WHO’S AFRAID OF ADAM SMITH? HOW THE MARKET GOT ITS SOUL PETER J. DOUGHERTY JOHN WILEY & SONS, INC. Copyright © 2002 by Peter J. Dougherty. All rights reserved. Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in anyformor by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, 978-750-8400, fax 978-750-4470, or on the web at www.copyright.com. 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HB501 D673 2002 330.15′3—dc21 2002072551 Printed in the United States of America. 10 9 8 7 6 5 4 3 2 1 For Peter Bernstein “However selfish soever man may be supposed, there are evidently some principles in his nature, which interest him in the fortune of others, and render their happiness necessary to him, though he derives nothing from it except the pleasure of seeing it.” Adam Smith, The Theory of Moral Sentiments We must encourage capitalism, it being the hope for the poor of the world and being in any case what we are, but our capitalism need not be hedonistic or monadic, and certainly not unethical. An aris- tocratic, country-club capitalism, well satisfied with itself, or a peasant, grasping capitalism, hating itself, are both lacking in the virtues. And neither works. They lead to monopoly and economic failure, alienation and revolution. We need a capitalism that nur- tures communities of good townsfolk, in South Central LA as much as in Iowa City. Deirdre N. McCloskey Socialism is not the only enemy of the market economy. Another enemy, all the more powerful for its recent global triumph, is the market economy itself. When everything that matters can be bought and sold, when commitments can be broken because they are no longer to our advantage, when shopping becomes salvation and advertising slogans become our litany, when our worth is measured by how much we earn and spend, then the market is de- stroying the very virtues on which in the long run it depends. Jonathan Sacks Preface: Sympathy for the Dismal Morals and metaphysics, politics and political economy, the way to make the most of all the modifications of smoke, gas, and paper currency; you have all these to learn from us; in short, all the arts and sciences. We are the modern Athenians. Thomas Love Peacock No real Englishman, in his secret soul, was ever sorry for the death of a political economist. Walter Bagehot I n January 1985, in my capacity as an editor of economics books, I at- tended the annual New Year’s meeting of the American Economic As- sociation (AEA), held that year in Dallas. The events coordinator of the Dallas Convention Center, the same venue that had hosted the Republican National Convention a year earlier, must have been the wickedest wit—or most witless wonder—in the West, for he or she had booked, into one side of the Center, 5,000 dismal scientists—economists—and into the other, the National Cheerleaders Association. ix x PREFACE In nearly 20 years of dragging my holiday-weary bones to the AEA meetings, I’ve never enjoyed any economists’ convocation quite so much as this one. Every so often, having tired of meeting, greeting, and talking textbooks with the predominantly middle-aged, overwhelmingly male, relentlessly gray-suited economists, I could stroll behind the movable wall that split the convention center beyond the dismal din, and there sample, if only momentarily, the neon universe of cheerleaders—all bouncing pom- poms and gleaming smiles, and not a gray suit anywhere. And yet, in the generation since I’ve been working with economists Y to publish their books, if there is a group in our society that deserves to flash a toothsome grin and maybe even wavLe a pom-pom or two, it is the dismal doctors of economics themselvFes. Whatever may befall us in the decades to come, the past severalM have been a time of triumph for economists, their students, their clients, and, most of all, their ideas. Even during recession, the woArld expects capitalism to bounce back more or less according to the economists’ playbook—which is dramati- E cally more than could have been asked for only a few generations ago, when competing economTic systems were still very much in view. Dar- win, for the time being, can take a back seat: We live foursquare in the age of Adam Smith, author of the two foundational works of modern economic society: The Wealth of Nations and The Theory of Moral Sentiments. Market Wrap The transition from central planning to markets, the restructuring of corporations, the liberalization of world trade, the surge in technological innovation, the spread of the international division of labor, the revolu- tion in finance, the privatization of many public services, the rise of strategic management, the changing economic status of women, and the coming of a multinational commercial culture—what economists term the second great globalization—have generally conformed to the canon of modern economics.1 Add this recent record to the remarkable rise in living standards achieved throughout commercial society since the Industrial Revolution, and the relative stability of the major western economies since World War Team-Fly® Preface xi II, and even the most stoic, cloistered, test-tube economist has reason to feel pride in the legacy of Adam Smith. To an impressive degree, the world now runs according to his rules, revised and updated for the chang- ing times. To paraphrase a prominent economist, economic reality has come to resemble the model.2 The economists’ recent run of success would seem to give more pow- erful credence than ever to the prophetic words of that most eloquent of self-described academic scribblers, John Maynard Keynes, who noted: “Practicalmen...are usually the slaves of some defunct economist.”3De- funct or otherwise, economists have had not only their day, but, of late, an entire era. There is little reason to expect their influence to wane, much less to end. If economic events take a turn for the worse, the demand for economists and their ideas will only increase, and their influence will only improve. Economists, while not being wholly dismal, do hold an option on gloom. An Undismal Dispatch This book is a personal report from an observer on the economists’ side of the convention floor, the gray-garbed assemblage that has produced some of the multichrome ideas that have influenced and will continue to influ- ence the lives of practical men and women—and even blessedly impracti- cal cheerleaders—everywhere. Economicideas in the tradition of Adam Smith are to democratic cap- italism what an operating system is to a computer. The possibilities for capitalism, as for computing, are prodigious, depending on what we make ofthem; but they are only as good as the instructions that drive the respec- tive systems. In the chapters that follow, I hope to persuade you that our society will continue to benefit from the instructive economic legacy of Adam Smith, but also—dare I say more so—from contemporary economists’ re- cently revived transfiguration of Smith’s