ECS3705 Exam Preparations 2021.

ECS3705 Exam Prep. History Of Economic Thought. Mercantilism can roughly be characterised as an exercise in nation building by way of an alliance between the city merchant and the monarch, both of whom had gained in power and prestige. The monarch (king or queen) gave the merchant the protection and privileges of monopoly that he needed for his business endeavours and, conversely, the merchant provided the monarch with the tax income in the form of precious metals (gold and silver) to finance his or her wars. Major Tenants • Gold and Silver the most desirable form of wealth. Mercantilists tended to equate the wealth of the nation with the amount of gold and silver bullion it possessed. • Nationalism. All countries could not simultaneously export more than they imported. Therefore one’s own county should promote exports at the expense of its neigbours. • Duty Free Importation of raw materials that could not be produced domestically, protection for manufactured and raw materials that could not be produced domestically and export restriction on raw material. The emphasis on exports and reluctance to imports has called “the fear of goods” • Colonization and Monopolization of colonial trade. Keep the colonies dependent and subservient to the mother country and also the colony remains suppliers of low cost raw materials to the mother county. • Opposition to Internal toll, taxes and other restrictions the movement of goods, they recognized that toll and taxes could throttle business and drive up prices of the country’s exports. • Strong central Government was needed to promote mercantilist goals, nationalism, protectionism, colonialism and internal trade unhampered by tolls and international trade protected via tariffs on imports. • Importance of large, hard working population, to fight for the glory and wealth of the nation, but also would also keep labour supply high and wages therefore low. The meaning of bullionism, and the advantage of wealth-as-money (as opposed to wealth-as-useful-goods) for the monarch. ECS3705 OCT/NOV 2015 2 HISTORY OF ECONOMIC THOUGHT Bullion is another word for plain bars of (unminted or uncoined) precious metal. Accordingly, the idea that wealth is equal to precious metal money (gold and silver or “treasure”) and that a nation’s wealth, therefore, consists of the total amount of gold and silver within its borders is called “bullionism”. The modern contrary view is that the wealth of a nation consists of the quantity and quality of useful goods (food, housing, clothing, education, law and order, entertainment, etcetera), which its citizens can enjoy. Hence, a “wealthy” nation is a nation in which people can enjoy an abundance of such goods. Mercantilists view wealth as money rather than as useful goods, because wealth in the form of money is malleable. The meaning of the “fear of goods”. One of the principles of the Mercantilist school is duty free importation of raw materials that could not be produced domestically, protection for manufactured goods and raw materials that could be produced domestically and export restrictions on raw materials. Emphasis on exports & a reluctance to import has been called the fear of goods. The view of international trade as a zero-sum game and how it encourages conflict between nations. They believed there is a total sum of gold in the world and the gain of one nation is a loss in another nation. Hence Zero sum game. They applied restriction on their colonies not to import from other nations. This is how merchant capitalism control the colonies “wanted to keep the colonies eternally dependent upon and subservient to the mother country”. In mercantilist times, there was host of restrictions and punitive taxations on the colony. Mercantilism as “rent-seeking behaviour”. The strong mercantilist emphasis on state regulation may sound strange on modern ears; after all, modern merchants and capitalists advocate laissez-faire and economic freedom rather than government regulation. However government regulation can, also be used to favour the Merchants commercial interests, namely when aimed at preserving monopoly rights and keeping out any ECS3705 OCT/NOV 2015 3 HISTORY OF ECONOMIC THOUGHT emerging competitors within the nation. Also Restricting imports trade by imposing tariffs on import. Indeed such lobbying for government favours can be regarded as “rent seeking”, The role of “derived demand” in mercantilist thought. “Derived demand”. This term is often used in the context of the labour market, meaning that the demand for labour is derived from the demand for goods, either generally for all goods or particularly for a certain good requiring a particular labour skill. In this context, the demand for fishermen is derived from an enforced demand for fish enacting a law coercing people to eat fish on Friday - still a common practice in many European countries), which in turn guaranteed a supply of experienced sailors for a country's navy The ways in which bullionism did make some economic sense, valid at the time The growth of