If we were to apply the unmodified, uncurbed rules of the micro-cosmos (i.e., of the small band or troop, or say our families) to the macro-cosmos (our wider civilization), as our instincts and sentimental yearnings often make us wish to do, we would destroy it. Yet if we were always to apply rules of the extended order to our more intimate groupings, we would crush them.

—F. A. Hayek,
The Fatal Conceit: The Errors of Socialism

The widespread belief that markets are immoral is a major reason they are so poorly understood and so rarely appreciated. This belief is not easily overcome. The fundamental problem is that our instinctive sense of morality, which I shall call magnanimous morality (the morality of caring and sharing), makes it easy to see markets as morally flawed. Furthermore, the explanation economists give for what they see as the major advantage of markets reinforces the instinctive tendency to see them as immoral. Unless economists recognize the source of this hostility and acknowledge it is based on a praiseworthy morality—but one not fundamental to the success of markets—there can be little progress overcoming the view that markets are immoral. This would be a shame since there is a strong moral case to be made for markets.

Markets are based on a morality, which I shall call market morality, that helps to direct our actions into a global pattern of mutual assistance which appears to result from magnanimous morality but in fact could never be achieved by that morality. Because market morality lacks instinctive appeal, there is widespread support for attempts to create a more moral economic order by substituting magnanimous morality for market morality. Such attempts unavoidably erode the benefits from both moralities and lower the overall morality of the economy.

I wish to emphasize the difference between magnanimous and market moralities, showing that each supplements the other in contributing to a moral social order—but only if they are confined to their proper spheres of human action.

The Magnanimous Morality of Caring and Sharing

We instinctively think of morality as personally caring for and sharing with others. It can be defined briefly as satisfying three conditions: 1) helping others intentionally; 2) doing so at a personal sacrifice; and 3) providing the help to identifiable individuals or groups. Behavior of this sort is clearly beneficial to the well-being of small groups in which the members are in close personal contact and knowledgeable of the circumstances and concerns of one another. We spent most of our evolutionary history in small hunter/gatherer tribes fitting this description, so a strong affinity for magnanimous morality has been hardwired into our emotional makeup. Its presence or absence has predictable effects on how we view behavior and social arrangements.

The enduring popularity of Charles Dickens’s A Christmas Carol, published in 1843, illustrates the emotional appeal of intentionally caring for and sharing with identifiable people at personal sacrifice. Ebenezer Scrooge is introduced as “a squeezing, wrenching, grasping, scraping, clutching, covetous, old sinner” with no regard for the welfare of this employee, Bob Cratchit, his own family, or anyone else. But after Scrooge’s encounter with the ghost of his former partner and the three ghosts of Christmas he experiences a moral transformation. He finds true happiness in paying for the medical care needed by Tiny Tim, the Cratchits’ crippled son, raising Bob’s salary, and more generally using his wealth for the benefit of others.

The appeal of magnanimous morality is fully warranted and understandable. The relationships we have with family and friends are rooted in it, providing us with our greatest happiness and most satisfying and meaningful moments. It should be emphasized that magnanimous morality is not inconsistent with the proper functioning of a market economy. Success in market transactions depends on being sensitive to the concerns of others. And this sensitivity seems to extend beyond strictly market transactions. Based on experimental evidence from a number of countries with wide differences in the degree of integration into global markets, Herb Gintis concludes, “[S]ocieties that use markets extensively develop a culture of cooperation, fairness and respect for the individual” (quoted in Matt Ridley’s The Rational Optimist).

It should also be admitted, however, that the proper functioning of a market economy does not depend primarily on magnanimous morality. Indeed, the morality on which markets primarily depend is easily seen as rejecting magnanimous morality, and the way most economists make the case for markets encourages this view and the instinctive hostility that so many have for markets.

The Morality of the Market

Market morality is rather modest, with little if any emotional appeal; in fact, it scarcely seems to deserve the name “morality,” instead being commonly seen as a justification for behavior widely held to be immoral. This morality can be defined as following the general rules and norms of market exchanges, such as respecting property rights, honoring contractual obligations, and not harming others by violating their legitimate rights and expectations through force or fraud. Market morality can be achieved, according to Adam Smith in The Theory of Moral Sentiments, “by sitting still and doing nothing.” And while markets reward kindness and caring for those with whom we have personal exchanges, the vast majority of the exchanges we benefit from are impersonal; we neither know nor meaningfully care for those on the other side of the exchange.

Since these impersonal exchanges create enormous benefits from outcomes that emerge without conscious direction, people seldom give much thought to those benefits or the market morality on which they depend. Of course people do think about markets occasionally, but when they do it is seldom with appreciation for the benefits they are receiving. More often than not people think about markets when they are being inconvenienced by the market discipline—the requirements “imposed” on us, for example, in return for income—that makes their benefits possible. Few of us connect such discipline to the far greater benefits we receive as a consequence, particularly when we see others who appear to be reaping great rewards from the very discipline that is apparently making us so much worse off. Under these circumstances it is easy to conclude that we are imposed on unnecessarily by the greed of others. How easy it is to also believe there is something immoral with an economic system that not only tolerates greed but also rewards it.

When economists make the case for what they see as the most impressive feature of markets, they typically do so with the aid of Adam Smith in a way that reinforces the view that markets at best lack morality. Smith understood and appreciated magnanimous morality, as any reader of The Theory of Moral Sentiments, his first book, knows. But this would not be known to someone who knew only Smith’s “invisible hand” argument for markets in The Wealth of Nations. The advantage of markets, according to Smith, is that by pursuing their own interests in the marketplace, people unintentionally do more to promote the public interest (the interest of no one in particular) than if it had been their intention to do so. This argument ignores every requirement for magnanimous morality, and the way economists phrase the argument makes it easy for people to conclude erroneously that the argument for the market rules out the more personal caring and sharing in which our personal relationships are rooted.

I am not proposing that economists discard the invisible-hand explanation of the market. But to make the case for the morality of markets, economists should recognize the tendency for people to dismiss the benefits of the market for its apparent moral failing and counter that tendency by pointing out the inability of magnanimous morality to achieve the desirable economic outcomes expected of it.

Demanding More Than Magnanimous Morality Can Deliver

The belief that markets are immoral causes many either to fail to notice or to dismiss the benefits they realize from them. For example, while most people claim to value conservation and clearly benefit from the conservation that smoothes the availability of goods and resources over time, the nearly unanimous criticism of speculators, whose profit-seeking behavior makes this conservation possible, suggests that most people are unaware that this is a benefit of markets.

Even those aware that they are receiving a benefit from market activity commonly feel it is contaminated by the process providing it. This was illustrated after Hurricane Fran knocked out power in Raleigh, North Carolina, in September 1996. According to Michael Munger, four men from Goldsboro, North Carolina (an hour from Raleigh), rented two freezer trucks and drove to Raleigh with a thousand bags of ice, which they bought for $1.70 each. Customers quickly queued up to pay $8 a bag, with each limited to five bags. Some complained about the price, but no one refused to pay. With the line still long, the local police arrived in force, arrested the four men for price gouging, and confiscated their trucks and all the remaining ice—which was not distributed to those in line. Surprisingly, at least to economists, the frustrated shoppers applauded the police for arresting those whose activities would have made them better off; would the customers have been happier had the sellers not bothered at all? The applause strongly suggests that those in the line felt that the benefit for which they had lined up was contaminated by the profit motive.

