Smith on the Boundaries of State and Market Interventions

A correspondent writes:

I would be interested in your comments on this:

"Smith also believed that competition in the market, without government intervention would best facilitate the efficient allocation of resources Adam Smith believed that the ‘invisible hand’ of the market efficiently allocated resources"

From reading your blog would I be right in saying that you agree with the first sentence but as far as the second sentence goes, 'his' 'an invisible hand' was nothing to do with market forces?

My response:

Interesting questions.

For the first part: “Smith also believed that competition in the market, without government intervention would best facilitate the efficient allocation of resources...”, my comment is in two parts.

1.  Smith’s stance on competition is somewhat more complex – and realistic – than modern interpretations allow. He tended to prefer competitive markets to monopoly supply because monopolists tended to narrow the competition and increase prices.  

This was not unconditional.  For instance, he supported the Navigation Acts, first introduced by Cromwell and amended during the 18^th century (repealed in ye 20^th). His grounds were that Britain was an island and freedom of access to the sea and trading partners was strategically essential.  These provided a monopoly to British-built ships, manned by 100% British crews, which included North Americans.  These ships had absolute monopoly preference carrying exports or imports to and from Britain, particularly to the North American colonies.  Foreign ships and crews were subject to fines and other harassments.  The aim was to always have sufficient ships and experienced crews for the Royal Navy to break any attempted blockades.  He called it the wisest of all “commercial” acts.

2.  Contrary to neoclassical inspired ideologues, Smith favoured regulation where the actions of “merchants and manufacturers” threatened the Natural Liberties of citizens.   One example was the need for “party fire walls” in buildings in case of fires.  Another would be the need to prevent Banks from issuing low-denomination notes backed by gold in case of starting bank runs.  We could also add the need for government to act in matters of weights and measures, stamping cloth for quality.

I append a long list extracted from Wealth Of Nations:

• the Navigation Acts, blessed by Smith under the assertion that ‘defence, however, is of much more importance than opulence’ (WN464);

• Sterling marks on plate and stamps on linen and woollen cloth (WN138–9);

• enforcement of contracts by a system of justice (WN720);

• wages to be paid in money, not goods;

• regulations of paper money in banking (WN437);

• obligations to build party walls to prevent the spread of fire (WN324);

• rights of farmers to send farm produce to the best market (except ‘only in the most urgent necessity’) (WN539);

• ‘Premiums and other encouragements to advance the linen and woollen industries’ (TMS185);

• ‘Police’, or preservation of the ‘cleanliness of roads, streets, and to prevent the bad effects of corruption and putrifying substances’;

• ensuring the ‘cheapness or plenty [of provisions]’ (LJ6; 331);

• patrols by town guards and fire fighters to watch for hazardous accidents (LJ331–2);

• erecting and maintaining certain public works and public institutions intended to facilitate commerce (roads, bridges, canals and harbours) (WN723);

• coinage and the mint (WN478; 1724);

• post office (WN724);

• regulation of institutions, such as company structures (joint- stock companies, co-partneries, regulated companies and so on) (WN731–58);

• temporary monopolies, including copyright and patents, of fixed duration (WN754);

• education of youth (‘village schools’, curriculum design and so on) (WN758–89);

• education of people of all ages (tythes or land tax) (WN788);

• encouragement of ‘the frequency and gaiety of publick diversions’(WN796);

• the prevention of ‘leprosy or any other loathsome and offensive disease’ from spreading among the population (WN787–88);

• encouragement of martial exercises (WN786);

• registration of mortgages for land, houses and boats over two tons (WN861, 863);

• government restrictions on interest for borrowing (usury laws) to overcome investor ‘stupidity’ (WN356–7);

• laws against banks issuing low-denomination promissory notes (WN324);

• natural liberty may be breached if individuals ‘endanger the security of the whole society’ (WN324);

• limiting ‘free exportation of corn’ only ‘in cases of the most urgent necessity’ (‘dearth’ turning into ‘famine’) (WN539); 

• moderate export taxes on wool exports for government revenue (WN879).

(See Lost Legacy Blog, 4 March, 2010).

For the second part of your question: “Adam Smith believed that the ‘invisible hand’ of the market efficiently allocated resources”.  I answer this regularly on Lost Legacy. He never referred to the invisible hand in relation to the market, prices, supply and demand, or equilibrium, and assertions to the contrary are invented.  The invisible hand metaphor is completely identified in TMS and WN - where he referred to it once only in each book.  See Lost Legacy for Adam Smith's meaning in his uses of the IH Metaphor.

Smith did not think “Princes” or “Government Ministers” were able to direct industry into what and when to produce anything.  This in general was best left to individuals risking their fortunes; in fact state officials were most likely to do it badly.  However, there was a necessary role for the State, as shown in the above list from the 18th century and which has greatly expanded since, mostly but by no means always for the good.  How much intervention and to what ends is a political decision.  Smith was always pragmatic not ideological.    He denounced manifest failings and supported what worked best. This does not give individuals carte blanche to do anything they like in their activities; he considered the justice system suitable to constrain anti-social behaviours.  Markets only function well under laws.  Hayek probably captures this approach in his account of the detailed knowledge required (but not available to planners) to produce almost anything and certainly not everything in complex economies.  New York, for example, has 30 billion product variations on sale daily compared with a few hundred or a thousand available to the Orinoco hunter-gatherer tribes in Brazil.