Modern economy

Introduction

Hutchison reviewed many areas of Adam Smith works. One of the significant work of Adam Smith is the concept and theory of market liberalization and market self adjustment which Smith described as an invisible hand. The modern economic view developed from Smith theories such as Keynesian and Friedman . These contemporary view represents the advance and superior approach to Adam Smith. This is due to these theories have adjusted many factors that are in today economy but not a big issue during Smith's period like inflation, money supply ,globalization, consumers behaviors and the flow of fund. As the modern economy is an opened not a closed economy like Smith's period.

Body

Hutchison (2007) stated that the Wealth of Nations by Adam Smith played such an important role in establishing political economy as an independent subject is one of those felicitous, unintended, and quite unplanned outcomes to which Smith himself assigned such an important and often beneficent role in human affairs.

The effectiveness of market liberalization represents advance on that proposed by Adam Smith. The concept of invisible hand that proposed by Adam Smith is about the effectiveness of free market and market self adjustment .

Smith is classical economic. Hutchison (2007) mentioned area of the forces should be allowed to work themselves out free of government intervention. Also, Adam Smith believes that market will best allocate the resources . This is due to people have right to choose what are best for them. Therefore, products that can compete will stay in the market ,while products that can not compete will be forced to go out of markets because people will not purchase those products. Due to many reasons such as , costs , design, preferences and trends etc. The concept of market liberalization is opposite to Karl Marx who against Smith's theory. Karl Marx proposed the concept of socialist that all capitals should be centralized and allocated by the government. This is due to Marx believes that resources that allocate by the government can narrow the gap between the rich and poor people. However, Karl Marx's theory worked well in the beginning as there were less poor people but in the long run .For instance 20 years later, it is ineffective and the nation is becoming poor. This is due to the decline in nations' productivity. As a result of equalization that ignores who produce more or less productivity. This is because there is no motivation for people to work hard as there is no reward for hard working. The income and standard of living remains unchanged. Eventually, there is the end of socialist 80 years later because it doesn't work in practice. Karl Marx's theory ignores the fact that human behaviors go along the motivations.

From Hutchison's reviews Smith's contribution .Thecontemporary approach is considered to be superior to Smith's as it considers current world economic, political and social situation in into theory and assumption such as Fiscal Policy and Monetary Policy.

According to Adam Smith, when the demand exceeds production capacity products' price increases . Conversely, when production capacity which represent supply side increases products' price will fall .And when product prices fall businesses will decrease their production capacity until utilization rate is below the production potential. Hence, unemployment will increase when there is a production reduction. When products price fall greater than the demand . The business will expand the production capacity again due to increase in prices. This is how the invisible hand works. It is the concept of market self adjustment. It brings market back to the equilibrium. Hutchison (2007) confirmed that Adam Smith valued economic freedom and Smith system is natural liberty as Smith believes in invisible hand.

However, during the US economic crisis in 1929 US GDP contracted dramatically and economy had not recovered for a long time despite the utilization and production capcuty was far below its equilibrium as well as the demand did not recover . Therefore, the invisible hand did not work. Many economists were skeptical and wondering why invisible hand that proposed by Adam Smith did not work at that time. Until, John Maynard Keynes (1883-1946) who is a British Economist proposed that when economic declines despite price fall but unemployment rise definitely .As a consequence of this, people do not have purchasing power .Therefore, demand will not recover. So, he proposed that Government need to stimulate the economy by increase government spending and aim to reduce unemployment rate. Once people have jobs and unemployment rate decrease . The market will start to stabilize and people will feel confident that they have constant income. Hence, the demand will pick up and market will start to recover. The key is consumers' confidence.Keynes claimed that it is the government role to stabilize the market and create jobs. Also, government spending will substitute the lack of demand during recession and depression.

As a result of Keynesian Economics, US economy recovered in 1941 when US joined World War 2 as a result of extremely high government spending on military and result in increase in production capacity and utilization rate in the economy. The unemployment rate went down very fast. Therefore, it proved that Keynesian economic did work. Keynesian Economic is called a Fiscal Policy which government will intervene and stimulate when there is an economic recession.

