Adam Smith would have hated market fundamentalism

[Extract from The Nature of the Beast]

Most people don’t deal much with abstract ideas and theories, yet ideas exert a powerful influence on societies and history. Societies and civilisations have come to grief because they held ill-adapted ideas. What idea was it, for example, that led the Easter Islanders to obsessively build huge stone effigies even as the ecosystem of their island was collapsing around them? Richard Dawkins, in The Selfish Gene (1976) invented the term meme for key ideas. Memes are to cultural evolution as genes are to biological evolution. A very powerful meme abroad in the world today is that free markets are the best way to organise economies. Where did this meme come from? Is it serving us?

Adam Smith is regarded as having founded modern economics in his great book of 1776 The Wealth of Nations. He is hailed as a hero by many free-market economists, and derided as a villain by some critics of free-market economics. He is credited with the great insight that people trading in markets will, if the markets are left to operate freely, bring prices, supplies and demands into a balance, and that balance will achieve the greatest benefit to society. Smith is also credited with the famous metaphor of the invisible hand, in which he is purported to have argued that each person, by following only his own self interest, is “led by an invisible hand to promote an end which was no part of his intention”. These claims, except possibly the first, are mostly nonsense.

Smith did argue that sometimes free markets and free trade would produce results beneficial to a whole society. However he did not argue they are always of benefit. Nor was he railing against any and all government involvement in markets. What animated Smith was mercantilism, which was an unholy alliance of big merchants and manufacturers with government to create monopolies in trade with various parts of the world, such as The East India Company, The Hudson Bay Company and the Massachusetts Bay Company. Smith argued that when trade was monopolised in this way it bred corruption, colossal inefficiency, exploitation and poverty of colonials, neglect of the needs of the common people of England, and great expense for England, particularly when England was drawn into wars to extend or defend colonies (Buckley, Meeropol pdf, Schlefer).  He argued that trade, peacefully conducted for the mutual benefit of traders, could be a useful adjunct to the primary activities of a nation, which were domestic agriculture and domestic manufacturing.

The famous invisible hand metaphor occurs almost as an aside in a passage arguing that the self-interest of the entrepreneur would usually lead him to prefer investing in the domestic market rather than abroad.  The full quote is

By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.

This is hardly the manifesto for free markets, free trade and globalisation that Smith is claimed to have provided. Rather the reverse.

According to Schlefer, among those most responsible for this misrepresentation are the famous economists Paul Samuelson and William Nordhaus. Their textbook Economics has been the leading text since the 1950s, and in it they cherry-picked words from Smith and rendered them as

Every individual endeavors to employ his capital so that its produce may be of greatest value. He generally neither intends to promote the public interest, nor knows how much he is promoting it. He intends only his own security, only his own gain. And he is in this led by an invisible hand to promote an end which was no part of his intention. By pursuing his own interest he frequently promotes that of society more effectually than when he really intends to promote it.

This makes it sounds as if Smith was saying that the interest of society is always promoted by people pursuing their self-interest. This is the claim of modern free-market economists, but it was not Smith’s claim. When he did argue for freeing-up trade, he was arguing for freeing it from interference by big business.

The parallels between eighteenth century mercantilism and the giant transnational corporations and predatory globalisation of the past several decades are obvious. Smith would no doubt have railed against them too. He has been grossly misrepresented, to the point of essentially reversing a key message of his great work.

Adam Smith  was also the author, seventeen years before his more famous Wealth of Nations, of a book called Theory of Moral Sentiments. In the earlier book he writes of trust among familiar people as being necessary to discourage cheating and for the good functioning of society.  He detested great concentrations of wealth and privilege and saw his insights as a means to prevent them from developing.  He certainly did not imagine that the functions of commerce should override social and moral values.  Thus modern advocates of unfettered markets who invoke his name to justify their narrow ideas merely reveal their ignorance.  Nor do opponents of modern capitalism need to vilify Smith, as he was a considerably more moral and balanced person than some of those who take his name in vain.

2 thoughts on “Adam Smith would have hated market fundamentalism

  1. Pingback: Framing the Market « Poor Richard's Almanack 2010

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s