Adam Smith's View of The Free Market as Described in His Book, The Wealth of Nations

Adam Smith’s work The Wealth of Nations has given him an association with capitalism and the invisible hand that guides individuals in economic activities. This invisible hand is both local in nature for the benefit of the individual and the community as a whole. He promotes this system of free markets as a means by which the individual can provide for society by advancing his own self-interest. However, this market has its limitations even Smith concedes that oftentimes an individual can damage society through pursuing their own self-interest. But these are exceptions and abuses and not how the market should operate. This reliance on self-interest is effective in matters of the economy, but is not the way that the social or natural world should necessarily operate. Although Smith criticizes these excesses and abuses, he fails to offer safeguards against them. In Kant’s Groundwork of the Metaphysics of Morals he expressed the belief that treating people as ends and not objects brings about a moral and happy community can serve as a safeguard against a purely self-interested society. But the emphasis that Smith places on outcomes and the importance Kant places on intentions mean that one system will at times take precedent over the other.

Smith’s reasoning for advocating for a free market where individuals can pursue their self-interest is at least in part due to his observation that men, like breeds of dogs have various qualities such as swiftness, strength and sagacity (Smith 15). The distinction that is made, by Smith is that unlike animals, man is able to derive direct benefit from his peers through economic activity (Smith 15). According to Smith this is because “Among men, on the contrary, the most dissimilar geniuses are of use to one another; the different produces of their respective talents, by the general disposition to truck, barter, and exchange, being brought, as it were, into a common stock, where every man may purchase whatever part of the produce of other men's talents he has occasion for.”(Smith 15) This provides mankind with the ability to specialize instead of individuals having to be the provider of all goods and services that are needed for their family unit. Furthermore, this specialization increases the economic productivity of a nation as a whole and provides the individual with more leisure because one does not have to perform every task in the creation of goods and services. Having established that placing goods in a common stock provides society with an economy that can provide, Smith addresses the driving force of this economic system.

This concept of comparative advantage leads Smith to see self-interest as a means by, which an individual advances the society as a whole. To quote Smith, “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own self-interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities, but of their advantages” (Smith 15). This underpins Smith’s economic philosophy, by pursuing our own self-interest in our comparative advantage we achieve a more productive society. Smith in this particular excerpt uses three professions all three are involved with the production of goods. This is of importance because one can easily say that both the producer and the consumers in these given situations benefit from the economic transaction. This is due to the market, having several producers of these products, which allows the market to reach a market price that is suitable for both producers and consumers.

The invisible hand from Smith’s Wealth of Nations has become the symbol of the force that guides this free market. Smith’s idea of the invisible hand, contrary to popular belief, is much narrower than many in modern society believe it to be. Smith states that, “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… By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it” (Smith 485). Within this context Smith simply meant that when an individual engages in economic activity in his immediate community or country he benefits his society as a whole. The “invisible hand” does not mean that every economic decision a person makes abroad will necessarily benefit the world economy or the individual. In this context an individual is acting in a market that they know well, so they are more likely to know what their self-interest is. In this new global economy, it has become fairly difficult for an individual to make decisions based on the limited information that they may have on overseas markets. So pursuing one’s self-interest and by extension the benefit of other economic actors has become less clear. The invisible hand was a metaphor intended to explain the benefits self-interested decisions had on a localized economy. But this metaphor is now used in a way that may not be all too pertinent in this age of a globalized economy.

There is little doubt that self-interest and this invisible hand is what drive Smith’s economic system. Even though it often proves to be beneficial to society, there can arise inefficiencies and complications within the system. The most obvious critique of this system of self-interest has been abuses, by producers. We previously discussed the benefit market competition has for the consumer, but what happens when there is one producer in a given market and that individual pursues their self-interest. Smith states that a monopoly, can keep “the market constantly understocked, by never fully supplying the effectual demand, sell their commodities much above the natural price, and raise their emoluments, whether they consist in wages or profit, greatly above their natural rate”(Smith 69). By producing less than the demand the company or individual is pursuing their self-interest, but is pricing out individuals out of the market and producing less than demand, which reduces the overall productivity of an economic system.

