August 13, 2023

by Stephen Stofka

This week’s letter explores the free market and rule of two laws in our lives. Advocates for a laissez-faire market quote Adam Smith’s mention of the invisible hand in The Wealth of Nations, or WON. In a free market, individuals pursuing their own self-interest unintentionally promote a general welfare, a positive outcome as a result of the Law of Unintended Consequences.

Smith was particularly concerned with what I will call the Law of Intended Consequences. Under the guise of acting in the public interest, individuals furthered their own self-interest at the expense of the public welfare. In Part I of WON, Smith spent several chapters documenting many examples of collusion between business owners and merchants, labor guilds and city magistrates to further the gains of a small minority at the expense of the majority. This included price supports, price fixing, protective trade restrictions and the granting of monopolies through licensing. The only solution was a system of governance that promoted a general law and order with as few laws as possible.

The free market encourages a set of problems that subtract from the general welfare. Individuals pursue the most gain with the least cost. We want to buy low and sell high. We tout the principles of equality, but more often choose to maximize our own welfare. Transportation is most affected by this trait. Railroad, truck and airline carriers would prefer to supply the shorter distance routes which generate the most profits at the least cost. Without regulation and cross-subsidy, long distance routes that connect local or regional markets are underserved. This cripples the formation of a national transportation system. Although Adam Smith died a few decades before the introduction of railroads, he compared shipping goods by water to land based transportation by horse drawn wagon (Chapter 3). The former was far more profitable and explained why the “art and industry” of cities and towns close to water improved at a faster pace than inland communities.

This free market mechanism of the invisible hand fostered densely populated cities whose crude sanitation promoted epidemics of disease. In 1800 London had a population density averaging 30,000 people per square kilometer, a density more than twice as high as present-day New York City. The rich could afford a wagon and horse for transportation and moved to the outskirts of a city to escape the filth, smoke and disease of congested cities. The poor died prematurely. That was the invisible hand at work, subject to the same Law of Unintended Consequences.

In an ideal world, public laws would strike a balance between the laws of intended and unintended consequences. However, the very making of public law invokes the Law of Intended Consequences. Elected representatives tend to serve narrow ideological or geographical constituencies that are aligned with a representative’s own welfare. That is not a condemnation of their self interest but a description of the difficulty an elected body faces when trying to pass any law that claims to serve the public welfare.

In Article I, Section 8 of the Constitution, the framers limited Congress’ lawmaking authority to specific powers and those that promoted the general welfare. To James Madison, the main architect of the Constitution, that wording was clear. It meant only those laws that supported a broad public welfare like the common defense. Richard Lee, one of the anti-Federalists suspicious of centralized authority, protested that the general welfare could include “every possible object of human legislation,” as Michael Klarman (2016) quoted in his account of the making of the Constitution. Lee was worried that a strong central government could expand its power to tax for any reason that it deemed to be in the general welfare. A small class of people or a central government could argue that their welfare was the general welfare.

People in difficult circumstances clamor for a piece of the tax purse. Pharmaceutical manufacturers argue that a liberal extension of profit-protecting patent rights will promote more drug development and advance the general welfare. Advocates of trickle-down economics champion laws that promote lower taxes and fewer regulations, arguing that business owners will spread the wealth to working families. This is the collusion between private industry and lawmakers that Adam Smith documented 250 years ago. Our motivations and machinations do not evolve.

The welfare of the individual and that of the public must ever come in conflict. There is an inherent weighting we attach to each person’s welfare and each of us gives greater value to our own welfare. In the Part II, Chapter 3 of the Theory of Moral Sentiments, Smith remarked that we get more upset over the loss of the tip of a finger than we do over the loss of millions of lives if China were to be swallowed up by an earthquake. We cannot agree on society’s maximum welfare, or ophelimity, because we use different weighting coefficients to measure welfare. Lawmaking is a compromise between competing calculations of interest, both individual and public.

A laissez-faire market, like a pure white paint, is not efficient. A bit of black or umber tint mixed into a white paint base gets a wall covered in fewer coats and the tint is not noticeable. Each participant in a free market gains from cheating so some regulation is necessary as an incentive toward self-policing. We argue over how much regulation to mix into the free market base. We have different personal convictions, values and tastes, ensuring that our disagreements will persist.

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Photo by Tom Wilson on Unsplash

Keywords: general welfare, trickle-down economics, free market, invisible hand

Klarman, M.J. (2016). The Framers’ Coup: The making of the United States Constitution. New York: Oxford University Press, pp. 322-3.