, busts, panics, bubbles and manias could all happen and required explanation. For example, Malthus and Ricardo were concerned about effective demand, prefigured Keynes and did not assume markets handled all economic problems automatically.
• Historical Determinism Modern economics has no role for History. Models are timeless and general, much as universal physical forces. The Classics, particularly Malthus and Marx, understood that different models were required for different periods. Premodern societies are best described by the  Malthusian Stagnation Model rather than the Neoclassical Growth Model. Marx thought that the Asiatic Model of Production was different from the Capitalist Model.
• Alternative Economic Models can be developed based on the Classics (see below). The models can and should be tested. Right now, the Neoclassical Economic Model is dominant and it is incomplete.
  
  

Modern Economics based on overdetermined, stable equation systems doesn't have a role for cycles, depressions, pre-modern models of production and History. Systems Theory, on the other hand, can easily handle cycles, instability, growth and steady states.  Not that every problem is solved by recovering the past. Both the Classics and the Moderns jumped too quickly from their (mental) models to policy recommendations.  Real SocioEconomic systems are far too complicated to be controlled by simple feed forward systems. The best we can do is analyze natural experiments as they are conducted in History and see if our systems models can capture what happened. 

The bigger problem here is that Economics has been co-opted by Neoliberalism and Market Fundamentalism. What you get in ECON 101 is an attempt to describe the Economic System and an attempt to proscribe policy measures to tell politicians how to run the Economy. These attempts are largely a failure and have little historical justification or empirical support--at least the little that is offered in ECON 101. And, this is what the average student gets, if anything, as an introduction to Economics.

The Classical writers had very few mathematical, statistical or historical tools at their command for understanding the Economic System. They struggled with definitional issues and wrote in a verbose style we no longer find very straightforward. If we trained students to be Classical economists, we would just end up generating an avalanche of speculative, qualitative writing that never gets tested. In other words, we wouldn't get Science.

My recommendation is that we use the new tools available to us, primarily Systems Theory, to move on from both the Classical Economists and current Neoclassical Economics. Critics will argue that this has already been tried an failed, in Sociology by Talcott Parsons (1902-1979) and in Economics by Kenneth Boulding (1910-1993). The critics are wrong but having an argument won't solve anything.

Let me just make these assertions: Economics went wrong by insisting that everything has to be derived from individual, rational behavior, i.e., Homo Economicus. Systems theory argues that the the Economy is not just an aggregation of individual, rational behaviors. The system has both aggregate growth and aggregate feedback processes. We understand the variables involved in Growth (the Neoclassical Growth Model) but we have little understanding of the macro-feedback process and how the Economic System is controlled beyond the Aggregate Demand and Supply model (AD-AS model) which is incomplete. Just consider the simple Impact Model with markets for aggregate production (Q), energy (PE), and CO2 (PC, price of carbon--a market which is very incomplete).

What controls Global Temperature (T)? What controls Population Growth (N)? There are other Human Feedback Loops in the complete TechnoSocial system that we barely understand. The Subprime Mortgage Crisis (2007-2010), the COVID-19 Pandemic (2019-2023) and the resulting economic shocks and fumbled government response made clear that markets didn't help control inflation and we really didn't understand the effect of many supply chain delays and disruptions caused by exogenous shocks. And, the expanded Impact Model above is not a system because there are no feedback loops (just self-loops).

In summary, we should continue to be interested in the Classics because they asked the right questions. We have to get beyond the Classics because the tools available to them (arm-chair speculation) did not produce the best answers. Western Civilization has not collapsed (yet). All the -isms (Liberalism, Communism, Fascism, Socialism, etc.) are flawed. And, we have new questions based on Systems Theory: Is the Economy Stable? Is the Economic System Under Control? What feedback loops are activated by crises? So many questions.

Classic References

These works are available on line:

• Adam Smith Wealth of Nations
• Malthus An Essay on the Principal of Population
• Malthus Principles of Political Economy
• Ricardo Collected Works
• Marx Collected Works
• JS Mill Collected Works
• JM Keynes The Collected Writings

Excellent Secondary Works

These secondary sources are worth tracking down and reading:

• Hicks Keynes and the Classics
• Higgins Economic Development
• Saeed Limits to Growth Concepts in Classical Economics
• Baumol Economic Dynamics
• Boulding The Malthusian Model as a General System
• Galor From Malthusian Stagnation to Demographic Transition
• Ripple Many Risky Feedback Loops Amplify the Need for Climate Action
• Dong Human-Nature Feedback Loops
• Kalman A System-theoretic Critique of Dynamic Economic Models
• Baumol Economic Dynamics 

Causal Economic History

Adam Smith I: A Random Walk of the Invisible Hand

 

This Page is UNDER CONSTRUCTION but you can watch the video above and follow the links below until it is completed.

