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Moral Issues of Capitalism in Adam Smith's Philosophy and the Birth of

Neoclassical Economics

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DOI: 10.13140/RG.2.2.17233.15202

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 Moral Issues of Capitalism in Adam Smith's Philosophy
and the Birth of Neoclassical Economics

Dr. József Móczár1

Abstract

We live in an unstable world, while all citizens of every nation want to live in
peace and wealth. In contrast, social and wealth inequalities are growing, most
people live in poverty. Economists apologize but bypass the problem. The
politicians, governments, and the world’s leading businessmen with their
psychological egoism ignore the fact that Adam Smith’s moral philosophy and
economics did not outline such capitalism 250 years ago. This study analyzes the
moral-philosophical issues of the good life on the basis of Adam Smith’s Theory
of Moral Sentiments (1759) and Ryan P. Hanley’s (2019) book, which focuses
excellently on the issue, and concluded that the virtues required have not changed
too much in our days. This finding was confirmed by Angus Deaton and Daniel
Kahneman (2010), winners of the Swedish central bank prize in memory of Alfred
Nobel, who arrived at similar results in their research. Smith derived the necessary
virtues from ancient philosophy and religion, and his visions of faith and moral
categories foresaw the need for further development in the modern world. He
accepted the teachings of religion only through his moral glasses. In the Wealth
of Nations (1776), however, Smith discussed liberal capitalism on the basis of
self-interest and utilitarian ethics, that is, as it is proven by the author, he broke
with his former moral-philosophical virtues. The main finding of this paper as
follows: the economic policy may change, but human nature does not, just like
Adam Smith’s moral admonition, nor the classical economics of welfare
capitalism. The author aims to present a standard modern explanation of “the
greatest happiness for most people” based on the work of Adam Smith; highlights
the hitherto undiscovered source and birth of neoclassical economics and its
inadequacy in the study of contemporary social and economic issues.

Journal of Economic Literature (JEL) codes: B12, B13, B21, B52

Keywords: philosophy of morality and religion, sympathy, self-interest, laissez
faire, utilitarianism, neoclassical economics.

1
Professor of Mathematical Economics, Corvinus University of Budapest.
E-Mail address: jozsef.moczar@uni-corvinus.hu
1
 1. Introduction
Dr. Ryan Patrick Hanley, professor of political science at Boston College, author
of several outstanding books on the life and moral philosophy of Adam Smith
(Hanley, 2009a, 2009b, 2016, 2017), he has surprised the scientific world with a
new book, Hanley (2019), in which he answered the 'how to live a better life'
question by using the works of Adam Smith (1759, 1776). The author uses a
special matrix approach to answer the question, which means that in Smith's book
(1759) he jumps back and forth between chapters and quotes essential moral
virtues, with which he rearranges and interprets it in a new structure. He explains
Smith's moral philosophical research, supplemented by his own remarks, as
required by the strict logic order of the components of good life.

So the book is not easy to read, but it's worth it to everyone to chew through the
book, for he/she will become acquainted with the moral philosophical issues of
life on the 'dawn' of capitalism, and will realize that human nature has not changed
much since Adam Smith. This has been confirmed by two Nobel Prize winners in
economics, Angus Deaton and Daniel Kahneman (Kahneman and Deaton, 2010),
who, independently of the results of Professor Hanley and Adam Smith, tested
similar questions and came to numerical conclusions by their partial analysis of
questionnaire data from the US and 150 other countries, more specifically, they
analyzed responses to the Gallup-Healthways Well-Being Index (GHWBI).
However, life assessment was partially tested for emotional well-being, emotional
happiness, financial security, failure, alienation, and stress, using multiple
regression models in their pragmatic research.

What are the reasons, which make it worthwhile to study Smith's nearly 250-year-
old moral philosophy in the hope of 'living a better life' in the 21st century?

Traditionally, Smith had two sources to study the principles of a good life: religion
and philosophy. In the former, there are many meaningful hints for 'living a wise
life’, whereas in the latter the philosophers of ancient Greece and ancient Rome
meditate about the good and the bad lifestyle.2 While many of us still live by
2
Its focus was on classical Greco-Christian ethics, which was developed in the 15th – 18th
centuries, the schools of Naples and Milan preached in their civic humanist teachings. [Cf.
Zamagni-Bruni (2017)] .. "(…) Economics was primarily an Italian science until the last quarter
of the eighteenth century." (Schumpeter, 1955, 162). These schools in the 18th century, due to
the economic dominance of England in the 19th century, lost their influence on the global
development of economics, and the classical economists took over many perceptions of Italian
scholastics without reference: for example, the value of a good is determined by its usefulness
(St. Bernard of Siena).
2
religious beliefs, our modern world is no longer characterized by a religious
worldview. Many people read Plato, Socrates, and Stoicism, but modern science
questioned their teachings on a metaphysical basis. That is, we need resources that
shape our world through faith and moral categories. This is the first reason,
according to Hanley, that Smith's (1759) work is still a useful source. Smith
learned a lot from the deep wells of antiquity and Christianity for his moral
philosophy, but he recognized the need to further develop it for the modern worlds
that follow his era.