trade and commerce required more money in circulation, banking wasn’t able or developed to produce it, therefore the utilisation of Gold and silver bullionism, was more useful. It paid for the wars and building ships along with bribing enemies. Before the development of International finance bullion was a major significance in making international payment. The lasting contributions of Mercantilist: The merits of mercantilism in enhancing our understanding: a) the economic contribution of commerce and trade, international trade in particular, b) the concept of the balance of payments, c) the benefit of state regulation in certain areas, and d) the role and nature of the chartered trading company as the forerunner to the modern limited-liability corporation. ECS3705 OCT/NOV 2015 4 HISTORY OF ECONOMIC THOUGHT ECS3705 OCT/NOV 2015 5 HISTORY OF ECONOMIC THOUGHT ECS3705 OCT/NOV 2015 6 HISTORY OF ECONOMIC THOUGHT Chapter 3: The Physiocratic School The phsyiocrats appeared after the mercantilist period. The school started in 1756(When Quesnay published his first article on economics in the Grande Encloypedia) and ended in 1776, when Turgot lost his high position in the French Government and when Smith released his book “Wealth of Nations”. The phsyiocrats led the world in economic thinking, and had influence for about two decades. We look at two prominent phsyiocrats: Quesnay and Turgot. Major Tenets: 1. Natural Order: The phsyiocrats introduced the natural order of thinking. Physiocrat means” rule of nature”.Laws of nature govern human societies. Influenced by newton. Bring society into harmony with laws of nature. This included the rights to the fruit of one’s own labour provided that such enjoyment was consistent with the rights of others. 2. Laissez-Faire: Let people do as they please without the interference of government. Government should never extend their in economic affairs. Government should only protect life, property, and contracts. They believed in free trade within the world. 3. Emphasized Agricultured: Only agriculture produced new wealth . Production,industry etc were sterile. Agriculture produced a surplus. 4. Taxation of the landowner: Physiocrats thought that because only agriculture produce surplus, which the landowner received in the form of rent, only the landowner should be taxed. All tax imposed on others would be passed to the landowners. A direct tax to the landowner was much more preferable than indirect taxes, which were increased as they were passed along to others. 5. Interrelatedness of the economy: Circular flow of goods and money in the economy. WHO BENEFITTED OR SEEK TO BENEFIT They thought they could help everyone. But they would have benefitted the rents and peasant rather than the landowners. They would have hurt the government sector. Physiocrats were never politically influential , they would have helped the industry because of free trade. H ECS3705 OCT/NOV 2015 7 HISTORY OF ECONOMIC THOUGHT HOW WAS THE PHYSIOCRATIC SCHOOL VALID, USEFUL, OR CORRECT IN ITS TIME??? French industry was devoted to producing “sterile goods”. In that sense the French industry was sterile. Laissez-fare would have encouraged real industry and production. Direct taxation focus was a reaction to the bewildering profusion of indirect taxes. WHICH TENETS OF THE PHYSIOCRATIC SCHOOL BECAME LASTING CONTRIBUTIONS Physiocrats were wrong in saying industry and trade were sterile. They also thought that th e”capitalist farmer” was the wave of the future. The tax on nobility land would have been good but it became impossible. They were correct at looking at the circular flow and national accounting.It founded economic sciences as separate from government, a natural order separate from government. Orginated the theory of tax shifting and tax incidence. FRANCOIS QUESNAY He made his fortune from his skill in medicine and surgery (physician). In 1750 he met Gournay and soon become interested in economics rather than in medicine.He noted that small firms were incapable of using the most productive methods. He favoured large farms managed by “entrepreneurs”. He saw economics as a physical organism, the circulation of goods and wealth in the economy was like blood circulating the body. Both conformed to the natural order. He belived that laws made by people should be harmony with natural laws. Tableau Economique: Judicial ANNE ROBERT JACQUES TURGOT: He had a theological degree ,but instead decided to enter the judicial and administrative service. Became finance minister in 1774. After less than two years he introduced antifeudal and antimercantilist measures in keeping with the physicratic ideas. Ran everything through the king instead of parliament. Early believer in the “iron law of wages”, he also understood the law of diminishing returns. And even how returns can first rise then later diminish. Much of what he did was incorporated into French revolution. ECS3705 OCT/NOV 2015 8 HISTORY OF ECONOMIC THOUGHT Chapter 4: David Hume & the Classical Forerunners Classical School History - Scientific revolution. - Industrial revolution. - Major tenets of the classical school 1. Minimal government involvement. 