Freeman

ARTICLE

A New Look at the Invisible Hand

JULY 01, 1979 by MELVIN D. BARGER

Mr. Barger is a corporate public relations executive and writer in Toledo, Ohio.

. . . (E )very individual . . . endeavors as much as he can both to employ his capital in the support of domestic industry, and so to direct that industry that its produce may be of the greatest value, every individual necessarily labors to render the annual income of the society as great as he can.

It makes no difference that he neither intends to promote the public interest, nor knows how much he is promoting it. By . . . directing that industry so as to produce the greatest value, he intends only his own gain.

In this, as in many other cases, he is led by an invisible hand to promote an end which was no part of his intention. (Emphasis added)

—Adam Smith

THE WEALTH OF NATIONS, 1776

The most famous doctrine of the moral philosopher Adam Smith was that of the "invisible hand." It usually comes in for ridicule from those who seek the planned society. To them, Smith’s unobtrusive hand was either a myth or only a quaint idea that might have worked in the Eighteenth Century. But they say it is naive to believe, as Smith did, that private and social interests are brought into harmony by the self-interested actions of all.

But Smith has actually been misunderstood by friends as well as foes of the free market economy. Never for a moment would Adam Smith have believed that any individual’s self-interest is always in harmony with the good of society. That would be an absurdity that is easily disproved by human experience. Nor did Smith believe that any action by a businessman is always good. Smith knew as well as anybody that certain people will practice fraud and deception in the market place, and no "invisible hand" slaps them down before others are cheated. So how does the "invisible hand" really work and what are its limitations?

A new Adam Smith, looking at today’s world, could still trace the benign effects of the "invisible hand" —something that Smith’s critics begrudgingly acknowledged.

But the "hand" also works in sinister ways to destroy society, and it is doing so now. The key to understanding this is to look at the nature of the self-interested actions which might benefit society and to contrast them with other self-interested actions which destroy society. The actions described in Smith’s famous example were both productive and peaceful, and they were aimed at producing goods and services which others would value as determined by the market. But what about self-interested actions that are destructive and violent, and might be aimed at goals which do not have sufficient value in a market?

Every sensible person knows that ordinary criminal actions harm not only individuals, but society as well. The robbery of a bank, for example, is considered a crime against the whole society and not just the bank owners and depositors. Most other crimes are in the same category, a tacit recognition of the fact that a good society depends on honest and orderly human actions. It would be ridiculous to suggest that a society of John Dillingers, however, self-interested their actions, could be anything but a nightmare world. Most people will admit that this is true, so they support the government in its efforts to hold the John Dillingers at bay.

But there are other wrongful actions that are not so easy to detect as the robbery of a bank. In these actions, the government itself is both a sponsor and a partner. These actions have a great deal of social approval and have been authorized by the political processes, so a person is almost shouting into the wind by questioning them. Yet, the right or wrong of something is not determined by its political support, but by observing its effects over the long term and at every level of society. Adam Smith saw favorable effects in certain productive, peaceful market actions. How would he view the following practices?

1)       Payment of benefits to politically active groups and their clients;

2)       Granting coercive power to certain favored groups;

3)       Intervening in the market with price controls.

All of these practices are standard features of American government today and have actually become an integral part of the system. It is useless, in most cases, to consider dismantling any governmental program until it has been almost thoroughly discredited. It is also futile to expect to abolish governmental programs simply by proving that they are wrong and inefficient. The would-be reformer always finds himself on a collision course with powerful groups who have an interest in protecting certain programs, no matter how bad and even counter-productive these programs have become. Most people who support certain government programs and interventions will also admit that we are being crushed by excessive government spending and controls. Why, then, do they support something which is economically inefficient and results in loss of liberty? They have actually been moved, as if by an invisible hand, to give such support. Here’s how it happened.

The Lure of Benefits

One of the most destructive and divisive practices of American government is the payment of benefits to politically active groups and their clients. At one time, such payments were only an insignificant part of the national budget. In the past 30 years, however, the Congress and Administrative branch have become centers for the massive distribution of funds to various localities and groups for numerous social and political purposes. This distribution of benefits goes under a variety of names and is justified by a number of sophisticated arguments and cliches. Some of the benefits programs have become so well-entrenched that they function as part of the economy and people have become totally dependent on them. The person who dares to question such programs runs the risk of being a villain who would leave people destitute and helpless. A good example of this is the Social Security program; one cannot even criticize it without appearing as cruel and heartless, and the same seems to be true of countless other social welfare ventures.

