More Welcome Ideas from Australia

Nicholas Gruen, CEO of Lateral Economics and Chairman of Peach Discount Mortgage Broking, contributes a welcome piece on the lively “ON LINE Opinion” e-journal in Australia, entitled “Group and self-interests coincide” (30 June 2005: www.onlineopinion.co.au).

His basic argument (supported by examples from “Micro-credit” and the Gameen Bank and by “Linux” software and “Copyleft”) is that within social and economic systems there is always a mix of “self-interest” and the “community – where people look out for each other. He says that “dotted throughout our market system – which encourages people to pursue their own self interest –are systems in which groups pursue group interests”.

He states boldly and correctly:

“So long as people can behave collectively in the right context – within firms, within families and in administering the rule of law, as Adam Smith argued centuries ago, self interest and community interests coalesce in a miraculous way. Smith is famous for saying in the Wealth of Nations that in securing our dinner “We address ourselves” not to the humanity of the butcher and the baker “but to their self-love”.

And he adds:

“But in is less well-known book, The Theory of Moral Sentiments, [he] explored the importance of sentimental attachments, of people to one another, within families, and communities and nations. That was the great backdrop in which the market’s miraculous “invisible hand” could work.”

Now, it is not a quibble to question two aspects of Nicholas Gruen’s otherwise most encouraging theme, though I risk accusations of doing so. It is important to get the points right that Nicholas Gruen makes, particular as accurate statements of Smith’s views strengthens the points Gruen makes.

First, ignore the hyperbole of the use of “miraculous”. Look at the wording of Smith’s famous statement about getting our dinners from the “Butcher, the Brewer and the Baker” (for some reason it is becoming commonplace for people quoting Smith here to drop his reference to the “Brewer”).

As explained in my “Adam Smith’s Lost Legacy” (ISBN 1-44039-4789-9: Chapters 22-25), this has become the “fundamental error” among modern economists (e.g., Paul Samuelson and George Stigler), who misread Smith’s statement into him saying that markets are driven by self-interest when in fact they are driven by its mediation, even its neutralisation or suspension).

Briefly, we must not forget that Smith’s markets were driven by “truck, barter and trade”. We call it negotiation, today. There are two parties to every attempted and successful market transaction. The focus is on the sellers’ “self-love” not our own self-interests. In Smith’s even lesser known “Lectures in Jurisprudence” (Liberty Press/Oxford University Press) we see one of several of his earlier presentations of the famous paragraph, all along the same lines. Smith says:

“Many continually standing in need of the assistance of others, must fall upon some means to procure their help. This he does not merely by coaxing and courting; he does not expect it unless he can turn it to your advantage or make it appear to be so. Mere self-love is not sufficient for it, till he applies it in some way to your self-love. A bargain does this in the easiest manner. When you apply to a brewer or butcher for beer of for beef you do not explain to him how much you stand in need of these, but how much it would be in [his] interest to allow you to have them for a certain price.” [Lectures in Jurisprudence, 1763, LJ(A) v.45, OUP 1978]

Read that paragraph carefully for it states the important principle of trade: you serve your own self-interests best by serving the self-interests of the other party to the trade. Just as you suppress the urge to elaborate on your self-interest at the moment of the traded exchange, the other party suppresses his self-interest to serve yours: you hand over the agreed price and he hands over your dinner. Both of you serve your their self-interest by serving the other’s self-interest. It is not self-interest for self that makes peaceful trade possible, but only by addressing the self-interest of the other. “Mere self-love is not sufficient”!

This is the correct understanding of what Smith taught in his classrooms from 1751-64 and of what he wrote in “Wealth of Nations” in 1776.

It is also necessary to correct the modern use of the “invisible hand” for the working of markets (a mainly US corruption of Smith’s scarce use of the metaphor).

Smith mentioned the “invisible hand” three times only in his Works.

First in his “History of Astronomy” (written between 1743-51 but not published until 1793, three years after he died) where he refers in a sarcastic comment about pagan superstition to the “invisible hand of Jupiter”, the Roman God not the planet; second in “Moral Sentiments” (1759, pp.184-5) in a comment on the Feudal Lords spending the surpluses from their estates on their Retainers and poor labourers in nearly the same distribution as would occur if the retainers and poor owned little plots themselves (note there were no markets involved); and on the third and last occasion in “Wealth of Nations”, Book IV, p. 456) when describing the preference of local “merchants and manufacturers” to employ their capital in support of the domestic industry rather than abroad in foreign industry. Again this is not about how ‘markets’ operate but about the proclivities of people to prefer having their capital close at hand to where they live. The unintended consequence was for domestic industry to grow faster than it would grow if they preferred to export their capital and grow industries abroad. Again this is not about how markets operate but about how human intentions have unintentional consequences, a wholly different meaning.

Hence, Smith’s “invisible hand” was to do with the consequences of people’s preferences and prejudices and not with “miraculous markets”. The two should be disconnected. There is plenty of evidence that Smith was also (but more so) suspicious of the consequences of the proclivities of “merchants and manufacturers” for pursuing their self-love against the interests of consumers by restricting supplies, forming monopolies and raising prices. No “invisible hand” protects consumers from these depredations in markets!

It might also be worth noting that the metaphor of the “invisible hand” belongs not to Smith but to Shakespeare (who else?) in Macbeth: “thy bloody and invisible hand”.

How does this help Nicholas Gruen? Quite a lot.

Smith did see a connection between the moral sentiments of humans that added to and maintained social cohesion stability and the cohesion of peaceful “markets”, which in the same manner that the Impartial Spectator procedure reduced individual hostility down to what the Impartial Spectator could “go along with” (i.e., a force for the moderation of the passions), the propensity to “truck, barter and exchange” reduces the very real temptations to acquire other people’s goods and services by theft, coercion and violence.

Combined together, these peaceful and moral propensities, under the rule of law and without undue interference, were sufficient for a society in the Age of Commerce (“at last”) to grow gradually from poverty to general opulence for all.