Where Adam Smith Was Wrong

Government is under attack these days, especially here in the USA. It seems clear to me that we need strong government action to create jobs, but the Tea Party proclaims that government is too big now, and that what we need to do is leave everything to the efficiency of the market.

I have argued earlier that this anti-government view is just bad policy, so I won’t repeat that here. Today I want to reflect on the philosophy of the matter, which brings me to Adam Smith and his two great books, The Theory of Moral Sentiments and The Wealth of Nations. Smith pointed that in an ideal market transaction, both sides are made better off by the result. That’s a tautology – without coercion, you wouldn’t enter into a transaction unless it would make you better off in some way. Thus, in a society where everything is done by ideal market transactions, everyone should become better off continually, day by day, with the sole (but important) exception of market failure. The latter occurs when you want to make an exchange, but can’t find anyone willing to make that exchange with you.

So if the market makes everyone better off, it follows that government intervention makes someone worse off, right? This, too, is a tautology. The essence of government is force, and you wouldn’t need force (except for basic security functions, i.e. preventing theft) unless someone did not want to do what is required.

That’s the argument, in a nutshell. Milton Friedman went on at much greater length, but really made only one additional point – that the market is more intelligent than any planners could be – which is demonstrably and obviously wrong (think: bubbles).

The problem is, Smith’s argument (like any argument) is derived from some assumptions, several of which are incorrect: the assumption of uncoerced exchange, the assumption of basic morality, and the assumption of the commensurability of values. Each of these is fundamentally wrong; let me explain!

Coerced exchanges. The essence of capitalism is not the market, but the wage relationship. The capitalist is different from the feudal lord or the slaveowner because he or she (or more likely it, since the capitalist is likely to be a corporation) buys labor for a wage rather than exchanging it for the right to use land or compelling it by brute force. But why would anyone be willing to sell his or her labor to a capitalist? That may seem like a silly question today, when the need for jobs is a given. However, you only need a job because you cannot support yourself by your own independent efforts – and you probably can’t, for the simple reason that you do not have access to the things you need: tools, materials, machines, a distribution network for the things you make – unless you become the employee of a capitalist. Capitalism was only able to get going because a lot of people who had lived on the land were driven off it by the enclosure movement. Once they had no other way to support themselves, they became available as full-time wage laborers.

You can probably see where this is going. If you have no other way to live you have to get a job, whether you think the wages are enough or not. Workers can try to force up the wage level through collective bargaining – but if they are in the job market as individuals, it is not a free exchange; one side, the employer, can dictate the terms.

Failure of moral limits.  Adam Smith thought that abuses of the market would be prevented by the basic humanity of morality. Of course he was right to think that people are moral beings, and the vast majority of us try to do what is right, at least as we see it. Unfortunately, however, “the vast majority” is not enough. Immorality gives a competitive advantage, so the people whose behavior is not limited by moral principles – in other words, those willing to lie, cheat, and steal – tend to rise to the top. One very important reason we need government is to keep immorality from prevailing.

Money can’t buy happiness. Finally, it’s simply not true that values are commensurable (i.e., that they can be measured by a common unit, which we call “money.”) In practice, there is very solid evidence that more money does not lead to more happiness – after a certain point (basically, enough money to maintain a modicum of comfort) there is simply no relationship between wealth and happiness. (See Gross National Happiness by Arthur C. Brooks.) Contemporary society, driven by the imperative of increasing wealth, is producing higher levels of stress, despair, and depression. It seems safe to assume that no one chooses despair or depression (and few choose stress), we must conclude that people are not achieving Pareto optimality. Instead, they are entering into transacions that make them worse off.

None of this is an argument that any particular government intervention in the market would be a good idea. But it does mean that we should never simply assume that markets are good, and government is bad. After that, we need to look at the details.