2. Self-interest economic behaviour. 3. Harmony of interest. 4. Importance of all economic resources and activities. 5. Economic laws. Who did the Classical school benefit or seek to benefit? It benefitted business people and respect was gained. How was Classical school valid, useful or correct? It was useful as competition was a growing phenomenon and less government involvement was needed as government was wasteful and corrupt. Which tenets of the classical school become lasting contributions? Tenets that become lasting contributions but not limited to: • Law of diminishing returns. • Law of comparative advantage. • Notion of consumer sovereignty. • Importance of capital accumulation and economic growth. • The market as a mechanism for reconciling the interests of individuals with those of the society. • ECS3705 OCT/NOV 2015 9 HISTORY OF ECONOMIC THOUGHT David Hume. Hume’s Price specie-flow mechanism and why it undermines the practicality of mercantilist policy A natural law, proceeding from the assumption of equilibrium. Once the economy moves away from the equilibrium, events will automatically occur to restore it. Hume disputed the concept of trading states with one gaining at the expense of the other. He believed in positive sum game. Hume’s reasoning to why international trade may not be a zero-sum game? He said it was a positive sum game, one in which the pay offs sum up to a positive number as opposed to zero-sum game. Hume’s reasoning as to why international trade will tend to melt away the difference between rich and poor nations? With international trade taking place the poor got a chance to improve their standard of living and moving them away from the poor position. Chapter 5: Adam Smith STUDY UNIT 2: ADAM SMITH STUDY OUTCOMES When studying this unit, you should aim at gaining knowledge and understanding of the following: • The main tenets of the Enlightenment worldview. • How both the Theory of Moral Sentiments and the Wealth of Nations suggest different ways of reconciling individual freedom with the achievement of the common good. • How the division of labour enhances productivity and ultimately leads to mechanisation and industrialisation. • How the size of the market limits the division of labour. • The meaning of Smith’s concept of self-interest and how that concept may be differentiated from pure selfishness or greed. • Why in modern capitalism competition is less likely to guide private interests towards the common good than in Smith’s time. • The two main reasons why, according to Smith, state interference is likely to be ineffective in furthering the common good. • The forms of state interference which Smith, nonetheless, advocates. • Smith’s argument in favour of free international trade. • Smith’s distinction between value in use and value in exchange. • The meaning of the water-diamond paradox, why it caused Smith to focus on value in exchange and ignore value in use (utility). ECS3705 OCT/NOV 2015 10 HISTORY OF ECONOMIC THOUGHT • The distinction between relative price and absolute nominal price, and the role it plays in Smith’s labour theory of exchange value. • The distinction between short-term market price and long-term natural price, and the role it plays in Smith’s labour theory of exchange value. • The sense in which Smith’s labour theory of exchange value is applicable to an “early and rude state of society”. • How, according to Smith (and Hume), the general price level is determined by the quantity of money in circulation. • The wages-fund theory, and why it is more applicable to an agricultural society than to a modern industrial society. • On what grounds Smith disagreed with the low wage doctrine of the mercantilists, and the “iron law of wages” of later classical authors. • Smith’s determinants of the wage structure in a free society. • Smith’s view of profit as the reward for risk-taking. • How the classical authors in general insufficiently distinguished between profit and interest. • Why profit rates, according to Smith, tend to be lower in rapidly advancing nations than in poor stagnating nations, which can be more than offset by the lower wages paid in poor nations. • After having studied Ricardo: how Smith’s theory of rent is similar to Ricardo’s. • How Smith’s anti-bullionist stance caused him to underestimate the contribution of money to wealth creation. • The grounds on which Smith opposed the rising national debt of his day. • The virtuous circle implicit in Smith’s ideas, according to which increased productivity and wealth creation leads to even greater increases in productivity and wealth creation. • Smith’s distinction between productive and unproductive labour Adam Smith (1723–1790) An influential Scottish economist who objected to the stifling mercantilist systems that were in place during the late eighteenth century. In response, Smith wrote the seminal Wealth of Nations (1776), a dissertation criticising mercantilism and describing the many merits of a free trade