Market Failure: The Back of the Invisible Hand

[CrisisPapers]

| Ernest Partridge |

The concept of "the invisible hand," cherished by self-designated "conservatives," has its origin in Adam Smith's Wealth of Nations.

(The individual) neither intends to promote the public interest, nor knows how much he is promoting it... (H)e 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.

An unyielding faith in the infallible beneficence of "the invisible hand," leads to "market absolutism" -- the doctrine that whatever government attempts, privatization and the free-market can do better.

What market absolutists (unlike Smith) fail to notice, is that not all workings of "the invisible hand" are beneficial. Some unintended consequences of market activity are harmful -- "the back of the invisible hand." Economists call these "market failures."

One cannot enroll in an Introduction to Economics class, without encountering the concept of "market failure" -- the acknowledgment that a totally unconstrained and unregulated free market can, at times, have socially undesirable consequences (as I will exemplify below). It is one of the most obvious and incontrovertible facts of economics. Almost all of us are aware of market failures, whether or not we have ever studied economics.

Some students of Econ. 101 choose to major in Economics, and a few of these earn doctorates in the field. Those scholars who go on to work for The Heritage Foundation, The American Enterprise Institute, The Cato Institute, etc. somehow manage to completely forget about "market failures." The free unregulated market, they tell us, always brings about the socially optimum result. This cheerful assessment of free markets is called by some "market absolutism." Some examples:

• "In the free market, the individual would have to produce a good that the other person desired in order to receive a good in return. Adam Smith's "invisible hand" of the market guides all participants in society to promote the best wishes of everyone else by pursuing his own wants and desires." (Jacob Halbrooks)


• "(T)he free market allows more people to satisfy more of their desires, and ultimately to enjoy a higher standard of living than any other social system... We need simply to remember to let the market process work in its apparent magic and not let the government clumsily intervene in it so deeply that it grinds to a halt." (David Boaz, Libertarianism, a Primer, p. 40, 185.)


• "A free market (co-ordinates) the activity of millions of people, each seeking his own interest, in such a way as to make everyone better off... Economic order can emerge as the unintended consequence of the actions of many people, each seeking his own interest." (Milton and Rose Friedman: Free to Choose, pp 13-14).

Accordingly, governments should never interfere with markets. Furthermore, governments should not own property, which is better managed by private individuals. So argues the libertarian, Robert J. Smith: "The problems of environmental degradation, pollution, overexploitation of natural resources, and depletion of wildlife all derive from their being treated as common property resources. Whenever we find an approach to the extension of private property rights in these areas, we find superior results." (My italics). "All," "whenever" -- no compromise or qualification here!

In short: let the free market decide. The mysterious "invisible hand" of the free market will "promote the best wishes of everyone..," (Halbrooks), "(allow) more people to satisfy more of their desires" (Boas), and "make everyone better off" (Freidman).

Practical experience tells us otherwise:

• The unconstrained chemical industry promoted pesticides and caused extensive damage to the ecosystem, until the public and then the government, aroused by Rachel Carson's book, "Silent Spring," put a stop to it.


• Similarly, the chemical industry strenuously resisted demands that it cease the manufacture and distribution of chloro-fluorocarbons (CFCs), when atmospheric scientists discovered that the CFCs were eroding the stratospheric ozone, which protects the earth's inhabitants from ultra-violet radiation. Once again, the federal government, joined by the governments of other industrialized nations, enforced a ban on CFCs.


• "global warming") were countered by "junk science" sponsored by the energy industry. Now, at last, as the fact of climate change becomes undeniable and widely acknowledged, the same industry is promulgating the "line" that climate change may not be all that bad, and might even be beneficial. Clearly, mankind can not count on private enterprise to solve this grave crisis. Only international agreement among the industrial nations will suffice. Meanwhile, the Bush administration, on behalf of its "sponsors" the energy industry, is resisting international action.


