Leithner Letter No. 31
26 July 2002

In every civilised society there have been always two different schemes or systems of morality current at the same time; of which the one may be called the strict or austere; and the other liberal, or, if you will, the loose system. The former is generally admired and revered by the common people, and the latter is commonly more esteemed and adopted by what are called people of fashion. The degree of disapprobation with which we ought to mark the vices of levity, the vices which are apt to arise from great prosperity ... seems to constitute the principal distinction between those two opposite schemes or systems. ... The wiser and better sort of the common people, therefore, have always the utmost abhorrence and detestation of such excesses, which their experience tells them are so immediately fatal to people of their condition.

Adam Smith, The Theory of Moral Sentiments (1759)

Every man, as long as he does not violate the laws of justice, [should be] left perfectly free to pursue his own interest his own way, and to bring both his industry and capital into competition with those of any other man.

Adam Smith, The Wealth of Nations (1776)

Quis Custodiet Ipsos Custodies?

In Anglo-American countries and perhaps other lands, business schools suffer from two critical and largely undiagnosed shortcomings. Like certain accounting and managerial practices which have recently and belatedly attracted attention, key assumptions underlying business education were tolerated (indeed, celebrated) during the manias of the 1980s and 1990s. Also like those accounting and managerial practices, these educational assumptions have distinctly unpleasant consequences for companies’ owners and employees. Perhaps one day these invidious consequences will be recognised.

The first shortcoming is that a business degree per se provides neither a better career trajectory nor a higher salary. According to Jeffrey Pfeffer, a professor of business at Stanford University who has concluded an analysis of 40 years of research about the economic value of the Master of Business Administration degree (reported in The Chicago Sun-Times on 5 July), this is partly because little that is taught in business schools prepares students for the realities of contemporary commerce. B-students, in effect, are neither purchasing nor receiving education and training; instead, they are acquiring a “brand” to place on their résumés and the opportunity to associate with like-minded people.

Prof Pfeffer (whose paper, co-written with a Stanford business student, will appear shortly in the journal Academy of Management Learning and Education) says “the simplest advice is that if you don’t get into a leading business school, the economic value of the degree is really quite limited. Obviously, if you get admitted to Harvard or Stanford or another élite school, the very fact of your admission is going to increase your worth in the job market. But there is not much evidence the actual education does very much.”

Pfeffer had long been sceptical of the economic value of the MBA. He became convinced after a group of consulting firms and investment banks compared the performance of B-school graduates to those trained in two- or three-week programs that teach new employees the basics of business. They found that the non-MBA benighted did no worse, and in some cases rather better, than their MBA-anointed peers. They also found that more business education did not beget higher rank or salary. The implication is startling: “you have to question what goes on in the two years it takes to get an MBA if someone can virtually be equivalent in two or three weeks. What that suggests to me is that if you take a smart person, and give them [sic] a relatively short course, a mini-MBA if you will, they basically do as well as the MBAs.”

The first undiagnosed problem with B-schools is that much of the present curriculum (which is quite comparable from one institution to the next) is stuffed with irrelevancies and woolly and esoteric nonsense. The second and closely related problem is that truly valuable ideas embodied in applied works of immediate significance, and philosophical and moral treatises of enduring importance, have, consciously or otherwise, been banished from virtually all business schools (and universities more generally).

Forgotten Classics Can Teach Us Much

If a sound business education in an Anglo-American country had to rely upon a single book (assuming that it can be derived from books), then Benjamin Graham’s Security Analysis (1934) and Adam Smith’s An Inquiry into the Nature and Causes of the Wealth of Nations (1776) would be strong contenders. Perhaps the strongest candidate would be the King James Bible (1611). With some notable exceptions (such as Murray N. Rothbard, Man, Economy, and State, Ludwig von Mises Institute, 1962, 1993, ISBN: 0945466323; and Thomas Sowell, Knowledge and Decisions, Basic Books, 1996, ISBN 0465037380), surprisingly little written since 1950 builds dramatically upon what was once known about business but thereafter apparently forgotten.