On the other hand, Milton Friedman (1912-2006) proposed that why economic did not recovered for a long time during recession in 1929 was not because of invisible hand ,but it was because lack of money supply in the US economy during the Great Depression. Milton Friedman believed that money supply and liquidity have a significant impact on the economy. Milton Friedman economic is called Monetarism. Friedman believed that when government need to stimulate the economy the government need to ask Central Bank increase money supply. Money supply can be injected into economy by 1) lower interest rates 2) Loosening Bank Reserve Requirements 3) Central Bank (Fed) can injected money directly by purchase government bond.

Friedman believed that money supply works really well to stimulate the economy. To demonstrate this during 1987 US stock market crashed and economy started to slow down. Alan Greenspan who was Fed chairman during that time increased money supply into economy tremendously .Eventually, US economy had recovered.

Friedman has an idea against Keynes's believe . This is due to crowd out effect when government increase spending. Therefore, government needs to borrow money in the market. As a result of this, interest rates will increase and there is no motivation for the private sectors to invest. However, Keynes believes that during crisis people loss confident and want to save money. This is called a Liquidity Trap and it prevents an interest rates to rise due to excess money. And, Friedman was skeptical about Keynes' assumption. Milton Friedman approach is called a Monetary Policy.

The modern view on Smith's simple system of competitive freedom can and will always be so flexible as to adjust satisfactorily to any variations in the money supply. It can be concluded that the contemporary economic view is superior than Smith due to it is more suitable to the globalization and consider current economic, social , political and people behaviors into assumption such as Keynes and Friedman that become the Fiscal and Monetary Policy of the modern economists' tools. Nowadays, most of nations used hybrid policy with all the tools proposed by Adam, Keynes and Friedman to stimulate and rescue the economy. This is because current world economic and as result of globalization is much more complicated than the past.

According to Blaug's absolutism and relativism's distinction reading. Blaug (no date ) stated that no assumption about economic behavior are absolutely true and no theoretical conclusions are valid for all times and places. Also, shifts in emphasis within economics are due to changes in philosophical attitudes or dominant modes of reasoning (Blaug , no date) Smith's time reflects the context social, political, economic in which economists formulate their theories. During, Adam Smith period the economy was less complicated than today there was no globalization and the flow of fund .Hence, Adam Smith concentrated on the closed economy . But the modern economy is an open economy.

As a result of this, economists like Milton Friedman understood the importance of money supply and the flow of fund in the economy. It can be concluded that economic theories developed and reflects context , social , political and economic of the particular period. Therefore, the economists after Smith's period developed and adjusted theories and tools to solve the economic problems.

Conclusion

In a nutshell, Adam Smith's theory like invisible hand that represents market self adjustment in the market liberalization contribute to economists and theories significantly. As the economists after Smith's period studied and learned from Adam Smith. Hence, they developed and advance theories that suit to current economic issues like Keynes and Friedman .They learned a lot from Smith and invented tools such as Fiscal Policy that concentrated on government spending where as Friedman proposed the money supply concepts to boost the economy. Both Keynes and Friedman concepts are useful and have been proved to rescue the economic crisis. However, it is better to use the both policies as a hybrid tools to stimulate and rescue the economy. For instance, 2008 Financial Crisis the US Central Bank led by Ben Bernanke used the Monetary policy to boost the economy by lowering the interest rate to near zero at 0.25% ,while print more money and purchase government bond . This is how Fed injected the money supply into economy directly .It is a strong remedy. Where as the US government proposed rescue package and increase government spending like lower tax rate, increase tax exemption and increase social welfare to support unemployment.

References

Blaug, M., Economic Theory in Retrospect .

Frank, Robert A.(2006)Macroeconomics and Behavior. McGraw-Hill/Irwin, 6th Edition:

Hutchison S. (2007) Journal of Law and Economics, Vol. 19, No. 3, 1776: The Revolution in Social Thought. (Oct.,1976), pp. 507-528. Available From: http://www.jstor.org/pss/725079[Accessed 28th March 2010]

James, N. Gregory (2000) Principles of Macroeconomics. South-Western Pub, 2nd Edition:

Yerk , T. (2003) Modern Macroeconomics. McGraw-Hill/Irwin, 4th Edition:

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