In our world, one of the prerequisites for a good life is happiness, which also
requires some wealth (income) and luck. The most significant finding in
Kahneman and Deaton's research (Kahneman-Deaton, 2010) is that: people with
$ 75,000 in household income are about as happy as anyone else because higher
income does not increase the feeling of happiness. But happiness is now self-
centered, less suited to the happiness and well-being of others. In a capitalist
society, that is, in a commercial society, as Smith called it, considerable material
wealth also entails significant moral costs. These costs include phenomena
dangerous to social trust and political order, selfishness, alienation, etc. which
jeopardize our efforts to create a good life.3 As a second reason why it is worth
studying Smith (1759), we can understand how commercial (capitalist) society
creates these benefits and moral challenges. As an enlightened philosopher, he has
interpreted the challenges of market society by ethical evaluation, but he has also
responded to the challenges such that are the preconditions for a good life in our
modern capitalist world.

The third reason is that in Smith's moral philosophical works, he considered living
a good life to be the privilege of a distinguished and praiseworthy, wise, and
virtuous man; that was a message to mankind at all ages. Today, Smith is primarily
known for the "invisible hand" metaphor, which he calls the "system of natural
freedom." This system is an extremely complex machine and Smith shows how
to aggregate the discrete activities of each component to understand how the
system works as a whole. Hanley sees Smith as a genius economist and discovers
the same system in his moral philosophy, primarily in his philosophy of life,
which I will discuss in detail below.

3
Kahneman and Deaton (2010) talk about poverty and emotional costs, such as alienation,
failure, and stress, caused by the lack of goals.
3
Finally, the fourth reason is to learn about Adam Smith’s laissez-faire capitalism,
his economics founded on Bentham’s moral philosophy, and the famous water-
diamond paradox that results in the development of various schools of economics,
including his path to the neoclassical trend. The latter sheds new light on
neoclassical economics, which has now become a primary school but is
completely unsuitable for studying today’s complex social and economic
processes. This is the case in the author's article (Móczár, 2020), which examines
neoclassical economics in the light of the Arrow-Debreu model of general
equilibrium and Kornai's critique.

2. The moral philosophy of Adam Smith

In the 17th and 18th centuries, money and self-interest have reigned in England,
the cradle of capitalism. People's natural emotions were characterized by egoism
and altruism, i.e. selfishness and benevolence, as they are today. The right
balance, between perfect egoism and perfect altruism, is provided by human
actions when the support of a specific group or individual (including ourselves) is
not done to the detriment of another group or individual.4 This approach is due to
Hanley: Smith takes sympathy and self-interest5 into account, the former is an
innate tendency in which we are all born, the latter is part of human nature, which
are the focus of his research; both in The Theory of Moral Sentiments (1759) and
the latter only in Wealth of Nations (1776). Smith connects sympathy to attention
(to recognition) and in doing so, he examines the components of ’living a good
life’.

Happiness

Happiness is the most important prerequisite for living a good life.6 Contrary to
popular belief, happiness does not depend on our physical state but on our
psychological state, that is, happiness lies in the healthy mind. The main part of
human happiness comes from the consciousness of being in love that we receive
4
This is the rule of behavior formulated in a broad sense by Vilfredo Pareto in 1906 in the so-
called Pareto optimality criterion in welfare economics.
5
According to Smith, self-interest and market competition serve the well-being of society. See
Móczár (2017) for more details.
6
At the book launch event organized by the American Enterprise Institute in Washington DC
on December 6, 2019, Professor Hanley considered happiness to be the key to a good life.
4
from others in exchange for our love. Sympathy is the first step to gaining the love
of others, which later takes us at the center of attention with appropriate
recognition and a sense of happiness. In contrast, unhappiness in Smith's
formulation is usually caused by overestimating what we miss and undervaluing
what we have. A happy life is based on tranquility and enjoyment, not on material
goods.

At the same time, the modern world is full of challenges that can upset the rest of
our mind or our happiness. How do we best meet these challenges, Smith asks. In
this case, the company of a friend restores the mind's confused state to a state of
calm to a degree. In other words, the ideal friendship is the mutual sharing of joy
that we need to organize in time and enjoy healthy self-control, says Smith's
warning.

Anti-social phenomena such as hate and anger are the most poisonous to
happiness, but it is maintained by gratitude and love. The material benefits of
capitalism are also dangerous for happiness, which is explained by the division of
labor in the Smith Paradox: wealth enrichment results in mental bowdlerization,
alienation, and the deterioration of our moral emotions, which can only be
remedied through a comprehensive education system.