Consider the second of these nominations. Adam Smith, first and foremost a moral philosopher, was (as an academic but not as Scotland’s Commissioner of Customs) nonetheless far more “entrepreneurial” and “customer oriented” than the largely tenured and mostly self-absorbed academics at today’s MBA factories. Smith’s dislike, not so much of Oxford University (where he studied from 1740 to 1746) but of those systems of education that were financed by endowments and whose instructors received a salary independent of their efforts, was fully elaborated in The Wealth of Nations. “The endowments of schools and colleges have diminished more or less the necessity of application in the teachers. Their subsistence, so far as it arises from their salaries, is evidently derived from a fund altogether independent of their success and reputation in their particular professions.”

Exactly the same might be said of many of today’s funds managers. Smith went further: the discipline of colleges and universities was generally contrived, not for the benefit of the students but for the interest “or more properly speaking the ease of the masters.” Such was the dons’ comfortable repose, Smith asserted in a passage that could have been written this morning, that universities had become “sanctuaries in which exploded systems and obsolete prejudices found shelter and protection, after they had been hunted out of every corner of the world.” Prominent among these obsolete prejudices is the mantra that research conducted at universities creates wealth. The reality, as Terence Kealey (The Economic Laws of Scientific Research, Palgrave Macmillan, 1997, ISBN: 0312173067) demonstrates, is quite the contrary: university R&D consumes capital and dissipates wealth. Capital, riches and prosperity are created by individuals and businesses and then channeled via taxes and subsidies towards universities.

More generally, and far more than most of today’s journalists, academics, investors, consumers and taxpayers, Adam Smith held subtle, thoroughly considered – and, it seems to me, acutely perceptive – views about people, businesses and governments. Like most of today’s journalists and their readers, his opinion of businessmen was decidedly jaundiced. (For equally measured but unreservedly positive assessments, see Michael Novak, Business As a Calling: Work and the Examined Life, The Free Press, 1996, ISBN 0684827484; and James Chesher and Tibor Machan, The Business of Commerce: Examining an Honorable Profession, Hoover Institution Press, 1999, ISBN: 0817996222). Smith famously observed in The Wealth of Nations that “people of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public or some contrivance to raise prices.” Further (and bearing in mind that he wrote before the rise of the nation-state and welfare-warfare state), whilst “the violence and injustice of the rulers of mankind is an ancient evil” it is not as bad as “the mean rapacity, the monopolising spirit of merchants and manufacturers.”

For these reasons, and also because they are “silent with regard to the pernicious effects of their own gains,” businessmen “neither are, nor ought to be, the rulers of mankind.” Hence Smith unreservedly despised Holland, a leading commercial nation of the seventeenth and eighteenth centuries, because it was governed by plutocrats; and he denounced the Dutch tycoons’ approach to commerce and politics (which regarded the one as a variant of the other) as “monopolistic, imperialistic, oppressive, corrupt and obnoxious.”

Smith therefore favoured the independence of the American colonies (whose Declaration of Independence was transmitted to George III in the same year that The Wealth of Nations was published). “To propose that Great Britain should voluntarily give up all authority over her colonies ... would be to propose such a measure as never was, and never will be adopted, by any nation of the world. ... If it was adopted, however, Great Britain would not only be immediately freed from the whole annual expense of the peace establishment of the colonies, but might settle with them such a treaty of commerce as would effectually secure to her a free trade, more advantageous to the great body of the people, though less so to the merchants, than the monopoly which she at present enjoys. By thus parting good friends, the natural affection of the colonies to the mother country which, perhaps, our late dissensions have well nigh extinguished, would quickly revive.”

Company directors and shareholders – indeed, the very notion of a limited liability, joint-stock company – also failed to impress Smith. He stated in The Wealth of Nations that “the greater part of those proprietors [i.e., shareholders] seldom pretend to understand anything of the business of the company, and when the spirit of faction happens not to prevail among them, give themselves no trouble about it, but receive contentedly such half-yearly or yearly dividend as the directors think proper to make to them. This total exemption from trouble and from risk, beyond a limited sum, encourages many people to become adventurers in joint stock companies, who would, upon no account, hazard their fortunes in any private copartnery.”