Or consider the idea of getting consumers in developed countries to pay extra for “fair trade” coffee, bananas, tea, and chocolate to reduce the poverty of poor farmers in developing countries. Assuming the premiums paid for “fair trade” products go to the intended recipients and forgetting Gene Callahan’s economic analysis suggesting these recipients may be harmed even if they do (“Is Fair Trade a Fair Deal?,” Freeman, March 2008), it is clear that “fair trade” advocates are sincere in their belief that this approach will reduce poverty and hope that it will catch on with consumers. Yet many are conflicted by what has been described as a paradox in the “fair trade” movement resulting from the widespread hostility toward markets that pervades it. As described by Sarah Lyon and Mark Moberg in Fair Trade and Social Justice, “In seeking social justice . . . fair trade . . . pursues a market-based solution to the very problems developing from free markets.” When large corporations such as Starbucks, Nestlé, Walmart, and McDonald’s signed on to sell “Fair Trade” products, which would clearly increase sales and supposedly the incomes of poor farmers, many in the movement objected. Representative of these objections are those voiced by Pedro Haslam and Nicholas Hoskyns (in their contribution to The Fair Trade Revolution), who see these corporations motivated by “marketing success rather than ideology.” “[F]air trade certified farmers who sell to them [big corporations]. . . ,” they continue, “are still locked into the traditional supply chain dominated by the largest companies. This is not the vision of sustainability and community many of us started out with, where local family-owned businesses sell the products of small farmers and personal relations are maintained throughout the supply chain.”

These statements reflect hostility for economies based on “marketing success” and impersonal exchanges between large companies and the suppliers they depend on. The statements, and numerous others from “fair trade” enthusiasts, express a yearning for economies based on personal dealings between consumers in developed countries and those in poor countries who supply them with products anonymously. In this they are like many others who are emotionally attracted to the idea of economies based more on the magnanimous morality of caring and sharing and less on the market morality of pursuing self-interest through impersonal market exchange.

While it is hard to imagine a life of meaning and joy without mutual caring and sharing, we shouldn’t demand more of magnanimous morality than it can deliver. Calls for a more moral marketplace—sometimes referred to as capitalism with a human face—are invariably motivated by the hope of substituting the instinctive morality of the small group for the morality of impersonal markets. When such a substitution goes beyond feel-good rhetoric and is actually attempted, the result is less morality and prosperity as political power replaces voluntary exchange.

Good economists see nothing wrong with caring and sharing. But they also see the opportunity to supplement that morality by extending our ability to help far more people than we can personally care about. The primary advantage of markets is that they provide each of us with the information and motivation to share with literally millions of people, without caring for them.

Of course some will say, “Yes, people are helping each other, but they are doing so for the wrong reason by considering only what’s in it for them.” Such people may never be convinced that self-interest is a legitimate motivation. But one would like to ask them if, when enjoying a good cup of coffee, reading a thrilling mystery on their e-reader, or boarding an airplane to visit a sick friend, they are troubled by the thought that all the many people who made those things possible were motivated primarily by a desire to improve their own conditions and the conditions of the families they love. I doubt they are, and for their sake I hope they aren’t.

The healthiest and certainly the most compassionate way to think about markets is by recognizing that they allow us to provide better for the few we genuinely do care about by doing more to serve and share with the multitude of those we don’t. This suggests that a strong moral case can be made for the market by explaining why the noble desires inspired by magnanimous morality are more fully realized when the urge to substitute that morality for market morality is resisted.

The battle for the preservation and advancement of liberty is a battle not against personalities but against opposing ideas. The French author Victor Hugo declared that “One resists the invasion of armies; one does not resist the invasion of ideas.” This is often rendered as, “More powerful than armies is an idea whose time has come.”

In the past ideas have had earthshaking consequences. They have determined the course of history.

The system of feudalism existed for a thousand years in large part because scholars, teachers, intellectuals, educators, clergymen, and politicians propagated feudalistic ideas. The notion “once a serf, always a serf” kept millions of people from ever questioning their station in life.

Under mercantilism, the widely accepted concept that the world’s wealth is fixed prompted men to take what they wanted from others in a long series of bloody wars.

The publication of Adam Smith’s The Wealth of Nations in 1776 is a landmark in the history of the power of ideas. As Smith’s message of free trade spread, political barriers to peaceful cooperation collapsed, and virtually the whole world decided to try freedom for a change.

Marx and the Marxists would have us believe that socialism is inevitable, that it will embrace the world as surely as the sun will rise in the east tomorrow. As long as men have free will (the power to choose right from wrong), however, nothing that involves this human volition can ever be inevitable! If socialism comes it will come because men choose to embrace its principles.

Socialism is an age-old failure, yet the socialist idea constitutes the chief threat to liberty today. As I see it, socialism can be broken into five ideas.

1. The Pass-a-Law Syndrome. Passing laws has become a national pastime. Business in trouble? Pass a law to give it public subsidies or restrict its freedom of action. Poverty? Pass a law to abolish it. Perhaps America needs a law against passing more laws.

Almost invariably a new law means: a) more taxes to finance its administration; b) additional government officials to regulate some heretofore unregulated aspect of life; and c) new penalties for violating the law. In brief, more laws mean more regimentation, more coercion. Let there be no doubt about what the word coercion means: force, plunder, compulsion, restraint. Synonyms for the verb form of the word are even more instructive: impel, exact, subject, conscript, extort, wring, pry, twist, dragoon, bludgeon, and squeeze.

When government begins to intervene in the free economy, bureaucrats and politicians spend most of their time undoing their own handiwork. To repair the damage of Provision A, they pass Provision B. Then they find that to repair Provision B, they need Provision C, and to undo C, they need D, and so on until the alphabet and our freedoms are exhausted.

The Pass-a-Law Syndrome is evidence of a misplaced faith in the political process, a reliance on force, which is anathema to a free society.

2. The Get-Something-from-Government Fantasy. Government by definition has nothing to distribute except what it first takes from people. Taxes are not donations.

In the welfare state this basic fact gets lost in the rush for special favors and giveaways. People speak of “government money” as if it were truly free.

One who is thinking of accepting something from government that he could not acquire voluntarily should ask, “From whose pocket is it coming? Am I being robbed to pay for this benefit or is government robbing someone else on my behalf?” Frequently the answer will be both.

The end result of this “fantasy” is that everyone in society has his hands in someone else’s pockets.

Everyone Else’s Problem

3. The Pass-the-Buck Psychosis. Recently a welfare recipient wrote her welfare office and demanded, “This is my sixth child. What are you going to do about it?”

An individual is victim to the Pass-the-Buck Psychosis when he abandons himself as the solver of his problems. He might say, “My problems are really not mine at all. They are society’s, and if society doesn’t solve them and solve them quickly, there’s going to be trouble!”

Socialism thrives on the shirking of responsibility. When men lose their spirit of independence and initiative, their confidence in themselves, they become clay in the hands of tyrants and despots.

4. The Know-It-All Affliction. Leonard Read, in The Free Market and Its Enemy, identified “know-it-allness” as a central feature of the socialist idea. The know-it-all is a meddler in the affairs of others. His attitude can be expressed in this way: “I know what’s best for you, but I’m not content to merely convince you of my rightness; I’d rather force you to adopt my ways.” The know-it-all evinces arrogance and a lack of tolerance for the great diversity among people.