Mutual love, gratitude, ideal friendship and healthy self-esteem not only ensure
the happiness, and prosperity of the individual but also of society. But Smith also
notes that only a free society can be happy and prosperous, and denying freedom
leads to disaster. Therefore, he emphasizes the superiority of society controlled
by the invisible hand7 over the society manipulated by the hands of the political
system, which is provided by the perfection of politics and law as well as moral
life. In the absence of the latter, both individuals and society are less happy and
prosperous.

Talent and ability

No matter how difficult it is to admit, Smith admitted, nature creates us more or

less as the same: you are no better than anyone and no one is better than you.
Smith called this warning the most difficult part of morality to accept. Here he
asks from us to humiliate and degrade the arrogance of self-love. True self-

7
Smith (1776) took the metaphor of the "invisible hand of the market" from Mandeville's
(1732) book, though he only mentioned it once because Mandeville's satire was very against
the laissez-faire principle..
5
control, Smith argues, requires more than the obscure syllogism of a quibbling
dialectic, and by accepting it, we see more of how we live our lives.

While many people may be different, some are more talented, others show more
abilities, but the truth is that these differences do not come from nature, but from
habit, habitus, and education: what our social background was. The occupational
disease of scientists is called vanity by Max Weber (1905). In Plato's Republic,
Socrates explains that in an ideal city people must be taught what he calls a noble
lie. The relevant part of the writing where the inhabitants of the ideal city should
be warned, that they were born with metal in their souls, and souls born with gold
nature has made them better like those born with an iron soul. This proves that
some people are superior to others by nature. But Smith disagrees with Socrates:
people are, in fact, equal in talent and ability.8 He refers to Thomas Jefferson's
Declaration of Independence, which reads: “It is obvious that all men are equal”.
But Jefferson preached equality in a legal sense, and Smith talks about talent and
ability, which is a significant difference.

Lucky ones in life can rightly ask to whom they owe for their talents and abilities:
those are due to the genes of their parents, their hard work, the teachers who
educated them, or simply the big lottery prize?

Respect and admiration

To attain and enjoy the respect and admiration of mankind is an object of ambition
and emulation, which comes in two ways: one is the practice of wise learning and
virtue, and the other is the acquisition of wealth and power. The followers of the
second path are self-conceited, we see them primarily in politics, arrogant
blockheads, and often vulgar, which in many cases brings them success. Without
excessive self-admiration, world success, or power over humanity's feelings and
opinions, can rarely be gained. The first way, wise learning and practicing virtue,
is the way of humble modesty and equal justice. This road is more correct and
perfect, but it is much harder to navigate, so fewer people choose it.

The man of the most perfect virtue, according to Smith, is the one we love and
respect the most, joining the most perfect command of our original and selfish
feelings, and showing the greatest sensitivity to the original and compassionate
feelings of others.

8
In Smith's time, there was no gene research.
6
What does it mean to be wise and virtuous? – Smith asks. The man of the most
perfect virtue has a definite purpose, follows ancient philosophy, its perfection
lies in reaching or accomplishing the ultimate goal. Smith is a teleological thinker
and uses the language of virtue, which is more closely related to ancient moral
philosophy than to modern moral philosophy. When ethics talk about virtue today,
they think of something more than life-knowledge or strong character; they rather
think of the all-encompassing excellence focused on the ancient studies of virtue,
such as Plato's Meno9 or Aristotle's Nicomachean Ethics10.

Smith defines a virtuous man as an excellent character, with something

extraordinarily great and beautiful in performance, far beyond what is vulgar and
ordinary. The perfection of human nature is to feel much for others and little for
ourselves, to give up our selfishness, and to show benevolent love for others, in
which we must ensure a proper harmony between our emotions and our passions.

Wisdom and Virtue

The attributes of a wise and virtuous man refer to his character, which makes him
so wonderful. Plato and Socrates differentiated the wise life embodied by
philosophers from the virtuous ethical life of good citizens and gentlemen, vita
completiva from vita activa. Smith denies this vision: the wise and virtuous man
is precisely whose virtue gives his wisdom and his wisdom gives his virtue.
Professor Hanley notes here that Smith defines wisdom with absolute perfection
and good manners.