As the graphic below shows, Adam Smith (1723 – 1790) is considered the Father of Classical Economics.

He influenced David Ricardo, Karl Marx, Thomas Robert Malthus, Neoclassical Economics and everything after (Joseph Schumpeter, World-Systems Theory, Limits-to-Growth, Unified Growth Theory, and The DICE Model Dynamic Integrated Climate-Economy model).

The problem with this 250+ year History of Economic Thought is that, while the Sources of Economic Growth have been fully studies and understood, control of the Economic System, Feedback Loops and the Limits-to-Growth have not. Khalid Saeed (2005) went back and analyzed the Classical Economics looking for what writers thought placed Limits on Economic Growth. He found that this strain of Economic Theory had largely been forgotten in the rush to develop a Strategy of Economic Development.

Saeed (2005) developed System Dynamics models for Smith, Malthus, RIcardo, Marx and Schumpeter concentrating on how each thinker saw the Limits-to-Growth. In this post, I will start with the Smith Model, but rather than just replicate Saeed (2005), I will estimate State-Space (SS) and Dynamic Components Models (DCM) from the output of Saeed's (2005) models. The purpose of the exercise is to (1) allow the models to be estimated (see Cole et. al., 1973 for a filed attempt to estimate System Dynamics models) on historical data from any country and any time period and (2) allow us to identify the Control Components for each model.

Saeed (2005) develops two Smith Models, the first with a "Labor "Constraint" and the second without.

Labor Constraint

From a causal diagram of the Smith Model, based on the Kaya Identity (see below):

Since Labor (L) is the only exogenous variable (Technology, T, and  Capital Stock, K, are endogenous and based on Investment), it provides the only constraint on the system.

Without Labor Input, the system goes quickly to equilibrium (Saeed's data above). When estimated the year-to-year model is a Random Walk (RW, see below) and the Attractor Path Model (a free simulation starting at time one) has no state variables and would be recognized as a Small Country Model (see below).

You can inspect actual examples of countries, during particular time periods, that are Random Walks here.

Notes

• Khalid Saeed (2005)  Classical Economics on Limits to Growth Develops System Dynamics models for the Classical Economics: Adam Smith, David Ricardo, Thomas Robert Malthus, Karl Marx and Joseph Schumpeter searching for the Limits-to-Growth in each model. I have used the output of these models as the basis for my State Space (SS) Dynamic Component Models (DCM) of the Classical Economists. I have based all my models on the Kaya Identity.
• Benjamin Higgins (1968) Economic Development develops models of the Classical Economics on which Saeed based his models.
• Joseph Schumpeter (1942) Capitalism, Socialism and Democracy 
• Cole et. al., (1973) Models of Doom: A Critique of the Limits to Growth 

Kaya Identity

The Kaya Identity is a mathematical identity that disaggregates the total emission level of the greenhouse gas carbon dioxide so that it can be expressed as the product of four calculable factors: human population, GDP per capita, energy intensity (per unit of GDP), and carbon intensity (emissions per unit of energy consumed). It is a concrete form of the more general I = PAT equation relating factors that determine the level of human impact on climate. Although the terms in the Kaya identity would in theory cancel out, it is useful in practice to calculate emissions in terms of more readily available data, namely population, GDP per capita, energy per unit GDP, and emissions per unit energy. It furthermore highlights the elements of the global economy on which one could act to reduce emissions, notably the energy intensity per unit GDP and the emissions per unit energy.

As a causal diagram (above) I use it as the basis for all the theory development. The Kaya Identity is true by definition.

State-Space Theoretical Dynamic Component Models

• Smith Growth Model
• Smith Controller Model
• Smith Small Country Model
• Ricardo Cyclical Model
• Malthusian Model 
• The Leibenstein Malthusian Model
• Schumpeter Model Creative Destruction.
• Marx Steady State Model
• Marx Collapse Model 
• Marx Cyclical Model
• The Leibenstein Expanded Model
• The Leibenstein Controller
• Forrester's World1 Model (NeoMalthusian) The Original Limits-to-Growth Model.
• IPCC Scenario Models
• Kaya Growth State Space Model