lesser known, yet surpassingly powerful, civic, social, and cultural legacy, lodged in the phrase “moral sentiments.” This moral dimension of Adam Smith gives market society its soul, and this soul could very well reveal itself in unanticipated and ex- citing ways in the decades to come. How it came into being, faded from xii PREFACE center stage in the theater of ideas, and returned to meet the challenges of our day, is the subject of my story. Accounts Payable I admire the British bibliographic practice of restricting acknowledgments to a spartan few, and I will be happy to abide by that tradition if ever I write another book. However, in this case, I have too many debts to pay in full. Typically, a first-time author dedicates his or her book to a family member. It is only a small stretch to say that Peter L. Bernstein, to whom this book is dedicated, comes under this definition. I honor the day in the late 1980s when, in my capacity as a book editor at The Free Press, I called Peter, a celebrated Wall Street economist, to ask him about his book-writing plans. Since then, I have edited three of his marvelous, best- selling books. Several years ago, after I had given a talk at the University of Califor- nia, San Diego, on my approach to social science publishing, which I called “Recombinant Ideas and Enlightenment Ideals: Making Capitalism Work,” I sent a copy of the talk to Peter. Peter liked the talk and featured it in his newsletter, Economics and Portfolio Strategy. Moreover, he saw in it the possibility of a book—specifically, this book. Peter urged me to talk to his editor, Myles Thompson, then a publisher at John Wiley & Sons, about de- veloping the talk into a book proposal, which I did. After I began to write this book, Peter Bernstein pushed, prodded, poked, and pulled the chapters out of their primordial maw. He combined his knowledge of economic history and macroeconomics with his shrewd literary sensibility—and his seemingly bottomless red pen—and delivered advice with what I can describe only as a father’s sensitivity. He got me, a book editor, to learn the book-writing process as an author. Peter is my dear friend and I am eternally grateful to him. In the late ’Eighties, I was also introduced to another invaluable asso- ciate and friend who ultimately had a hugely formative influence on this book. While at The Free Press, I had the good luck to sign the distin- guished author and historian, Jerry Z. Muller. While working with him on his 1993 book, Adam Smith in His Time and Ours: Designing the Preface xiii Decent Society, Jerry opened my eyes and my imagination to the work of the great philosopher Adam Smith. My experience with Jerry made me appreciate Smith’s style of think- ing—namely, that Smith had puzzled out a progressive concept of society and retrofitted it with the incentive structures necessary to achieve a broadly humane vision. This intellectual style has conditioned my own thinking and informed my efforts to reckon the lofty ideas of social philosophers with the flintier prescriptions of economists in my publish- ing. Jerry did not read this book in its manuscript form, but I hope that when he reads it in published form, he will see his ideas as being effec- tively served. I am deeply indebted to him. Robert K. Merton, with whom I had the great privilege of working some 20 years ago (he was my adviser during my days as a yearling social science editor), also played a direct and an indirect role in the publication of this book, for which I am grateful. When I sent Bob a copy of the afore- mentioned San Diego talk, he was kind enough to forward it to Jonathan Imber, who, much to my gratitude, published it in the Fall 1997 issue of The American Sociologist. Indirectly, Bob Merton’s intellectual influence, resonant with the Smithian principle that form follows function in the way we attempt to shape our destiny, has governed my own way of thinking as wellas my publishing—and, certainly, this book. The example of this great man has never left me since the summer day in 1979 when I met him in the Oak Room of the Plaza Hotel. Several friends, authors, and associates read drafts of this manuscript, and I am most thankful to them for their criticisms and observations. Richard Swedberg, Shlomo Maital, James Meehan, Mike Elia, Romesh Vaitilingam, and, especially, Daniel Chirot (who read two drafts) sent me valuable comments on the chapters. I hope I have done them proud in ren- dering their wisdom in my revisions. Shlomo was generous in inviting me to deliver my first chapter as a talk at the June 2001 meetings of the Society for the Advancement of Behavioral Economics, which he organized, with Hugh Schwartz, at George Washington University in Washington, DC. My own loving family, Elizabeth Hock and Colman Dougherty, had their patience tested well beyond reasonable saintliness as they watched me litter my home office and our den with files, books, articles, diskettes, and bad nerves in the preparation of this volume. Liz did dou- ble duty by lavishing her considerable editorial skills on the final draft. xiv PREFACE Cole did yeoman’s work by constantly reassuring me that I hadn’t lost this chapter or that file in the remote recesses of my computers. My mother, VeraDougherty, is hardly an enthusiast of Enlightenment ideas, but having raised three sons in extraordinarily trying circumstances, she exhibited, and continues to exhibit, the kind of moral sentiments that even Adam Smith would have regarded as heroic. So, too, did my late father, Joseph A. Dougherty—soldier, barkeeper, and family man—whose memory daily in- spires my better sentiments. As they awaited the completion of this manuscript, Jeanne Glasser, Joan O’Neil, and Jeff Brown, of John Wiley & Sons, displayed a level of patience that only a fellow publisher could appreciate. I hope that the fin- ished product meets their expectations and those of my original editor and great friend, Myles Thompson. To Grady Klein, cunning designer, my thanks for a jacket that so beautifully captures the spirit of this work, and to the staff of Publications Development Company for their skillful and patient transformation of my manuscript into a book. Finally, I wish to thank my authors of the past 20 years, whose books have enriched my life so greatly. Most of my authors and advisers are economists, and much of this book represents my attempt to do justice to their ideas, individually and collectively. This book does not purport to be a work of economics, nor economic history, nor economic theory, nor, God knows, empirical economics. As noted above, it is a “personal report” from an observer who spends his days within the culture of economics and social science, and who hopes to convey to his readers the potent and re- markably salutary ways in which economics can transform the culture for the better. Any and all mistakes are mine alone. PETER J.DOUGHERTY Princeton, New Jersey July 2002