9
The dialogue between Menon and Socrates, written by Plato. The dialogue begins with
Menon's question: Can virtue be taught? Socrates bypasses the question and answers that he
does not know what virtue is. Here Menon explains what He knows about virtue: different
people have different virtues a virtuous man helps his friends, wounds his enemies, virtuous
women run the household and obey their husbands, the kids and older people have other virtues.
Socrates' position: virtues are common to all people, regardless of gender and age, moderation
and self-control. According to a myth, souls are immortal and have learned everything before
they enter the human body, so they need only be reminded when they come to life. Menon
returns to the original question, and there is a new one: will we be virtuous through teaching or
life experience ?; is virtue really knowledge? In his answer, Socrates distinguishes between
'true faith' and knowledge, which forms the basis of the philosophy of knowledge as 'proven
true faith'. In the virtuous people of the present and the past, virtue is the result of divine
inspiration. In modern reading, these words of Socrates are obviously ironic. See Scott (2006)
for details.
10
The work of Aristotle, which consisted of 10 books, originally in separate scrolls. The title
probably refers to the son he dedicated the work to, or the father, also called Nicomachos. The
subject of the work was Socrates' question, recorded by Plato: how do people live their lives
best? See Pakaluk (2005) for more details.
7
How can absolute or exact good manners and perfection be defined? Plato
proclaimed that there are figures in the world above us that represent various types
of perfection that can only be achieved through some form of divine
enlightenment or philosophical genius. Christianity put it simply: one must
witness to perfection that transcends the things of the earthly world. According to
Smith, there is in fact the concept of lofty perfection in every man's mind.
Perfection is the result of careful observation and inferring from the things of the
world to the general, which can be achieved by slow, gradual, and progressive
reasoning.

The wise and virtuous virtue lies in humility and charity, Smith proclaimed.
Wisdom definitely shapes virtue: it transforms our relationship with ourselves and
with others. The reward of a wise and virtuous man is the joy of self-
determination: the life of a wise and virtuous man is the best life that sacrifices
his life to improve the living conditions of others. Another Smith paradox
deserves mention here: by sacrificing our interests, we realize a deeper self-
interest. In fact, the highest wisdom and virtue lies in never letting our suppression
or frustration rest upon the malicious and ungrateful behavior of rich people.

It is not enough to be wise if one wants to be wise and virtuous. Smith referred to
the example of his friend Benjamin Franklin, who compiled a list of 13 virtues to
achieve moral perfection. The last virtue was "humility," which was accompanied
by an instruction to "Imitate Jesus and Socrates." How does Smith's
transcendental ideal, the wise and virtuous man, resemble Jesus or Socrates, as
does transcendental life in the traditional classical models of the West? Smith
regards Socrates as comparable to a wise and virtuous man, which is particularly
evident in Socrates' attitude toward death.

Smith thought Socrates was a wise and virtuous man who served as an example
of how a mortal man could overcome the terror of death. In the early stages of our
lives, all of us are shaped by fear of death in one way or another: death deprives
us of sunlight, excludes conversation and life, places our bodies in a cold grave,
and makes us a victim of rot and reptiles. That is, the greatest venom of human
happiness is the fear of death, which makes us miserable while we live. Smith
considered Socrates a hero who, after being sentenced to death by the Athens
court, did not seek escape, would not contradict his own teaching, and bravely
drank the last potion, while the gayest and most cheerful tranquility showed.
Thanks to Socrates’ heroic attitude, he shines for centuries, but he would not have

8
had the glory if he had quietly died in his own bed and his enemies would see him
as if he had suffered.

In Montaigne's famous study (see in Villey and Saulner, 1978), Socrates taught
us how to die, how to get rid of the fear of death, which does not mean giving up
on self-interest and love. Smith goes so far in his praise that he mentioned Socrates
along with Alexander the Great and Julius Caesar. However, the great wisdom of
Socrates does not prevent Smith from accusing Socrates of secret intimacy with a
divine being. Smith based his accusation on that Socrates often talks about his
demon, who is a kind of pagan version of the guardian angel. At some level, this
means that Socrates' wisdom is the product of his philosophy, which places him
above the level of the gods and other people. But Smith clearly saw that this
contradicted what he thought of wisdom and virtue, that is, Socrates' "sublime
speculation" had not misled him.

Religion and Morals

The wise and virtuous man is similar to Socrates, but not completely. What can
we say about Jesus of Benjamin Franklin? The name of Jesus is not, but the
religion of Christianity he founded is mentioned three times in the book of Smith
(1959), in the context of love. Smith was an enlightened thinker, and religion had
long regarded Enlightenment as the enemy. On the issue of religion, Smith
followed David Hume, but he had a very different view of religion. Hume
considered that religious belief can be traced back to the most cowardly and self-
interested parts of human nature, with particular reference to our hopes and fears
(cf. Hume, 1757, 6-8 and 30-32). Hume considers faith to what is worst in us,
however, Smith holds the opposite: religious belief is guided by the noblest and
best principles of human nature — in fact, love for virtue and faith itself.
According to Smith, religious principles are natural to us, of these, the modest
hope and the expectation of the life to come, which are deeply rooted in human
nature and which in themselves can support the lofty ideas of one's dignity.