Wikipedia Links

• Adam Smith  (1723 – 1790) was a Scottish economist and philosopher who was a pioneer in the field of political economy and key figure during the Scottish Enlightenment. Seen by many as the "father of economics", or the "father of capitalism", he is primarily known for two classic works: The Theory of Moral Sentiments (1759) and An Inquiry into the Nature and Causes of the Wealth of Nations (1776).
• The Invisible Hand a metaphor inspired by the Scottish economist and moral philosopher Adam Smith that describes the incentives which free markets sometimes create for self-interested people to accidentally act in the public interest, even when this is not something they intend. Smith originally mentioned the term in two specific, but different, economic examples. It is used once in his Theory of Moral Sentiments when discussing a hypothetical example of wealth being concentrated in the hands of one person, who wastes his wealth, but thereby employs others. More famously, it is also used once in his Wealth of Nations, when arguing that governments do not normally need to force international traders to invest in their own home country. In both cases, Adam Smith speaks of an invisible hand, never of the invisible hand.
• Classical Economics a school of thought in political economy that flourished primarily in Britain in the late 18th and early-to-mid 19th century. It includes both the Smithian and Ricardian schools. Its main thinkers are held to be Adam Smith, Jean-Baptiste Say, David Ricardo, Thomas Robert Malthus, and John Stuart Mill. These economists produced a theory of market economies as largely self-regulating systems, governed by natural laws of production and exchange (famously captured by Adam Smith's metaphor of the invisible hand).
• Market Economy an economic system in which decisions regarding investment, production, and commerce (the distribution of goods and services) are guided by price signals resulting from the forces of supply and demand. A key characteristic of a market economy is the presence of factor markets, which play a major role in allocating capital and other factors of production such as labor and land.
• Benjamin Higgins  a Canadian development economists especially, noted for his work in and on Indonesia during the 1950s. Perhaps his greatest practical achievement was his role in producing Indonesia's first Five-Year Plan (1956–60). ,And his most influential academic achievement was his textbook Economic Development, one of the earliest in the field.
• David Ricardo (18 April 1772 – 11 September 1823) was a British economist and politician. He is recognized as one of the most influential classical economists, alongside figures such as Thomas Malthus, Adam Smith and James Mill.
• Thomas Robert Malthus  (1766 – 1834) was an English economist, Christian priest, and scholar influential in the fields of political economy and demography.
• Karl Marx (1818 – 1883) was a German philosopher, social and political theorist, journalist, and revolutionary socialist. He developed the theory of historical materialism, analyzing societal structure and change, particularly class struggle under capitalism, and predicting the system's ultimate replacement by communism. Marx co-authored The Communist Manifesto (1848) with Friedrich Engels, and undertook a critique of classical political economy in his magnum opus, Das Kapital (1867–1894).
• Joseph Schumpeter (1883 – 1950) was an Austrian political economist. He served briefly as Finance Minister of Austria in 1919. In 1932, he emigrated to the United States to become a professor at Harvard University, where he remained until the end of his career, and in 1939 obtained American citizenship.
• Neoclassical Economics an approach to economics in which the production, consumption, and valuation (pricing) of goods and services are observed as driven by the supply and demand model. According to this line of thought, the value of a good or service is determined through a hypothetical maximization of utility by income-constrained individuals and of profits by firms facing production costs and employing available information and factors of production. This approach has often been justified by appealing to rational choice theory.
• World-Systems Theory  multidisciplinary approach to world history and social change which emphasizes the world-system (and not nation states) as the primary (but not exclusive) unit of social analysis. World-systems theorists argue that their theory explains the rise and fall of states, income inequality, social unrest, and imperialism.
• Limits-to-Growth a 1972 report that discussed the possibility of exponential economic and population growth with a finite supply of resources, studied by computer simulation. The study used the World3 computer model to simulate the consequence of interactions between the Earth and human systems.
• Unified Growth Theory forces operating in the distant past have shaped the growth process and determined the differential timing of transitions from stagnation to growth across the globe. For most of human history, technological progress expanded population size but had little effect on living standards. As technological progress gradually gathered momentum, through the mutually reinforcing interaction between population growth, adaptation, and innovation, the increasing importance of human capital in coping with a rapidly changing technological environment prompted parents to prioritize child quality over quantity, triggering the onset of the demographic transition. The decline in fertility freed the growth process from the counterbalancing effects of population growth and, along with advancements in knowledge and education, laid the foundation for sustained economic expansion and modern prosperity.
• The DICE Model  The Dynamic Integrated Climate-Economy model, referred to as the DICE model or Dice model, is a neoclassical integrated assessment model developed by 2018 Nobel Laureate William Nordhaus that integrates in the neoclassical economics, carbon cycle, climate science, and estimated impacts allowing the weighing of subjectively guessed costs and subjectively guessed benefits of taking steps to slow climate change. Nordhaus also developed the RICE model (Regional Integrated Climate-Economy model), a variant of the DICE model that was updated and developed alongside the DICE model. Researchers who collaborated with Nordhaus to develop the model include David Popp, Zili Yang, and Joseph Boyer. The DICE model is one of the three main integrated assessment models used by the United States Environmental Protection Agency, and it provides estimates intermediate between the other two models.

Adam Smith Random Walk