Smith added that “being the managers of other people’s money than of their own, it cannot well be expected that [company directors] should watch over it with the same anxious vigilance with which partners in a private copartnery frequently watch over their own …Negligence and profusion therefore must prevail more or less in the management of such a company. ... Without an exclusive privilege ... [corporations] have commonly mismanaged [their] trade. With an exclusive privilege they have both mismanaged and confined it.” Almost a quarter of a millennium ago, Smith’s recognition that the interests of owners and managers seldom coincide, that institutional arrangements affect individuals’ incentives and behaviour – and that many private sector managers are profligate clowns – was more perceptive than the received wisdom of many of today’s management academics and consultants (see also Frédéric Sautet, An Entrepreneurial Theory of the Firm, Routledge, 2000, ISBN: 0415229774).

Smith also gave governments, civil servants and their actions vigorous and extended sprays. In general, “there is no art which one government sooner learns of another, than that of draining money from the pockets of the people.” With respect to the state’s finances, “when national debt levels have once been accumulated to a certain degree, there is scarce, I believe, a single instance of their having been fairly and completely paid. The liberation of the public revenue, if it has ever been brought about at all, has always been brought about by a bankruptcy; sometimes by an avowed one, but always by a real one, though frequently by pretended payment.” And with respect to public policy, “a famine has never arisen from any other cause but the violence of government attempting, by improper means, to remedy the inconveniences of a dearth.”

Finally, in The Theory of Moral Sentiments Smith’s fearful attitude towards politicians and civil servants is expressed plainly: “in all governments accordingly, even in monarchies, the highest offices are generally possessed, and the whole detail of the administration conducted, by men who were educated in the middle and inferior ranks of life, who have been carried forward by their own industry and abilities, though loaded with jealousy, and opposed by the resentment of all those who were born their superiors, and to whom the great, after having regarded them, first with contempt and afterwards with envy, are at last contented to truckle with the same abject meanness which they desire that the rest of mankind should behave to themselves.”

The Morals of Markets

It is the tried and tested, self-made, economically independent, critically thinking and therefore morally impregnable individual who emerges as the hero of Smith’s analysis and of the philosophical framework derived from it (see also David Gordon and Jeremy Shearmur, H.B. Acton: The Morals of Markets and Related Essays, The Liberty Fund, 1993, ISBN: 0865971064; and Murray N. Rothbard, The Ethics of Liberty, New York University Press, 2002 ISBN: 0814775594. According to Smith, “in the midst of all the exactions of government ... capital has been silently and gradually accumulated by the private frugality and good conduct of individuals, by their universal, continual, and uninterrupted effort to better their own condition. It is this effort, protected by law and allowed by liberty to exert itself in the manner that is most advantageous, which has maintained the progress of England towards opulence and improvement in almost all former times, and which, it is to be hoped, will do so in all future times.”

Smith regarded selfishness and greed as vices and industriousness and enlightened self-interest as virtues. (Ronald Reagan summarised in three words the gist of enlightened self-interest: “trust, but verify”). The free market, i.e., the voluntary exchange of goods, services, labour and capital by buyers and sellers who rely not upon force but upon the principle of caveat emptor and the common law of contract, fraud and tort, represents a “system of natural liberty” whose processes, checks and balances constrain (but, alas, hardly banish) greed and selfishness and encourage plain-dealing and generosity.

In Smith’s system of natural liberty, individuals are not innately virtuous – indeed, the contrary may be closer to the mark. Rather, it is the dynamics of voluntary and lightly regulated exchange that encourage individuals, perhaps despite themselves, to consider others. “Man has almost constant occasion for the help of his brethren, and it is in vain for him to expect it from their benevolence only. He will be more likely to prevail if he can interest their self-love in his favour, and show them that it is for their own advantage to do for him what he requires of them. ... 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. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages.”