From the time of Hume to the present, religious critics argue that believers,
through cowardice or fear, and those who are anxious, get to the faith. They
believe that religion frees them from their fear and anxiety. They show sorrow
and compassion for the suffering of the innocent, not for self-interest, but because
of concern for others, as well as the concern for the innocent, who suffer from the
hands of the wicked and the unjust. They believe it is natural that faith in heaven
helps them in the hope that God will ultimately bring them justice. Professor

9
Hanley pointed out in his book, that belief was important relating to an almighty
God, who punishes the unjust in the afterlife, that is, Smith accepted the teachings
of religion only through the glasses of morality.

Smith claimed that man's wisdom and virtue lie in God's wisdom and virtue. What
is the connection between a wise and virtuous man and a wise and good God?
Smith labeled answering of the question and exploring the connection as a human
task. He justified the idea of the divine being by eternally and forever creating and
operating the mighty machinery of the universe with kindness and wisdom, to
always bring the greatest amount of happiness, of course, the noblest one of all
human commitments. Smith, with the idea of a divine being, suggested that the
idea of God's existence could really help our moral actions, for him God is the
creator and ruler of the world.

Smith accepted the teachings of the ancient Stoics, who treated the world with all
the providence of a wise, strong, and good God, in which the wicked and foolish
of mankind, with their wisdom and virtue, played the appropriate necessary role.
The wise man is expected to show respect for the benevolent wisdom that guides
all events in human life. The Stoics taught that wisdom leads us to appreciate our
position in our good and carefully ordered world, which causes us to contribute
our own actions to the order and goodness of the world. And that was Smith's
position as well. „By acting according to the dictates of our moral faculties, we
necessarily pursue the most effectual means for promoting the happiness of
mankind, and may therefore be said, in some sense, to cooperate with the Deity,
and to advance as far as in our power the plan of Providence.” (Smith, 1759, 126,
quoted Hanley, 2019, 132.) That is, your goodness does not end with your own
happiness, but by promoting the happiness of each of us, and thus the will of God
is done here on Earth.

3. Adam Smith is the founder of capitalism

Some scholars, including August Oncken (1897), see a contradiction between The
Theory of Moral Sentiments (1759) and the Wealth of Nations (1776); the former
emphasizes sympathy for others, while the latter the role of self-interest. Others
argue that there is no contradiction, as Smith’s works emphasize various aspects
of human nature that have changed depending on the conditions. According to
some scholars, self-interest is present in both works; in the first book, sympathy
is the moral sense that controls self-interest, while in the other one, competition
is the economic sense that limits self-interest. Others argue that both books are

10
Newtonian in style and use a similar “market model” to explain the formation and
development of the human social order, including morality, economics, and
language.

Smith was convinced that if the individual according to justice exercised self-
interest, he would unintentionally promote social good. According to him, in a
free market, self-interest competition benefits society as a whole by maintaining
low prices while continuing to encourage the diversity of products and services.
Smith in the Wealth of Nations argued that reasonable self-interest and
competition could lead to economic recovery, material prosperity to human
happiness. But he never gave an answer as to exactly how this could happen; the
answer he gave was largely intuitive. He reacted only cautiously to business
people and warned them of ‘conspiracy by the community or attempts to raise
prices’, which is a threat to happiness. Smith has repeatedly warned of conflicting
business interests that could lead to kabbalah or monopolies and fix the highest
price ‘that can still be pushed out of customers’.

He supported the establishment of a civilian government, insofar as it is created

for the security of wealth, in fact, to protect the rich against the poor, or against
those who have wealth against those who have none at all. In addition, he
acknowledged that punitive tariffs could be useful in certain circumstances:
restoring a large foreign market usually compensates for temporary
inconveniences if they pay for the product in a short period of time. He added,
however, that in general, an anti-dumping duty seems to be ‘a bad way to
compensate for the damage caused to a particular stratum of people in order to
cause even greater hardship to ourselves, not only to the strata in question but to
almost all other strata’ (cf. Smith, 1776, 338-355). This also proves that Smith
was a strong supporter of free markets and limited government and did not
interpret laissez-faire dogmatically.

Smith supported the progressive income tax, specifically naming the taxes he
thought the state could demand, including luxury goods and rents. He argued that
taxes should be primarily aimed at protecting ‘justice’ and ‘certain public
institutions’, which are needed in the interests of society as a whole but which
could not be provided by a private company. The government is responsible for
enforcing contracts and ensuring the justice system, granting patents and
copyrights, providing public goods such as infrastructure (roads, bridges, canals,
ports) and national defense, and regulating banks, and patenting inventions and
new ideas. He supported the partial state funding of general education and

11
believed that competition between religious institutions was of general benefit to
society. In such cases, however, Smith argued in favor of local rather than
centralized control: ‘Even utilities that are of such a nature that they cannot afford
an income to sustain themselves ... it is still better to use local or provincial
revenues under the control of the local and provincial administration than the
central revenues of the state’ (cf. Smith, 1776, 566).

