One of the greatest discoveries of the 18th century did not come from physics or astronomy but from the nascent science of economics. It is the theory that if individuals independently and freely pursue their ordinary self-interest, the resulting social order will be efficient, that is, will allow virtually all these individuals—or at least their vast majority, given their starting points in life—to better satisfy their own preferences.
Adam Smith is, among the first modern economists, the one who, in his 1776 The Wealth of Nations, best formulated the idea:
The natural effort of every individual to better his own condition, when suffered to exert itself with freedom and security, is so powerful a principle, that it is alone, and without any assistance, not only capable of carrying on the society to wealth and prosperity, but of surmounting a hundred impertinent obstructions with which the folly of human laws too often incumbers its operations; though the effect of these obstructions is always more or less either to encroach upon its freedom, or to diminish its security.
Most schools of economics, with notable exceptions (orthodox Marxian and Keynesian beliefs, for instance), have carried this idea to our days.
The 18th-century idea of an autoregulating society was deeply revolutionary as it had been unknown all along the previous 500,000 years of mankind. It would make it possible to understand, during the following three centuries, the escape of ordinary people from hunger and poverty through the multiplication of real goods and services (GDP) in countries where political authorities stopped trying to control everything. Between 1775 and 2018, it is estimated that the British GDP per capita was multiplied by 13 (see the Maddison Project).
Among many illustrations of the power of the idea of autoregulation, consider a story in yesterday’s Wall Street Journal: Leslie Scism, “Car Insurance Prices Fell in 2020 as Pandemic Reduced Driving.” Why did car insurance prices decrease by an average of 4% last year? Is it because the shareholders of property-casualty insurance companies started being altruistic? It would be a complex and unrealistic hypothesis to entertain. Nor would it be a credible hypothesis that altruistic governments across all American states forced the insurance companies to cut their prices. It is true that car insurance rates are monitored or controlled by many state governments (not everybody understands Adam Smith!) but only a minority of them require prior approval—which could probably not have worked so rapidly after Covid-19 hit in 2020. (See Marianne Bonner, “How Insurance Rates are Regulated,” December 14, 2018.)
The explanation of the price reductions lies in the simple fact that that the several hundreds of car insurance companies in America are in competition and cannot avoid cutting their prices if only one of them does it to gain a competitive advantage. So if reduced driving pushes down automobile accidents and their cost during a pandemic, the price of insurance will automatically decrease.
This is a general feature of free markets. Suppliers try to get the highest prices while buyers try to pay as little as possible. It would be vain to blame individuals in either group. On the contrary, it is because they act this way that prices are autoregulated towards the lowest possible prices for consumers consistent with suppliers’ costs.
The drama is that many people still don’t understand the autoregulating character of free interindividual relations. A well-known story is that of the Russian official who, shortly after the collapse of the Soviet Union, asked British economist Paul Seabright, “Who is in charge of the supply of bread to the population of London?”
There are many examples of the persistent ignorance of the autoregulating character of free interindividual relations, and one does not need to look at poor countries laboring under tyranny to find them.
Consider the vice mayor of Long Beach in California who defended the imposition of a $15 per hour minimum wage for grocery workers. Two grocery stores just announced they were closing: see Havley Munguia, “Long Beach’s Grocery-Worker Wage Bump Spurs Closure of Ralphs, Food 4 Less Sites in City,” Press-Telegram, February 1, 2021 (H/T: Andrea Mays). “Our job is to keep providing for the residents,” he declared, not realizing that providing for the resident grocery workers means not providing for the residents who eat food, as food prices (or travel costs) will rise. More fundamentally, the vice mayor does not understand that the most efficient way to determine wages is to let the market do it.
Another exquisite example is the postal inspector who opined on the conduct of a convenience store owner who sold Covid-19 supplies at a price the politicians and bureaucrats considered too high (see the Department of Justice press release):
Unfortunately, Mr. Singh allegedly chose to use this opportunity to make money by hoarding and price gouging PPE [personal protection equipment]. The conduct charged in the complaint is reprehensible and against our most fundamental American values.
Singh later entered into a deferred prosecution agreement and agreed to “donate” $450,000 of PPE, to be distributed by politicians and bureaucrats instead of being sold on the market to ordinary individuals who needed it urgently. If he thought he was in the “country of free enterprise,” he was obviously mistaken.