But there are increasing signs that Social Security is becoming a bankrupt program, while demands for other benefits are outrunning the government’s ability to collect equivalent amounts in taxes. The competition for government funds has degenerated into a bitter and abrasive contest, with each favored group attacking the others’ premises and claims. Meanwhile, taxpayers are balking at the demands placed on them and are beginning to react by supporting legislative proposals aimed at curtailing government spending or taxation. Far from creating a good and harmonious society, the struggle for government funds has split society into clusters of special interest groups which snarl incessantly at each other when they aren’t busy raiding the federal treasury. If self-interest was seen by Adam Smith as good, why has it led to such disastrous results?

Perhaps the answer lies in the basic nature of benefit-seeking through political action. It is essentially a destructive and violent action, however peaceful it may seem when channeled routinely through the American political processes. Benefits are obtained by using government police power to force certain people to give up goods and services which are then redistributed to others. Moreover, the persons who obtain the benefits have not produced anything of marketable value as a means of establishing their claims.

It is true that the advocates of this redistribution are always able to present their demands as a good cause that is "in the public interest." It is often the seeming righteousness of their cause, as much as political power, that helps disarm their opponents. Indeed, it is often impossible to oppose certain benefit programs without being smeared as a selfish reactionary who hates the poor or is indifferent to the plight of old and sick people.

No decent person should oppose reasonable welfare measures. But everybody should be suspicious of practices which are obviously bad if everybody adopts them. That is because self-interest is omnipresent in society, and is always alert to new opportunities for personal gain at the expense of others. Let one group establish its claim to government benefits, and this becomes the precedent for all groups to do the same. None of these groups want to destroy society or to drive the government into bankruptcy. But "in this, as in many other cases, they are led by an invisible hand to promote an end which was no part of their intention."

Promoting Coercion

The "invisible hand" is also active in private plans for the coercion of others. There are numerous examples of such coercion, but one of the most notable is compulsory union membership. Although unions are private organizations, the police power of government is decisive in giving them the authority to impose sanctions on dissidents. In this case, the controlling group also has power over a person’s livelihood, which is no small thing. Unions’ success in obtaining coercive power has also led others to seek similar authority in other ways.

The use of coercive power by unions began in the 1930s with the passage of the National Labor Relations Act (the Wagner Act). It was an astonishing breakthrough for union organizers who, until then, had faced resistance not only from employers but also from certain workers who refused to belong to their unions. But the Wagner Act changed all that and eventually had the effect of making union membership and the payment of union dues compulsory. It was argued that every worker benefited from union activity; therefore, every worker had a duty to pay dues and to support the union.

Whose self-interest was being promoted here? Undeniably, many workers believed that they benefited from their union membership, so they had an interest in making the organizing power of the union all-inclusive. Coercion was even more in the interests of union officials, who no longer needed to persuade dissidents to join the unions. The extraordinary argument was even made that workers did not really understand their own self-interest and had to be prodded into it by their more enlightened leaders. In this argument, the intellectuals who supported coercive union activity were showing their contempt for the individual worker. They simply could not believe that men who labored with their hands might also be thoughtful people with strong philosophical and personal reasons for not joining a union.

But the argument for coercion carried the day, and union membership burgeoned. This was to be expected, and it was a natural action of the invisible hand. Witnessing the success of one union, other self-interested organizers went to work forming organizations of their own. Of course they always insisted that they were working either in the workers’ interest or in the public interest. But anybody who is familiar with union activities soon learns that self-interest is the controlling factor. Unions do not fight with unusual zeal, for example, to organize small, isolated firms having only a few workers. They are drawn as if led by an invisible hand to the organizations which have a large potential for union membership, dues, and power.

But unions fail to meet the test of the examples in Smith’s famous doctrine. They are neither productive nor peaceful, and they produce no goods or services that others would value as determined by the market. The union is simply an intervening third party. All of the goods and services produced by unionized firms could be supplied even more efficiently without the union.

The success of unions in obtaining coercive power has encouraged other movements to adopt similar programs. In most cases, the activists of the 1960s and 1970s have sought the coercive power of government rather than peaceful cooperation as a means of getting their way. For the most part, there has been little interest shown by these groups in using friendly persuasion; i.e., in promoting their cause by showing people a way that is superior and desirable. Instead, most of these cause groups prefer tactics of intimidation and threats which force compliance with their point of view.

The consumer movement that coalesced around Ralph Nader typifies this approach. Many consumer activists are sincere reformers who actually believe they are helping people. Yet it is almost impossible to find a single consumerist action that could really be considered productive and peaceful, or was aimed at producing something that others would value in the market. The main goal of consumerists has always been to exercise a life-and-death power over the production processes, without regard for the opinions and rights of participants. They apparently take the position that the righteousness of their cause gives them the right to make the consumer’s decisions for him.

The success of these activists, like that of the unions, has spawned countless other movements aimed at changing society and bringing their own leaders into positions of prominence and power. It is sometimes disturbing to note how radical and arrogant these groups have become in their demands for power and authority. But the precedent of giving coercive power to favored groups was established long ago, and we should not be surprised that self-interest leads an increasing number of activist groups to seek similar advantages.