system. Tenets of the Enlightenment Worldview: Several key influences on Smith’s thinking 1. Period of Enlightenment • General Intellectual Climate • Intellectual Movement built on 2 pillars - People’s reasoning Ability - Concept of Natural Order Scientific revolution associated with Newton established order and harmony characterise the physical universe • Through systematic reasoning people discover physical laws and those that govern society • Enlightenment Thinkers: - Optimists: Believe that human thought and energy could produce unlimited progress 2. Influence of Physiocrats Quesnay & Targot • Against Mercantilism • Propose removal of trade barriers ECS3705 OCT/NOV 2015 11 HISTORY OF ECONOMIC THOUGHT • From them he drew • Theme of wealth: Consumable goods annually reproduced by labour of society • Minimal interference in economy from government • Circular process of production and distribution 3. Influence of Francis Hutcheson • Instructor @ Glasgow College - People will discover themselves what is ethically good - the will of God - by discovering actions that serve the good of humankind 4. David Hume • Letters and conversations contributed to intellectual development & economic ideas Fundamental principles of Enlightenment: • Reason: Truth could be discovered through reason or logical thinking • Nature: That what was natural was also good and reasonable • Happiness: Rejected the medieval idea that people should find joy in the hereafter and urged people to find well-being here on earth • Progress: Society and humankind could improve • Liberty: People had the right to freedom -like freedom of speech and religion- and that these freedoms should be guaranteed by people's governments. They also believed that government should be for people, not the other way around. John Locke wrote, "Man is born free, and everywhere he is in chains.” Theory of Moral Sentiment & Wealth of Nations: Moral Sentiments Moral forces that restrain selfishness and bind people together in workable society. Sympathy overcomes selfishness and interest us in fortune of others and make their happiness necessary to us. This is true even though one does not derive anything from someone else happiness except the pleasure of seeing it. Grief and joy arouse similar emotions in ourselves. By placing one in another persons’s position our imagination can evoke sympathy for a situation of which the other person is unaware. If someone go mad they are insensible of any misery. Anguish that stems from observing them comes from our own powers of reason and judgement. This is sympathy. Smith differentiate between unsocial and social passion. • Unsocial: hatred & resentment Divide sympathy between person who feel them and person who is the object of them as the interest of the 2 individuals are contradictory • Social: generosity, humanity, kindness, compassion, mutual friendship and esteem Sympathy with person who feels passions coincides exactly with their concern for person who is object of them. Always have strongest sympathy for benevolent passions as they appear agreeable to us. People identify more with joy than sorrow and therefore we parade our riches and hide our poverty. Toil and bustle of world undertaken to gratify our vanity and not to supply necessities. We want to be noticed with sympathy and approval. The rich glory in their riches because they get the attention of the world and the poor are ashamed of their poverty which leaves them in obscurity. Smith states that people can only exist in society where they are exposed to mutual injuries and need one another’s assistance. When the necessary assistance is reciprocally offered out of love, gratitude, friendship and esteem the society flourish and is happy. If mutual love and affection are absent the society will continue to exist because of utility even though it might be less happy and agreeable. It cannot exist among those who wants to hurt and injure each other. Therefore a system of justice is required. ECS3705 OCT/NOV 2015 12 HISTORY OF ECONOMIC THOUGHT Smith then consider the problem of our own selfishness and how it can be curbed and controlled. Our morals prescribe rules of conduct that restrain our actions of selfishness. Rules can be seen as commands and laws of deity. If we violate God’s rules we will be punished by torments of inward shame and self condemnation. If we obey God’s wishes we will be rewarded with tranquility of mind, contentment and self satisfaction. Therefore God promote our happiness. Smith states that the rich tend to save and reinvest and therefore consume little more than the workers. They unintentionally share the produce of improvements with the poor. Relevance Today: Society without people caring for one another will not be very nice but will survive. However a society without law and order will destroy itself. Wealth of Nations Assumes existence of a just society and show how the individual is guided and limited by economic forces. Division of labour Smith states that the greatest improvements in the productive power of labour lie in the division of