Laissez-Faire: Fact or Fiction? (Part 1)

Let us begin with an oft-repeated quote from the “Father of Western Economics”:

It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own self-interest. We address ourselves not to their humanity but to their self-love, and never talk to them of our own necessities, but of their advantages (Smith (1776); Book 1, Ch. 2).

The above quote is from the famed economist Adam Smith from his masterwork The Wealth of Nations and, like Marx’s Das Kapital and Plato’s The Republic, it is frequently cited but rarely is it ever actually read[1]. That being said, Smith is regularly mentioned and quoted when invoking the inherent nature of human self-interest. The idea is that world of goods and services goes round not out of altruism, but of each individual’s interest in their own happiness and gains. The baker does not through the process of making bread out of the kindness of his/her heart. Instead, the baker produces and sells bread in order to turn a profit and buy other goods and services s/he desires. Because of such behavior, Smith believes that we should neither expect nor demand others to act out of egalitarianism, but of egoism.

The question that is regularly asked is whether or not Smith was promoting an early form of Gordon Gekko’s “greed is good”? Does self-interest truly drive our decision-making behavior? Further, what do we, as Muslims, take from all of this?

First off, what is meant by laissez-faire? The standard translation from the original French is along the lines of “let us do” or “let us be”. While the etymology, or origination, of the phrase is still debated (neither Adam Smith, David Ricardo, Thomas Malthus, John Stuart Mill nor any of the “classical” economic thinkers ever used the term explicitly), the underlying meaning — or intent — of the phrase is much broader. When the concept of laissez-faire capitalism is evoked, what is usually inferred is a system of consumption and production that has no non-market (such as the government or other similar agencies) involvement. In other words, “keep the government out of my economics”.

Although he presented the concept in precise and explicit prose, Smith did not originate the concept himself. Before the writing of The Wealth of Nations, many philosophers, theologians and sociologists expressed similar sentiments relating the role of self-interest on the market — Ibn Kaldun is a common example. Therefore, there is a solid philosophical foundation that is implied within the laissez-faire market theory. Smith referred to it as the invisible hand. It works like this:

  • When the market price for some good or service is too high, there exists a surplus (producers are willing to sell more goods/services than consumers are willing to buy) within the market. Reacting to this surplus, producers will begin to compete against each other by cutting prices, in order to increase consumer attraction and profits, and decrease the market price to the equilibrium[2].
  • When the market price is too low, there will exist a shortage (consumers are willing to buy more goods/services than producers are willing to sell) in the market. To secure the purchase of a desired good or service, consumers will offer higher prices (think of an eBay auction) and the market price will increase to the equilibrium.

The concept of the invisible hand illustrates that markets have the potential to self-correct. Implicitly, Smith is showing here the importance of self-interest not only for one’s own personal benefit but also for the benefit of society as a whole. Producers do not lower their prices nor do consumers bid up prices purely for societal gain, but for their own. By acting in our own self-interest, we not only benefit ourselves and the market, but also everyone else engaged in the market. Therefore, being self-interested is no longer a trait of the vile and avarice (as was believed during the proverbial Dark Ages of Europe), but now a praiseworthy characteristic of the modern human. Modern and Post-Modern writers would later amplify such a notion by developing a full-fledged system of moral philosophy around it[3].

What’s the problem then? Seems simple enough, right? Well, it gets a bit more complicated. The concept of the invisible hand has been criticized throughout the years of economic study. Below are a few.

Marx

Both Marx and Engels defined their thought within the construct of scientific socialism as opposed to utopian socialism a la de Saint-Simon. Marx and Engels criticized capitalism for its emphasis on the self versus the community. Both authors believed that capitalism’s fundamental flaw is the self-interested nature of the capitalist class. If the capitalists were able to see the external effects his/her actions had on the future instability of the market and society, their decisions would possibly change. The same holds true of the proletariat. Marx and Engels cited the ineffectiveness of collective bargaining within a market system lay in the self-interested mindset of the work. Any strike demanding high wages (read: higher market prices for buying and selling of labor) would be crushed due to other labor producers (read: non-union workers) bidding down the price. They called this the problem of the labor reserve army.

But the value of the community is based upon value the individual places upon it; that is, the effectiveness and the set of advantages that came along with a communist state were derived by the same sense of personal self-interest and not, like many religious socialist in Europe at the time, based upon egalitarianism or religious belief of divine reward. In fact, as a philosopher, Marx had many gripes with contemporary Teutonic thinkers who believed that the value/concern/importance/survival of German culture is above one’s own benefits[4].

Keynes

John Maynard Keynes, the English macroeconomist that advocated the government’s role in economic decision-making, wrote extensively on the theoretical underpinnings of classical economic theory. In fact, one of his lesser-known works was a full piece on what he felt were the inaccuracies on the laissez-faire concept. He aptly titled it “The End of Laissez-Faire”. Keynes did not disagree with the virtues of the market and what it was capable of achieving, only that there were may be areas where self-interest fails to address:

The important thing for Government is not to do things which individuals are doing already, and to do them a little better or a little worse; but to do those things which at present are not done at all (Keynes (1926)).

Specifically, Keynes believed that people act differently when they make decisions as individuals and when they make decisions as individuals within a group. For example, Keynes’s research of the stock market lead him to judge that investors rarely make decisions in such rational matters. Instead, investors, shareholders and financiers react to movements in the market like gazelles in a pack: following the signals of the leading few in order not to be the last ones eaten by the lion.

