the baker may sometimes offer a loaf for free, but altruism of this sort cannot be the core activity of a business and they are not assumptions upon which a sound economic theory can be based.
The crucial point is that in a free market it makes no difference whether the entrepreneur is impeccably well-intentioned or unashamedly self-serving. Introducing the famous phrase ‘the invisible hand’, Smith (1957: 400) wrote:
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.
Here are two of Smith’s key lessons. Firstly, that each person can best pursue their own interests by serving the interests of others – there is no need for force or central planning. By pursuing ‘his own gain’, the individual adds value to the economy and benefits his fellow man. The benefits extend to people he has never met and whose company he may not enjoy. The self-interest of the butcher and the brewer makes life easier for those who do not want to slaughter their own livestock and make their own beer. The butcher does not have to go to the trouble of baking his own bread, and the baker can use the profit he makes to buy from the brewer. The profit motive ensures a supply of bread, meat and beer at a lower cost and of a better quality than each worker could provide for himself.
The second lesson is that these mutual benefits come about despite the individual being an unwitting and unconscious player. The profit motive provides incentives for people to do good even when they are not trying to. A selfish and uncharitable entrepreneur can benefit society by meeting the wants and needs of his customers. Indeed, he will have to meet their wants and needs if he is to prosper in business. He may understand the laws of economics or may be totally ignorant, but so long as he labours for himself, he ‘necessarily labours to render the annual revenue of the society as great as he can’ even though he ‘neither intends to promote the public interest, nor knows how much he is promoting it.’
Smith’s great heresy was to show that there is nothing grubby or disreputable about selling at a profit. Friedrich Hayek believed that Smith’s ideas ‘offended a deeply ingrained instinct that man … should aim at doing a visible good to his known fellows (the “neighbour” of the Bible). These are the feelings that still, under the name of “social justice”, govern all socialist demands and easily engage the sympathies of all good men, but which are irreconcilable with the open society to which today all the inhabitants of the West owe the general level of their wealth’ (Hayek 1991: 118). Today, even those critics who concede that capitalism successfully creates growth and prosperity retain their disgust at the mechanism of self-interest that drives it. Skidelsky and Skidelsky (2012: 5), for example, complain that ‘the present system relies on motives of greed and acquisitiveness, which are morally repugnant.’
Many people find it incongruous that noble ends can result from ignoble – or at least morally neutral – motives. ‘The public has severe doubts about how much it can count on profit-seeking business to produce socially beneficial outcomes,’ writes Bryan Caplan. ‘They focus on the motives of business, and neglect the discipline imposed by competition’ (Caplan 2007: 30; emphasis in the original). The observation that man can help others by helping himself is easily mistaken for a celebration of greed and selfishness. And since greed is morally objectionable, nothing good should come of it – the best intentions should result in the best outcomes. But Smith showed this to be untrue. Not only did those who worked for profit often do good for society, but those who professed to be working for society often did ill. ‘I have never known much good done by those who affected to trade for the public good,’ he wrote (Smith 1957: 400). The reasons for this are discussed in the next chapter.
In short, the pursuit of self-interest is not the same as greed. The brewer, the baker and the butcher may not be providing beer, meat and bread motivated by the needs of others. However, there is nothing grubby, ignoble or even necessarily greedy about pursuing a business or career to provide for one’s family. Some supporters of a free market may celebrate greed; others may see greed as self-interest gone too far. It is benign self-interest which believers in a free market regard as the motives for economic action and not greed and selfishness. However, supporters of a free market would also argue that greed in the context of a market economy causes much less harm than greed exercised by those who have political control over the allocation of resources.
1 Like many classic texts, Smith’s book is more talked about than read. Those who do not have time to read it all should at least read its full title: An Inquiry into the Nature and Causes of the Wealth of Nations. Unlike so many critics of capitalism, Smith understood that it is wealth that has ‘causes’, not poverty.
2 Since The Wealth of Nations was published seventeen years after The Theory of Moral Sentiments, some have suggested that Smith abandoned his belief in mankind’s benevolence in favour of a model of cold self-interest in the interim. In fact, large sections of the later book were taken verbatim from lectures he gave fifteen years earlier so this is most unlikely (see Butler 2007: 15).
The parable of the steel company
In applied cost–benefit analyses economists typically assume a large element of narrow self-interest. There is no compelling evidence to suggest that they are mistaken. The matter-of-fact observation that butchers and bakers work for money does not preclude them from enjoying their work, nor does it preclude them from working for nothing if they can afford to. It merely reminds us that without financial incentives very little work would get done.
Why, then, does Chang think that his fellow economists are wrong in believing that people’s financial decisions are largely driven by self-interest? A clue to his thinking comes when he quotes the manager of the Japanese company, Kobe Steel, whom he once heard speak at a conference. This gentleman stood up in front of a panel of economists and, as Chang recalls, delivered the following speech (Chang 2010: 43):
I am sorry to say this, but you economists don’t understand how the real world works. I have a PhD in metallurgy and have been working in Kobe Steel for nearly three decades, so I know a thing or two about steel-making. However, my company is now so large and complex that even I do not understand more than half the things that are going on within it. As for the other managers – with backgrounds in accounting and marketing – they really don’t have much of a clue. Despite this, our board of directors routinely approves the majority of projects submitted by our employees, because we believe that our employees work for the good of the company. If we assumed that everyone is out to promote their own interests and questioned the motivations of our employees all the time, the company would grind to a halt, as we would spend all our time going through proposals that we really don’t understand. You simply cannot run a large bureaucratic organisation, be it Kobe Steel or your government, if you assume that everyone is out for himself.
Chang describes this little monologue as ‘a powerful testimony to the limitations of standard economic theory, which assumes that self-interest is the only human motivation that counts.’ But let us look at what this manager is actually saying. He is describing a business that has become too large for any single individual to be able to supervise every aspect of its operation. Naturally, therefore, a certain amount of trust has to be placed in the staff. It is possible that this trust could be misplaced and that middle managers are putting forward foolish proposals that will lose the company money. It is also possible that the staff could abuse this trust by stealing from the company.
Since neither of these undesirable outcomes appears to have resulted, the manager believes that his staff are not as self-serving as an economist would assume. But he is wrong. In truth, the employees are being guided by the same incentives and disincentives as Adam Smith’s victuallers. Unless Kobe Steel is a very peculiar firm, its workers will not be volunteers
