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With one word economics lurched into fantasy

Steve Keen

“Adam Smith” by Bernt Rostad is licenced by CC BY 2.0 DEED. A statue of Adam Smith, the man behind “the invisible hand”, standing in the Royal Mile (Edinburgh) near St Giles Cathedral.

Human society is energy blind. Like a fish in water, it takes for granted the existence of that without which it could not survive.

As with so many of humanity’s problems, this conceptual failure can be traced back to an economist. But the guilty party is not one of “the usual suspects” Neoclassical economists but the person virtually all economists describe as “the Father of Economics”, Adam Smith.

Smith led economics astray on the vital issue of energy in the very first sentence of The Wealth of Nations, when he stated that:
“The annual labour of every nation is the fund which originally supplies it with all the necessaries and conveniences of life which it annually consumes…” (Smith 1776, p10). (my emphasis added)
I emphasize “labour” in that sentence because, apart from that word, it is virtually identical to the opening sentence of Richard Cantillon’s Essay on Economic Theory, which was published two decades before The Wealth of Nations:
“Land is the source or matter from which all wealth is drawn; man’s labor provides the form for its production, and wealth in itself is nothing but the food, conveniences, and pleasures of life” (Cantillon 1755, p21). (my emphasis added)

With that one word altered, economics took a terrible lurch away from realism and into fantasy. Cantillon’s insight was that what existed before Man and outside human society let alone outside “the economy” was the source of the material wealth we generate within the economy. Smith’s substitution saw an action within the economy itself the work of the labourer as the source of value, and the division of labour over time as the source of its growth.

Cantillon’s perspective, that wealth originated from outside the economy though the form that wealth took was shaped within it was correct, according to the incontrovertible Laws of Thermodynamics (Ulgiati and Bianciardi 2004; Eddington 1928, p37).
Smith’s perspective happened to be wrong, because he contemplated that the closed system of the economy could produce more outputs than inputs over time. This wasn’t known to be false until a century after The Wealth of Nations appeared, when the Laws of Thermodynamics were developed, so Smith cannot be criticised for that mistake. But economists today should not persist with using models of production that violate the Laws of Thermodynamics.

Real World Econ Rev Blogs, 9 Jan 2024
Extracted by Prof Steve Keen from his paper published in RWER issue 106.

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