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In the Nation's Interest

Getting to Know Adam Smith—and the Committee for Economic Development

Hello to my new colleagues and other interested people out there!  This is my first blog post for the Committee for Economic Development and my first since I suspended my EconomistMom blog a couple years ago.  I’m Diane Lim, CED’s new Vice President for Economic Research, and I’m very excited to be working here with a great group of colleagues, especially Joe Minarik, with whom I’ve worked before but never quite for the exact same organization at the exact same time.

As I’m getting to know CED’s mission as “a nonprofit, nonpartisan, business-led public-policy organization that delivers well-researched analysis and reasoned solutions to our nation’s most critical issues,” I’m also learning what makes CED uniquely qualified and well-positioned to weigh in on those policies designed to improve the strength and vibrancy of our economy.  As a public finance economist who has worked in academia, government, think tanks, and other nonprofit organizations, I’ve always focused my research on how various fiscal and economic policies affect economic activity and household well-being—based mostly on the theories I was taught in grad school or the aggregate data I’ve tortured into validating those theories.  I’m looking forward to the opportunity to better understand, at the ground (“micro”) level and in real time, how real-world businesses actually respond to alternative public policies, in their everyday decisions about what, when, and how to produce their goods and services, hire their workers, and invest in their future.  So my joining the CED staff and working with business leaders is my chance to finally learn more about how the “real” economy operates in practice—not just in the theory of my (old) economics textbooks.

In my first week at this “business-led” yet “public-policy” organization, I’ve spent some time getting reacquainted with a man known not just as the founder of the field of economics but also as a strong defender of the “Invisible Hand” of free-market capitalism, Adam Smith. In his latest blog, Joe wrote about the caricatured version of Keynes. So I thought I’d follow Joe’s model and start my first CED blog post with a common caricatured version of Smith and go from there.

The caricature of Adam Smith is that of a “laissez-faire” (French for “let do”, typically translated into “hands off” in economics courses) ideologue to the extreme: that he thought the economy performed best with absolutely no government involvement.  As Charley Dewberry (of Gutenberg College) explains, this simplistic portrayal of Smith has proved useful both to those who are truly and more absolutely free-market capitalism proponents (who think their caricatured version of government can only mess things up—say, the Tea Party movement) as well as those who view capitalism as essentially evil (who think unfettered private capitalism leads only to wealth for the lucky few at the expense of the rest of society—say, the 99 Percent movement).  But neither extreme represents Smith’s views of capitalism.  Dewberry emphasizes that Smith’s high regard for the capitalist economic system was because Smith believed that social well-being often coincided, perhaps even just coincidentally(!), with private profits:  that in seeking to make money in a self-interested way, economic agents (businesses, investors) would end up contributing to a stronger economy, which in turn would benefit all of society.  The businesses that get the most business must be selling what has the greatest public appeal and what serves the most people’s needs, so serving (the sum of) private self-interests turns out to be not that different from serving the (collective) public interest.  In fact, it is through the very interaction with other self-interested individuals via the marketplace that mutually-beneficial relationships can be found that would otherwise not exist, creating new social value out of purely privately-motivated market transactions. In Smith’s own words (my emphasis added):

Nobody ever saw a dog make a fair and deliberate exchange of one bone for another with another dog. Nobody ever saw one animal by its gestures and natural cries signify to another, this is mine, that yours; I am willing to give this for that....But man has almost constant occasion for the help of his brethren, and it is in vain for him to expect it from their benevolence only. He will be more likely to prevail if he can interest their self-love in his favour, and show them that it is for their own advantage to do for him what he requires of them. Whoever offers to another a bargain of any kind, proposes to do this. Give me that which I want, and you shall have this which you want, is the meaning of every such offer; and it is in this manner that we obtain from one another the far greater part of those good offices which we stand in need of. (Adam Smith, Wealth of Nations, Book I, ii, 2)

I’d note that in today’s social-media-laden society, social values are even more likely to turn up in market-based values.  These days it seems at least part of what makes consumers demand a product or service is inevitably an imbedded (or explicitly “tweeted”!) social value in his/her consuming it, because all of our self-interested choices are not—indeed, cannot be, given social media’s huge reach and influence—in complete disregard of the preferences and well-being of other people.

And to those who think that all pro-capitalists view income inequality as just part of what keeps the capitalist machine running properly (because everyone would have an incentive to work hard to become one of the super-rich), well, to the contrary, Adam Smith would have viewed any large amount of inequality as capitalism having, at least to some extent, failed.  Far from caring only about the total size of the economy with little regard for economic equity, Smith’s notion of economic prosperity (the true “wealth of a nation”) was very clearly tied to a just distribution of wealth and not just a nation’s aggregate wealth.  He viewed the free-market system as conveying benefits on ordinary citizens, not just business and capital owners, through less expensive consumer goods and higher wages.  To the extent that the market system would not produce broadly shared prosperity, Smith would have labeled it an unsuccessful system:

No society can surely be flourishing and happy, of which the far greater part of the members are poor and miserable. It is but equity, besides, that they who feed, cloath and lodge the whole body of the people, should have such a share of the produce of their own labour as to be themselves tolerably well fed, cloathed and lodged. (Adam Smith, Wealth of Nations, I, viii, 35)