This does not serve the society at large as Smith argues that a free market should. Smith believes that the market would soon correct itself because those that would be willing to purchase the product would sell or withdraw capital to reach the demand, in a perfect market economy (Smith 70). The issue I find with this, especially in the modern age where some monopolies exist, you could have individuals being priced out of the market for essentials, such as medicine and water. Although Smith believes it is rare for a monopoly to exist for long, they often have, and many in the United States have had to be broken up into competing companies to preserve this competition that Smith advocates to lower prices. This breaking up of companies such as Standard Oil and the Bell System were done to do away with these harmful practices that Smith knew monopolies are capable of pursuing. Although Smith is right on both the effects of competition and monopolies, the self-interest of one in control of a monopoly is at odds with the society at large.

Smith also critiques the greed often exhibited by the merchant class in regards to their tendency to raise prices for the purpose of excessive profit, “Our merchants and master-manufacturers complain much of the bad effects of high wages in raising the price, and thereby lessening the sale of their goods both at home and abroad. They say nothing concerning the bad effects of high profits. They are silent with regard to the pernicious effects of their own gains. They complain only of those of other people” (Smith 113). In this situation the merchant or manufacturer no doubt benefits from his decision to raise prices, but it places an unnecessary burden upon the consumers. The decision by the producer is one of self-interest, which does not produce a more productive or happier society. Rather it is a society where one person or group of persons benefits from those that have the capital to pay for these goods, but those who cannot afford the expense are priced out of the market. Granted in Smith’s ideal world of perfect competition there would be other companies that would force the overcharging company to lower their prices. But the incentive that exists for companies to collude is high, especially if the practice is legal. Even when such a practice is illegal the penalty is often not a deterrent because the profits often outweigh this disincentive. Although this does further Smith’s point that people generally do make economic decisions based on self-interest, it is a hindrance to the idea that all self-interest serves to benefit society. Such collusion results in price fixing, which causes an economy to expend an unnecessary amount of resources to a particular product that would be much lower in a truly competitive market.

Another issue with the idea that all economic transactions are both beneficial to all parties and society at large is it makes a few assumptions. First, that both the seller and buyer in a transaction have perfect information, without perfect information a seller can easily sell a consumer a product that is overpriced or faulty. This is seen even today as many individuals buy products such as cars with malfunctioning breaks even though the producer had evidence that there was an issue with the product. The second assumption made is that all people act rationally with the information that they are provided with. The third assumption that is made is that a market economy is always self-correcting in regards to the equilibrium or natural price. This is certainly not the case when companies pursue their own self-interest and are allowed to collude or create a monopoly within the market. This market economy based on self-interest does provide for a productive society for the most part, but it also creates complications that make individuals suffer.

The market economy is effective for creating a productive society that benefits most economic actors. Smith advocated for an essentially unregulated free market, but if monopolies and collusion have taught us anything it’s that some government regulation is needed because the market does not always self-correct. With these common sense regulations to protect the consumer in combination with a self-interested market economy long term growth and innovation should be achieved. Unfortunately, this rational self-interest model is not a panacea for creating a happy and moral society. Although one is typically happier when they have a higher standard of living, which should result from this free market economy, at a certain point it can only provide so much meaning. Even with the creature comforts that a free market economy can provide, a purely self-interested society would not provide the good that people often seek through social relationships. In fact, even in a self-interested market economy, we have seen that self-interest does not always produce beneficial economic results for society as a whole.

Kant differs from Smith in that above all else it is the intention of an action that matters and not the results. The distinction must be made that Smith is addressing the creation of a productive society and Kant a moral one, but it is difficult to imagine a society that is both filled with immorality and is economically productive. Smith’s Wealth of Nations fails to adequately address the criticism that a purely self-interested society may negatively impact its morality and social norms. Arguably, Kant’s most major contribution to ethics has been the treatment of people as deserving of dignity; “So act that you use humanity, whether in your own person or in the person of any others, always at the same time as an end, never merely as a means” (Kant 41). Here Kant expresses that people should never be treated as an object or a tool to reach an end. Rather people should acknowledge that all people are ends, meaning that all should be treated with a level of humanity that they would expect from one another.

