Adam Smith and the Invisible Hand
JUNE 01, 1976 by EDMUND OPITZ
The Reverend Mr. Opitz is a member of the staff of the Foundation for Economic Education, a seminar lecturer, and author of the book, Religion and Capitalism: Allies Not Enemies.
This article is from a lecture of February ¹7, ¹976, at the Taft School, Watertown, Connecticut.
We celebrate in 1976 the bicentennial of two significant events, the signing of the American Declaration of Independence, and the publication of The Wealth of Nations by Adam Smith.
Smith had made a name for himself with an earlier volume entitled Theory of the Moral Sentiments, published in 1759, but he is now remembered mainly for his Wealth of Nations, on which he labored for ten years. The Wealth of Nations sold briskly in the American colonies, some 2,500 copies within five years of publication, even though our people were at war. This is a remarkable fact, for there were only three million people living on these shores two centuries ago, and about one-third of these were Loyalists. In England, as in the colonies, there were two opposed political factions—Whigs and Tories. The Tories favored the King and the old regime; the Whigs worked to increase freedom in society. Adam Smith was a Whig; the men we call Founding Fathers were Whigs. There was a Whig faction in the British Parliament and many Englishmen were bound to the American cause by strong intellectual and emotional ties.
Adam Smith’s book was warmly received here, not only because it was a great work of literature, but also because it provided a philosophical justification for individual freedom in the areas of manufacture and trade. The colonies, of course, were largely agricultural; but of necessity there were also artisans of all sorts. There had to be carpenters and cabinet makers, bricklayers and blacksmiths, weavers and tailors, gunsmiths and bootmakers. These colonial manufacturers and farmers had been practicing economic freedom all along; simply because the Crown was too busy with other matters to interfere seriously. There were numerous laws designed to regulate trade, but the laws were difficult to enforce, and so they were ignored.
The nations of Europe at this time embraced a theory of economic organization called "Mercantilism." Mercantilism was based upon the idea of national rivalry, and each nation sought to get the better of other nations by exporting merchandise in exchange for gold and silver. The goal of Mercantilism was the enhancement of national prestige by accumulating the precious metals, but the goal was not nearly so significant as the means employed to reach it. Mercantilism was the planned economy par excellence; the nation was trussed up in a strait jacket ofregulations just about as severe as the controls imposed today upon the people of Russia or China. The modern authoritarian state, of course, has more efficient methods of surveillance and control than did the governments of the seventeenth and eighteenth centuries, but the basic idea is similar.
Take the theory of Mercantilism and boil it down. What do you get? You get political control over what you eat. Now, if someone holds the power of decision over you as to whether you eat or starve, he’s acquired considerable leverage over every aspect of your life; you do not bite the hand that feeds you! If someone controls your livelihood, you do his bidding, or people start talking about you in the past tense!
Mercantilism, in short, is the prototype of today’s totalitarian state, where government — by controlling the economy — exerts a commanding influence over people in every sector of their lives.
The major theme of The Wealth of Nations has to do with the interaction between government and the economic order. The theory of Mercantilism held that government must control and manage the economy, else production would be chaotic and the right people would not be properly rewarded. Present-day collectivists concur; they want a national plan which taxes away about 40 per cent of the peoples’ earnings in order to redistribute these billions of tax dollars to politically selected individuals and groups.
Questions of Political Power
The actions of the redistributive state — call it the welfare state if you prefer — are political actions. From ancient times to the present, every political theorist — except the Classical Liberals — tried to frame answers for three questions.
The first question was: Who shall wield power? Whether the structure took the form of a monarchy backed by divine right or a democracy based on the so-called will of the majority, it was essential that power be wielded by the small group thought most fit to exercise rule. The ruler’s job is to program our lives toward the achievement of national goals. But it was never power simply for power’s sake; it was political power for the sake of the economic advantage power bestows.
So the second question is: For whose benefit shall this power be wielded? The court at Versailles is a good example of what I mean. The French nobles favored by royalty lived rather well, although they’d rather be caught dead than working. In virtue of their privileged position in the political structure, they got something for nothing. I daresay that each of you can think of parallel instances operating today, even in our own country. Now, when someone in a society gets something for nothing through political channels, there are others in that society who are forced to accept nothing for something! And the third question, of course, is: At whose expense shall this power be wielded? Somebody must be sacrificed.
Let me repeat these three questions, for they provide an apt key to many political puzzles: Who shall wield power? For whose benefit? At whose expense? One might put this in a formula: Votes and taxes for all; subsidies and privileges for us, our friends, and whoever else happens at the moment to pack a lot of political clout. The American system was to be based upon a different idea. It took seriously the ideas of God, the moral order, and the rights of persons. It discarded the notion of using government to arbitrarily disadvantage a selected segment of society, and instead embraced the ideal of equality before the law. Government, in this scheme, functioned somewhat like an umpire on the baseball field. The umpire does not write the rules for baseball; these have emerged and been inscribed in rule books over the years and they lay down the norms as to how the game shall be played.