The Wealth of Nations also formed an opinion on the imperial issue. In his chapter
on colonies, Smith pondered how to resolve the crisis on the other side of the
Atlantic between the empire and its 13 American colonies. He made two different
proposals to ease tensions. The first proposal called for the independence of the
colonies to be ensured, and thus, through friendly separation, Britain will be able
to develop and maintain free trade relations with them, possibly even as an
informal military alliance. Smith’s second proposal called for the creation of an
imperial alliance that would bring the colonies and London closer together
through the imperial parliamentary system and imperial free trade.

4. Adam Smith is the father of economics

Smith explained the theory of the political economy of liberal capitalism in his
book Wealth of Nations in 1776, which was written to replace mercantilist and
physiocrat economic theories. Smith's book proclaimed free trade and the market
demand-supply mechanism as opposed to state intervention; the book marked the
beginning of classical economics, which is the new name for political economy
in the formulation of Karl Marx. But Smith, as the “father of economics”,
considered only self-interest in his book and explained how reasonable self-
interest and economic competition could lead to economic recovery. He discussed
the political economics of liberal capitalism on the basis of another version of
moral philosophy, utilitarianism, following Jeremy Bentham’s book (Bentham
1780). The basic idea of Benthamian utilitarianism is, in a sense, to maximize
utility, which is often defined by well-being or related concepts, and to promote
measures that maximize the happiness and well-being of those involved. While
classical empiricism proclaimed in Smith's time that "there is nothing in the mind
that is not first in the senses" (nihil est in intellectu quod non prius in sensu11),
that is, we decide on the basis of our senses and not rational arguments, however,
Bentham focused on practical legal and political reforms. Thus, it is

11
Saint Thomas Aquinas: Peripatetic Axiom. De veritate, q. 2a. 3 arg.19.

12
understandable that Smith discussed liberal capitalism alongside the principle of
laissez-faire on the basis of utilitarian ethics.

Smith (1776) distinguished use-value and the exchange-value (the price) and
created an artificial dichotomy between ‘goods in use’ and ‘goods in exchange’.
Water is used in large quantities, so it has a high use-value and a low exchange-
value. Diamond, on the other hand, is used in smaller quantities, has little value
in use, and because it is a ‘commodity in exchange’, it has a high exchange-value.
In other words, water has a much higher value in use than diamond, yet its
exchange-value (its price) is much lower. Smith explained the paradox with the
labor value theory. He argued that the exchange-value of the goods produced, and
thus their price, was determined by the amount of work invested in them, which,
while not always an acceptable explanation for the water-diamond paradox,
generated a very lively debate and to some extent guided the development of
economics. (Cf. Smith, 1776, 171.)

Smith’s quasi-explanation of his paradox based on artificial dichotomy was a first

studied, among others, David Ricardo (1772-1823), who concluded that the
working class does not receive all the value of the goods it produces. Capital
owners only pay workers as much as they need for subsistence and childbearing.
Ricardo disregarded the fact that Adam Smith later argued that embodied work
was a true measure of value only at a low level of social development; he
determined the natural price of the goods by adding capital and land rents to the
value of the work, that is, like William Petty (1620-1687), he interpreted the
natural price.12 According to Jean-Baptiste Say (1767-1832), the value does not
come from work, but from the subjective usefulness created by goods in its
consumers.13 Nor did Thomas Malthus (1776-1834) rule out the role of the
consumer side in determining value, and thus in price formation, so he did not
accept Ricardo's theory of labor value either. It can be seen that this theory was
already the most controversial issue among classical economists. In Ricardo’s
theory, the difference between revenue and wages is completely expropriated by

12
Petty was the first to determine wages and surplus-value. The surplus-value is made up of the
land annuity and the cash annuity (interest), which together with the wage form the natural basis
of the price. According to him, the interest rate depends on the supply and demand for money.
He called the price of land a capitalized annuity.
13
Shortly before Say, the Italian Abbé Ferdinado Galiani (1728–1997) saw utility and a scarcity
as determinants of price. His contemporaries were the Italian economist Antonio Genovési
(1712–69), who, against Smith, interpreted a political economy along with ethics. Cf. Dolon
(1976).
13
capitalists, which has provoked a constant class struggle between workers and
capitalists to change the wage-profit ratio. This led to Marxist economic theory. 14

An acceptable explanation for the water-diamond paradox was as a first given by

Herman H. Gossen in 1854 using the concepts of subjective value theory. A new
school, that is, the neoclassical economics has been emerged from classical
economics, according to which prices are determined by marginal buying or
selling on the basis of the relative abundance or scarcity of goods: subjective
utility theory has been incorporated into economics, together with the Benthamian
utilitarianism and meeting the consumer demand.

5. Welfare capitalism of Adam Smith

Adam Smith was taught at the University of Glasgow by Francis Hutcheson

(1794-1746), the founding father of the Scottish Enlightenment. The notes of
Hutcheson's lectures on moral philosophy were also used by Smith, respectively,
in his teaching at University of Glasgow (1755) and in his book The Theory of
Moral Sentiments (1759).