In government the know-it-all refrain sounds like this: “If I didn’t think of it, then it can’t be done, and since it can’t be done, we must prevent anyone from trying.” A group of West Coast businessmen once ran into this snag when their request to operate barge service between the Pacific Northwest and Southern California was denied by the (now-defunct) Interstate Commerce Commission because the agency felt the group could not operate such a service profitably.

The miracle of the market is that when individuals are free to try, they can and do accomplish great things. Read’s well-known admonition that there should be “no man-concocted restraints against the release of creative energy” is a powerful rejection of the Know-It-All Affliction.

5. The Envy Obsession. Coveting the wealth and income of others has given rise to a sizable chunk of today’s socialist legislation. Envy is the fuel that runs the engine of redistribution. Surely, the many soak-the-rich schemes are rooted in envy and covetousness.

What happens when people are obsessed with envy? They blame those who are better off than themselves for their troubles. Society is fractured into classes and faction preys on faction. Civilizations have been known to crumble under the weight of envy and the disrespect for property it entails.

A common thread runs through these five socialist ideas. They all appeal to the darker side of man: the primitive, noncreative, slothful, dependent, demoralizing, unproductive, and destructive side of human nature. No society can long endure if its people practice such suicidal notions.

Consider the freedom philosophy. It is an uplifting, regenerative, motivating, creative, exciting philosophy. It appeals to and relies on the higher qualities of human nature such as self-reliance, personal responsibility, individual initiative, respect for property, and voluntary cooperation.

The outcome of the struggle between freedom and serfdom depends entirely on what percolates in the hearts and minds of men. At the present time the jury is still deliberating.

Critics of laissez faire—from Cambridge economic historian Emma Rothschild to British Labor Party leader Gordon Brown—have recently attempted to wrestle Adam Smith out of the hands of the free-market camp and into the camp of the social democrats. According to Iain McLean, professor of politics at Oxford University, and Samuel Fleschaker, professor of philosophy at the University of Illinois at Chicago, the Scottish philosopher was a “radical egalitarian” who, while endorsing economic liberalism, had a lively appreciation of market failure and ultimately rejected “ruthless laissez-faire capitalism” in favor of “human equality” and “distributive justice.”

These critics are quick to claim that Smith was no friend of rent-seeking landlords, monopolistic merchants, and conspiring businessmen, and that he advocated an active State authority in support of free education, large-scale public works, usury laws, progressive taxation, and even limits on free trade.

What about the metaphor of the “invisible hand,” the famous Smithian idea that “by pursuing his own self-interest, [every individual] frequently promotes that of the society”? Free-market economists from Ludwig von Mises to Milton Friedman have regarded it as a powerful symbol of unfettered market forces, what Adam Smith called his “system of natural liberty.” In rebuttal the new critics belittle Smith’s metaphor as a “passing, satirical” reference and suggest that he favored more of a “helping hand.” They emphasize that Smith used the phrase “invisible hand” only once in each of his two major works, The Theory of Moral Sentiments (1759) and The Wealth of Nations (1776). The references are so sparse that commentators seldom mentioned the expression by name in the nineteenth century. No notice was made of it during the celebrations of the centenary of The Wealth of Nations in 1876. Until well into the twentieth century, no subject index listed “invisible hand” as a separate entry. It was finally added to the index in 1937 by Max Lerner for the Modern Library edition. Clearly, it wasn’t until the twentieth century that the invisible hand became a popular symbol of laissez faire.

Could the detractors be correct in their assessment of Adam Smith’s sentiments? Is the metaphor central or marginal to his “system of natural liberty”?

Friedman refers to Adam Smith’s symbol as a “key insight” into the cooperative, self-regulating “power of the market to produce our food, our clothing, our housing . . . without central direction.” Economist George Stigler calls it the “crown jewel” of The Wealth of Nations and “the most important substantive proposition in all of economics.”

On the other hand, economist Gavin Kennedy contended in earlier writings that the invisible hand is nothing more than an afterthought, a “casual metaphor” with limited value. Rothschild, the Harvard University economic historian, even goes so far as to declare, “What I will suggest is that Smith did not especially esteem the invisible hand. . . . It is un-Smithian and unimportant to his theory” and was nothing more than a “mildly ironic joke.”

Who’s right?

A fascinating discovery by Daniel Klein, professor of economics at George Mason University, may shed light on this debate. Based on a brief remark by Peter Minowitz, the Santa Clara University political philosopher, that the “invisible hand” phrase lies roughly in the middle of both of Smith’s books, Klein made preliminary investigations. He next recruited Brandon Lucas, then a doctoral student at Mason, to investigate further. Klein and Lucas reported in Economic Affairs (March 2011) that they found considerable evidence that Smith “deliberately placed ‘led by an invisible hand’ at the centre of his tomes” and that the concept “holds special and positive significance in Smith’s thought.”

Klein and Lucas base their conjecture on two major points. First, the physical location of the metaphor: The single expression “led by an invisible hand” occurs almost dead center in the first and second editions of The Wealth of Nations. (It moves slightly away from the middle after an index and other material were added to later editions.)

Moreover, it appears again “well-nigh dead centre” in the final edition of The Theory of Moral Sentiments. Klein and Lucas admit that it was not in the middle of the first edition in 1759, speculating that “physical centrality was not initially a part of his intentions . . . [but that] by 1776, Smith had become intent on centrality.” Indeed, Smith moved the phrase “invisible hand” closer to the center of the book, first by appending an important essay on the origin of language and finally by making substantial revisions in the final edition.

Second, they note that as a historian and moral philosopher, Adam Smith commented frequently on the importance of middleness in architecture, literature, science, and philosophy. For example:

• Smith wrote sympathetically about the Aristotelian golden mean, the idea that virtue exists “between two opposite vices.” For instance, between the two extremes of cowardice and recklessness lies the central virtue of courage.
• In his essays on astronomy and ancient physics, he was captivated by Newtonian central forces and periodical revolutions.
• Klein discovered that in his lectures on rhetoric, Smith admired the poetry of the Greek poet Thucydides, who “often expresses all that he labours so much in a word or two, sometimes placed in the middle of the narration.”

In sum, according to Klein and Lucas, the invisible hand represents the centrality of Smith’s “system of natural liberty” and is appropriately found in the middle of his works. By this discovery, if true, one goes from one extreme to the other—from seeing the invisible hand as a marginal concept to accepting it as the touchstone of his philosophy.

Klein and Lucas’s list of evidence is what a lawyer might call circumstantial, or “impressionistic,” to use their own adjective. Taken as a whole, the documentation is either an ingenious breakthrough or a “remarkable coincidence,” to quote Kennedy.

A few Smithian experts have warmed up to Klein and Lucas’s claim. Kennedy, who previously considered the invisible hand a “casual” metaphor, now sees a “high probability” in their thesis of deliberate centrality. Others are more skeptical. “We have no direct evidence for the conjecture,” states Craig Smith, an expert on Adam Smith at the University of St. Andrews. The idea that Smith deliberately hid his favorite symbol of his philosophy “strikes me . . . as very un-Smithian,” he states, and runs contrary to his policy of expressing thoughts in a “neat, plain and clever manner.” Placing the shorthand phrase “invisible hand” in the middle of his works may not be plain, but is it not neat and clever?