If any person is on the field it is to be presumed that he has freely chosen to be there, and in his thoughtful moments he knows that the game cannot go on unless there is an impartial arbiter on the field to interpret and enforce last-resort decisions — such as ball or strike, safe or out at first. Government, similarily, enforces the previously agreed upon rules.
This is the political theory of Classical Liberalism, and it marks a radical departure from all other political theories. It declared that the end of government is justice between persons, and maximum liberty for everyone in society. "Justice is the end of government," wrote Madison in the 51st Federalist Paper; "it is the end of civil society."
Government Is Force
The point to be stressed is that the essential nature of government — its license to resort to force at some point — is not changed by merely altering the warrant under which government acts. Divine right or popular sovereignty — it makes no difference to this point: Government is as government does.
Governmental action is what it is, no matter what sanction might be offered to justify what it does. The nature of goverment remains the same even though its sponsorship be changed from monarchial power to majority rule. Government always acts with power; in the last resort government uses force to back up its decrees. The government of a society is its police power, and the nature of government remains the same, even when office holders are elected by a vote of the people. And when the police power — government — is limited to keeping the peace of the community by curbing those who disturb the peace — criminals —then there is maximum liberty for peaceful citizens.
"The history of liberty," wrote Woodrow Wilson in 1912, "is the history of the limitations placed upon governmental power." The 18th century Whigs achieved a limited monarchy in England, and a constitutional republic for the thirteen colonies. This was a victory for freedom over tyranny. Such battles, however, do not stay won, and in our time many people have lost their freedom.
Twentieth century political despotism is much more extensive and severe than the monarchial rule of Smith’s day, which is why The Wealth of Nations is still a relevant book. Smith demonstrated that a country does not need an overall national plan enforced upon people in order to achieve social harmony. This is not to say that a peaceful, orderly society comes about by accident, or as the result of doing nothing. Certain requirements must be met if people are to live at peace with their neighbors. It is required, first of all, that there be widespread obedience to the moral commandments which forbid murder, theft, misrepresentation, and covetousness. The second requirement is for a legal system which secures equal justice before the law for every person. When these moral and legal requirements are met, then the people will be led into a system of social cooperation under the division of labor "as if by an invisible hand."
Adam Smith liked this metaphor of "an invisible hand" and used it in Theory of the Moral Sentiments as well as in The Wealth of Nations. Every person, Smith writes, employs his time, his talents, his capital, so as to direct "industry that its produce may be of the greatest value…. He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it…. 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 intentions." Smith concludes this passage by adding, sardonically, "I have never known much good done by those who affected to trade for the public good."
What is Adam Smith telling us? He is saying that if we operate within the proper moral and legal framework, employing our God-given talents to the limit of our powers, then we will find individual fulfillment directly and get the good society as an unexpected bonus.
Equality, Liberty, Justice
The Wealth of Nations is generally regarded as a work on economics, but Smith did not think of himself as an economist. Smith was a professor of Moral Philosophy at the University of Glasgow, where he lectured on ethics, rhetoric, jurisprudence, and political economy. Ask Adam Smith for a thumbnail description of the system of political economy he believed in, and he’d reply that he advocated "the liberal plan of equality, liberty and justice."
These three virtues together characterize the free society, and in fact they are but three facets of a single truth. Equality, as the term is used in the Declaration of Independence, and here by Adam Smith, means the abolition of privilege — one law for all men alike because all men are one in their essential humanity. Because all people are created equal, it is wrong for government to play favorites and bestow advantages on some at the expense of others. The goal is "equal and exact justice for all men, of whatever state or persuasion" — to quote from Jefferson’s First Inaugural. Justice is equality before the law, and this describes a society where each person may freely pursue his own goals, provided he does not infringe the equal right of all the others to pursue theirs.
You’re all familiar with the division of society into a public sector and a private sector; call the former the governmental, coercive sector, if you prefer, and the latter the voluntary sector. When the governmental sector expands, the voluntary sector contracts, and vice versa. The efforts of the old-fashioned Whigs and the Classical Liberals were directed toward the goal of a government limited to maintaining the peace of the community and assuring justice and fair play among people — the umpire role in society. This expanded the voluntary sector and gave us the ideals of freedom of speech, freedom of the press, and religious liberty. And in 1776, Adam Smith provided a rationale for freedom of economic action.
One of the large questions which every society has to face and resolve is: How shall the economic rewards be allocated? Food, clothing, shelter — as well as things like automobiles, television sets, refrigerators, concerts, and trips to Europe — are in limited supply. How shall we "divvy up" the available quantity of these goods? Who gets what?
We know how it was under the old regime: those who wielded political power used it for the economic advantage of themselves and their friends, at the expense of those who lacked political power. There were Haves and Have-nots, and the Haves obtained their wealth by seizing it.
But when men are free, economic rewards are parceled out in a different manner. The free society allocates rewards in the market place; the Haves get that way by pleasing the customers, at which game some are more successful than others.
Every one of us in a free society is rewarded in the marketplace by his peers, according to the value willing buyers attach to the goods and services he offers for exchange. This marketplace assessment is made by consumers who are ignorant, venal, biased, stupid; in short, by people very much like us! This does seem to be a clumsy way of deciding how much or how little of this world’s goods shall be put at this or that man’s disposal, and so people of every age look for an alternative.
