The Wealth of Nations Revisited; It All Descends from Adam

Saturday, May 26, 2007 at 08:12 PM

Adam Smith's famous "invisible hand" purportedly leads all individuals to follow their own self interest in a way that produces the greatest good for all. Just reading that idea leaves me amazed that such a counterintuitive idea has come to be so thoroughly accepted by really smart people, many of whom have really good educations.

On the micro level, the idea doesn't hold up at all. Just imagine living in a relationship with other human beings in one family household. If the husband always acts only for his own self interest, how exactly will that serve the interests of the family? How does the family benefit if dad spends the entire month's food budget on a trip to Las Vegas? The same analysis holds for the wife, and the same holds for each child.

The one way in which Smith's theory might apply to a family is if each member of the family recognizes that part of his/her self interest is the health and survival of the family unit. If Dad recognizes that going to Las Vegas will cause the family hardship, and is sufficiently committed to the family that he views family hardship as contrary to his self interest, he won't take the trip.

It seems to me that recognizing that the health of the larger unit is part of the self interest of the individual is the key to Smith's theory. If the individual sees that the health of the entire nation is in the individual's self-interest, then Smith may be right--depending on the quality of the individual's judgment.

Without that recognition, I think Smith's theory turns out to be false in many circumstances. With that recognition, however, Smith's theory holds up much more frequently but still suffers from failure to recognize that individuals do not, in fact, follow what is in their self interest, they only follow what they perceive to be in their self interest. If their perception is wrong, if they stink at understanding their own self interest, they will not produce what is good for all of us.

So how in the hell does Adam Smith manage to hold the allegiance of so many smart, educated people? Easy. There are two parts to that answer:

1. Smith's Followers Are Among Those Who Misperceive Their Own Self Interest

Many Smith followers are the very people who cannot understand how their own interests are affected by the interests of others. They are the ones that cannot see how a massive increase in poverty in their own country will be bad for them, even though they have millions upon millions of dollars. They are the ones who think that self interest is measured only in the short term, and only in terms of $$ and power.

2. Smith's Followers Frequently Don't Understand Smith

Many Smith lovers simply find his theory a convenient cover for being as selfishly greedy as they feel like being. They are uninterested in what Smith actually thought, only in how they can act as selfishly as possible and still claim to be doing good for the rest of us.

Smith did not write in a vacuum of time, and Smith did not speak as unqualifiedly as he is portrayed as having spoken.

Here, for example, is one author's summary of the explicit and implicit limits on Smith's theory:

Classical free market economic theory originated with Adam Smith and David Ricardo in the early days of the Industrial Revolution (late 1700s, early 1800s). It was intended to apply under certain conditions and certain conditions only, namely:

(1) All business was small-to-medium sized and entrepreneurial (not corporate). Mostly the people who ran the business owned the business, and financed it with their own capital, or capital raised in partnership with others [1]. There were stock exchanges, but corporations (joint stock companies) were rare and required a special act of parliament, so there were few of them listed [2].

(2) The free market was defined as a market of potentially unlimited numbers of these small/medium sized businesses, competing on a more or less equal footing, in a market which newcomers could freely enter, and in which none could control prices.

(3) The economy was national; capital must not flow freely across national borders or the theory did not hold (Ricardo)[5].

(4) The market had to be supervised by a sovereign government which (a) protected the public interest (b) made sure all businesses played by the rules (c) provided a stable currency, and (d) ran public utilities, which were regarded as not profitable for private enterprise.

Here's a concrete example of limitations in Smith's own words from The Wealth of Nations (emphasis added):
...every individual necessarily labours to render the annual revenue of the society as great as he can. He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. 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. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good.
How many people leave out that FREQUENTLY qualifier? How many people leave out the fact that he talked about ANNUAL REVENUE as an equivalent of the greater good? How many people are aware of Smith's assumption that people prefer support of domestic industry to that of foreign industry?

Probably just as important, how many people realize:

  • Smith was deeply religious, and believed that God Himself had endowed human beings with such character that they would produce good simply by following their self interest?
  • Smith described a world in which most business, especially domestic business, was not corporate, but sole proprietors, with no distance between ownership and management, and no means of limiting the personal liability of the owner?
  • Smith described a world in which it was quite difficult for capital to travel from one nation to another, and barriers of physical distance virtually precluded the import of goods and services which were already available locally?
John Kenneth Galbraith has a famous quote on modern conservatives that seems to explain a lot about how these conservatives can continue to rely on Adam Smith's theory to justify their policies in the modern world:
The modern conservative is engaged in one of man's oldest exercises in moral philosophy; that is, the search for a superior moral justification for selfishness.
Galbraith undoubtedly realized the limitations on Smith's Wealth of Nations. Milton Friedman....probably not.


