1.1.1 Economic perspective

Wealth of Nations is a very thick book, almost 800 pages. If the large excursions to history were eliminated, the book could be reduced to 200 pages. Economists are bad historians, as we will see later on when discussing Friedrich Hayek, Milton Friedman and Walter Eucken. This is because economists try to prove the existence of general rules through history. That's the opposite of what historians do. Historians attempt to understand a historic situation as a singular constellation of casual facts. The most prominent example of 'unhistoric' thinking is Marxism, but we find similar approaches everywhere.

(For the same reason, the assumption that we can learn something from history is as wrong as the idea that we need to know something about history in order to know where we came from or things like that. Human beings are determined by the future, not by the past. They are determined by what they want to be, not by what they have been in the past. In ordinary life, the future is more important than the past. In any case: If the past is more important than the future and the past determines the future, something is going wrong. We will return to the topic when talking about Ernst Bloch.)

Equally superfluous are his evaluation of the "lower" classes and their assumed vices. We know little about the "lower" classes in the 18th century, but if we analyse the popular music of this time, infos24 GmbH, the company behind that website did that some years ago, see www.classic-rocks.com, we realised quickly that these lower classes were much smarter that Adam Smith believed them to be.

If Wealth of Nations were reduced to 200 pages, it would be an excellent introduction to market economy. In contemporary textbooks, Wealth of Nations is reduced to one concept, the invisible hand. In this case, it has been reduced too much.

The teaching of economics can be reduced to three words: 'Wealth of Nations' of Adam Smith, 'Principles of Economics' of Alfred Marshall and the General Theory of Employment, Interest and Money of Keynes. 'Wealth of Nations' can be substituted by the Traité d'économie politique of Jean-Baptiste Say. With these three words, we get a full picture of the strength and problems of market economies. This can be taught in 1.5 years in an easy and straightforward way. The rest of the time should be spent in specialisation, see preliminaries.

The first thing that captures the attention of Wealth of Nations is the full title is 'An Inquiry into the Nature and Causes of the Wealth of Nations', is the title. One can wonder what this means.

Did he want to explain only the general mechanisms which promotes the economic development?
Did he want to suggest that the economy will end up in a stationary state where no more economic growth is possible as described by David Ricardo or the Club of Rome?
What does he mean by nature and causes?

Although not in a precise way, Adam Smith describes the mechanism which promotes the economic development. The division of labour is without any doubt a favourable element to the promotion of economic growth, although the way how Adam Smith describes it is not very precise. More important than division is specialisation.

The optimal allocation of resources is explained very well through its concept of natural price and market price. (Actually, it’s much better than through the very famous 'invisible hand'.)

Other mechanisms he describes as necessary for economic growth is simply wrong. His concept of saving as a condition of investment is wrong and a fatal error in economic thinking. The strange thing concerning this issue is that the concept seems plausible to everyone, although everybody acts in daily life in a way that contradicts this assumption. We all know that we can buy a car after having saved enough money to buy it, but that we can as well take a loan and buy it and 'save' afterwards when paying the loan back.

There is no need at all that the money has been saved before by the buyer of the car nor that other person has saved the money before. The bank system can generate the money or printed by the central bank. The only important thing is that we pay back the loan and that someone can produce the car. If there is a productive POTENTIAL, it can be activated with money. If there is no productive POTENTIAL, there is nothing to activate, not even with savings defined as non-consumed income of the past. We will return to the topic in the chapter about Keynes.

There is a big difference between Jean-Baptiste Say and Adam Smith. Jean-Baptiste Say pays a lot of attention to research and development and has, in general, a less "mechanical" perspective. Jean Baptiste Say pays more attention to dynamic aspects of the economy, to qualitative changes more than to quantitative one. We see that as well by the fact that Jean-Baptiste Say takes into account the role of the entrepreneur, something completely inexistent in Wealth of Nations. This difference can be explained by the fact that Jean-Baptiste Say has more professional experience while Adam Smith passed his life in the parallel academic world.

The most important element for economic growth is missing in Wealth of Nations and only considered by Alfred Marshall, see education.

These three mistakes, misleading ideas about capital and confusion between capital, non-consumed income of the past and money, claim at a part of the productive potential, the absence of entrepreneurs and non-consideration of the impact of education we can find until today in any textbook about economics. There was little improvement since the days of Adam Smith.

[Keynes didn't pay attention to entrepreneurs and education either, but this case is different. Keynes excluded explicitly for the scope of his analysis any kind of change in the production structure. The question Keynes tried to answer is what can be done if we have no influence on the underlying economic structures, what we actually don't have. It is crystal clear that all the problems of the Greeks would be resolved if they could produce a smartphone with a mini beamer able to show the content of the display on just any surface being "touchable" with the help of a camera following the movements of the fingers. Samsung, HTC, Apple and Google smartphones would disappear from the earth in one month and the Greeks were rich and happy. Unfortunately, qualitative changes can only be indirectly influenced by governmental activities, by investing more in research and development, but not directly with concrete, predictable results.]

The reason for that can be explained, see mathematical modelling. If economists would accept the impact of spontaneous processes like innovation or unpredictable effects like the ones produced by education, they were obliged to accept that the future is unpredictable and all their universal laws are just intuitively obtained trivialities given a scientific outlook through mathematical formalisation.

It is nice to know that the equilibrium price of rice can be at the level of starvation and as well so low, that people don't care about the price. We are very happy that in both cases, the sum of the consumer rent and the producer rent is maximised, see elasticity. However, people actually concerned about the price of rice are better off if they find a way to desalinate water through solar energy and increase the production of rice or corn.

It is completely unclear how a concept from complex theories found their way into textbooks and was canonised, and it is as well unclear, which authors have been canonised. Actually, Jean-Baptiste Say describes the dynamic of market economies much better than Adam Smith.

Adam Smith shows through many examples, see governmental activities, that for the sake of efficiency, the government should stay out of the economy. Customers duties, for instance, have the effect that something is produced inside the country that can be bought at a lower price from a foreign country. That helps perhaps the national industry, but the consumers pay the price. If the foreign countries react by imposing customers duties as well, division of labour and specialisation is no longer possible, because that is only possible, if the markets are big enough.

Wealth of Nations is full of contradictions. The concept of natural price/market price describes very well the function of prices in market economies. If for any reason the price people are willing to pay for an item raises, the resources will be reallocated until the marginal benefit is once again the same in all branches, in other words, will fall back to the natural price.

This is correct but is not compatible with the concept of labour and capital as homogeneous productive factors. If labour and capital were completely homogeneous, no adaptation in the quality of labour and capital is needed. The same kind of labour and capital could produce just everything. If this were the case, the market price would never differ from the natural price.

If demand shifts from furniture to clothes, the same labour and capital used before to produce clothes, would now with no delay be used to produce clothes. The same machines used before to produce clothes would be used immediately to produce clothes. The market price can never differ from the natural price under these circumstances.