A Hand in the Marketplace

Still, while the "invisible hand" works in every type of human activity, it’s probably the customary marketplace of direct transactions that gives us the best examples of its workings. Now that price controls are again being considered, we can easily predict how self-interest will cause them to fail. Of course, while the proponents of price controls usually agree that "greedy business interests" cause their program to fail, they should at least realize that everybody’s self-interest will tend to thwart the aims of the price controllers.

Price controls are laws or administrative rules devised to prevent producers and sellers from raising their prices above certain levels which are deemed to be fair or in the public interest. The current purpose is to restrain inflation and protect the consumer’s purchasing power. When price controls are being proposed, the producer or seller is often portrayed as a heartless wretch who has both the desire and the power to price-gouge the consumer.

Commercial Decisions

What would our friend Adam Smith have to say about that? He would have agreed, most heartily, that producers and sellers have a self-interest in earning as much as they can. But they never have the power to charge more than customers are willing to pay, nor is it always in their self-interest to raise prices. Sellers frequently improve their earnings or cut their losses by lowering prices. But it is as wrong to condemn a price increase as it is to praise a price cut, because both price adjustments should be viewed as commercial decisions which the seller made in his own self-interest. The supermarket produce manager who slashes the price of bananas on Saturday afternoon is not performing an act of charity; he is only trying to reduce his losses on supplies that would otherwise spoil. Nor is he a scoundrel when he raises banana prices on Monday. He is only responding in a proper businesslike manner to market conditions of supply and demand.

But price controllers either ignore the normal operations of prices in the market or declare that special conditions make price controls necessary, at least for the time being. When the controls are enacted, however, much mischief happens—and it’s all directed by the invisible hand of self-interest.

First, there’s the self-interest of buyers, who welcome the opportunity to purchase goods and services at below-market prices. Their demands will naturally exceed the supplies being offered at that price level. Producers and sellers, who were prevented from expressing their self-interest in pricing, now curtail their production or shift their resources into other product lines. When shortages develop, those producers who are willing to take the risk will sell above the controlled price in the so-called "black" market. Or both sellers and buyers may create ways of getting around the controlled prices without appearing to break the law. Both parties to the transaction may find it in their self-interest to ignore the controlled price. The buyer would appear to be the victim of price-gouging, but he prefers that to the bleak alternative of not being able to complete a purchase of needed goods. So he cooperates in circumventing a law that was supposedly designed to protect him.

Self-Interest Is Always Present

It would be possible to detect the workings of Adam Smith’s "invisible hand" in an infinite number of economic decisions. For example, what form of communications causes used car dealers to raise and lower car prices almost simultaneously? Some naive people would charge collusion, but price changes occur automatically at businesses owned by car dealers who haven’t spoken to one another in years! Or, what causes the prices of real estate to rise and fall, and why do sellers seem to know the "going" price of their houses even when they do not ordinarily deal in real estate? How do unlettered immigrants, though unable to speak the language of the country, quickly learn how to identify currency values and make ordinary transactions with the shrewdness of native citizens?

The answer is that we can always depend on self-interest to work in certain ways most of the time. People do not usually need to be instructed to take actions which they perceive to be in their self-interest. This is not to say that everybody has the same goals or always takes actions which are good for him in the long run. Human beings do seem to be remarkably perceptive, however, about things they are interested in and want to do. The dedicated farmer who expects to get a good price for his crops does not have to be ordered out into the field at gunpoint; the inventor who hopes to reap a fortune with his new gadget does not have to be locked into his workshop; the investor who expects a handsome return does not have to be coaxed to save and invest. People do all these productive and peaceful things voluntarily because they will be rewarded if their efforts have value in the market. Nobody has to worry about directing or organizing their efforts; indeed, all this activity is best coordinated when government planners stay out of it. The omnipresence of self-interest will see to it that each individual finds a place of service and ways of supplying his needs in peaceful ways. As Adam Smith showed, the total wealth of the nation will then grow by a seemingly mysterious process. That same self-interest can become troublesome, however, when people are rewarded for destructive and violent actions. The effect of such rewards is to encourage others to use the same tactics, which encourages still others to do the same, ad infinitum. This can only result in a slowing down of productive efforts and an eventual breakdown in society and the economy. Nobody but a madman would desire such an end, and certainly nobody believes his own actions are taking society in that direction. But people can be led, "as if by an invisible hand," to promote a sad end which was not part of their original intentions. This is no more surprising than Adam Smith’s observation that self-interested actions can promote good ends. He might have added that the ends are predetermined by the nature of the actions. Peaceful actions will lead to desirable ends, violent actions lead to chaos and disorder. We choose the ends when we choose the actions.  

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July 1979

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