Hutcheson did not confuse moral ability with the moral norm, he foresaw
Bentham’s utilitarianism - and not just in principle, but even in the standard
explanation of “greatest happiness for most people”. It is easy to trace the impact
of Hutcheson’s ethical theories on the systems of David Hume and Adam Smith;
the unequivocal acceptance of the utilitarian standard is most likely attributed to
Hume, and if this is true, then Hutcheson’s moral philosophy came from Hume to
Bentham.

Jeremy Bentham (1748-1832) was an English utilitarian philosopher and social

reformer, an advocate of psychological egoism. Psychological egoism represents
the view that people are always motivated by selfishness and self-interest, even if
it seems like altruism. It states that when people decide to help others, then they
do so, after all, because of the personal advantage which they themselves expect,
directly or indirectly, as a result of their action. Bentham’s (1780) book focused
on the principle of benefit and the incorporation of his moral approach into
14
Marxist economic theory is the only economic current that has been tested in practice, along
with Marxist philosophy and political theory, in the Soviet Union of 1917, a Leninist-Stalinist
authoritarian socialist system that later underwent several reforms until December 31, 1991.,
when the Soviet Union ceased to exist, together with the unsuccessful tendencies of socialism:
the Leninist, Stalinist, and Maoist tendencies failed.
14
legislative practice. The principle of utility considers "good" to be that which
causes the greatest pleasure and minimal pain, and "evil" as that which causes the
most pain without pleasure, while by "happiness" he meant the predominance of
"joy" over "pain".

Bentham’s economic theory focused on monetary expansion rather than helping

to create full employment. He also understood forced savings, propensity to
consume, the savings-investment relationship, and other concepts that affected
modern income and employment relationships. His work is seen as an early
forerunner of modern welfare economics.

From then on, economists easily accepted the principles of welfare economics: in
a competitive equilibrium, the marginal utility of the goods purchased equals the
marginal cost of production. Therefore, it can be easily demonstrated that the
competitive balance of the economy is Pareto optimal. This theorem of welfare
economics prevented neoliberal economists to deregulate markets and potentially
to increase happiness.

6. The birth of neoclassical economics

Classical economics split in two schools: in addition into the neoclassical school,
the institutional school appeared; the latter’s studies are based on real social and
economic assumptions. Economics has embarked on the path that has made
economics the queen of the social sciences.

Neoclassical economics, on the other hand, excluded people from economics;

each representative agent has only one choice and must maximize what is dictated
by their unintended preferences. While classical empiricism preached that in
Smith’s time, that “there is nothing in the mind that is not in the senses first” (nihil
est in itellectu quod non prius in sensu), otherwise we decide on the basis of our
senses and not on rational arguments, but here all choices are perfectly reasonable,
all rational action is based on calculus, topology, and Bourbaki mathematics, in
the misconception that economics will be real science. Adam Smith (1776) sees
self-interest and self-interest competition as a competition that promotes people’s
happiness and social good. In contrast, neoclassical economics focuses on the
oxymoron competitive equilibrium, Bentham’s utilitarianism, and money as a
source of happiness. Adam Smith critically examined dynamic interactive social
and economic-financial relationships. Analysis of neoclassical economics is
generally static, focusing on the real sphere, and ignoring the financial sphere and
social relations.
15
Politics can change, but the nature of man cannot change, nor can the moral virtue
of Adam Smith (1759), nor the economics of laissez-faire capitalism. It is now
well known that neoclassical economics uses its axiomatic abstract assumptions
and formalism, mathematics based on Newtonian mechanics, to study and model
the momentary relationship of a non-existent parallel world. Neoclassical theories
and models have mostly rewritten versions of the equilibrium models of earlier
classical economists (Cournot, Walras, etc.) using calculus, topology, and
Bourbaki mathematics with a consistent and brilliant logical structure.

That is, neoclassical economics can play only a very small, mainly indirect, role
in the analysis of today's complex socio-economic issues. Their mostly static
analyzes ignore the financial sphere, the role of banks, interactive socio-economic
relationships, etc., although one of the most important tools of modern economic
governance today is monetary policy.