Price would still signal scarcity, one of his functions, but wouldn't be an incentive anymore, because no incentive to adapt to new circumstances is needed. Higher prices for an item means that resources get, at least for a while, better paid if they produce this item. That has the effect that people undergo some training to get the skills required for producing this item. This is no longer needed, if there are no special skills required.

The same thing is valid for capital (machine, buildings, tools, raw material). It is true that there would be no destruction of capital if there is no demand anymore for some items because the same capital can be used to produce just anything. (Something that agrees perfectly with the Ricardian and Marxist idea of eternal accumulation excluding capital destruction.) However, unfortunately, that has nothing to do with the world we are living in.

We find in the work of Adam Smith a tendency we can find as well in any modern textbook about economics. In theory, economics is about markets, but the terms used denies the necessity of markets.

The most illustrative example of that is the assumption of complete transparency and the perfect market we find in any textbook about microeconomics. Complete transparency and perfect market means that all the market player have the same information, the products are homogeneous, there are no personal preferences etc. This means as well that there is no difference in the production structure of the suppliers because all the companies are perfectly informed about how to produce an item best and they will adapt themselves without delay to any change on the supply or demand side. In this case, there is no decentral information processing, the basic strength of a market economy, needed because there is no need for information.

If we don't need information processing, we don't need human beings and as a logical consequence, we don't have human beings, neither entrepreneurs nor workers, who process information. Instead of entrepreneurs and workers, we have, in the Marxist theory as well as in the work of Léon Walras, capital and labour. They allocate themselves alone in the most optimal way. Given the perfect information, they do that without any risk. Capital is never destroyed. That's a nice world, but unfortunately not our world.

Our world is about insecurity and imperfect information. That is a message of crucial importance on which the Keynesian theory is based on. Keynesian theory is about insecurity. By supposing perfect transparency and perfect information we don't resolve the problem of insecurity, we just ignore it.

We have the same problem with the ceteris paribus clause. Ceteris paribus means that only the causal relationship between a few parameters is analysed under the assumption that the others doesn't change. Almost every textbook starts by explaining that this assumption is necessary to study some aspects in detail, otherwise, it would be too complicated to study them. Actually, the efficiency of this approach is never illustrated by concrete examples, but from a theoretical point of view, it is dubious that this could work.

If we exclude a parameter in order to study the remaining ones more in detail, we must be sure that the parameter excluded doesn't have a decisive impact on the remaining ones. Ex-post it is for instance always true, that the amount of savings equals investments. The money that has not been spent in consumption has been invested. However, if investment depends on know-how and innovation, this is a mere tautology. Without profitable possibilities to invest, both saving and investment would have been inferior, although equal in the amount.

It may be possible to prove with a ceteris paribus clause which assumes that know how and innovation don't change that savings always equals investment, but nevertheless the model is useless.

To illustrate it with another example. We can analyse the impact of the amount of water on the growth of plants assuming that the sun doesn't shine. We will get to the conclusion that the amount of water doesn't have any impact on the growth of plants and that in any case the plants will die. What is the message of this model?

In other words, to define a useful ceteris paribus clause, we need to have already an idea or assumption about the casual relationships and this is only plausible, if these causal relationships are trivial, as it is the case in all the models we find in textbooks about economics.

In order to make a usefull use of the ceteris paribus clause, the causal relationship of the remaining parameters must be clear. If the casual relationship is clear, we don't need the ceteris paribus clause. With the ceteris paribus clause we have the same problem that we have with any kind of modeling, see mathematical modeling.

If we put all that together, the assumed homogenity of labour and capital, the inexistence of entrenpreneurs and workers, the assumed transparency and perfect information, the reduction of complexity through the ceteris paribus clause we see that in theory economics is about markets, but in economic teaching everything that caracterises markets is eliminated. The author assumes that there are a lot of graduates in economics who knows a lot about consumer surplus, producer surplus, elasticities of all kinds, the optimum of Cournot, equilibrium prices in different defintions, the optimum of Pareto, marginal revenues and marginal utilitiy etc. without having a concrete idea about the function of prices.

We are not going to discuss right now the more fundamental problems of a market economy. We will do that in the chapter about Keynes.

If we only are concerned about efficiency and if we abstract from the points addressed by Keynes, the market economy is the most efficient economic system. (Although high unemployment is the maximum of inefficiency, because in this case part of the resources are not used at all. That is worse than a suboptimal allocation of resources. However, as already said, we abstract from this point right now.)

The decentral information processing characterises market economies through prices. That is faster and more efficient than central planning. If prices are fixed by the government, as it happened in all planned economies, there are two problems. Prices doesn't reflect scarcity and there is no incentive to reallocate the resources or to undergo training in order to adapt oneself to new circumstances. In other words, the optimal allocation is unknown due to a lack of information and besides that, there is no incentive to eliminate or reduce scarcity.

In this simplified view, there is little that can be done by governments. Market processes lead to the optimal allocation of resources, and governmental intervention can only distort the allocation, see governmental activities and governemental expenditures.

The problem is that public discussion is less about efficiency than about distribution. The welfare economy made many efforts, based on the writings of Pareto, to avoid the term "theory", that it is impossible to define or determine scientifically a fair distribution of the social product. That might be true but is irrelevant.

Only the distribution of the social product accepted by the voters in a democratic decision process are relevant. Any other distribution has no chance to be realised and any discussion about this kind of distribution is, therefore, irrelevant. No need to discuss about something that never is going to happen and never happened.

If a king, in the time of Adam Smith George III, is more interested in efficiency is doubtful. A king is most of all interested in getting rich himself.

The programme of Adam Smith, complete retreat of the government from any economic activity except the few cases mentioned in governmental activities has, therefore, no chance to be realised and was actually never on the political agenda.

He has, therefore, the same problem than any textbook about microeconomics. Microeconomics is about optimization, efficiency and optimal allocation of resources. Textbooks on Microeconomics tell us in hundreds of different ways why different types of equilibriums, see Alfred Marshall, Vilfredo Pareto and Léon Walras are efficient and why the resources are optimally allocated.

That's interesting to know and to discuss these topics half an hour is useful. In this different kind of optima, the distribution of the social product doesn't play any role. To discuss them half a year is a little bit too much because, from a practical point of view efficiency, it is only one aspect of the picture.

In both cases, in modern textbooks and in Wealth of Nations there is transmission mechanism missing, see politics and economics. We don't know who Adam Smith and modern textbooks about microeconomics address. It is to suppose that the aim of both is to advise politicians, in the case of nowadays economists through governmental subsidised "scientific" institutions, so that these politicians once enlightened by the advice of economists do the right thing. That's not going to work.

The message of Wealth of Nations is that the best thing governments can do is to stay out of the economy. This way, the economy will work the most efficient way plausible and politicians will lose their jobs. Besides the politics, the electorate won't find this programme charming either.