We may never know the truth, since we have no record of Smith’s confession on the matter. Fortunately, one does not need to depend on the physical centrality of the “invisible hand” to recognize the doctrinal centrality of his philosophy.

There are many passages from The Wealth of Nations and The Theory of Moral Sentiments that elucidate the “invisible hand” theme, the idea that individuals acting in their own self-interest unwittingly benefit the public weal, or that eliminating restrictions on individuals’ behaviors “better[s] their own condition” and makes society better off. Smith repeatedly advocated removal of trade barriers, State-granted privileges, and employment regulations so that individuals could flourish.

In The Theory of Moral Sentiments, Smith writes:

The man of system . . . seems to imagine that he can arrange the different members of a great society with as much ease as the hand arranges the different pieces upon a chess-board. He does not consider that the pieces upon the chess-board have no other principle of motion besides that which the hand impresses upon them; but that, in the great chess-board of human society, every single piece has a principle of motion of its own, altogether different from that which the legislature might chuse to impress upon it. If those two principles coincide and act in the same direction, the game of human society will go on easily and harmoniously, and is very likely to be happy and successful. If they are opposite or different, the game will go on miserably, and the society must be at all times in the highest degree of disorder.

Smith’s argument is comparative. To quote Klein: “Hewing to the liberty principle generally works out better than not doing so—in this respect, [Kenneth] Arrow, Joseph Stiglitz, and Frank Hahn do disfigure Smith when they identify the invisible hand with some rarified perfection. We need not rehearse Smith on the ignorance, folly, and presumption of political power, on the corruption and pathology of political ecology. . . . Smith sees the liberty principle as a moral, cultural, and political focal point, a worthy and workable principle in the otherwise dreadful fog of interventionism.”

To think that Adam Smith, the renowned absent-minded professor, hid a little “invisible” secret in his tomes is indeed the ultimate irony. As Klein concludes, “That the phrase appears close to the center, and but once, in TMS and in WN might be taken as evidence that Smith did intend for us to take up the phrase.”

I find Professor Klein’s story compelling and have enjoyed showing copies of Smith’s works with a bookmark in the key pages to students, faculty, and interested friends.

Adam Smith had one overwhelmingly important triumph:  he put into the center of economics the systematic analysis of the behavior of individuals pursuing their self-interest under conditions of competition. — George Stigler (emphasis added)

Critics of laissez faire — from Cambridge economic historian Emma Rothschild to British Labor Party leader Gordon Brown — have recently attempted to wrestle Adam Smith out of the hands of the free-market camp and into the camp of the social democrats.  According to Iain McLean, professor of politics at Oxford University, and Samuel Fleschaker, professor of philosophy at the University of Illinois at Chicago, the Scottish philosopher was a “radical egalitarian” who, while endorsing economic liberalism, had a lively appreciation of market failure and ultimately rejected “ruthless laissez-faire capitalism” in favor of “human equality” and “distributive justice.”

These critics are quick to claim that Smith was no friend of rent-seeking landlords, monopolistic merchants, and conspiring businessmen, and that he advocated an active State authority in support of free education, large-scale public works, usury laws, progressive taxation, and even limits on free trade.

Powerful Symbol

What about the metaphor of the “invisible hand,” the famous Smithian idea that “by pursuing his own self interest, [every individual] frequently promotes that of the society”?  Free-market economists from Ludwig von Mises to Milton Friedman have regarded it as a powerful symbol of unfettered market forces, what Adam Smith called his “system of natural liberty.”  In rebuttal, the new critics belittle Smith’s metaphor as a “passing, satirical” reference and suggest that he favored more of a “helping hand.” They emphasize that Smith used the phrase “invisible hand” only once in each of his two major works, The Theory of Moral Sentiments (1759) and The Wealth of Nations (1776).   The references are so sparse that commentators seldom mentioned the expression by name in the nineteenth century.  No notice was made of it during the celebrations of the centenary of The Wealth of Nations in 1876.  In the eighteenth, nineteenth centuries, and early twentieth centuries, no subject index, including that of the well-known edition edited by Edwin Cannan (1904), listed “invisible hand” as a separate entry.  It was finally added to the index in 1937 by Max Lerner for the Modern Library edition.  Clearly, it wasn’t until the later twentieth century that the invisible hand became a popular symbol of laissez faire.

Could the detractors be correct in their assessment of Adam Smith’s sentiments?  Is the invisible-hand metaphor central or marginal to his “system of natural liberty”?

Milton Friedman refers to Adam Smith’s symbol as a “key insight” into the cooperative, self-regulating “power of the market to produce our food, our clothing, our housing . . . without central direction.” Economist George Stigler calls it the “crown jewel” of The Wealth of Nations and “the most important substantive proposition in all of economics.”

On the other hand, economist Gavin Kennedy contended in earlier writings that the invisible hand is nothing more than an after-thought, a “casual metaphor” with limited value.  Rothschild, the Harvard University economic historian, even goes so far as to declare, “What I will suggest is that Smith did not especially esteem the invisible hand. . . .  It is un-Smithian and unimportant to his theory” and was nothing more than a “mildly ironic joke.”

Who’s right?

The Discovery

A fascinating discovery uncovered by Daniel Klein, professor of economics at George Mason University, may shed light on this debate.  Based on a brief remark by Peter Minowitz, the Santa Clara University political philosopher, that the “invisible hand” phrase lies roughly in the middle of both of Smith’s books, Klein made preliminary investigations.  He next recruited Brandon Lucas, then a doctoral student at Mason, to investigate further.  Klein and Lucas report in Economic Affairs (March 2011) that they found considerable evidence that Smith “deliberately placed ‘led by an invisible hand’ at the centre of his tomes” and that the concept “holds special and positive significance in Smith’s thought.”

Klein and Lucas base their conjecture on two major points.  First, the physical location of the metaphor:  The single expression “led by an invisible hand” occurs almost dead center in the first and second editions of the Wealth of Nations.  (It moves slightly away from the middle after an index and other material were added to later editions.)

Moreover, it appears “well-nigh dead centre” in the final edition of The Theory of Moral Sentiments.  Klein and Lucas admit that it was not in the middle of the first edition in 1759, speculating that “physical centrality was not initially a part of his intentions . . . [but that] by 1776, Smith had become intent on centrality.”  Indeed, Smith moved the phrase “invisible hand” closer to the center of the book, first by appending an important essay on the origin of language and finally by making substantial revisions in the final edition.

Second, they note that as a historian and moral philosopher, Adam Smith commented frequently on the importance of middleness in architecture, literature, science, and philosophy.  For example:

• Smith wrote sympathetically about the Aristotelian golden mean, the idea that virtue exists “between two opposite vices.”  For instance, between the two extremes of cowardice and recklessness lies the central virtue of courage.
• In his  essays on astronomy and ancient physics, he was captivated by Newtonian central forces and periodical revolutions.
• Klein discovered that in his lectures on rhetoric Smith admired the poetry of Thucydides, who “often expresses all that he labours so much in a word or two, sometimes placed in the middle of the narration.”

Midpoint analysis and centralized themes existed long before Smith’s time.  For example, the Talmud offers considerable commentary about midpoints in the Torah, especially in a poetic form called chiasmus.

