Monday, January 01, 2007

Adam Smith On An Information Asymmetry

I think I once read Michael Perelman pointing out this parallel between Smith and Stiglitz:
"...In a country, such as Great Britain, where money is lent to government at three per cent. and to private people upon good security at four, and four and a half, the present legal rate, five per cent., is perhaps as proper as any.

The legal rate, it is to be observed, though it ought to be somewhat above, ought not to be too much above the lowest market rate. If the legal rate of interest in Great Britain, for example, was fixed so high as eight or ten per cent., the greater part of the money which was to be lent, would be lent to prodigals and projectors, who alone would be willing to give this high interest. Sober people, who will give for the use of money no more than a part of what they are likely to make by the use of it, would not venture into the competition. A great part of the capital of the country would thus be kept out of the hands which were most likely to make a profitable and advantageous use of it, and thrown into the those which were most likely to waste and destroy it. Where the legal rate of interest, on the contrary, is fixed but a very little above the lowest market rate, sober people are universally preferred as borrowers to prodigals and projectors. The person who lends money gets nearly as much interest from the former as he dares to take from the latter, and his money is much safer in the hands of the one set of people, then in those of the other. A great part of the capital of the country is thus thrown into the hands in which it is most likely to be employed with advantage." -- Adam Smith, Wealth of Nations, Book II, Chapter IV
Gavin Kennedy titles his blog, "Adam Smith's Lost Legacy". So he must be only joking in this post when he whines about Stiglitz advocating government action to counter imperfections in information. (Kennedy also goes off, as right-wingers tend to do, with strawpersons and irrelevancies about the former Soviet Union.)

1 comment:

Cahal said...

Sorry I know this is an old post, but it caught my eye because of the similarity between Keynes and Smith's views on the rate of interest. Keynes would have argued the reason for the current crisis was that long term borrowing rates were too high, forcing people into riskier and more speculative endeavours.

If you haven't read it, I'd recommend Geoff Tily's 'Keynes Betrayed' for more on this.