Many who claim to be "free market proponents" cite the "invisible hand" of Adam Smith in "The Wealth of Nations". However, Adam Smith only uses the term once, only in reference to individuals, and in the context of trade among nations. The chapter is "Of Restraints upon the Importation from Foreign Countries of Such Goods as Can Be Produced at Home". Among the questions Smith raises is :
If a restriction benefits an industry, does it also benefit society?
As to the "invisible hand", Smith does not apply it as a metaphor for an absolutely free market, but as an indication that the acts of an individual can lead to consequences not intended by the individual. A more complete citation than "invisible hand" is:
"[The individual] generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. By preferring the support of domestic to that of foreign industry, he 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." - pages 242-243
In other words, seeking his own security he may benefit society and seeking his own gain he may harm society, or otherwise, depending on the circumstances. In no way does this describe a "perfect market".
All page references are to the PDF version of "Wealth of Nations" transcribed by the Gutenberg Project. You can select your preferred format from http://www.gutenberg.org/files/3300.
For the most part, I don't think Adam Smith provides a prescription of how an economy works. Instead he provides a description of what he observed worked or didn't work.
Smith only uses "free market" once, in a discussion of the bad effects of restricting exports - pages 353-354. Woolen manufacturers wanted to restrict exports of wool so that their supply of wool would be increased. The problem was that English wool was inferior for clothing compared to wool from other countries. The prohibition of exports caused the price of wool to drop drastically, making it unprofitable to produce. The "invisible hand" now works to raise the price of mutton because the farmer has to pay his costs. That means to give the woolen manufacturers cheap wool is to give the consumers expensive meat. So, restricting exports did not give society much benefit.
A word that Smith uses frequently is "labour", would you believe over one thousand times? And how many times do you hear proponents of the "invisible hand" talk about labor, other than "greedy labor unions"? Smith looked favorably on labour, both as the basis of all economic activity and how labor can be marginalized by those with power.
The opening paragraph of "The Wealth of Nations" is:
"The annual labour of every nation is the fund which originally supplies it with all the necessaries and conveniencies [sic] of life which it annually consumes, and which consist always either in the immediate produce of that labour, or in what is purchased with that produce from other nations." - page 3
In other words, without labor, nothing happens.
"The liberal reward of labour, therefore, as it is the necessary effect, so it is the natural symptom of increasing national wealth. The scanty maintenance of the labouring poor, on the other hand, is the natural symptom that things are at a stand, and their starving condition, that they are going fast backwards."
As the National Football League found out, not paying referees what they asked lowered the owners wealth.
As for those who complain about "greedy unions" and promote "right-to-work laws", consider:
"The masters, being fewer in number, can combine much more easily: and the law, besides, authorises, or at least does not prohibit, their combinations, while it prohibits those of the workmen. We have no acts of parliament against combining to lower the price of work, but many against combining to raise it. In all such disputes, the masters can hold out much longer. A landlord, a farmer, a master manufacturer, or merchant, though they did not employ a single workman, could generally live a year or two upon the stocks, which they have already acquired. Many workmen could not subsist a week, few could subsist a month, and scarce any a year, without employment." - page 142
Few seem to understand the need to balance interests. When profits and wages are out of balance we are in deep trouble. Given the rising cash hoard of many large corporations and the still uncertain job market, we should consider:
"It is the stock [materials, equipment, and workplaces] that is employed for the sake of profit, which puts into motion the greater part of the useful labour of every society. The plans and projects of the employers of stock regulate and direct all the most important operation of labour, and profit is the end proposed by all those plans and projects. But the rate of profit does not, like rent and wages, rise with the prosperity, and fall with the declension of the society. On the contrary, it is naturally low in rich, and high in poor countries, and it is always highest in the countries which are going fastest to ruin." - page 142
In other words, without corporations much work doesn't get started and without labor it doesn't get finished.
Finally, Smith didn't think business people ["those who live by profit"] should be trusted in public affairs:
"The proposal of any new law or regulation of commerce which comes from this order, ought always to be listened to with great precaution, and ought never to be adopted till after having been long and carefully examined, not only with the most scrupulous, but with the most suspicious attention. It comes from an order of men, whose interest is never exactly the same with that of the public, who have generally an interest to deceive and even to oppress the public, and who accordingly have, upon many occasions, both deceived and oppressed it." - pages 142-143
Adam Smith was an academic who read widely, considered what he read, and wrote an opinion for the powers-that-be. Those who consider "invisible hand" and "free market" as the only things important about economics, should consider reading more of modern economists, who have the benefit of having read all of "Wealth of Nations" and over two centuries more of data to consider. They are no more in an ivory tower than Adam Smith was.
For a poster of "The proposal of any new law…" see "Poster: A warning from the 'Invisible Hand'".
Updated 2013-07-21 to include Adam Smith's words for "business people.
Updated 2013-08-20 to include link to the poster.