7. Conclusion: ethical economy

Smith's moral philosophy, in Hanley's structure, emphasized the premise of

human nature, wise and virtuous life, as the basic principles of morality, the
prerequisite for living a happy life, which has not changed much in our world.
The theory and practice of the political economy of emerging capitalism is
described in Wealth of Nations. In his seminal book, he explained that he was
replacing mercantilist and physiocratic economic theories with free trade, which
allowed businesses to specialize in producing the most efficiently produced
products, resulting in higher productivity and greater economic growth.15 But
Smith, the "father of economics" from The Theory of Moral Sentiments explicitly
took over only the self-interest into the Wealth of Nations; here he used another
version of moral philosophy i.e. the utilitarianism, following Jeremy Bentham
(Bentham, 1780). The fundamental idea behind Bentham’s utilitarianism is to
maximize, in a sense, the utility that is often defined by well-being or related
concepts and promotes measures that maximize the happiness and well-being of
those affected. While classical empiricism proclaimed that "there is nothing in the
mind that is not first in the senses" (nihil est in itellectu quod non prius in sensu),
otherwise we decide on the basis of our senses and non-rational arguments, while
15
In a free trade system, individuals benefit from a greater choice of affordable goods, while
Jean-Baptiste Colbert’s mercantilism restricted imports and reduced the choices available to
consumers which led to less competition and higher prices. The physiocrats, led by Francois
Quesnay, believed that the wealth of nations was derived solely from the value of agriculture.

16
Bentham has focused on practical legal and political reforms. Thus, it is
understandable that Smith discussed liberal capitalism alongside laissez faire in
utilitarian ethics.

Smith (1776) separated the value in use from the exchange value (price), and
created an artificial dichotomy between "in use" and "in exchange". Water is a
'used commodity' in large quantities, so it has high value in use and low exchange
value. However, diamonds are used in smaller quantities and have a small value
in use, and since it is a 'commodity in exchange', its exchange value is high. In
other words, water has a much higher use value however, its exchange value (its
price) is much lower than that of a diamond. Smith explained the paradox with
work value theory, which is not always acceptable. An acceptable explanation
was first provided by Hermann Heinrich Gossen in 1854, using the concepts of
subjective value theory. In neoclassical economic theory, prices are determined
by marginal buying or selling, meeting consumer demand based on the relative
abundance or scarcity of commodities.

Neoclassical economics, which with its abstract assumptions and formalism, its
mathematics based on Newtonian mechanics, explores and models the momentary
connections of the parallel world that does not exist in reality, and then its
deterministic and stochastic dynamics, an intellectual product of the last third of
the 19th century and the 20th century. We have seen that neoclassical economics
evolved with the liberal laissez faire philosophy following the latest advances in
physics and mathematics (cf. Móczár, 2020). The ‘core’ of their questions was
provided by the essences of classical economics for further study with the latest
advances in the age of mathematics and physics; in this sense, they are merely
transcriptions with another orchestration, similar to Wolfgang Amadeus Mozart’s
Haydn transcriptions. Yet the intellectual market prizes the highest consistent
achievements of the human mind in this field in some parts of the developed
Western world, winning the Nobel Prize, despite the questionability of its elegant
theories due to its unrealistic assumptions and neo-positive formalizations for
human well-being. Their contribution is debatable, and in some cases, their
application has in fact led to a global economic crisis.

In today’s unstable world, what kind of state interventions can economics propose
to ensure that all citizens of every nation live in peace and wealth?

One of the only effective solution may be to integrate the economy and Aristotle's
and Christian-based ethics, both in theoretical economic research and in socio-

17
economic life, which was separated by classical economists along with Adam
Smith nearly 250 years ago. Following the principle of liberal laissez-faire,
neoclassical economists clearly neglected ethics which support a good and happy
life. Integration of the economy and ethics (ethical economy), including ethical
distribution of income based on current property rights, it leads to the eradication
of huge wealth inequality and poverty, and a better, happier life.

Institutional economist Keynes's (1936) theory identified wealth and its moral
costs as a source of economic and social instability. Piketty's (2014) book goes
further and examines wealth inequality, explained by ceteris paribus as the
difference between the return on capital (r) and the growth rate of the economy
(g), whereas the database of 20 developed countries goes back three centuries
found that r > g. This result is questioned by many in the literature, for example,
Acemoglu and Robinson (2015) lack the endogenous evolution of economic and
political institutions in the valuation of capital. Neither their regression
calculations for South Africa and Sweden nor the Gini indices confirmed Thomas
Piketty's results; moreover, Góes (2016, p. 4) strongly states, based on his
calculations with VAR Panel models, that the “potential causes of increasing
inequality [...] are not related to r–g.” We have no reason to doubt the
calculations of any author, but without calculations in terms of statistics the huge
wealth inequality is a fact. Piketty's suggestion to reduce inequality by introducing
progressive wealth tax and supplement progressive personal income tax can be
the radical solution to the problem. Such taxation helps to eradicate poverty, live
happier lives, and develop social services, that is, health and education.

Ethical economics requires a paradigm shift in modern economics science. The

time of neoclassical economics is over, as too many observers clearly see that
there is no connection with reality. (For details see Móczár, 2020.) The new
paradigm can only be a non-equilibrium economics that recognizes human nature
and the social and economic-financial processes of interaction and, with this in
mind, examines the product, money, capital and labor markets from a scientific
point of view, rather than hypothetical-axiomatic approach.

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