Smith’s system of self-interested economic actors often had producers treat consumers and laborers as a means rather than ends. The raising of prices for the sake of profits, the creation of monopolies and the general disregard for the welfare of others is due to a failure to take into consideration another’s humanity. If these actors acted with the premise that people are ends rather than means to reach their selfish ends, they would act in self-interested manner that would preserve the humanity of those they interact with. Kant says, “That it is impossible to think of anything at all in the world, or indeed even beyond it, that could be taken to be good without limitation, except a good will” (Kant 9). Kant holds that this will that individual’s possess is all that matter in terms of morality of a particular action. This intention based moral system stands in stark contrast to Smith’s focus on the results of a given action.

Furthermore, the value Kant places on intentions could also prove of value to Smith’s system. Although Smith holds the belief that self-interest is the best way to drive economic activity, the consideration of morality would reduce the negative externalities that we have previously discussed. However, these two systems certainly conflict when an individual pursues an action with an immoral intention that actually improves the productiveness of society. For example, if a CEO in his own self-interest lied about the state of his company to secure a loan that would result in allowing the company to avoid bankruptcy. Kant would no doubt disapprove because he committed an immoral act by violating a maxim, but he was of course pursuing his self-interest, which proved beneficial to society at large. In a system that takes into consideration both self-interest and intentions one has to consider, which is of a greater value.

The 2008 financial crisis exemplifies the treatment of individuals as means rather than ends to further an actor’s self-interest and allows us to contrast the ideas of Smith with Kant. The potential failure of several large financial institutions was due to the practice of giving adjusted rate mortgages and loans to those with a low likelihood of being able to pay them back in full(Kaiser 3). These companies would then package these loans as mortgage backed securities and take that money to repeat the process. When these mortgages began to adjust to the higher rate people began to default on these loans, causing these securities to be worthless and let the economy go over the cliff (Kaiser 3). These banks gave loans knowing full well many of these clients would be unable to pay it back and that there could be disastrous implications if the system came falling down. This practice was due to the fact that the boards of these financial institutions knew that this process proved to be profitable each year. This decisions made by both the lender and the loan recipient was based on self-interest because one received a house and the other on the macro level received high level profits by selling these securities. This reveals a failure of the market, all individuals acted in their self-interest, yet the outcome proved detrimental. This crisis can be traced to the fact that those issuing the loans saw their clients as a means to make a profit, rather than fallible people that could suffer as a result of their liberality in issuing loans. The result of the practice was trillions of dollars in losses for investors, retirement plans and pensions (Kaiser 32).

Alan Greenspan, served as chairman of the Federal Reserve from 1986-2006 oversaw the economy with his belief in the near infallibility of market forces and a belief that deregulation of the financial sector was the key to economic growth (Kaiser 33). In a congressional hearing Greenspan was questioned whether he believed his ideology had been proven to be flawed. He had this to say, “Absolutely, precisely. You know that’s precisely the reason I was shocked, because I have been going for 40 years or more very considerable evidence that it was working exceptionally well”(Kaiser 34). For the forty years that Greenspan was involved in the Federal Reserve he had pursued an ideology that had worked well, but all it took was one practice based on self-interest to have it come crashing down. This shows both the strength and weakness of this market based economy; it proves to be unbelievably effective at raising standards of living and creating an innovated economic system. But without a strict rulebook with some sense of morality, it can result in the suffering of millions. This is where Kant’s beliefs protect people from self-interest, society needs individuals to have this good will and a moral system where intentions matter. Without these considerations, we are often faced with crises, which are caused by those that pursue self-interest with no qualms with treating others as objects to fulfill their ends.

Smith’s economic system based on self-interest is one that has the potential to benefit the multitude in society. However, it has a tendency to also do great harm to individuals when self-interest overrules their regard for the humanity of their peers. The emphasis that Kant places on the treatment of others as means rather than ends, although idealistic is a value that a self-interested economic model would benefit from. This is due to the fact that when a self-interested economic actor makes a decision they often see people as means to their ends rather than ends. If people are purely self-interested the thought process of many begins to become how this person can further my ends rather than treating them as an end. Although in most cases even with this thinking, both parties and society do benefit, there are cases whereby treating others as means the result is dehumanizing. This is what causes the abuses and outliers that we have previously discussed. With all this being said Smith’s emphasis on results is the strength of his system, but only because in an economy intentions rarely matter. But they do matter when an individuals’ self-interest intentionally damages society for the benefit of a person or groups of persons. This is why it is vital to have morality in an economic system that sees people as ends and never as means.