In sum, according to Klein and Lucas, the invisible hand represents the centrality of Smith’s “system of natural liberty” and is appropriately found in the middle of his works.  By this discovery, if true, one goes from one extreme to the other — from seeing the invisible hand as a marginal concept to accepting it as the touchstone of his philosophy.

“Impressionistic” Evidence

Klein and Lucas’s list of evidence is what a lawyer might call circumstantial, or “impressionistic,” to use their own adjective.  Taken as a whole, the documentation is either an ingenious breakthrough or a “remarkable coincidence,” to quote Kennedy.

A few Smithian experts have warmed up to Klein and Lucas’s claim.  Kennedy, who previously considered the invisible hand a “casual” metaphor, now sees a “high probability” in their thesis of deliberate centrality.  Others are more skeptical.  “We have no direct evidence for the conjecture,” says Craig Smith, an expert on Adam Smith at the University of St. Andrews.  The idea that Adam Smith deliberately hid his favorite symbol of his philosophy “strikes me . . .  as very un-Smithian” and runs contrary to his policy of expressing thoughts in a “neat, plain and clever manner.”

Placing the shorthand phrase “invisible hand” in the middle of his works may not be plain, but is it not neat and clever?

We may never know the truth, since we have no record of Smith’s confession on the matter.  Fortunately, one does not need to depend on the physical centrality of the “invisible hand” to recognize the doctrinal centrality of his philosophy.  As Craig Smith states, “I’m not convinced that Smith deliberately placed the invisible hand at the centre of his books, but I am certain that it lies at the heart of his thinking.”

There are many passages from The Wealth of Nations and The Theory of Moral Sentiments that elucidate the “invisible hand” theme, the idea that individuals acting in their own self-interest unwittingly benefit the public weal, or that eliminating restrictions on individuals’ behaviors “better[s] their own condition” and makes society better off.  Smith repeatedly advocated removal of trade barriers, State-granted privileges, and employment regulations so that individuals can flourish.

In The Theory of Moral Sentiments, Smith writes:

The man of system … seems to imagine that he can arrange the different members of a great society with as much ease as the hand arranges the different pieces upon a chess-board. He does not consider that the pieces upon the chess-board have no other principle of motion besides that which the hand impresses upon them; but that, in the great chess-board of human society, every single piece has a principle of motion of its own, altogether different from that which the legislature might chuse to impress upon it. If those two principles coincide and act in the same direction, the game of human society will go on easily and harmoniously, and is very likely to be happy and successful. If they are opposite or different, the game will go on miserably, and the society must be at all times in the highest degree of disorder.

Smith’s argument is comparative.  To quote Klein:  “Hewing to the liberty principle generally works out better than not doing so—in this respect, [Kenneth] Arrow, Joseph Stiglitz, and Frank Hahn do disfigure Smith when they identify the invisible hand with some rarified perfection. We need not rehearse Smith on the ignorance, folly, and presumption of political power, on the corruption and pathology of political ecology…. Smith sees the liberty principle as a moral, cultural, and political focal point, a worthy and workable principle in the otherwise dreadful fog of interventionism.”

To think that Adam Smith, the renowned absent-minded professor, hid a little “invisible” secret in his tomes is indeed the ultimate irony.  As Klein concludes, “That the phrase appears close to the center, and but once, in TMS and in WN might be taken as evidence that Smith did intend for us to take up the phrase.”

I find Professor Klein’s story compelling and have enjoyed showing copies of Smith’s works with a bookmark in the key pages to students, faculty, and interested friends.  It has, in the words of philosopher Robert Nozick, “a certain lovely quality.”

Much of this well-written study, however, is devoted to describing the intellectual origins of the approach to political economy known today as “Public Choice”—the economics of politics. Nevertheless, its subject is the history of the analysis of nonmarket activity generally.

Modern economics offers two separate grounds for interventionism. One traces its origins to John Maynard Keynes, the other to Arthur Cecil Pigou. Both were students of Alfred Marshall; both were fellows of King’s College, Cambridge, in the 1930s; and both proposed theories of “market failure.” Pigou was probably the first to examine so-called “market failure” within a Marshallian, microeconomic framework, pointing out how self-interest can produce systematic inefficiencies. His intellectual descendants often use the framework he created to conduct “welfare analyses” of positive and negative externalities, as well as of the taxes, subsidies, and other measures that are supposed to fix them.

Steven G. Medema deals with the Pigouvian legacy in this fascinating intellectual history. But Pigou lies somewhere in the middle of the story Professor Medema tells.

The book presumes familiarity with economic theory and contemporary ideas in political economy, so I would not recommend this book for the general reader. But anyone who has taken an introductory course in microeconomics should be reasonably comfortable with the discussion. The book opens with a short overview of Adam Smith’s explanation of how self-interest promotes the general welfare via the “invisible hand,” contrasting that view with the more statist approaches of the earlier French Physiocrats and English Mercantilists. In the hands of Smith, self-interest “had finally found legitimacy.” But this is not the Smith of laissez-faire caricature. Medema offers an impressive list of interventions Smith advocated, from regulating public hygiene to taxes on liquor. For Medema, Smith’s great achievement, however, was to make laissez-faire capitalism the “default mode” of government policy.

The next two chapters trace the swing from widespread support for laissez faire among British intellectuals back to a more interventionist proclivity in the latter nineteenth century in the writings of Jeremy Bentham, J. R. McCulloch, J. E. Cairnes, and especially John Stuart Mill and Henry Sidgwick. However, despite important reservations, the default remained laissez-faire capitalism, more or less.

In chapter four we see how, beginning with the Italian La Scienza delle Finanze and the work of the Swedish economist Knut Wicksell, some economists by the mid-twentieth century were beginning to integrate political incentives into the area that we today call “public finance,” something British political economy (Keynes included) had neglected to do. This gave rise to a systematic examination of the causes and consequences of “government failure.”

Chapter five discusses the contributions of Ronald Coase, who opened inroads into the study of nonmarket phenomena. What later became known as the “Coase theorem” emerged from an explicit critique of the Pigouvian market-failure theory (though, as Medema argues, not of Pigou himself), and is the basis of the “economic analysis of law” tradition and modern theories of regulation.

Chapter six addresses the Public Choice school itself, moving in a most welcome and informative way from intellectual to institutional history. It chronicles the beginnings of Public Choice from the University of Virginia in the late 1950s, to the ideological tensions that may have scattered its most important scholars in the 1960s, to its reestablishment at Virginia Polytechnic Institute and the founding of the Center for the Study of Public Choice, as well as the journal Public Choice, in the late 1960s.

Finally, chapter seven could actually stand alone as an essay on how, largely in the masterful hands of Richard Posner, the law-and-economics tradition evolved into the “economic analysis of law.”

This book reads a bit like a “Whig interpretation of the history of political economy,” in that it gives the impression that the developments in political economy after Smith have led to Public Choice as not only the predominant but perhaps the sole market-based theory of government failure.

Thus there is only the briefest, nonsubstantive reference to F. A. Hayek and his influential book The Road to Serfdom and none at all to Ludwig von Mises, who wrote many tracts critiquing the doctrine of interventionism. While their take on government failure does appreciate the role of (perverse) incentives in the political process, its main focus is on how knowledge and calculation problems tend to thwart interventionism by systematically creating negative unintended consequences.