The way Adam Smith presents its theory, efficiency means the maximum of poverty for the greatest amount of people. He doesn't state that in such a crude way as David Ricardo, but there is little difference.

This result nevertheless is not a necessary consequence of the market economy, where everyone pursues only its own happiness. This is a result of the role played by capital in the work of Adam Smith and the supposed surplus of labour demand, people who want to work, over the supply of work, jobs offered. In this constellation capital is scarce and labour abundant and the 'capitalist' can exploit the worker by taking away the surplus value accumulating this way his capital stock.

The reality is somehow different. Capital, actually money, it not scarce at all, can be printed with any amount, but qualified labour, able to introduce innovations and start a company is scarce.

It is very easy to imagine a situation where the "capitalist" the one which only has capital is very poor and the labour, the one who possess the knowledge, is rich.

The 'capitalist' is only rich if the central banks keep the interest rates high. Then he can earn good money with money. However, central banks can as well keep the interest rate at a level near to zero as they do right now, we have reached the year 2015 at the moment of writing, and then he doesn't earn any money with money.

In public debate free market economies are perceived as systems with great inequalities and sometimes as bellum omnium contra omnes (a war in which everybody is fighting against everybody), see homo oeconomicus. That might be true because some people are better qualified than others. It is therefore in the interest of the consumer to increase the qualification of the people in order to strengthen competition and decrease the prices. Qualification is just a means of production like gas, water, tools or raw materials.

Still more misleading is the idea that a free market economy has to do something with 'capitalism'. Most people talk about 'capitalism', even if they mean actually free market. Milton Friedman is a prominent example of that phenomenon. His book is called Capitalism and Freedom. We admit that Capitalism and Freedom sounds much better than "Decentral information processing through prices in market economies', but is not helpful when it comes to understanding market economies.

There is no need for 'capital' in the sense of non-consumed income of the past. In theory, the central banks can print and borrow it to everybody who has a profitable project that allows him to pay the loan back. This way the money would be produced and afterwards destroyed. That would have the effect that the market processes would be accelerated and existing capital would be faster destroyed when it becomes obsolete and substituted by more efficient capital that better satisfy the needs and preferences of the customers. We will return to the topic when discussing about Joseph Schumpeter.

The idea that capital, thought as a homogenous productive factor together with the equally homogeneous labour is a productive factor, as stated by Adam Smith, is incompatible with a market economy. If capital is the driving force of history, economic development doesn't depend on human decisions or at least they are not the decisive factors.

[We don't discuss here whether it is true that fortune and income are more and more unequally distributed. This is the thesis of Thomas Piketty. We only say that this development is not a logic and inexorable consequence of the accumulation of capital.]

We don't need to read David Ricardo and Karl Marx, where capital and capitalists are the same things, to understand that. These authors only brought the concept to its utmost consequences. We see that already in the work of Adam Smith.

It seems that the big defender of market economies, Milton Friedman, didn't understand really what market economy is about.

Besides the fact that the concept of capital we find in Wealth of Nations is incompatible with a market economy, this kind of 'capitalism' would lead inexorably to a more and more unequal distribution of income and fortune and would end up in a destabilisation of the political system. It is not very plausible that the 'proletarians' would accept to live eternally in misery. They would hang David Ricardo and his fellow capitalists on the trees.

It can be discussed about the idea of Friedrich Hayek and Milton Friedman that everything should be decided by the market and what can not be decided by the market, doesn't need to be decided. In this case, there is no need for a democratic decision-making process because there is nothing left to be decided. The thesis is not plausible, but we can discuss about it.

However, if we mix this idea with the idea that capital is the driving force of history, then we get nonsense. In this case, capital alone decides on economic development, there is little need for cooperation through markets, see Power of the Market - The Pencil. Whatever people agrees upon, the capital would have the final word. (As if explicitly stated in Marxism.)

The oppositors of Milton Friedman can find themselves in the very strange situation that they have to defend the thesis of Milton Friedman, the power of the market, against Milton Friedman.

One of the basic problems of Wealth of Nations is the same we find in any textbook of economics. The transmission mecHanism of economic knowledge to practise are unclear. See economics and the journaille, economics and politics, the fascinated and fascinating public.

The distribution on income depends in Wealth of Nations from the natural price paid for each productive factors, in the world of the classic
theory capital, labour and land.

When the price of any commodity is neither more nor less than what is sufficient to pay the rent of the land, the wages of the labour, and the profits of the stock employed in raising, preparing, and bringing it to market, according to their natural rates, the commodity is then sold for what may be called its natural price.

aus: Book I, chapter VII

The logic is clear, what he describes is a kind of total equilibrium, similar to the one described but Léon Walras. The productive factors, land, capital and labour are paid with their natural price. The natural price is the price where no reallocation is useful because the productive factors earn the same in any use. If this were not the case, they would move to a more profitable use, until the difference is eliminated. This is, by the way, is a marginal consideration. The marginal revolution attributed to neoclassic theory therefore, never happened, because we find that already in the classic theory.

If we add what was paid for the resources at their natural price, we get the price that must be paid for the item. If the market price is lower, the supplier will lose money and in the long run he will stop offering it.

That means that the distribution of the social product depends on the prices paid for the productive resources. This contradicts the theory of Adam Smith, David Ricardo and Karl Marx that capital accumulates or at least this is only a possibility.

If the price to pay for labour is so high, that the "capitalist" has to pay the workers with the full value of what they have produced, there is no added surplus to be accumulated. That's one problem.

The other problem is, that in a situation of competition the price will fall to the natural price. The neoclassics will express the same idea with the famous equation marginal costs equals price. In this case there will be no added surplus either.

The author supposes that the household of Karl Marx was managed by his wife Jenny. If there are two bakeries selling bread and one bakery sells bread more expensive than the other, one both pay their workers a wage at subsistence level, in order to get an added value, he actually won't get any added surplus. He will become bankrupt. Perhaps, Karl Marx will buy his bread at the more expensive bakery in order to confirm his theory, but Jenny won't do that.

The third problem with that theory is that it is difficult to understand when the demand is irrelevant, as stated by David Ricardo and Karl Marx, why the bakery who wants a big added surplus doesn't offer his bread for 100 dollars a loaf. (The author is talking about the French bread, the flûte.) Karl Marx would buy a flûte for 100 dollars. But Jenny would not.

The interesting point of the marxist weird ideas is not the fact that they are completely abstruse. There are million of thick books with abstruse theories. The interesting aspect is that these completely abstruse ideas had been taught for fifty years in any university of the Soviet dominated bloc. It is a psychological problem.

The concept of the natural price/market price is obviously correct. The only thing to be added is that the same goes for the price of the resources at all levels and any kind of qualification and specialisation. There is a natural price and a market price. What is of course not true is the idea that labour and capital, in the sense of building, tools, raw materials etc. can flow to another sector if the prices paid there are higher. In the case of labour, qualification is needed, and specialised machines can't be used in another sector.