Fortunately Smith did not write anything like your first paragraph's remotely crude version of self-interest (or self love) in either the Theory Of Moral Sentiments', or Wealth Of Nations' .

In Moral Sentiments (apologies for not quoting the exact reference, but I did not bring my copy to France, wrongly believing I had another copy here) Smith writes critical comments on selfishness, but also notes that some degree of apparently selfish conduct is actually praise worthy.

Specifically, a man (it was 18th-century Scotland, not PC Boston) would be regarded with disdain who did not make provision for his family here his selfishness' for his family's subsistence would be excused by the impartial spectator' and he would not be guilty of improper conduct. Indeed, should a man not act in his self-interest to provide for his health and well-being, and for his family's, he would be regarded as deficient morally.

Moreover, regard for the welfare for one's family, next for relatives, next for friends and acquaintances, was regarded by Smith as appropriate behaviour for people who actions are consistent with praiseworthy moral sentiments.

Therefore, Smith's actual writings correspond to your third paragraph. Where you go wrong is to passively extend the actions of the moral man to all of society, a rather daunting task given the numbers involved. Most people only know, in addition to their family, a few friends (count your current number of active friends), add your numerous acquaintances, even add in your past friends with whom you have lost contact), and I predict with some confidence that even if you double or quadruple the total you came to, that the number of strangers in society (in your state or county, your country, and then the world), will dwarf your personal total by a large multiple.

It is not a question of your personal intentions you may intend to love all the people of the world' but your time and resources are never, repeat never, going to affect the billions in the world, the millions in your country, the thousands in your community. This does not condemn your attitudes, nor your genuine feelings. It only places them in perspective.

Smith's contribution as a moral philosopher was to work out, given the moral sentiments of people and given their relative isolation from all but a few others, how it is that societies tends to be stable and harmonious, and the people in them remain totally dependent upon each other, though they live in the main as total strangers. The other side of his contention was about how societies can collapse into disorder and destruction.

He argued that whatever else we can say about people, in the main they are concerned about others as well as themselves. They are interested in the welfare of others. These moral sentiments are learned from within the family first and then in the great school of self command' (the school yard) their selfish expectations are curbed by the effect such self-indulgent behaviour has on other children, and how they react to such behaviour in others.

Their parents consider them special'; others do not. This process, which today we call socialisation', continues through to adulthood. They learn to temper their self-indulgence to the level that their colleagues (immediate family, relatives, friends and acquaintances) will tolerate. They are aided in this by what he called the impartial spectator' of their behaviour (closely akin to their conscience). Behaviours that are rejected by their fellows, and which they reject in others, are curbed, as they learn to get on' with others, and learn to mutually avoid causing strife and offence.

This is what Smith call's society's mirror'. In dealing with strangers we lower' our passions to the level that strangers will tolerate, as they will lower theirs. Hence, vast multitudes learn to behave in ways that even strangers, and not just over indulgent parents, will tolerate. It has nothing to do with being greedy'; Greko's greed is good' was not in Smith's litany at all.

I shall come back to the rest of your article later in Part Two. I shall return to you almost correct, but not quite correct, view of the context in which he wrote his Wealth Of Nations. I shall also challenge the idea that Smith was deeply religious'.

Gavin Kennedy

Watching the Watchers: "The Wealth of Nations Revisited; It All Descends from Adam"
By Lee Russ Part Two

"It was intended to apply under certain conditions and certain conditions only"

In the case of Adam Smith this statement is not true. David Ricardo was the analytical economist, not Smith. Any acquaintance with these authors shows a deep difference in their theorising. Smith was not an analytical economist; he was primarily a moral philosopher, who included political economy in his philosophy courses while he taught at Glasgow University. His approach was an historical, looking backwards, long view of how anything he was studying originated, be it philosophy, astronomy, languages, moral sentiments, jurisprudence, police' (i.e., the provision of subsistence to a society), also known as political economy.