labour. Labour specialisation occurs in two forms. • Product Specialisation bake bread, brew beer, make pins • Operation Specialisation specialise in parts of production to produce product When Smith refers to labour specialisation her mainly refers to operations specialisation. Even in the production of very simple products, division of labour always increases productivity exponentially. (Example of pin factory) Smith offers three reasons for this increase in productivity. • Division of labour creates specialised knowledge of a particular trade or task This, in turn, makes the labourers engaged in this task more dexterous, and therefore more productive. • Division of labor saves the labourer time In focusing on one task, rather than passing from one task to another, a process that requires him to use different tools and materials, he is able to maximise his time, thus increasing productivity. • Technological innovation that ultimately makes that task easier The amount of time spent by labourers on an isolated task leads to innovation in the methods and tools employed in the task. Therefore, increased division of the labour involved in the production of a particular product leads to increased productivity. By increasing productivity, the division of labour also increases the opulence of a particular society, increasing the standard of living even of the most poor. Division of labour also means that many people are involved in the production of each and every manufactured product. This is a testament to the interconnectedness not only of the labourers employed in manufacturing, but of all the branches of commerce. Mercantilists: How exchange of goods could add to nations well-being Physiocrats: Focus on agricultural output Smith: Increase output by dividing labour ECS3705 OCT/NOV 2015 13 HISTORY OF ECONOMIC THOUGHT Division of labour enhance productivity mechanisation & industrialisation: Labour specialisation creates possibilities for mechanisation and, as such, paves the way for industrialisation. Labour (operation) specialisation facilitates mechanisation, because it divides up the production process into a large number of repetitive, standardised productive handlings, which makes it possible for machines to take over these repetitive handlings. The enormous productivity gains from industrialisation and mechanisation, which Smith only partly anticipated, can thus indirectly be attributed to Smithian labour specialisation too. The scope for labour specialisation, and thus for industrialisation too, is limited by the size of the market. Harmony of interest & limited Government: Participants in the economy tend to pursue their own personal interests. Consumers looks for lowest price for good, given its quality. Workers tries to find highest pay, given nonage aspects of the job. There is a natural order in the seemingly economic chaos. There is an invisible hand that channels self-interested behaviour in such a way that the social good emerges. Invisible hand: A term used by Adam Smith to describe his belief that individuals seeking their economic self-interest actually benefit society more than they would if they tried to benefit society directly. Key to understanding the invisible hand is competition. Action of each producer who attempt to garner profit is restrained by the other producers also attempting to make money. Competition drives down prices and by doing so reduce profit for the seller. Initially when there is only one seller, the huge profits attracts new competitors which increase supply and reduce profit. Employers compete with one another for best workers, workers compete for best jobs and consumers compete for the right to consume products. Resources gets allocated to to their highest valued uses economic efficiency prevail. Business persons save and invest (out of self-interest), capital accumulates and economy grow. Therefore the pursuit of self-interest, restrained by competition tend to produce Smith’s social good: Maximum Output & Economic Growth. This harmony implies that Government intrusion is unneeded and undesirable. According to Smith governments are wasteful, corrupt, inefficient and the granters of monopoly privileges to the detriment of society as a whole. His distrust of the government is further reflected in his references to his own government which was at the time thought of as one of the honest and efficient ones in the world. He extended his belief in the harmony of interest and laissez-faire to international trade. He directly attack mercantilism and argued that the government should not interfere in international trade. Nations like individuals, should specialise in producing goods in which they have an advantage and trade for goods which the other nations have an advantage. If a foreign country can supply us with commodity cheaper than what we can make it, it is better to buy it. ECS3705 OCT/NOV 2015 14 HISTORY OF ECONOMIC THOUGHT Foreign trade can also promote division of labour by overcoming narrowness of home market. Exports remove surplus products for which there is no