In this concept, both functions of prices are considered. Prices indicate scarcity and are at the same time an incentive to reduce scarcity. If for instance the economy is looking for programmers and they are scarce, programmers will earn a lot of money. This will induce a lot of people to study informatics or to obtain these skills in an informal way. Scarcity will be eliminated, and the prices for programmers will fall again.

The two function of prices are 1) indicating scarcity and 2) giving an incentive to reduce scarcity. It is not necessary that we have a natural price or a total equilibrium, in other word one price. A tendency is enough.

In reality, we need both functions and Adam Smith insisted in his famous example of the baker and butcher that we get something to eat because prices are an incentive. At the other side, Adam Smith assumes that capital and labour are completely homogeneous, no difference in qualification and specialisation. They flow alone in the most profitable use. In this case, the second function of prices is not needed. We don't need an incentive in order to induce people to qualify for new jobs. Unfortunately, that's not the way things work in the world we are living in.

We don't find the concept of natural price/market price in nowadays textbooks of economics, although the express the same idea than the neoclassical concept that marginal costs of a productive factor equal the marginal revenue for this factor that we find in any textbook.

The natural price paid for the productive factors corresponds to the marginal costs in the sense of Léon Walras; the market price is simply the marginal revenue. An equilibrium is a situation where nobody in induced to change his or her behaviour. In the terms of Adam Smith, this is the case if the natural price equals the market price and in terms of Léon Walras if the marginal costs equal the price. Both concepts describe a total equilibrium.

[The errors of Léon Walras is another one. His errors consist in the fact that all his funny mathematical equations are based on a market where products are only EXCHANGED, but not PRODUCED. This makes a big difference as we will see later on, see markets where products are changed/markets where products are produced. The difference is, to keep it short, the same as in a short term or long term perspective.]

The neoclassical concepts look more intelligent, because it is mathematically formalised, but means the same thing. The idea is not difficult to understand, by the way; everybody understand that in two minutes.

If this concept is used to explain the two functions of prices, we have no problem with it. However, we find it in a second context, where it doesn't make any sense. The neoclassic theory states that unemployment is the result of wages that exceeds the marginal revenue. The basic idea is simple: No one would employ someone for a wage of 15 dollars if the marginal revenue is only 10 dollars, in other words if he loses 5 dollars an hour. The proposed solution to the problem of unemployment given by the neoclassical is, therefore, simple. The wages must be lowered.

The author would say the marginal revenue must be increased. This is obviously a complicated debate, which can not be resolved with some mathematical equations. This discussion would be about improving the educational system, the quality of universities, a better transfer of knowledge from research institutions to industry, better conditions of start-ups, more international cooperation, reducing bureaucracy and so on. Complicated questions and nothing for people with no working experience like the academic teaching staff of economics, see preliminaries.

Even in the first context, this model, natural price/market price or his pendant marginal revenue of labour equals wages, is used, we can't actually abstract from these issues. How much time it takes to adapt to changes in the economic structures depend on these issues. .

The producer surplus of Alfred Marshall, the difference between the market price, determined by the less productive producer, and the actual costs of the companies, is a useless term without a period of time given. This can be very long; the competitors are not able to improve productivity or very short, any improvement in productivity is immediately copied.

It is to assume that somebody who didn't study economics have a broader vision of economic problems than economists trained to consider economics under a narrowed perspective.

That's a strange situation. Actually, there are a lot of jobs where a transverals knowledge is requiered, politicians for instance to name the most prominent one, and the economics is actually a transversal science. But with their modeling of parallel worlds, economists pushed themselves out of the market.

What does narrowing of the perspective concretely mean? That's simple. There is no direct relationship between the natural price and the market price, or the marginal costs and the marginal revenue if we prefer the neoclassical terms, as suggested in any textbook. Both of them are effects of something, but not causes.

If we take them for causes, there is no need to take into consideration issues beyond these terms. If we consider them as mere effects, we have to study the causes of these effects.

More concretely, if we consider the marginal costs of labour per unit as a cause, there is no need to study how to improve the transfer of know how or the formal/informal training. If we consider the marginal costs of labour per unit as a mere effect, then we have to study the causes of this effect.

In other words, the natural costs per unit equals the price for on unit is true all over the world, but not helpful because the economic structures which leads to the natural costs per unit, are very different. What we really want to know is how we can improve productivity.

Besides that, the equation maginal costs of labour per unit = marginal revenue per unit is not true. If it were true, it should be the same all over the world. If the marginal revenue per unit is determined in Germany, USA, England etc. then the marginal costs per unit should equal this marginal revenue per unit and therefore, the wage should be all over the world the one paid in Germany, USA, England etc. That's obviously not the case. In Bangladesh, Burma, Indonesia etc. the wage doesn't equal the marginal revenue in Germany.

The fact that in hundred of textbooks the same stupidities are counted is an impressing phenomenon. The paragraph below for instance is a quote from a course about microeconomics, see MICRO-ECONOMIE given in Tunis. It's an impressive document. While the economy of the country is collapsing and the whole country is falling into chaos, thousands of people try to escape on ships not suited to cross the Mediterranean Sea, this guy thinks about total equilibrium.

It is impressing to see that from Tunis to Berlin, from Paris to Buenos Aires and from Madrid to New York, the same irrelevant issues are discussed. It's kind of a virus.

En parlant de la rareté des ressources en tant que fondement de l'Economie nous nous étions particulièrement rapprochés de la définition de l'Economie. En effet presque toutes les définitions qui en sont proposées sont construites autour de cette notion-clé de ressources rares. La définition suivante due à E.Malinvaud en est un exemple :"L'Economie est la science qui étudie comment des ressources rares sont employées pour la satisfaction des besoins des hommes vivant en société ; elle s'intéresse d'une part aux opérations essentielles que sont la production, la distribution et la consommation des biens, d'autre part aux institutions et activités ayant pour objet de faciliter ces opérations."

Speaking about the scarcity of resources as the basis of Economy, we approached the definition of economics. Actually, all the definitions that have been proposed turn around this central term of scarce resources. The following definition of E.Malinavaud is an example: "Economics is the science that studies how scarce ressources are employed to satisfy the necessities of the people living in a society. Economics studies basic operations as production, distribution and consumption of goods as well as the institutions and activities aiming to make this operations possible.

MICRO-ECONOMIE

Beast of England, Beast of Ireland
Beast of every land and clime ... this is not human. That's awfully stupid. It doesn't make sense to repeat the same nonsense as a parrot all over the world year after year. It is comprehensible that everyone want to get a little job at the university, but it is a bad idea to abase oneself so much and to tell the same bullshit year after year.

Besides that, no scarcity exists and never existed. Economics is the science that studies the phenomenon that the productive potential is never used fully and what can be done to make the most of the productive potential. Economics is about idle ressources that are not used and never about scarcity.