There are quite probably exceptions to, and within, the theory that individual liberty generates an autoregulating social order—a “spontaneous order” as contemporary economists like F.A. Hayek call it. Justifications exist for governments acting under a realistic presumption of unanimous consent—for example around the goal of not settling conflicts by open violence and organizing protection against that or, more controversially, around other preferences for public goods. But to be credible, these justifications must be built up from an understanding of the general efficiency of the spontaneous order, not handed down from the millennial ideal of a shepherd or some political authority protecting his flock to better exploit it.
A good question is why the 18th-century monumental discovery is still ignored by so many people. Public choice theory suggests many answers, which revolve around the idea that it is in some individuals’ interests to make sure it is ignored. Think of shareholders and executives of steel companies and the bosses of their trade unions. But there are also purely intellectual reasons: after all, many people—despite, or because of, public schools—still believe that the earth is flat.
READER COMMENTS
Thomas Hutcheson
Feb 4 2021 at 7:15am
I have no knowledge of a “Keynesian” “school” of economics that does not recognize the positive role of markets in encouraging mutually beneficial cooperation. Which exponent do you have in mind?
Pierre Lemieux
Feb 4 2021 at 12:35pm
Thomas: Try Keynes himself and the mainstream of his followers, at least until the 1960s or 1970s. Or read the last chapter of the General Theory, or his little book The End of Laissez-Faire. Or read Ralph Raico’s article “Was Keynes a Liberal?” I provided an overview, with many links, in my Econlog post “The Beauty of Trade,” at https://stageeconlib.wpengine.com/archives/2018/05/the_beauty_of_t.html.
What you mean to say, I think, is that not all Keynesian schools or followers have ignored markets. I agree. This is certainly the case for the New Keynesians and for John Hicks, for example. In fact, the younger Keynes also appreciated markets and not only as something that Leviathan, in his wisdom, will allow here or there. You will also find these ideas in my “The Beauty of Trade” and my book Somebody in Charge (Palgrave Macmillan, 2011).
Craig
Feb 4 2021 at 3:11pm
“Two grocery stores just announced they were closing: see Havley Munguia, “Long Beach’s Grocery-Worker Wage Bump Spurs Closure of Ralphs, Food 4 Less Sites in City”
You can now also add 2 Krogers location in Long Beach to that list as well….
Mark Brady
Feb 5 2021 at 1:38pm
“It is the theory that if individuals independently and freely pursue their ordinary self-interest, the resulting social order will be efficient, that is, will allow virtually all these individuals—or at least their vast majority, given their starting points in life—to better satisfy their own preferences.”
Adam Smith did not write about the resulting social order being efficient. Yes, he thought of exchange in the market as mutually advantageous to the participants, but efficient, no. The concept of efficiency in economics comes much later and has particular meanings in particular contexts.
Pierre Lemieux
Feb 5 2021 at 3:21pm
Mark: That the theory of the spontaneous order was discovered in the 18th century (by Smith at the first rank) does not mean that it was also completed then. As you say, Smith never used the term” efficiency.” But 20th-century welfare economists, when they defined efficiency, formalized Smith’s benefits of trade into the “efficiency in consumption” on the Edgeworth contract curve. The second type of efficiency necessary to put society on the Pareto frontier (the production possibility frontier), “efficiency in production,” is also a matter of trade in labor services and other inputs; as Smith said, the individual who employs his capital “is led by an invisible hand to promote an end which was no part of his intention.”
Mark Brady
Feb 7 2021 at 5:19pm
1. I didn’t say that the theory of spontaneous order was completed in the 18th century. Indeed, I don’t claim that it was completed in the 20th century. Who knows what the future holds?
2. That said, it’s important to avoid using words and ideas in an ahistorical fashion. So whenever (far too often) I read that Adam Smith was an exponent of capitalism or laissez-faire, I cringe. The market order, yes, but neither capitalism nor laissez-faire.
3. And when I read that Smith said, the individual who employs his capital “is led by an invisible hand to promote an end which was no part of his intention,” it is imperative to remind the reader that “[T]his time Smith refers to a merchant who, of course, has a choice of investing locally, where he can watch more closely the fate of his investments, or take his perceived greater risk and invest in foreign trade. In acting on his concerns for the security of his capital, the merchant, writes Smith, is ‘led by an invisible hand’ to ‘invest in domestic industry’. This has the consequence that his contribution to domestic investment quantitatively adds to the amount of domestic investment, which leads to higher domestic ‘revenue and employment’, and assuages the felt concerns for the security of the merchant’s capital.” Gavin Kennedy, “Yet Again on Markets and the “Invisible Hand”: http://adamsmithslostlegacy.blogspot.com/2013/11/yet-again-on-markets-and-invisible-hand.html
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