Rethinking Economics, the Role of Insurance: Adam Smith Upside Down—The Central Role of Insurance in the New Post-Industrial (Service) Economy

In the first page of The Wealth of Nations, Adam Smith described an apparently trivial issue, the making of a pin. In his search for ways to effectively fight poverty, he formulated the basis for a new view of economy based on the Industrial Revolution. Two centuries later, the perspective he developed remains intact and is largely outdated. It does not reflect the radical shift from an industrial to a service economy, which occurred during the later half of the 20th century and prevails today. Insurance, a very important component of the modern service economy, was and has been ignored or dismissed by past and contemporary economists. Founded on the principle of uncertainty, insurance now provides the basis for valuable insights into the unique characteristics of the service economy. A rethinking of economics is needed from this perspective.

Adam Smith’s analysis in The Wealth of Nations gave birth at the end of the eighteenth century to what is today called ‘Economics’. A moral philosopher, Smith wanted to provide a better understanding of how to fight poverty. Most of his contemporaries insisted that wealth could only be developed from agriculture. Smith perceived that the beginning of the industri- alisation process was the key and priority to promote human wealth and welfare in the future. He was right. This article proposes some unconventional considerations to promote the Wealth of Nations by a reconsideration of key economic issues.

Economics did not start as a general social discipline concerning wealth in general, but as a consequence of the industrial revolution, an important historical event, which had a beginning, and had a glorious development for over two centuries. Contemporary economics is markedly different from the economics of the Industrial Revolution as Smith conceived it and has lost its initial and traditional connotations. We now live in a Service Economy, which implies that the economic theories and analyses built from the classical industrial framework need a serious, fundamental reappraisal. Many economists have long agreed that macroeconomics in particular is in a crisis. In addition, still today there are no clear economic explanations as to why after 1973 the rate of growth in GNP terms in the “industrialized
countries” fell from an average of 6% or more to an average of 2% or less. An understanding of these events is essential for understanding the real reasons for the recent financial and economic crises.

Some basic reference issues have to be reconsidered to address the problem: what is economic value and how is it produced today? What is productivity and how is it measured? These along with the other main indicators used today still reflect the basic industrialized manufacturing system. For instance, one calculates value added on the basis of the remuneration of production factors, say cost of machines and labor for an automobile and productivity measures, say the possibility of producing two cars instead of one in the same time period. But all this is less and less relevant. Classical theory divided economic activity into three sectors: agricultural, industrial-manufacturing, and services. Now the services sector, as a consequence of technological development, has become the main production factor in ALL activities: in total about 70 to 80% of economic value produced (whatever the way to account for it). Services are the key production function today.

It must be stressed, right away, that services do not exist without tools that are manufactured and manufacturing cannot exist without recourse to a wide range of services, so the two sectors are inextricably intertwined. The development of the modern Service Economy implies simply that there has been a reversal in dominance from manufacturing to services as the main contributor to the production of economic wealth.

Today, what we call a “production” system consists very largely of service functions. It begins with investments in R&D, long before a new product is ever manufactured. Research requires management of a system in which a portfolio of projects with perceived commercial potential has to be proposed, approved and managed in order to achieve usable results in an uncertain period of time. The research period is uncertain, although a good professional manager will do his best to reduce the risk resulting from time overruns. The size and the nature of the portfolio itself have to conform to the characteristics of the sector under enquiry i.e. pharmaceutical industry, high speed trains etc. to determine whether several projects or only a few should be selected. Here too there are risks and uncertainties to be controlled and reduced as far as possible. Doesn’t all this remind us of the management of an insurance contract?

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