Critics of Keynes argue that even in the mist of such herd mentality and “animal spirits”, the nature of self-interest is still apparent. Besides, it is out of one’s own self-interest to not be eaten by a lion that s/he follows the pack.

Nash

Game theorists have also criticized such a strong interpretation of the invisible hand. Most notably were the writings of mathematician John Nash who, through a number of assumptions, showed that when behavior was viewed as dependent upon the inter-linking actions of other decision makers, cooperation could lead to more optimal results than competition. Many will recall the prominent scene in A Beautiful Mind, where Nash — played by Russell Crowe — explains why “Adam Smith was wrong” to his friends in a bar[5].

This is not to say that Nash specifically and game theorists in general disbelieve in the role of self-interest. In fact, game theory puts such an immense amount of focus on it that they are criticized for going too far! The point that Nash was trying to make is not one against self-interest but on the perceived infallibility of the market. Yes, people act out of self-interest. Yes, decisions by an individual have external effects on other individuals and markets. But unlike the classical thinkers like Smith before, Nash was claiming that the result is not always the best. Sometimes the market attempts to correct itself but fails. In other words, the “hand” of the market may be invisible, but it wasn’t right.

And finally . . . Smith

We do not need to go too far because even Adam Smith himself criticized such interpretations. Many are unaware that The Wealth of Nations was not the only book Smith wrote . . . and he too would get quite upset about that. As it is today, many of his contemporaries ignored his other work: The Theory of Moral Sentiments. From the very first pages, Smith begins by explicitly acknowledging the importance of egalitarianism[6]:

How selfish soever man may be supposed, there are evidently some principles in his nature, which interest him in the fortune of others, and render their happiness necessary to him, though he derives nothing from it except the pleasure of seeing it. Of this kind is pity or compassion, the emotion which we feel for the misery of others, when we either see it, or are made to conceive it in a very lively manner. That we often derive sorrow from the sorrow of others, is a matter of fact too obvious to require any instances to prove it; for this sentiment, like all the other original passions of human nature, is by no means confined to the virtuous and humane, though they perhaps may feel it with the most exquisite sensibility. The greatest ruffian, the most hardened violator of the laws of society, is not altogether without it (Smith (1759); Chapter 1, Section 1, Part 1).

Smith is stating that while we may be making decisions based upon what is best for us, one cannot deny that there is apart of all of us that can defy this impulse. Two different books. Two different concepts. The conflict between Smith’s writings has lead modern scholars to continually debate if Adam Smith the moral philosopher and Adam Smith the economist could be reconciled as one-in-the-same. While the jury is still out, it should be known that there are compelling arguments on both sides.

One could make the argument — as Keynes had in The End of Laissez-Faire — that more has been placed upon Smith’s original ideas than originally intended. What was merely an observation of market behavior slowly transformed into a general philosophy of both social ordering and human psychology. Charles Darwin’s magnum opus On The Origin Of The Species never claimed to be an investigation of society or human behavior . . . nor did he ever state that the inherent law of nature is “survival of the fittest”. Darwin’s observations of evolution and the role of sexual-selection amongst certain animal species were eventually read and used by post-contemporary theorists, such as Herbert Spencer, to help create/validate much of the eugenically charged blood-science philosophies that later became known as Social Darwinism: those who are socially and economically successful must be genetically superior; those who are not must then be, by the laws of nature, weak and inferior. Similarly, much of the implied political connotations of Smith’s writings were amplified later in a response to both the rise in socialist thought and the embrace of Keynesianism.

In Part 2, we will continue this discussion by examining the relationship between Islam and the nature self-interested behavior.


[1] In all due fairness, much of both Das Kapital and The Wealth of Nations is beyond outdated. Most of what is quoted (and still relevant) from Smith can be found within the first fifty or so pages. The rest is a mix between uninteresting/dated data and political argumentation that really would only interest a trained historian. Similarly with Marx: unless you wish to read seven to eight hundred pages of sheep and gain prices of the early nineteenth century, you probably can skip Das Kapital . . . all four volumes.

[2] While the concept of the market equilibrium is beyond the scope of this brief article, think of it as the most desired/optimal/efficient price and production point within the market . . . given a whole host of assumptions, of course.

[3] There are a number of writers that could be referenced here but to create a short, short list, one name is needed: Ayn Rand. As a disclaimer, I find Rand’s writings and philosophy to be intellectually shallow and morally despicable.

[4] Nietzsche accentuated this point even more explicitly. Given European anti-Semitism and the bias against southern European countries, Nietzsche openly claimed that both the Greco-Roman and Jewish cultures offered more than that of Germany. A true provocateur, no doubt.

[5] It should be noted that A Beautiful Mind, while a great movie, incorrectly depicts Nash’s life, mental sickness (he was schizophrenic, not psychotic and delusional) and even the very concept of what a Nash equilibrium is! Remember that classic scene in the bar where he describes his theory? Yeah, the writers and director messed it all up . . . we as economists always make sure to tell people that. Sorry L

[6] It is legend that Smith sent his student Jeremy Bentham this book after a misinterpretation of what was said within The Wealth of Nations.

About Jerry Hionis

About Jerry Hionis

Jerry holds a PhD from Temple University. His primary research is in conflict theory with an emphasis on civil conflicts and Warlord-like competition. Other research interests include game theory, economic development, Islamic economic theory and history, political theory and African economics.

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