Smith’s idea of the “invisible hand” – that is, of a social mechanism that achieves benign consequences but does not require that individuals have benign intentions – is perhaps the most fundamental and enduring insight to emerge from the Scots Enlightenment. The much stronger contention, that doing good might actually require that individuals suspend their ordinary moral faculties, has, since Bernard Mandeville (The Fable of the Bees: Or Private Vices, Publick Benefits, The Liberty Fund, 1732, 1988, ISBN: 0865970750) first proposed it, been far more controversial. From both contentions stems the view by classical liberal philosophers and their adherents of human capabilities as severely limited; of social possibilities consisting not in “solutions” but in imperfect trade-offs that leave many “unmet needs;” of justice as a clear and inviolate set of processes rather than of particular results; of knowledge that comprises the fragmentary and unarticulated experiences of the many; of incentives rather than intentions; and of incremental decisions that convey the experiences and revealed preferences of the many (Thomas Sowell, A Conflict of Visions: Ideological Origins of Political Struggles, Basic Books, 2002, ISBN: 0465081428).

Hence their attempts to discover, understand and protect the social arrangements with this “invisible hand” characteristic, and their advocacy of property rights and limited government, the rule of law and voluntary transactions.

According to Smith, the conduct of commercial transactions under these conditions encourages people to inform themselves and to correct the errors and miscalculations that they will inevitably commit; thus industry, frugality, prudence, patience, fortitude and flexibility are key abilities required to buy and sell successfully, and are rewarded in a laissez-faire commercial society. The fear of losing reputation and customers restrains but hardly eliminates fraud, negligence and self-indulgence; and the desire to gain a long-run reputation for reliability (and hence to attract repeat customers), is a necessary but not sufficient condition for honesty, thoroughness, timeliness and the delay and moderation of pleasure. In Smith’s system of natural liberty, then, there exist both trickery and social arrangements to detect and punish it – and thus to deter its recurrence.

Red-Blooded Capitalism, Please

As Smith and his descendants in late-Georgian and early- and mid-Victorian Britain showed, the open, orderly and minimally regulated commercial society contrasts sharply and favourably to mercantilist (i.e., political) societies that place a premium upon status, ascribed characteristics and privilege. Generations of migrants who have endured risks and hardships to move from mercantilist lands to America, Australia and other such commercial lands seem to agree. Alas, the Enlightenment ideals of independence and self-employment, limited government and private property, the rule of law and free markets seem either to be alien to or derided by today’s B-school faculty and big business more generally. As Alan Kohler has noted (The Australian Financial Review 5 February), “very few people actually preach capitalism in public, especially CEOs. Mostly they preach its antidotes and constraints: regulation, triple bottom line, corporate governance, auditing, checks and balance, corporate citizenship, leadership in the modern age, transparency.”

This is perhaps because, as Smith stated in yet another passage with contemporary relevance in the wake of the Enron, WorldCom, Harris Scarfe, HIH and other débâcles, and whose premises are, “in the courts of princes, in the drawing-rooms of the great, where success and preferment depend, not upon the esteem of intelligent and well-informed equals, but upon the fanciful and foolish favour of ignorant, presumptuous and proud superiors; flattery and falsehood too often prevail over merit and abilities. ... This disposition to admire, and almost to worship the rich and the powerful, and to despise or, at least, to neglect, persons of poor and mean condition ... is ... the great and most universal cause of the corruption of our moral sentiments.”

Accordingly, and bearing in mind Smith’s distaste for the rule of plutocrats, “England [and Australia and most places other than Hong Kong] ... has never been blessed with a very parsimonious government, so parsimony has at no time been the [characteristic] virtue of its inhabitants. It is the highest impertinence and presumption, therefore, in kings and ministers, to pretend to watch over the economy of private people, and to restrain their expense by sumptuary laws ... [Kings and ministers] are themselves always, and without any exception, the greatest spendthrifts in the society. Let them look well after their own expense, and they may safely trust private people with theirs. If their own extravagance does not ruin the state, that of their subjects never will.”

Chris Leithner


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