By Doctor Michael Herron
Since the early 1980s free-marketers the world over have recited the mantra that the “invisible hand” of market forces should be the guiding light of the world economy. This phrase is most associated with the work of Adam Smith, the Scottish philosopher and appears in his two most famous works “The Wealth of Nations” and “The Theory of Moral Sentiments.” While, undoubtedly, Smith was a champion of the free market, arguably, it is important to view his ideas on the free market both in the context of the time in which they were written and within his wider philosophy. This is especially true for the role he envisaged for morality to play in shaping business affairs. These points are developed in an important work by Arthur Herman entitled “The Scottish Enlightenment.”
According to Herman, it is important to note that Smith wrote his most famous work “The Wealth of Nations” published in 1776 in response to the prevailing orthodox economic theory of the time, mercantilism. This theory stipulated that there was a finite amount of monetary wealth available at any one time. It was vital then for a country to acquire as much wealth as possible while keeping this wealth out of the hands of other states. This underpinned the notion of empire, whereby the British state would enrich itself at the expense of other states, principally its main rival at the time, France.
This theory was also used by British policymakers to justify granting and supporting monopolies to certain British companies such as the East India Company to conduct trade within the British Empire. Smith had seen how such monopolies had caused friction with American merchants in the thirteen colonies who felt shut out of imperial trade. Smith believed that these monopolies, particularly, that of the East India Company were the root causes of the demands by Americans for independence from Britain.
Smith argued against this government interference in the market supporting these monopolies and believed that “every man as long as he does not violate the laws of justice is left perfectly free to pursue his own interest in his own way.” Here is the basis for Smith’s reputation as the inspiration for the free market. While it is true, according to Herman, that Smith opposed government interference in the market for either imperial aggrandizement or to promote social justice, he also debunks three common myths about Smith.
The first myth is that Smith believed prosperity in the market was due to the “invisible hand” of the market. According to Herman this was meant to be ironic. He did not believe that the market system was perfect, only better than one driven by politicians. Again, his primary argument was against the mercantile system.
The second myth is that Smith invented the concept of laissez-faire capitalism, which was in fact developed by French thinkers. Smith did believe in a strong government to defend the nation, provide a system of justice and rights to allow commerce to flow freely.
The third myth is that Smith wished to excuse big business and the merchants class from all limits on their power and influence over society. In fact, he stated in “The Wealth of Nations” “the government of an exclusive company of merchants is, perhaps, the worst of all governments for any country whatsoever.”
His observations in “The Theory of Moral Sentiments” about the real drives of human nature and the need for morality to govern human relations were, perhaps, his most important and surprising legacies to us, given how Smith’s ideas have subsequently been interpreted. Smith did not believe that most people are driven by the need to acquire material wealth and are prepared to make the sacrifices to acquire it. Only that some are and these individuals drive progress. Smith also did not believe that individuals are completely free agents with no sense of responsibility to each other. In “The Theory of Moral Sentiments” Smith argued that people have a “fellow feeling” for each other that governs their behaviour to each other. In other words, people have natural empathy for each other and there is such a thing as society.
This has implications for policymakers today. Smith’s actual ideas contradict the arguments made by free marketers. One common argument made by these free marketers is that we are all rational free agents attempting to maximize our own material welfare and that somehow this will achieve maximum efficiency of the market, in other words, the fabled equilibrium. Arguably, Smith believed that since we are governed by morality and are not completely free agents we have to take others’ interests before acting. Of course our priority is to promote our interests, but this is not taken in isolation of society. When making economic decisions we have to weigh up a number of factors not just one or two.
The most famous proponent of the free marketers’ worldview was Milton Friedman, the American economist and high priest of monetarism, the theory that controlling the money supply is the chief method of stabilizing the economy. In one of his public statements, Friedman stated that “the world runs on individuals pursuing their separate interests.” While this statement does not contradict Smith, who made the same point, Friedman’s observation in his preface to Frank Knight’s book “The Ethics of Competition”, arguably, does. In this preface Friedman stated “social responsibility is a fundamentally subversive doctrine, there is one and only one social responsibility of business- to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.”
Friedman’s economic theories and the aversion to Socialism of the Austrian philosopher Friedrich von Hayek were the key inspirations behind many of Margaret Thatcher’s policies in the 1980s. Friedman’s thinking was certainly in tune with Thatcher’s when she made one of her most famous comments in an interview with “Woman’s Own” magazine in 1987. She stated, “there is no such thing as society. There are individual men and women and there are families. And no government can do anything except through people and people must look to themselves first.”
Perhaps the biggest contradiction between the arguments made by free marketers today and Smith’s original beliefs is their attitudes to monopoly capitalism. The Adam Smith Institute, the foremost champion of Smith’s ideas in British politics has lauded itself on its website as “one of the key drivers of the privatization revolutions in the 1980s and 1990s.” Much of this privatization has resulted in large companies acquiring monopolies over services in what used to be the public sector and over the railways. This outcome of monopoly capitalism and oligopoly, the concentration of politico/ economic power in few hands is surely the complete opposite of Smith’s thoughts on the matter. It was because of his opposition to monopoly capitalism that he wrote “The Wealth of Nations” in the first place since he believed the British government had encouraged monopolies to develop that excluded many businesses from trading profitably. If one wanted to create a true free market one should try to break up monopolies. Where Smith believed that monopolies were the unnatural results of government intervention and left to its own devices the market would right itself and eliminate monopolies, we know that often of their own accord, big businesses will tend to become monopolies and cartels against the public interest. As was the case in the United States in the late 19th and early 20th centuries it was left to the federal government to break up these combinations through anti-trust legislation. To create a true free market, there is therefore a role for government to ensure that monopolies do not emerge and to protect the public interest against any harmful consequences of their trading.
In conclusion, despite Adam Smith’s work being written to confront the problems caused by the trading system of the British Empire of the 18th century it has been invoked by ardent free marketers today to support their arguments. The fact that these arguments are so out of kilter with many of Smith’s actual beliefs should give many of these free marketers pause. If their founding principles are built on sand is it any wonder that the world economic system does not work the way they say it should. It, perhaps, explains why it works for the few and not the many.
Arthur Herman The Scottish Enlightenment: The Scots’ Invention of the Modern World (London: Harper Perennial,2006)
Adam Smith The Theory of Moral Sentiments (Strand & Edinburgh, 1761)
Adam Smith An Inquiry into the Nature and Causes of the Wealth of Nations (London: W Strahan, 1776)
The Concise Oxford Dictionary Ninth Edition (London: BCA, 1996)
Milton Friedman Preface to “The Ethics of Competition” by Frank H Knight (1935)
Margaret Thatcher in an interview with “Woman’s Own” on 23rd September 1987
Adam Smith Institute www.adamsmith.org