One of the basic problems, the mother of all problems, from political unrest to fundamentalism of all kind, is UNEMPLOYMENT. Unemployment has nothing to do with scarcity. It is the opposite. Resources are not used. They exist in abundance, but are not used.

The author guesses that this chap and all the others singing the same song are all sitting in rooms without windows. Only in very special conditions it is possible to ignore reality completely.

The problem is that sometimes we have too much of something, for instance economists, and not enough of qualified labour. The problem with economists is not only that they are useless, the problem is that they are disturbed. It is a tremendous problem of allocation of resources.

If the universities in Tunis, Spain, United States, France or Germany produce economists in abundance, but nothing really useful, then we have obviously scarcity of qualified people. That's obvious. If someone has a sausage in the refrigerator and throws it into the garbage can instead of eating it, then sausages are scarce. That's obvious. However, there is an effort needed to come to that situation. That's nothing natural.

There is another group of graduates that universities produce in abundance, although it is not very clear what they are good for; lawyers. The amount of established lawyers for instance doubled in Germany in ten years, from 80,000 to 160,000. That can't be explained by a greater demand for their "services". The problem is that universities offers little choices for people who don't know what to do in life. A lot of them study something simple like law. If the university system were more flexible, offered more choices, if the didactic were improved and so on, a lot of them can be induced to study something useful.

One can wonder why economics evolves so slowly. Why academic textbooks sticks to the same concepts since 50 years without any change. The problem is that economics can't evolve quickly because most of the assumptions of economics are based on false assumptions. If capital doesn't play the role, it is assumed to play in textbook about economics, then saving doesn't play the role it is assumed to play, then the type of interest is not a price for money in the sense of a market price. Half of what we found in economic textbooks becomes obsolete and the other half is irrelevant. The whole study should be reinvented.

That can explain as well why the Keynesian theory is explained only through the IS-LM Model. The original text of Keynes refutes completely basic assumptions of the classic and neoclassic theory. There is a tendency in textbooks of economics to attenuate the differences and the authors of these textbook avoid to position themselves clearly.

The truth is basic concepts, the concepts about capital, type of interest, money, saving, of the classical and neoclassical theory and therefore, all the tendencies that are based on these concepts like the Austrian school, the ordoliberalism, are wrong and Keynes is right. A somehow weird case is the monetarism. Monetarism argues with Keynesian monetary transfer mechanisms, but assumes a very special situation and therefore gets to the same results as the classic/neoclassic theory.

The abolition of the three productive factors, labour, capital and land and their substitution by costs is one of the view progresses made by the neoclassic economy.

[If we use the term classic theory or neoclassic theory we simplify it. Actually, something like the classic theory or the neoclassic theory doesn't exist.]

In the classic theory, three productive factors are needed to produce bread.

Land (that's where, following Adam Smith, the corn comes from. This is obviously wrong, the corn can as well be cultivated on the rough of the houses, see urban agriculture http://en.wikipedia.org/wiki/Urban_agriculture, but technological progress and know how don't belong to the things Adam Smith or economists in general are interested in. Beside that, the problem is water and fertiliser, not land.
Labour: imagined as something homogeneous that exists in any amount in any kind of qualification and specialisation, due to a special magic we don't understand, land is scarce, labour is not. Reality tells us something very different. Land exists in abundance and qualified labour is scarce.
Capital: This is something never defined in Wealth of Nations nor in any other book. Depending on the context, we can guess what is. Sometimes capital are the buildings, the tools, the raw material etc. needed to produce something. Sometimes it is income of the past not consumed. Sometimes it is simply money. Very often, Adam Smith uses the term capital and money as synonyms. Actually, capital and money are two very different beasts and confusing them is the beginning of the never ending tragedy. Money is a claim to a certain part of the productive POTENTIAL, but there is no need for prior saving to get it.

The concept of the natural price for a productive factor only takes into account and at least, we can deduce that from all the examples given in Wealth of Nations, the fact that in the long run the productive ressources tend to be paid equally.

Actually, in the long run, the marginal revenue and therefore the price paid will be the same for ALL productive resources. If the marginal revenue of 10 dollars invested in capital is 12 and the marginal revenue invested in labour is 15 dollars, the 10 dollars will be spent in labour.

There is, therefore, not only a substitution inside the same production factor, but as well a substitution between the different production factors.

As already said, things are much more complicated in reality, because the marginal revenue and the marginal costs are the mere effects of something, not the causes. The really interesting issues are the underlying economic structures.

We repeat, it is true that the wage equals the marginal revenue. All over the world. If we assume that the marginal revenue of labour is fixed by God in heaven, the only way to reduce unemployement is lowering the wage. If we assume that the marginal revenue is the mere effect of something, we have a large number of possibilities to reduce unemployement.

It is often said that a marginal revolution happened in neoclassic theory. This is actually not true. In the concept of the natural price, marginality is included.

If there is a reallocation of resources inside the same productive factor or between different productive factors, the focus is on THE LAST UNIT reallocated. Subsistution will take place until the marginal revenue, the revenue of the last unit reallocated is overall the same.

From that, we can deduce that the marginal revenue decreases. To the extent that resources or productive factors moves from one sector to another, the marginal revenue in the sector they move to will decrease, otherwise all the resources and productive factors would move to this sector.

The atmosphere of "Wealth of Nations" is in general, optimistic. It would be strange as well to write a book about the Wealth of Nations and describing the world as a big misery. 'On the Principle of Economics and Taxation' of David Ricardo, it is very different concerning this issue. The oultook of 'On the Principle of Economics and Taxation' is rather pessimistic.

If we want a good introduction to market economies, the " Traité d’économie politique' de Jean-Baptiste Say is better. 'Wealth of Nations' is interesting because it contains both the fundamentals of Marxism and the fundamentals of a market economy, although Adam Smith is not aware of this fact.

If we want to find something that distinguishes the classic authors, Adam Smith, David Ricardo, Jean-Baptiste Say, John Stuart Mill from the neoclassical authors (actually postclassical authors) like Alfred Marshall, Vilfredo Pareto, Carl Menger and Léon Walras, we can say that the classical authors are more interested in the long-term development of the economy and the steady state, where the economy doesn't grow any more, and neoclassical theory and modern textbooks are about equilibrium.

In a country which had acquired that full complement of riches which the nature of its soil and climate, and its situation with respect to other countries, allowed it to acquire, which could, therefore, advance no further, and which was not going backwards, both the wages of labour and the profits of stock would probably be very low. In a country fully peopled in proportion to what either its territory could maintain, or its stock employ, the competition for employment would necessarily be so great as to reduce the wages of labour to what was barely sufficient to keep up the number of labourers, and the country being already fully peopled, that number could never be augmented. In a country fully stocked in proportion to all the business it had to transact, as great a quantity of stock would be employed in every particular branch as the nature and extent of the trade would admit. The competition, therefore, would everywhere be as great, and, consequently, the ordinary profit as low as possible.

aus: Book IX, chapter IX

In detail the paragraph is somehow vague. One could say that David Ricardo is logically more coherent, althought all of his assumptions and most of his conclusions are wrong.