He is best known for the latter book, the Wealth Of Nations, which many casual readers treat as a normal economics textbook. It wasn't a textbook nor was it meant to be. Its full title, An Inquiry into the Nature and Causes of the Wealth of Nations', says it all. It was his report of his 12-year inquiry into how the British economy worked and how it got to where it was from where it came. It looks back to the situation in Western Europe following the fall of Rome in 476 and how it entered a thousand-year long interregnum under the rule of war-lords and feudal monarchs, when Europe regressed to an agricultural society and per capita incomes stood still at the pre-Roman level.

Smith treated the re-born commercial society as it was, which he described as 'mercantile commence', he did not discuss pre-conditions under certain conditions and certain conditions only' etc. His model, such as he had one, was set against an ideal that did not exist, known as Perfect Liberty', and which he states very clearly it would be utopian' to ever think it would. To confuse these two concepts, economic society as it was in mid-18th century Britain and how the monopoly, protectionist policies of mercantile commerce, is unfortunate.

The four conditions stated in the piece do not relate at all to Adam Smith. The quotation that follows with the famous invisible hand metaphor, is from a discussion Smith is undertaking about the natural risk-aversion of merchants to sending their capital out of their sight to distant places including foreign countries. Hence, their insecurity causes them to invest locally. By doing so, their capital grows locally and thereby the national capital grows faster than it would have if they sent part of their capital abroad. This is otherwise known as the whole is the sum of the parts'. Nothing more, nothing less and nothing invisible.

The three statements allegedly not realised' by anybody are defective.
"Smith was deeply religious, and believed that God Himself had endowed human beings with such character that they would produce good simply by following their self interest?
Smith described a world in which most business, especially domestic business, was not corporate, but sole proprietors, with no distance between ownership and management, and no means of limiting the personal liability of the owner?
Smith described a world in which it was quite difficult for capital to travel from one nation to another, and barriers of physical distance virtually precluded the import of goods and services which were already available locally?"

Smith was not deeply religious'. Far from it. He went to Oxford University to study for his MA and to prepare for ordination into the Church of England as a Minister in the Episcopalian Church of Scotland. He left before he took the ordination course and dropped the plans of his religious mother for a church career. Like all other men in Scotland at the time he worked under the tutelage of the zealots, a sort of Taliban' wing of the Church of Scotland, then the dominant religion in Scotland. He was careful to conform to the necessary public obligations, but it went no further. After his mother died in 1784, he dropped several religious sentences in Moral Sentiments. He did other things too, but space precludes elaboration.

Copartnery' and joint stock companies' appeared as capital requirements grew. He criticised chartered joint stock companies because of their monopoly status, granted by the King or Act of Parliament, but he also saw a role for joint stock companies without monopoly charters (Bank of England, Bank of Scotland, Royal Bank of Scotland). Normal commerce did not need vast capitals at that time but canals, and water supplies did and he acknowledged they could be a role in large capital project or high risk insurance business for joint stock companies. Neither he, nor anybody else, knew about capitalism.

The reference to it was quite difficult for capital to travel from one nation to another' is not quite the case (more a concern for Ricardo's theories than Smith's), but he did acknowledge that merchants owed by their conduct allegiance to no country and could and did move their capital at will ships bringing gold bullion to and from Britain and other countries weekly did so, and paper bills of trade travelled great distances in an early form of international credit.

In sum, the economics attributed by Lee to Smith are tenuous. The case made by Lee Russ is not sound.

Well, I'm not quite sure how to respond to that. Your comments here seem to assume that I personally believe that Smith did, in fact, hold the views on the working of the "invisible hand" that are often attributed to him in today's world. The posts on your own web site come closer to recognizing that my point was largely the opposite: that many people in the modern world use Smith's work to justify their own desires, frequently without regard for what Smith actually thought/wrote.

Am I correct in assuming from your comments that you think the modern reliance on Smith to justify totally unregulated markets, and to oppose government benefit programs, is dishonest? If I'm not correct, what is your view on that? What is your best guess as to how Smith would react to the 21st century business world?

I claim no particular academic expertise on the writings of Smith, and claimed none in my post. The business and economic conditions in Europe at the time he wrote are, I believe, largely as I described them. Yes, there was a booming import business, but largely for goods that were not available locally. And yes, business forms were changing, but limited liability organizations were not yet the norm.

As to Smith's religiosity, your views are not universal. I would be interested in hearing any specific evidence you have one way or the other; the actions you describe in your post do not necessarily prove a lack of internal belief.