demand and bring back products for which there is a demand. He condemned subsidies on exports. Limited role for government: • Protect society from foreign attack • Establish administration of justice • Erect and maintain public works & institutions that private entrepreneurs cannot undertake profitably Smith recommends taxation to fund the government activities. Maxims for good taxes: • Taxes should be proportional to the revenue • Taxes should be predictable and uniform • Taxes should be levied at time and in manner most convenient to contributor • Taxes should be collected at minimum cost to government Government intervention through coercive laws does not further the common good for two main reasons. • People know their own interest better than government officials do • Government officials tend to waste public resources Size of the market & division of labour: The size of the market limits the scope for labour specialisation, because increased specialisation, whether in product or in productive operation, always involves dividing up the market into smaller sub-markets – one for each specialised product or productive operation. In short: the division of labour implies a division of the market too. As a result, only when the market is initially large enough can its division into these sub-markets keep these submarkets large enough for a specialist to make a living. That is why the growth of a market, say of the population of a town, leads to the establishment of more specialised shops in that town. When a town is really small, only a single general store can make a living there. As the town grows, however, a specialised bakery, butchery and clothing shop may be able to establish themselves, offering better quality, a wider selection and better prices than the general store previously could. That general store, therefore, goes out of business unless it specialises itself. As the town grows even further, there may even be space for a watchmaker, a tobacco shop and a dentist. And so the process goes on. Labour specialisation in itself increases the size of the market: by being more productive and lowering the cost of production and thus the price of goods, more people can afford these goods, which in itself enlarges the market for these goods. This effect is, however, never quite so strong that the size of the market never limits the possibilities for labour specialisation. Given that the size of the market limits labour specialisation and industrialisation, any measure which increases the size of the market aids the scope for labour specialisation and thus for greater prosperity in general. Three ways in which markets can expand spring to mind. • Improvements in transport & communication technology increase the size of markets. Ability of potential demanders and suppliers to communicate with each other and transport goods (and money) to each other defines a market . As transport and communication keep on getting faster and cheaper, the market which any given producer with access to that technology can reach keeps on growing too, to the point where the whole world has now just about become one huge market for everyone. ECS3705 OCT/NOV 2015 15 HISTORY OF ECONOMIC THOUGHT On the downside, if transport and communication deteriorate through increased cost, slowness, unsafety or other forms of unreliability, the effects on the achievable degree of productivity through reduced specialisation and industrialisation will be equally significant. In some ways, modern industrialised economies have thus become more vulnerable. If the road, railway, air traffic and communication infrastructure deteriorate, farmers could no longer reliably and cheaply get their crops to their market, information about available qualities and prices could no longer be spread among potential market participants quickly and cheaply, producers could no longer reach their market except for those who live in close proximity to their factory, and so on. When markets shrink in this way, possibilities for labour specialisation decrease and productivity falls. Relevance today: it is imperative that we take good care of our transport and communications infrastructure. • Markets can grow by removing restrictions on international trade. Smith’s advocacy of free international trade is based on precisely this point. Smith thereby takes it for granted that countries always have some area in which to develop a competitive advantage vis- à-vis other countries. If this is not the case, a country will not necessarily benefit by free trade. The free trade argument then points out that a country, when exposed to the winds of competition, will eventually develop competitive strength in some area. The current trade policy of the South African government is roughly based on this very idea: the economy is gradually exposed to international competition by reducing its legacy of import protection and export subsidisation (partly because international trade agreements force the government to do so), in the hope that the South African economy will react to this greater