Adam Smith assumes that a country can acquiere "the full complement of riches", in other word, a steady state without growth. There is no reason given for this theory, but we can assume that the underlying assumptions are the same as in the theory of David Ricardo.

He assumes that "the nature of its soil and climate" is the ultimate limit. Population can only grow, if there is enough food and producing food requires soil. (That's at least what Adam Smith thinks. Actually, it requires freshwater.)

Secondly, he assumes that a decreasing marginal revenue for both captial and labour: "...both the wages of labour and the profits of stock would probably be very low...". Concerning the labour the reason given for that is competition:"...the competition for employment would necessarily be so great as to reduce the wages of labour to what was barely sufficient...". Concerning capital he gives a different explanation.

He assumes that at a certain point there is no need for more capital, "...quantity of stock would be employed in every particular branch as the nature and extent of the trade would admit...", but at the same time, he assumes that the competition will lower profits, ".... The competition, therefore, would everywhere be as great, and, consequently, the ordinary profit as low as possible.".

With the same ingredients, David Ricardo cobbled together a theory which is completely false, but at least logically coherent. It can be resumed like that. Only labour produces value => capitalists need workers to accumulate capital => more workers requires more food => this leeds to higher prices of food => the capitalists have to pay higher wages => their profits diminish in favour of the rent of land.

The result is the same, poor workers and low profits. We assume that Adam Smith assumes a similar causal chain.

It is often said that a marginal revolution happened in neoclassic theory. This is actually not true. In the concept of the natural price, marginality is included.

If there is a reallocation of resources, inside the same productive factor or between different productive factors, the focus is on THE LAST UNIT reallocated. Substitution will take place until the marginal revenue is overall the same.

From that we can deduce that the marginal revenue decreases. To the extent that resources or productive factors moves from one sector to another, the marginal revenue in the sector they move to will decrease, otherwise all the resources and productive factors would move to this sector.

Concerning the marginal revenue it could be assumed that Adam Smith presumes that the PHYSICAL output decreases the more units of a productive factor are used. Physical output are the concrete units of something, bread, knifes, needles whatever. Maybe the physical output in some branches decreases, but in general, at least in the short run, we have a certain combination of productive factors and adding only one unit is useless. With one man and one axe one tree could be cut and with two axes and two man, two trees. However, with two axes and one man, we can only cut one tree.

[In the long run, labour can be substituted by capital in the sense of building, tools, raw material etc. One can invest his money for three workers and three axes and cut down three trees a day. However, he can also invest his money in one saw machine and one man. This one will cut also three trees a day. In the long run, at least at a macroeconomic level, we have therefore a partial substitution of one production factor by another, normally labour is substituted by capital, in the sense of machines, tools etc..]

Acutally, the marginal output, the value in money, of an item is more relevant. The physical output of a unit of a productive factor can remain the same, but with decreasing supply the price, to which this item could be sold, fall. An increase of sale is only possible if people who want to pay only less, because they have other preferences, buy the item or if people who only can pay less buy the article. An increase in the supply is, therefore, normally only possible if the marginal output decreases.

Adam Smith doesn't give any example for a decrease of the physical output nor for a decrease in the marginal revenue. We can therefore, assume, that he doesn't mean a decrease in the physical output or the marginal revenue when he affirms that wages and profits would lower.

It is more plausible that he thinks in a Ricardian like causal chain. (Which means as well that landowners get richer and richer, because the "capitalist" has to pay more and more wages in order to keep their workers alive, what diminishes their profits.

[The question whether the physical marginal output or the marginal revenue of one unit of a productive factor decreases in the long run is a controversial question. Keynes supposes that the marginal revenue will decrease and therefore, an increase in the supply can therefore only be obtained by lowering the interest rates. In other words, high interest rates are an obstacle for less profitable investments, although they would allow to bring less qualified people back to work and allow to pay the credit back. Without innovations, Keynes abstracts from innovations, this it true but even with innovations it is not really clear why high interest rates can help the economy. It is to assume that in the short run, where the underlying economic structures doesn't change, the physical marginal product and the marginal revenue decreases. The first one because with a given technology, the machines are more and more inefficient if the output is increased and the second one because a greater output can only be sold at a lower price. In the long run, things are different. Technology changes and new products appear, for which people are willing to pay more.]

The idea that the economy approaches a steady state, a state without growth, is a widespread idea, although it doesn't make any sense. The last version of this idea is the Club of Rome. The argument of the Club of Rome is similar as to one of Adam Smith or David Ricardo. The difference is that David Ricardo and Adam Smith assumed that land is scarce, the Club of Rome assumes that the resources are scarce.

The first point is that economic growth has nothing to do with resources. Demand for instance can shift from consumer products to consumer services. If people for instance invest more money in education, sports, learning an instrument or whatever instead of buying a second car, we would only burn a resource that exists in abundance. Actually, more than needed and convenient: calories. It is not even sure that people wouldn't be more happy, if they use their bicycle sometimes and open their minds a bit.

At the other side, consumer preferences can change. For youngsters in Germany, for instance, a car is not a status symbol any more. This place was subsituted by smartphones and a smartphone consumes less resources than a car. In cities like Mexico, the traffic has already collapsed. A car can be used to read the newspaper, but not to get from point A to point B.

However, even if we assume that the consumer preferences didn't change, which is not the case, it is questionable whether an increase of resources consuming consumption good would lead to stagnation. The consumption of resources can be reduced and is actually reduced or substituted by renewable resources.

In part, there is not even a technological progress needed achieve that. A few times a year, people need a family car to visit their grandmother and grandfather and things like that. The rest of the year, they go to work and return home alone. It would, therefore, be useful to give an incentive for two cars. One very little, with low fuel consumption, very simple to go to work and a family car. This second car should be insured by the first car and now taxes should be paid for the second car. If the government wants to induce people to use this car to go to work, it can as well allow a bigger depreciation for this car than for the first one. That wouldn't increase the amount of the cars on the streets, or the total amount of miles driven. That would only have an effect on efficiency in that it would increase.

The error of the Club of Rome is typical for economic thinking. The most illustrative example is David Ricardo. The theory of David Ricardo is based on four basic assumptions, very plausible in his day, so plausible, that didn't even feel any need to question them, but all of them were wrong.

The difference between Adam Smith and David Ricardo and Karl Marx is that Adam Smith saw in the steady state only a possibility, but assumed that this state will never be reality.

But, perhaps, no country has ever yet arrived at this degree of opulence. China seems to have been long stationary, and had, probably, long ago acquired that full complement of riches which is consistent with the nature of its laws and institutions. But this complement may be much inferior to what, with other laws and institutions, the nature of its soil, climate, and situation, might admit of.

Book IX, chapter IX

What do we get? Actually Wealth of Nations are to books, unfortunately mixed, so we can't separate them.