Smith also recognized that the “invisible hand” of the private marketplace would sometimes fall short of maximizing social welfare, because there are situations where market values (prices) “fail” to incorporate social ones.  This is where Smith saw a necessary role for government to intervene—such as in the provision of goods that are truly “public” in nature where free-riding (and hence under-provision) would naturally occur if we relied on private funding alone.  He listed the “administration of justice,” “maintaining good roads and communications,” “institutions for education” (and interestingly, for “religious instruction” as well) among the necessary public functions where at least partial public provision was warranted (Book V, chpt. i of Wealth of Nations).  And in general, where benefits are shared by or spill over to others in society beyond the individuals who directly “consume” it, Smith stressed that government is needed to collect the costs of providing these public goods (emphasis added):

When the institutions or public works which are beneficial to the whole society either cannot be maintained altogether, or are not maintained altogether by the contribution of such particular members of the society as are most immediately benefited by them, the deficiency must in most cases be made up by the general contribution of the whole society. (Adam Smith, Wealth of Nations, Book V, i, 240)

To this day, correcting or at least compensating for “market failures” is taught as a fundamental role of government, typically on the very first day of a public-sector economics course. 

So Smith believed that capitalism and free-market competition can promote (direct resources toward) economic activities that contribute to the social good, and that government can help where private markets can’t be expected to get it right.  But he also warned of situations where the partnership would not work to society’s benefit—for example, where businessmen (“dealers”) would try to limit competition by influencing government policymakers in their favor (emphasis added):

To widen the market and to narrow the competition, is always the interest of the dealers…The proposal of any new law or regulation of commerce which comes from this order, ought always to be listened to with great precaution, and ought never to be adopted till after having been long and carefully examined, not only with the most scrupulous, but with the most suspicious attention. It comes from an order of men, whose interest is never exactly the same with that of the public, who have generally an interest to deceive and even oppress the public, and who accordingly have, upon many occasions, both deceived and oppressed it. (Adam Smith, Wealth of Nations, Book I, xi, 264)

…as well as situations where government involvement would be counterproductive—with government bureaucrats serving as meddlesome micro-managers who lose sight of (and in fact get in the way of) the government’s essential role in promoting the public good:

The man of system [(government)], on the contrary, is apt to be very wise in his own conceit; and is often so enamoured with the supposed beauty of his own ideal plan of government, that he cannot suffer the smallest deviation from any part of it. He goes on to establish it completely and in all its parts, without any regard either to the great interests, or to the strong prejudices which may oppose it.

He seems to imagine that he can arrange the different members of a great society with as much ease as the hand arranges the different pieces upon a chess-board. He does not consider that the pieces upon the chess-board have no other principle of motion besides that which the hand impresses upon them; but that, in the great chess-board of human society, every single piece has a principle of motion of its own, altogether different from that which the legislature might chuse to impress upon it. If those two principles coincide and act in the same direction, the game of human society will go on easily and harmoniously, and is very likely to be happy and successful. If they are opposite or different, the game will go on miserably, and the society must be at all times in the highest degree of disorder. (Adam Smith, The Theory of Moral Sentiments, Part VI, ii, 42)

Smith’s appreciation for both good business and good government (i.e., the “game of human society” going on “easily and harmoniously”) well describes the balanced role that each should play in our capitalist economy—a fruitful collaboration that CED promotes.  In fact, Thomas R. Wells, a philosophy professor at the University of Groningen in the Netherlands, points out in the Real-World Economics Review (I guess it takes a philosopher to talk about real-world economics!) that Adam Smith strongly opposed “crony capitalism” (a term CED uses within our Sustainable Capitalism project to describe an example of business and government behaving badly together) because it leads to inefficient and unfair allocations of resources and wealth—i.e., lower social welfare. Wells concludes his article by explaining the “real Adam Smith”:

Smith’s economic analysis was thoroughly entangled with a deeply humanistic ethical perspective. The picture of the real Adam Smith this reveals is of a true ‘friend of commerce’, supporting the project because of its achievements and its even greater potential, but constructively critical about both the shortcomings of the mercantilist society he lived in and commerce in general. He justified commercial society for its tremendous contribution to the prosperity, justice, and freedom of its members, and most particularly for the poor and powerless in society. But he was no naive ideologue for free markets and profits. He criticised the political machinations and moral character of the very merchants and manufacturers who, he acknowledged, were driving economic development, and not only told them they should act better, but also argued for institutional measures to restrict their worst proclivities (particularly by getting government out of the business of economic micro-management). Though its promise was great, the rise of commercial society also meant the loss of valuable old ways and posed new challenges of its own. Its success was not predetermined, but had to be worked for. That is a lesson modern economists, and politicians, would do well to relearn. (Thomas R. Wells, “Recovering Adam Smith’s Ethical Economics”)

So, in a nutshell, Adam Smith described the “invisible hand” of markets to explain how a capitalist system can do quite well for a society, but he also stressed the importance of a balanced interaction between the private and public sectors.  From this overdue reunion I’ve had with Mr. Smith since starting my new job, I have decided that I am pretty much an “Adam Smith” economist, which means I believe that capitalism has been very good for our society, but there’s obvious room for continuous improvement in both private-sector and government policies and how the two work together.  This means I fit into CED very well, and in my new role here I can keep studying and applying Smith’s wisdom to CED’s mission. I’m looking forward to working with my CED colleagues, both the staff and our business-leader members, figuring out how business and government can better understand each other and join forces to promote a strong and vibrant economy—one that is performing well not just on average or in aggregate but that better serves the interests of all the members of our society, current and future.