Friday, May 18, 2012

Hume On National Economies

Michael Burda (h/t nc links):
The great Scottish philosopher and economist David Hume understood all too well how national boundaries and balance-of-payment statistics affect and even determine flows of international trade. Where national boundaries exist, customs offices and government bureaucracies assiduously monitor the flow of goods and assets between countries. Surpluses and deficits are seen by politicians as a sign of national pride or shame. Hume criticised the mercantilist view but was optimistic that trading patterns would ultimately right themselves. In 1752 he wrote:
“Where one nation has gotten the start of another in trade, it is very difficult for the latter to regain the ground it has lost.... But these advantages are compensated, in some measure, by the low price of labour in every nation which has not an extensive commerce, and does not much abound in gold and silver. Manufactures, therefore gradually shift their places, leaving those countries and provinces which they have already enriched, and flying to others, whither they are allured by the cheapness of provisions and labour; till they have enriched these also, and are again banished by the same causes. And, in general, we may observe, that the dearness of every thing, from plenty of money, is a disadvantage, which attends an established commerce, and sets bounds to it in every country, by enabling the poorer states to undersell the richer in all foreign markets.”
In principle, the vaunted “Hume mechanism” should operate within the Eurozone. Countries which export less than they import should lose euros to surplus countries, unless offset by private capital inflows. Euro outflow leads to a scarcity of money and credit, less lending for consumption and investment, a slowdown in activity and falling prices. Chronic deficits will imply higher interest rates and declining creditworthiness for both sovereign and private borrowers. But declining domestic absorption and non-traded goods prices ultimately bring wages back into line with productivity and restore competitiveness. Similarly, chronic surplus countries should accumulate euros and domestic bank lending should expand, leading to more demand and inflation there relative to deficit countries.
Hume’s insights are as relevant today as they were 250 years ago.
It is amazing how in many ways Smith and Hume better understood people than today's economists.  Smith, while favoring free markets, knew that people generally worked against them, and Hume seems to have understood people's motivations better than almost anyone ever.

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