At one side, we have a book that describes the fundamentals of a market economy.

- the price as a signal of scarcity and an award to reduce this scarcity.
- the optimal allocation through market prices
- the fact that in market economies the personal interest agrees with the general interest
- the idea that this only works if the intensity of competition is strong enough
- governmental intervention can only distort the allocation of resources and is a source of false incentives

In the same book, we find concepts that are wrong and will be refuted by Keynes or are incompatible with a market economy.

- There is no clear distinction between capital and money and very often, they are even used as synonyms.
- Money is considered as a mere veil; in other words, the amount of money doesn't change the relationship between the different prices
- Interest rates are considered as a price in the sense of a market economy. This would only be true if capital were scarce.
- Saving is considered as a condition for investment

These concepts are the source of more fundamental problems adressed by Keynes. The other wrong ideas only requires some precisions.

- The idea that capital and labour are homogeneous would mean that there is no reallocation inside the same productive factor. For instance, labour is needed. It is never necessary to substitute one thing for another identical thing. Under these assumptions, homogenity of the productive factors we don't need the price signals at the production side. This is very misleading idea.

- The absence of the entrepreneur leads to the the identity of 'capitalist' and 'captial'. In the capitalist, the fatal consequences we will see in the work of David Ricardo and with even more fatal consequences in the work of Karl Marx, is not an entrepreneur, he doesn't take any decisions and no qualification is needed. Capital moves alone to the most profitable use and its best allocation. That includes that there is no risk. Capital alone will never get lost. It can only get lost, if a decision is wrong. However, in this system, nobody takes a decision.

- If capital and labour are homogeneous factors, there is no know how needed and even less know how is a poductive factor. Homogeneous capital comes out of homogeneous labour and is accumulated year after year. The problem is that know how and innovation can destroy capital in the sense of machines, tools, building etc. as well as human capital, in the sense of qualified work.

- The demand is taken into account in Wealth of Nations through the concept of the market price, but there is a tendency in Wealth of Nations to negate the influence of the demand on price building, especially related to the price of the productive resources.

- Adam Smith implicitely assumes transparency. If all the entrepreneur and all the workers are equally well informed, they are indeed homogeneous. There is no difference in qualification and know how. If they are homogeneous, everybody is equally well informed about market prices and productive resources are reallocated without delay, we don't have a producer surplus as described by Alfred Marshall, see equilibrium in the short run and in the long run.

The idea that capital defined is not consumed income of the past, is the necessary condition of investment is a fatal error. All the tendencies of economic thinking, the Austrian school, the neoliberals, ordoliberalism which are based on this ideas have serious problems.

In practice, it is fatal in the actual crises. We are in the year 2015 and some European countries, especially Greece, are still struggling with the financial crises. It is a widespread opinion that Greece should save more, but that doesn't make any sense in this context. Saving in this context actually means that Greece should save more in order to pay its debts. The only result would be that institutional investors who already have too much money, because they can get any amount of it from the central bank. The only thing they are able to do with that money is to speculate in the stock markets. Under these circumstances, the money can remain in Greece, that doesn't make any difference.

The implicit assumption of the politics who want Greece to save more is that savings are automatically invested. That's not the case. Not at all. The situation would be different if the Greece would reallocate money away from unproductive uses, for instance large bureaucracies, to productive, profitable uses. This is something impossible to do without a transfer of know how. That's nothing that works in the short run.

The most prominent politicians who urge Greece to save more are Germans. They should know it better. East Germany saved nothing after the fall of wall in 1989, but got a lot of money, 1.5 trillions Euros in ten years. That's really money. However, even this huge amount of money didn't allow to overcome the structural problems.

To tell the Greeks that they can pay back their credits, that's what saving means in this case, and resolve at the same time their structural problems is so stupid, that is hurts. The same advice given to the Germans after the fall of the wall, would have lead to riots in the streets and a second revolution, this one less peaceful than the first one.

If it is said that Adam Smith was the first who described a market economy, it is only half of truth. He described without any doubt, some basic concepts of a market economy but at the same time, concepts incompatible with a market economy.

Adam Smith underestimates completely the complexity of the markets. He assumes that the problem is saving and that investment is not a problem. The reader can easily see that the basic problem in a market economy consists in identifying profitable investments. Institutional investors right now have any amount of money, but are unable to detect investments. Let's assume that the reader wins 1 millIon dollars in the lottery. What he will do with that money? He'll obviously buy a house, a nice car and some other things. That's what everybody does. Let's say that at the end it remains 300,000 dollars. What he is going to do with this money? He will hand them over to institutional investors, banks or insurance companies in the hope that they will find interesting investments. That hope can be completely unfounded.

If it was so easy to detect profitable investments, if the only problem would be the impossibility to realise this investment because of a lack of money, then the solution would be simple. The only thing to do is print money.

There is no clear answer possible concerning the third question. Causes is obvious. Causes refers to the mechanisms and principles to be accepted which leads to economic growth. The problem is nature ("An Inquiry to the NATURE and of Wealth of Nations").

Nature refers to the characteristics of something. The term nature suggests that Adam Smith is trying to define wealth. An interesting question and a relevant one even in the 18th century, a lot of fairy tale are about this topic, but the only context where Adam Smith discusses about the 'nature' of wealth is in relatonship to mercantilism and it is to assume that he means that with 'nature'.

For the mercantilist, wealth meant gold. The more gold a country possessed, the richer it was. The thesis wouldn't be right either in the case that gold is a universal means of payment, but in this case, it would be at least suggestive.

Following the mercantilist theory, a country gets richer the more it exports and the less it imports. This theory is obviously refuted by Adam Smith. Money is only a means of payment. We get only richer if the amount of goods we can buy with this money increases.

OF THE PRINCIPLE OF THE COMMERCIAL OR MERCANTILE SYSTEM

THAT WEALTH consists of money, or in gold and silver, is a popular notion which naturally arises from the double function of money, as the instrument of commerce, and as the measure of value. In consequence of it being the instrument of commerce, when we have money, we can more readily obtain whatever else we have occasion for, than by means of any other commodity. The great affair, we always find, is to get money. When that is obtained, there is no difficulty in making any subsequent purchase. In consequence of it being the measure of value, we estimate that of all other commodities by the quantity of money which they will exchange for. We say of a rich man, that he is worth a great deal, and of a poor man, that he is worth very little money. A frugal man, or a man eager to be rich, is said to love money; and a careless, a generous, or a profuse man, is said to be indifferent about it. To grow rich is to get money; and wealth and money, in short, are, in common language, considered as in every respect synonymous. A rich country, in the same manner as a rich man, is supposed to be a country abounding in money; and to heap up gold and silver in any country is supposed to be the readiest way to enrich it.

Book VI, chapter I

In the logic of mercantilism, exports have to exceed import. If this is the case, foreign countries can only pay with gold or silver, which was the means of payment at that time, because they couldn't buy goods with goods if exports exceed imports.

