“Invisible hand” of Adam Smith (Smith 2/4)

By preferring the support of domestic to that of foreign industry, he [every manufacturer] 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.

What is he talking about here? About “preferring the support of domestic to that of foreign industry“?! It has nothing to do with our so pervasive notion of “self-correcting free market forces.” It is just a statement that every manufacturer “prefers” (motivated by “his own security“) to support the domestic market against the import of foreign goods. This statement is quite doubtful, by the way, and was not substantiated by Smith in any way, while we know already that many fortunes were made by exporting products (often using military force first to break into the new markets) by the modern advocates of the “free market” policy. But that is not the topic of my investigation. I just would like to point out that the author of the term “invisible hand” did not use it for describing the “free market forces.”

Meanwhile, if you google “invisible hand” now, you will find plenty definitions like this: “Invisible hand is the unobservable market force that helps the demand and supply of goods in a free market to reach equilibrium automatically.” It matches our modern meaning of the term, but it is almost nothing to do with Adam Smith.

To my utmost delight, I have found that many scientists have noticed this discrepancy long time ago. The Wikipedia states, “The concept of the “invisible hand” is nearly always generalized beyond Smith’s original uses.” It even quotes several more radical opinions. For example, the Nobel Prize-winning economist Joseph E. Stiglitz, says: “the reason that the invisible hand often seems invisible is that it is often not there.” Read the article Invisible hand in Wikipedia about the history of this term and how it has acquired the modern popular meaning. It seems to me such a meaning was assigned to it by people who just wanted their theory of a free market to be true and who used Adam Smith’ authority to support their claim (to compensate, I suspect, the weakness or even absence of scientific evidence). They exploited the fact that very few people read his works nowadays.

Even more, when I read Smith’s Wealth of Nations, I found that in fact, he advocated governmental interference in the market a lot (instead of just calling for the freedom to the “invisible hand”, as it is often presented now). Well, at that time Mercantilism was the dominant economic policy of the leading countries. It promoted governmental regulation for the purpose of increasing the state power at the expense of other nations. So, the government interfered already a lot. But Smith recommended a different kind of interference – a more flexible policy aimed to avoid wars between nations by using tariffs (we call such processes “tariff wars” now). He explained how protectionism could be beneficial sometimes and harmful in other cases. But I did not find him ever saying that government should let the market run on its own (in the contrast to many modern “free-market-oriented” politicians).

I was even more impressed by his extensive explanation of the three primary responsibilities of any government. First, obviously, defense from the external aggression. Second, “that of protecting, as far as possible, every member of the society from the injustice or oppression of every other member of it.” Third, “is that of erecting and maintaining those public institutions and those public works, which though they may be in the highest degree advantageous to a great society, are, however, of such a nature, that the profit could never repay the expense to any individual, or small number of individuals.” As the example of the latter, he talked about “facilitating the commerce of the society” and “promoting the instruction of the people … of two kinds: those for the education of the youth, and those for the instruction of people of all ages.”

As you can see, Adam Smith, although is often called a “founder of capitalism”, was far from advocating laissez-faire government policy. In this post of Economist’s View, you can find a long list of references to the examples of positive government activity provided in the Wealth of Nations. It is a big contrast with the current tendency in the US to privatize everything as the way to solve any problem. Prices for medical services in the US already very high. Now the new administration encourages wider privatization of the schooling, thus abandoning one of their primary duty as has been defined by Adam Smith. If there will be corporations with the bottom line based on their running schools, I do not expect a better quality of education for the majority of the population, but I can guarantee an increase in tuition for everybody.

And the last my surprise (as of today) from reading the Wealth of Nations, was Smith’s acknowledgment of the negative social side-effects of the division of labor and, again, the role of government to alleviate them.

But I have to stop now and continue in the next article of Smith series.