• Finally, the tobacco industry, whose corporate responsibility to its stockholders is to maximize profits, successfully marketed its products to the point where half of the US population were smokers. At that time, almost a half million Americans died prematurely each year -- more than the total US casualties in World War II. Today, a fifth of adult Americans are smokers. No thanks to the industry. Once again, government intervention, vigorously and persistently opposed by the tobacco industry, has curtailed marketing and has publicized the health hazards of smoking, saving the health and lives of millions.

We are all quite familiar with these "market failures," and many more. It is obvious that, in numerous undeniable cases the unregulated free market fails to "make everyone better off," as Milton Friedman would have us believe. So why are these failures even worth mentioning? The answer is that our present government is dominated by individuals who behave as if they don't recognize these malevolent consequences of free markets. So one after another, regulations and laws designed to correct market failures are being dismantled, as government regulatory agencies are staffed with lobbyists and officers from the corporations that these agencies are charged to regulate.

But why do markets fail to produce optimal results? Railroad tycoon, William Vanderbilt (1856-1938) said it all: "the public be damned, I work for my stockholders." Moreover individual entrepreneurs and workers also want and strive for what is best for themselves. Indeed, as any neo-classical economist will insist, personal want-satisfactions (e.g., profits) are what drive an economy.

Implicit in market absolutism and libertarianism is the belief that what is best for each individual is best for all individuals -- in other words, for "society at large." As President Eisenhower's Secretary of Defense, Charles Wilson, put it: "What is good for General Motors, is good for the country."

This belief has the status of a quasi-religious dogma; it stands strong in the minds of the true believers, notwithstanding what practical experience in the real world might tell us. (See my "Good for Each, Bad for All").

Those who are not captivated by the dogma of market absolutism (i.e., most of us), know better. We trust the scientists who tell us that pesticides damage the ecosystem, that CFCs erode the ozone in the stratosphere, that the continuing use of fossil fuels is changing the climate. And we know that smoking causes lung cancer and premature death -- the cigarette packs tell us so, not because the tobacco companies warn us out of a sense of social responsibility, but because the government requires them to print the warnings.

Government regulation, and laws restricting commercial activity, arise, not from dogma, but through accumulated practical experience and political action. As human institutions they are imperfect, which means, to be sure, that they are sometimes excessive. The appropriate response to "insolence of office" is reform, not abolition of the office -- reform through the same processes of practical experience and political action.

As James Galbraith puts it:

"A new spirit of pragmatism surely requires that we discard the metaphor of market determinism -- whole and entire. No more, let us bow and scrape before that altar. Markets have their place -- they are a reasonably open and orderly way to assure the distribution of services and goods. They are not a general formula for the expression of social will and the working out of social problems."

Corporations quite properly work for the stockholders, and private individuals, in their economic activities, work for themselves and their families. But when these corporate interests and private activities cause social harm, who or what is to act in behalf of society -- of all the people?

The solution is the same in all civilized societies: the law and the government that enacts and enforces the law. To be sure, law and government can be despotic and oppressive, and when they are, "it is (the) right, it is (the) duty" of the people "to throw off such government." (The Declaration of Independence). Such "despotism" surely includes the situation that we face today, as the corporations that should be regulated by government, instead have taken control of the government. However, in liberal democratic countries, law and government, unlike private enterprises, are authorized to act in behalf of the public at large. This, the unregulated free market can not do and must not presume to do.

There is nothing new or startling about these political principles. They are enshrined in our founding documents.

We hold these truths to be self-evident: that all men are created equal; that they are endowed by their Creator with certain unalienable Rights; that among these are Life, Liberty, and the pursuit of Happiness. That, to secure these Rights, Governments are instituted among Men, deriving their just powers from the consent of the governed, That, whenever any Form of Government becomes destructive of these ends, it is the Right of the People to alter or to abolish it, and to institute new Government... (Emphasis added).

And note in the Preamble to the Constitution, these enumerated legitimate functions of government: "... establish Justice, insure domestic Tranquility, provide for the common defence, promote the general Welfare, and secure the Blessings of Liberty to ourselves and our Posterity."

And yet, the dogma of the ruling elites would ordain that we put all these founding principles aside, and in matters of public interest and social welfare, "let the market decide."

These individuals have the nerve to call themselves "conservatives."

-- EP