Everybody would agree that Adam Smith is right in his refutation of this theory. We will find a similar description in the work of Jean-Baptiste Say, see Law of Say. However, the position of Adam Smith is only true at first glance. The really interesting question is whether money is a claim to the social product already produced or to a social product that will be produced in the future. This is not at all the same thing and crucial for the understanding of the keynesian theory.

If money is a claim to a part of the social product produced in the past, then the value of money depends, obviously, from the the social product produced in the past. If money is a claim to the social product in the future, its value depends on the productive POTENTIAL in the future. This version is the right one.

If someone saves money for five years in order to buy a car in five years, he hopes that he will be able to buy a car in five years, that actually someone will produce a car. All his savings are worth nothing if nobody can produce him the car.

Jean-Baptiste Says assumes that goods can only be paid with goods and that money is only something like a carriage that transports goods from one place to another. The value of money in this definition depend of things produced in the past because that's where the money comes from.

The question is whether the fact that money is the result of the past is really helpful, if we want to buy something in the future. The obvious answer is no. It is completely irrelevant, where the money comes from. The only interesting issue is whether someone in the future will be willing and able to produce what we want.

This means that there is no need for prior production to buy something in the future. Money can be simply printed if the corresponding products can be produced. We can even say that an economy that depends only on money as a result of the past, can't grow because in the extent that the social product grows, more money is needed. (Otherwise the prices must fall.)

The idea that goods are paid with goods, we assume that Adam Smith meant that, although Jean-Baptiste Say explicitly said it, it seems right at first glance, but is actually a fatal error. It is a misleading idea that complicates the comprehension of economic issues.

The idea that goods are paid with goods has a certain relevance at an individual level, although even at an individual level, it is not true because an individual can borrow money that nobody saved before. However, in general, an individual can't produce money. At a macroeconomic level, that's not true. At a macroeconomic level, money can be produced and is produced without prior production of goods.

That is actually very easy to understand, but a lot of people have problems with that. The problems arise because the relationship between the different prices and the value of money has been fixed in the past. Therefore, people assume that the value of money depends on actions in the past. However, that is only true because in general, the relationship between the prices are the same in the future than in the past.

In this sense, there is even a little bit of truth in mercantilism as Keynes stated. If paper money, or fiat money, doesn't exist because the government is not able to control it, only things that are scarce by nature can serve as money. If we need more money to make full use of the productive potential, the amount of gold or silver must be increased.

It is obvious that mercantilism only works if only ONE country follows this strategy. At the moment, Germany and China follow this strategy. A strategy which can't work in the long run. Nowadays, the same strategy exports exceeds imports, leads to an indebtness to foreign countries and finally to an economic collapse.

Nevertheless, we have to distinguish between a policy which only imports gold, as the Spaniard did in the 16th and 17th century, from another continent, and a policy based on getting gold by selling something.

In the case that the importation of gold is based on sold products, a country following a mercantilist policy is obliged to improve productivity, otherwise exports can't exceed imports. If foreign countries produce the same products better or cheaper, they are not going to buy them.

The case of Spain in the 16th and 17th century is very different. Gold and silver was just squeezed out from Latin America and brought to Spain without any improvement in productivity. That was the beginning of the decline of Spain. There was an increase in economic growth, but it happen in France and England as observed by David Hume, see balance of trade.

If there is no improvement in productivity, if the productive potential doesn't grow, the only effect of an increase of the amount of money will be inflation. That's what happened in Spain in the 16th and 17th century.

[Something that could be seen by analysing the expenditures of hospitals, who had always the same amount of patients.]

It is obvious that gold and silver, as a means of payment, only make sense if somebody is actually willing and able to produce and sell the things that people want to buy. Otherwise, as a means of payment, it is useless; but whether people can buy something or not, their gold and silver has nothing to do with the production of the past. That depends only on the productive potential in the future.

The Spanish system had one big advantage. If the gold and silver is just stolen, no debts remain after it was spent. With fiat money, the case is different. Every production of money leads to an increase of indebtedness at the same amount. That means that the fiat money created must be eliminated later otherwise, the amount of money would increase infinitrely and beyond the actual productive potential.

The classic authors assumes, in the most explicit way David Ricardo, that saving, in his case the added surplus squeezed out of the workers, is a condition for investment, what he calls accumulation of capital. Accumulation of capital derives from something happened in the past. The same thing is stated implicitely by Adam Smith, Jean-Baptiste Say and John Stuart Mill and all the authors of the neoclassic theory. This is the fundamental error.

This error leads to the assumption that money is a mere veil, that the prices raises proportionally to the amount of money, but money can't wake up an idle productive potential. Money is considered as something containing a value previously produced and only if there is a value previously produced it can be invested in something. That's not true. Money gets his value from the future.

If we say that Adam Smith presumes that saving is a condition for investment, it is not 100 percent true. We can find passages in the book where we can see that Adam Smith was well aware that money is more than a mere veil, that it can induce investments. His friend David Hume saw that even more clearly, see balance of trades. David Hume observed that the increasing amount of gold brought to Europe from South America lead to an increase of economic activities.

However, both Adam Smith and David Hume didn't realise this fact that money alone can induce economic growth, and contradicts their concept of capital.

The idea that money is only a claim to a productive potential and has little to do with an assumed value incorporated in the money, actually there is none, is very hard to understand for most of people and if they understand it, they are not aware of the consequences, for instance that the interest rate can't be the price for money in the sense of a market economy, because something that is not scarce, can't have a price in this sense.

All that is hard to understand because it contradicts at first glance every personal experience. Normally, we need money in our bank account if we want to buy something. The things we buy are, therefore, paid by products and services we delivered before. Nevertheless, we can buy things as well by borrowing money. Classic authors would say that this money has been saved before by other people. This is true only for a small part. Actually, the banking system can create money itself.

[To make this point clear, if someone earns 3,000 dollars and spends 100 dollars a day, taking these 100 dollars from his bank account every day in the morning, he has in average 1,500 dollars in his bank account, if the month has 30 days. 1900, 1800, 1700....400, 300, 200, 100, 0. If the banks know that, they borrow these 1,500 dollars to other people. If millions of people do that, they can borrows billions of dollars. There is not even a need to go to the central banks and ask for money.]

Another reason is that's something we find very often in economic thinking, the fact that certain terms narrows the perspective. Adam Smith was so convinced that unemployment is impossible, that it not even occurs to him that in a situation of unemployment an increase in money could lead to an increase in output, instead to an increase in prices.

La explicación más plausible es la misma que ya hemos visto varias veces. Determinados conceptos llevan a un estrechamiento de la perspectiva. Adam Smith estaba completamente convencido de que no puede haber subempleo, o sea, estaba convencido de que el potencial productivo ya estaba completamente agotado y que un aumento de dinero, oro, plata tendrá como efecto único una inflación.

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1.1.1 Economic perspective

THE WEALTH OF NATIONS