competition by eventually developing its own strengths. There are signs that this is indeed happening, although some sectors, like the textile industry, have been seriously hurt by foreign competition, especially from China. • The market for an individual firm can also expand by reducing the number of competing firms. Such a reduction is often a more or less spontaneous by-product of the process of advancing mechanisation: the firms which are quickest to apply the latest, most efficient machinery are typically also the ones which can produce at the lowest cost. By offering the goods at a lower price, they obtain a larger share of the market often at the expense of a multitude of smaller, less progressive operators, who are then forced out of business. That is partly why oligopoly rather than perfect competition is the typical market form in the modern industrialised world, in spite of the fact that markets have kept on growing due to the falling cost and increasing efficiency of transport and communication. Highly mechanised firms can only exist by virtue of large scale production, which means that, for a given size of the total market, there may only be space for a handful of firms – if we wish firms to produce at the lowest possible price. It seems that the loss of competition in markets is, to some extent, the inevitable downside of the economies of scale and the higher standard of living made possible by mechanisation and mass production. Smith assigns an important role to competition as the invisible hand which spontaneously guides individual interests towards the common good. In Smith’s day, however, industrialisation had not progressed very far in Britain. There were hardly any big factories. Most production was still handicraft production performed by artisans in small family enterprises organised as unincorporated proprietorships or partnerships. Under these ECS3705 OCT/NOV 2015 16 HISTORY OF ECONOMIC THOUGHT circumstances, there was indeed a good chance that competition was vigorous in most markets. Modern capitalism with its far advanced industrialisation dominated by corporate firms may have had huge advantages in terms of raised productivity, but it has not been conducive to competitive markets. Most markets in modern capitalism are oligopolistic rather than perfectly competitive. Hence Smith’s invisible hand has a much reduced chance of success in modern capitalism than in Smith’s own day. Both moral sentiments & wealth of nations reconcile the individual with social interest through the principle of the invisible hand, or natural harmony, and the principle of natural liberty of the individual, or the right to justice. In moral sentiments sympathy and benevolence restrain selfishness; in Wealth of nations competition channels economic self-interest toward the social good. Self-Interest: Self-interest is the driving force behind free-enterprise capitalism: “It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest.” This self-interest is supposed to be kept in check by competition. If your butcher charges unreasonably high prices for his meat, competition gives you the opportunity to go to another butcher. Butchers are thus forced, by the threat of losing customers to competing butchers, to be reasonable in the pricing of their meat. That is how their self-interest is kept in check by competition and how the “invisible hand” of competition, analogous to Newton’s law of gravity in a system of natural harmony, automatically guides self-interest towards the common good. Competition (understood as the availability of alternative suppliers or demanders) as a protection against social victimisation is a particular incidence of a more general principle. That general principle can formally be stated as follows: disassociation provides the best protection against possible harm resulting from association. For example, if I join an association like a trade union, a business agreement, a business partnership, a church or a sports club, but my associates turn out to be unpleasant, unreliable or even positively harmful and dangerous, I protect myself from any further harm by simply disassociating myself from them: leave that trade unions, business agreement, business partnership, church or sports club and join another. It is for that reason that both the freedom of association (the freedom to cooperate with others for mutual benefit) and the freedom of disassociation (the freedom to terminate that cooperation with others when it is perceived to be no longer beneficial) are necessary to balance the potential benefit and the potential harm of human cooperation. When the freedom to disassociate from others is absent, I get locked into association with them (no exit). People gain power over me, which creates scope for abuse. Such is also the power of monopoly, that is, the lack of competition (no exit). While Smith’s argument thus presented contains important truths, it is open to a number of misunderstandings. We will spend some time expelling some of these misunderstandings, which are still widespread in our day.