But these are really nits I’m picking here. I wholeheartedly recommend this informative book to anyone with a little background in microeconomics who is interested in a history of Chicago and Virginia political economy told in a clear, scholarly, and engaging way.

Why would increased saving reduce GDP? Saving, correctly understood or defined, is the acquisition of interest- or dividend-earning financial assets, such as bank deposits, certificates of deposit, mutual fund shares, bonds, and stocks. Thus saving is not cash hoarding but the transfer of funds from income earners to borrowers who spend the funds. Savings are the source of loanable capital sought by businesses, as Adam Smith in the Wealth of Nations well explains: “By what a frugal man saves, he not only affords maintenance to an additional number of productive hands, but like the founder of a public workhouse, he establishes as it were a perpetual fund for the maintenance of an equal number in times to come.” Also, “Capitals are increased by parsimony. . . . Whatever a person saves from his revenue he adds to his capital, and either employs it himself in maintaining an additional number of productive hands or enables some other person to do so, by lending it to him for an interest, that is, for a share of the profits.” Indeed, increased savings make increased borrowing at lower interest rates possible.

In his concluding paragraph, Gibson also quotes an explanation from Ludwig von Mises that is in accord with Smith’s argument and in contradiction to his earlier income-lowering claim: “There is but one means to improve the material well-being of men, viz., to accelerate the increase in capital accumulation as against population.” Gibson goes on to state: “Capital accumulation requires saving, saving requires confidence. . . .” I think he needs to acknowledge the error of attributing an income-lowering effect to savings or else explain the contradiction in the two paragraphs. We cannot get rid of the Keynesian nonsense that increased saving causes poverty—the so-called paradox-of-thrift proposition—by continuing to employ Keynes’s misconceived definition of saving to mean cash hoarding.

Warren Gibson replies:

Professor Ahiakpor quite reasonably questions my assertion that an increase in saving could temporarily suppress GDP. I lacked the space (and inclination) to explain this assertion in the article, but here it is: I agree with him that savings are invested in real assets, and I am willing to stipulate no growth in cash balances. And of course new investments do add to GDP. So it looks like a wash: some consumption is simply shifted to capital goods. But I suggest that if we consider the time structure of production we see a difference. Capital goods are priced at the estimated discounted value of the final products they are intended to produce, and because of this discounting the present value of new investments could well be lower than the consumption goods they replace. Only in the fullness of time will the productivity of the new capital work its way down to consumption, at which time we would expect increased GDP, other things being equal.

But the increase in wealth from the division of labor per se has to be explained on its own merits—that is, assuming no increase in individual productivity. What has to be explained is how the division of labor itself increases collective, not individual, productivity—be it of hunter-gatherers or an industrial society. Also needing explanation is how the division of labor came about spontaneously and flourished without a prior coherent explanation, and what mechanisms inform and induce people toward optimizing their well-being through the division of labor in the family, the group, the city, and the world. (Spontaneous generation and belated understanding are common to many other economic phenomena that, like money, have not until lately been explained by economists even though they have gone on for millennia.)

A frequently repeated explanation of the division of labor is Smith’s statement of the “natural propensity to truck, barter, and exchange.” Arguably, the human propensity is just the opposite: that people would prefer to be independent and self-sufficient, and that they trade because they perceive that they will be better off. They subjectively value what they receive more than what they give up. Thus people accept the disadvantage of becoming more dependent on others as a tradeoff for being better off. If people thought they would be worse off by trucking, bartering, and exchanging, we would not detect any such propensity. In other words, it is correctly perceived self-interest that drives exchange.

The explanation of the division of labor that refers to comparative cost has been used in mainstream economic texts almost exclusively to explain international trade. But international trade is only a special case of this principle, which explains many things, including the emergence of society itself. Because of its many neglected implications, the law of comparative cost is a principle that deserves more attention, especially in the economics texts—for, after all, the essence of the rest of the textbooks is no more than an elaboration of how this division of labor is spontaneously coordinated by market prices, money, and so on. It is unfortunate that in the overwhelming majority of textbooks, the division of labor is largely taken for granted. So, unsurprisingly, it is a rare student who can explain how people gain by exchange, without recourse to the increased productivity of specialization.

Some explanations of trade rely on the fact that people differ in their subjective valuations and so when they trade, they relinquish something they value less than what they get in return. True enough. But in this explanation, the amount of physical output does not increase; it only changes hands. We are not told how the division of labor itself increases real, valued output without an increase in individual productivity. So let’s give it a try with simple numbers.

Assume two parties in the worst case: one participant is less productive than the other in everything. This assumption is necessary to explain why the more productive party cooperates with the less productive party. (As will become clear, the sole exception would be the case in which the former is equally better endowed in every task.)

Peter and Paul require only bread (B) and garments (G). Peter makes bread twice as fast and garments three times as fast as Paul. Note that Peter’s superiority over Paul is greater in making garments than it is in making bread. That is what is meant by comparative (as opposed to absolute) advantage.

Let’s now see what their respective cost differences for the two products lead them to do. In looking at the results, we assume that their productivity does not increase as a result of the division of labor, or specialization. We will indicate the productivity of each according to how many loaves of bread and how many garments they can make in 24 hours. (As Mises wrote: “The theorem of comparative cost . . . does not deal with value or with prices. . . . [W]e can content ourselves with comparing only physical input and physical output.”)

Production Without Division of Labor

TOTAL PRODUCTION: 18B + 8G

Note that their rates of substitution (or opportunity cost) are different: for Peter, one garment equals two loaves of bread; that is, in the time it takes him to make one garment he can make two loaves, or the opportunity cost of one garment is two loaves. By the same standard, Paul forgoes three loaves for every garment he makes. That difference in opportunity costs represents a potential for gains from trade for each party.

Now let’s look at the results of Peter and Paul’s cooperation.

PRODUCTION WITH DIVISION OF LABOR

TOTAL PRODUCTION: 20B + 8G

Not bad: Production under a division of labor increased by two loaves of bread, without changing individual productivity or total time. The only change was in the way they allocated their time according to comparative advantage. Peter now has more garments than before and Paul has more bread, leaving them opportunities for exchange. Paul can now trade five of his loaves for two of Peter’s garments, leaving them each with the same number of garments as before they divided the labor, but with an additional loaf of bread—for the same amount of effort. Thus each is better off than before.

We can also look at this picture in terms of time gained. To Peter, the extra loaf of bread represents one hour—the time it would have taken him to bake it. To Paul, the loaf represents two hours. They can now put that time toward purposes they had to forgo previously. And if we express the time gained in terms of garments, Peter will have gained one-half G and Paul one-third G. Notice that the respective gains change according to how we measure them: if we measure them with bread, the gain is equal. If we measure them in hours, Paul gains more, and if we measure them in garments, Peter gains more. Is there an “objective” measure of gain?

Obviously, trade does not come about because people go through this exercise. But they intuitively do what goes by the name of cost/benefit analysis, for they are quite conscious of what they must forgo to acquire whatever they get in exchange. In our example, with the same expenditure of time and without increasing individual productivity, the productivity of the combined effort increases the wealth of the group, creating the opportunity for exchange with mutual gain.