There is an alternative, and it runs something like this: People are too dumb to know what is good for them, and they fall easy victims of Madison Avenue. Therefore, let’s invite the wise and good to come down from Olympus to sit as a council among men, and we’ll appear before them one by one, to be judged on personal merit and rewarded accordingly. Then we’ll be assured that those who make a million really deserve it, and those who are paupers belong at that level; and we’ll all be contented and happy. What lunacy! The genuinely wise and good would not accept such a role, and I quote the words of the highest authority declining it: "Who made me a judge over you?"
The Alternative Is Worse
The market-place decision that this man shall earn twenty-five thousand, this one ten, and so on, is not, of course, marked by supernal wisdom; no one claims this. But it is infinitely better than the alternative, which is to recast consumers into voters, who will elect a body of politicians, who will appoint bureaucrats, who will "divvy up" the wealth by governmental legerdemain. This mad scheme backs away from the imperfect and crashes into the impossible!
There are no perfect arrangements in human affairs, but the fairest distribution of material rewards attainable by imperfect men is to let a man’s customers decide how much he should earn; this method will distribute economic goods unequally, but nevertheless equitably. Parenthetically, it should be understood that the market does not measure the true worth of a man or a woman. If it did, we would have to rate all who make a lot of money as superior beings — rock music stars, producers of porno films, publishers of dirty books, television commentators, authors of best sellers — and they’re not superior. To the contrary! But such people constitute only a tiny sector of the free economy, and they are a very small price to pay for the blessings of liberty we enjoy.
In a free society, those who earn more than the national average are entitled to enjoy their possessions, for they’ve gained them in a system of voluntary exchange; the well-being the Haves enjoy is matched by the well-being they have bestowed upon other people —as these other people measure it. There is genuine reciprocity in the free society. But opponents of the market are blind to its built-in mutuality. The Left, therefore, will make a determined effort to instill a guilty conscience in everyone who lives above the poverty level. They use Karl Marx’s exploitation theory which alleges that the man who works for wages produces, over and above his wage, a "surplus value" which is garnisheed by his employer. To be employed — they tell us — is to be exploited, and the whole capitalist class should feel guilty for denying the working class its due!
"Surplus Value" Exposed
This naive and vicious notion was demolished even while Marx still lived, by the economist, Böhm-Bawerk — founder of the Austrian School. Bohm-Bawerk did it again in a second book, in 1896, with the result that the exploitation theory is not now promoted even by Communist theoreticians. But the "surplus value" idea does intensify feelings of envy and guilt, so it is still useful as propaganda.
The free economy sounds pretty good in theory, you might say, but what does it do for the poor? Well, it takes most of them out of that category! A free people becomes a properous people. To the extent that the free economy has been allowed to operate in a nation, in like measure has the free economy elevated more people further out of poverty, faster, than any other system.
It is easy to see why this is so. Poverty is a lack of certain things.
A man is poor whose supply of food, clothing, and shelter are meager; he has only one shabby suit, his diet is macaroni and cheese, and he lives in a sparsely furnished room. A man moves out of poverty only as he acquires better clothes, a more varied diet, and then expands into an apartment or a house. People are well off or less well off according as they command more or less of the things which are manufactured or grown. This is axiomatic, and it follows that poverty is overcome by increased productivity and in no other way. America is the world’s most properous nation because America has been the most productive nation; we have more wealth because we produce more wealth.
Who has the biggest stake in the free economy? Who has most to lose if the free economy lapses into the planned state? Not the rich; the poor! The corporate executive type; the shrewd, energetic, hard-driving, far-seeing, imaginative, nimble, smart, tough executive will make a bundle under any system. In Russia he’d be a commissar. It’s the not so smart, not so energetic, not so imaginative, plodder type who has the biggest stake in the free society. This description fits most of us, and there is a place for us in the free society, where we are rewarded quite handsomely. We’d be serfs, or worse, in most other societies — if we survived liquidation!
When people are free, there is no guarantee that they’ll use their freedom wisely. Freedom of speech does not assure witty conversation, eloquent preaching, or lofty utterance. Most talk, as a matter of fact, is banal and shallow and gossipy; but no one on this account suggests we put a political ban on free speech. We have freedom of the press, with the result that we are knee deep in triviality and garbage. But we support freedom of the press anyway, knowing that a governmentally controlled press would be far worse. Freedom of religion opens the door to all kinds of weird cults, as well as to exotic brands of superstition and magic; but no one advocates that we repeal the First Amendment and set up an American National Church!
That is what freedom is all about — putting up with things we don’t like, and living with a lot of people we can barely stand! We must support the processes of freedom even when we cannot endorse every one of the products of freedom. And that goes for freedom of economic enterprise as well —as Adam Smith advised 200 years ago.
Now, neither the free economy nor its business sector can guarantee to every person full realization of his potential talents; this is a matter for individual decision. All the free society can promise is maximum and equal opportunity —and this is all the guarantee we need.