The coordinating mechanism is, of course, the relative prices of things with which demand and supply are expressed, the study of which is called price theory. With prices, it is easy for someone to do a cost/benefit analysis, to figure whether it is worthwhile for him or her to make or to save a buck. No woman would buy a skirt if she could make it with less effort than it takes to earn the necessary money. And no woman would make a skirt if she could obtain it with less work making something else and trading for the skirt (unless she values skirt-making for its own sake—say, as a hobby).

The law of comparative cost may be best illustrated by the secretary who intercepts her boss on his way to the copy machine and suggests that she make the copies. When he informs her that he knows how to make copies better than she does, she replies, “Yes, but you earn more than I do, so your opportunity cost is higher.”

Among the important implications of the law of comparative cost is that the “wealth gap” in a market economy, the concern of so many people and such international organizations as the World Bank, does not mean that the rich are responsible for poverty.

In the market one can make a fortune only by trading with and by enriching others. This realization torpedoes the claim to the moral high ground of the wealth redistributionists.

Finally, comparative cost also helps us understand other “mysteries,” such as how all social and even professional activities and resources, including land—however slowly—tend to be allocated by the market process (the invisible hand) in a socially optimum manner. These and other insights have important implications for tax, social, and economic policies that, given due consideration, would avoid many undesirable and unintended consequences.

I have been asked what was my first introduction to libertarian thought. I find that hard to answer, involving as it does looking back nearly three quarters of a century. But if I had to make a guess, I would conjecture that it was John Stuart Mill ‘s Essay on Liberty, which I must have read in my first or second year of college.

Herewith are my five favorite libertarian books.

Adam Smith’s The Wealth of Nations

First, Adam Smith’s The Wealth of Nations. This book, published in 1776, founded economic science. It introduced the notion of the “invisible hand” and explained how free trade could produce cooperation among people in achieving economic productivity. It remains a book well worth reading, full of wonderful comments to warm a libertarian’s
heart.

Mill’s Essay on Liberty

Second, John Stuart Mill’s Essay on Liberty. The most concise and clearest statement of the fundamental libertarian principle, “The only purpose for which power can be rightfully exercised over any member of a civilized community, against his will, is to prevent harm to others …. ”

Dicey’s Lectures on Law and Public Opinion

Third, A. V. Dicey’s Lectures on the Relation between Law and Public Opinion in England during the Nineteenth Century. A remarkable work initially presented as lectures at Harvard in the 1890s and reprinted with a new and very important preface in 1914. Dicey saw clearly the ultimate outcome of initial social welfare measures in the first decade of the twentieth century. He essentially predicted the emergence of the full-fledged welfare state. More than a century ago, Dicey explained why the rhetoric in terms of the general interest is so persuasive: “The beneficial effect of state intervention, especially in the form of legislation, is direct, immediate, and so to speak, visible while its evil effects are gradual and indirect and lying out of sight …. Hence the majority of mankind must almost of necessity look with undue favor upon governmental intervention.”

Hayek’s The Road to Serfdom

Foutth, F. A. Hayek’s The Road to Serfdom. This profound book was highly influential in the immediate post-World War II period when it was a lone voice presenting the case for libertarian philosophy and pointing out the consequences of an increase in the role of the state. It was certainly one of the most effective works leading people to take libertarian principles seriously.

My Own Favorite: Capitalism and Freedom OR Free to Choose?

Fifth, I have been asked to include one of my own books. I am torn between Capitalism and Freedom, published in 1962 with the assistance of Rose D. Friedman, and Free to Choose, published in 1980 jointly with Rose D. Friedman. Both present the same philosophy and cover many of the same topics. Capitalism and Freedom is more succinct, scholarly, and abstract; it was a product of a series of lectures that I gave in June 1956 at a conference at Wabash College directed by John Van Sickle and Benjamin Rogge [a long-time FEE trustee] and sponsored by the Volker Foundation.

Free to Choose, based on the television program of the same title, is more popular, less abstract, more concrete. It presents a fuller development of the philosophy that permeates both books; it has more nuts and bolts, less theoretical framework. The TV program on which Free to Choose is based is available in videocassette and, if I were to consider it as a book, would clearly be my favorite.

*Excerpted from an insert that appeared in the April 2002 issue of The Freeman.

Both insights rely on the foundational idea that intentions and results are not the same thing. Thinking we ought to do something does not mean it will have the results that motivate the “ought.” With respect to profits we have to recognize that because someone does something to benefit himself, it does not mean the action doesn’t benefit others too. In both cases the core concept that is often overlooked is unintended consequences. Recognizing that intentions do not equal results and that we must consider the possibility of unintended consequences is what separates good social analysis from bad.

The issue of unintended consequences is interrelated with a more general aspect of human social existence: the pervasiveness of uncertainty. The future is not available to us in the present. We cannot know the course of nature, but neither can we know the course of human choices. We are always acting based on our best guesses about what others will do and how our actions will coordinate with theirs, which we can never know with certainty. This structural uncertainty of the human condition means that we can never know all the consequences of our choices, which implies that some of those consequences will be other than what we intend. Anyone who believes the consequences of his actions will be exactly as intended is blind to the fact that his choices must interact with those of others, creating outcomes that none of the choosers designed.

Unintended consequences come in two flavors: positive and negative. The concept of negative unintended consequences is acknowledged in some social analyses and in morality, but is certainly underdeveloped in the understanding of economic policy. Positive unintended consequences are rarely recognized in “serious” conversations about public policy, even though they are at the core of modern economics.

Consider the two-by-two matrix below.

We have moral language for three of the four possible combinations of intent and outcome. Vice and virtue are easy enough, as they are our common terms for discussing the morality or desirability of our actions when the outcomes match our intentions. But what about when they don’t? We have the category of “negligence” when we cause negative outcomes we did not intend, such as failing to set the brake on a car that rolls down a hill and damages property. But we do not have a word for the unintentional doing of good! That missing box is filled in by economics and good social science as they explain how, under the right institutional framework, the pursuit of self-interest leads to unintended benefits for society as a whole.

Naming the Unintentional Good

From Adam Smith in the eighteenth century to Carl Menger in the nineteenth to Ludwig von Mises and F. A. Hayek in the twentieth, the central mission of economics has been to understand how we can produce beneficial outcomes that were not intended. Smith captured this idea with the “invisible hand” that leads the butcher, baker, and brewer to provide us with our dinner not out of altruism but “self-love.” Smith understood how exchange guided by prices and profits would harmonize (to use a term associated with Frédéric Bastiat in the nineteenth century) the self-interest of producers with the self-interest of consumers. Even if we care not at all about the people we trade with, we will nonetheless be led to satisfy their wants in our attempt to satisfy our own. Looking only at the seller’s profits without tracing out the entire chain of beneficial though unintended consequences that his self-interest produces is to take an “unscientific” approach to understanding society.

Menger put the concept of unintended consequences (and the closely related idea of “spontaneous” or “unintended” order) at the center of his conception of the social sciences. In what is often termed “the Mengerian question,” he asked: “How can it be that institutions which serve the common welfare and are extremely significant for its development come into being without a common will directed toward establishing them?” Menger recognized that many social institutions are not the product of human design, but instead emerge as people seek their own self-interest. Menger’s own classic work on the evolution of money explains how it arose this way from barter.

Mises and Hayek deepened this argument another layer as both recognized, with somewhat different emphases, the role that knowledge plays in understanding the centrality of unintended consequences in social thought. Mises provided what we might call the “microfoundations” of Smith’s invisible hand by carefully explaining how we go from people’s subjective perceptions to market-level outcomes via prices, which facilitate our calculations about the effectiveness of the use of resources. Mises also explored how profit and loss provide further signals that serve as “aids to the mind” in guiding our behavior. Entrepreneurs are led to use resources wisely, profiting for themselves but also improving the well-being of others, thanks to the signals of the marketplace.

Hayek’s work on economics, knowledge, and the problems of socialism allowed us to see the opposite side of Mises’s analysis by exploring how socialist planners would be unable to replicate the workings of entrepreneurs. Hayek argued that without market signals government planners would be unable to marshal the dispersed knowledge available to entrepreneurs through prices and other market institutions. Because of their ignorance, planners would not only be unable to generate beneficial unintended consequences in their own pursuit of self-interest, they would in fact cause harmful ones by being unable to see how their mistakes would lead to further mistakes—not to mention accumulating State power. Both Mises and Hayek saw that regardless of the socialist planners’ good intentions, their inability to make use of the knowledge of the marketplace would lead to consequences very different from those intended—in fact, as history has clearly demonstrated, consequences devastating for millions.

Institutions Against Uncertainty

The Smith-Menger-Mises-Hayek line of thought can be tied back to our earlier discussion of uncertainty. This tradition argues that we use evolved social institutions, including the market, to get more accurate expectations of the behavior of others and push back against the uncertainty that threatens to derail our plans. At the simplest level we see this with prices: The prices of particular goods or services are “aids to the mind” regarding the preferences, knowledge, and expectations of others, enabling us to better anticipate the consequences of our choices and to thereby make better ones. Institutions that emerge as a result of unhampered social evolutionary processes all perform this uncertainty-reducing function.

Consider the institution of ownership. When someone says that he “owns” a particular good, we know that gives him a certain set of rights to it and imposes certain obligations, largely negative ones, on us. Knowing that the good is owned means we can form particular expectations about what the other person might and might not do with that object, and he in turn can have reliable expectations about what we will and will not do.

An irony of social institutions is that by limiting our choices they make us better able to execute our plans and anticipate their likely consequences. However, to perform that coordinative function in complex matters and help us overcome uncertainty, institutions need to emerge from people’s voluntary interactions, usually over a period long enough for them to embody the best ways of doing things. This is why markets are so good at generating positive unintended consequences and why institutions imposed by force from the top down tend to generate negative ones. Just as we are much more productive as a society when entrepreneurs and consumers have access to competitively determined prices, so in general does human action produce beneficial unintended consequences when social institutions generally are the result of unhampered evolutionary processes.

Even in less dramatic ways modern economics remains focused on unintended consequences, particularly in how economists like to make highly counterintuitive arguments. For example, a number of years ago there was a call for government to require very young children to sit in car seats rather than on their parents’ laps when flying on airplanes. This arose out of concern that in some circumstances lap children could be hurt or could hurt others. Critics, particularly economists, quickly responded that such a law would actually kill more children than it saved.

To see why, one has to explore the unintended consequences. Under the law parents would have had to buy tickets for children who formerly flew free in their laps. Faced with the additional charge, some families on the margin would switch from flying to driving. But the odds of being injured or killed in an automobile are much greater per mile than in a plane. Thankfully, that unintended consequence was anticipated before it was too late, saving many children in the process.

The idea of unintended consequences also helps us understand one process by which government has grown over the last century or two. Because even well-intentioned interventions produce consequences that political actors could not foresee and did not intend, every time government acts, it creates a new set of problems that in turn leads to calls for more government solutions.

A final observation: The neglect of unintended consequences and the focus on motives lead us to celebrate the lives and mourn the deaths of politicians, although they may have caused undesirable unintended consequences, while inventors and businesspeople who benefit humanity while pursuing their own ends go unnoticed. As my matrix on the previous page suggests, we simply don’t have a moral category for people who unintentionally benefit others in pursuit of their self-interest. And we also highly overvalue intentions as a measure of moral worth, leading to praise for those whose “hearts were in the right place” even as they have caused incalculable damage to prosperity and freedom.

A better understanding of the idea of unintended consequences will not only give us the tools we need to more accurately analyze social issues, it will also provide us with a different way of making moral judgments. After all, it is results that count, and we all know where the road paved with good intentions leads to.

The latest rendition of the “Fallacy of Production for its Own Sake” is in a Wall Street Journal commentary by Robert Reich, secretary of labor during Bill Clinton’s administration. Lamenting what he sees as an “economic imbalance” between the United States and China, Reich declares:

Its productive capacity keeps soaring, but Chinese consumers are taking home a shrinking proportion of the total economy. Last year, personal consumption in China amounted to only 35% of the Chinese economy; 10 years ago consumption was almost 50%. Capital investment, by contrast, rose to 44% from 35% over the decade.

…the larger explanation for Chinese frugality is that the nation is oriented to production, not consumption. China wants to become the world’s pre-eminent producer nation. It also wants to take the lead in the production of advanced technologies. The U.S. would like to retain the lead, but our economy is oriented to consumption rather than production.

Unfortunately, there’s more:

Deep down inside the cerebral cortex of our national consciousness we assume that the basic purpose of an economy is to provide more opportunities to consume. We grudgingly support government efforts to rebuild our infrastructure. We want our companies to invest in new equipment and technologies but also want them to pay generous dividends. We approve of government investments in basic research and development, but mainly for the purpose of making the nation more secure through advanced military technologies.

Even getting past silly terms like “inside the cerebral cortex or our national consciousness,” this article reflects the utter ignorance that influential Americans have about economics. Reflected in Reich’s article is the same mantra that he and others like him have been spouting for years: The government must direct the economy through subsidies, laws, and taxes to ensure that we engage in more production and less consumption. For example, 25 years ago Lester Thurow claimed that the implementation of a European-style “value-added” tax would “stimulate” more production and would be a “true supply-side policy.”

Now, I don’t have a degree from MIT and am not an economic “elite,” but I do remember something in my studies that said that a tax on producers would push supply curves to the left. A nice way to say it is this: More taxes on production means less production. And this is a “supply-side” economic solution?

Unfortunately, people like Reich see the economy as putty to be manipulated as government officials would like. Do we have “global warming”? Then subsidize the manufacturing of windmills and other high-cost devices to produce electricity or the making of vegetation-based fuels. Despite the fact that subsidies mean that we must use more resources to create fewer goods, lawmakers and their advisers apparently see no irony in this fact.

For example, we hear that by directing production of electricity and fuels, government is “creating green jobs.” While that might be true in that new jobs will have to exist to make these particular goods, nonetheless it is akin to claiming that going back to the horse-and-buggy will “solve” transportation problems.

Adam Smith said it best when he noted that “consumption is the sole end and purpose of all production.” Unlike what Reich claims, an economy cannot be oriented solely toward production or solely toward consumption. One cannot consume unless one produces, and if one produces but those who produce are not permitted to consume, then we see the perverse result of increased production actually making people poorer than they should be.

The United States has not earned its standard of living for many years. Government has been hostile to free markets and common sense. We have lived on virtual handouts from the rest of the world by sending them depreciating dollars, a state of affairs that is going to end soon enough, especially if the government makes it difficult to produce goods in the name of “creating jobs.”