Market Failure: The Back of the Invisible Hand

The concept of “the invisible hand,” cherished by self-designated “conservatives,” has its origin in Adam Smith’s Wealth of Nations.

[The individual] neither intends to promote the public interest, nor knows how much he is promoting it… [H]e intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.

An unyielding faith in the infallible beneficence of “the invisible hand,” leads to “market absolutism” — the doctrine that whatever government attempts, privatization and the free-market can do better.

What market absolutists (unlike Smith) fail to notice, is that not all workings of “the invisible hand” are beneficial. Some unintended consequences of market activity are harmful — “the back of the invisible hand.” Economists call these “market failures.”

One cannot enroll in an Introduction to Economics class, without encountering the concept of “market failure” – the acknowledgment that a totally unconstrained and unregulated free market can, at times, have socially undesirable consequences (as I will exemplify below). It is one of the most obvious and incontrovertible facts of economics. Almost all of us are aware of market failures, whether or not we have ever studied economics.

Some students of Econ. 101 choose to major in Economics, and a few of these earn doctorates in the field. Those scholars who go on to work for The Heritage Foundation, The American Enterprise Institute, The Cato Institute, and other such “conservative think-tanks” somehow manage to completely forget about “market failures.” The free unregulated market, they tell us, always brings about the socially optimum result. Some examples (with my italics):

    * “In the free market, the individual would have to produce a good that the other person desired in order to receive a good in return. Adam Smith’s “invisible hand” of the market guides all participants in society to promote the best wishes of everyone else by pursuing his own wants and desires.” (Jacob Halbrooks)

    * “[T]he free market allows more people to satisfy more of their desires, and ultimately to enjoy a higher standard of living than any other social system… We need simply to remember to let the market process work in its apparent magic and not let the government clumsily intervene in it so deeply that it grinds to a halt.” (David Boaz, Libertarianism, a Primer, p. 40, 185.)

    * “A free market [co-ordinates] the activity of millions of people, each seeking his own interest, in such a way as to make everyone better off… Economic order can emerge as the unintended consequence of the actions of many people, each seeking his own interest.” (Milton and Rose Friedman: Free to Choose, pp 13-14).

Accordingly, governments should never interfere with markets. Furthermore, governments should not own property, which is better managed by private individuals. So argues the libertarian, Robert J. Smith: “The problems of environmental degradation, pollution, overexploitation of natural resources, and depletion of wildlife all derive from their being treated as common property resources. Whenever we find an approach to the extension of private property rights in these areas, we find superior results.” (My italics). “All,” “whenever” — no compromise or qualification here!

In short: let the free market decide. The mysterious “invisible hand” of the free market will “promote the best wishes of everyone..,” (Halbrooks), “[allow] more people to satisfy more of their desires” (Boas), and “make everyone better off” (Freidman).

Practical experience tells us otherwise:

    * The unconstrained chemical industry promoted pesticides and caused extensive damage to the ecosystem, until the public and then the government, aroused by Rachel Carson’s book, Silent Spring, put a stop to it.

    * Similarly, the chemical industry strenuously resisted demands that it cease the manufacture and distribution of chloro-fluorocarbons (CFCs), when atmospheric scientists discovered that the CFCs were eroding the stratospheric ozone, which protects the earth’s inhabitants from ultra-violet radiation. Once again, the federal government, joined by the governments of other industrialized nations, enforced a ban on CFCs.

    * Scientific warnings about global climate change (“global warming”) were countered by “junk science” sponsored by the energy industry. Now, at last, as the fact of climate change becomes undeniable and widely acknowledged, the same industry is promulgating the “line” that climate change may not be all that bad, and might even be beneficial. Clearly, mankind can not count on private enterprise to solve this grave crisis. Only international agreement among the industrial nations will suffice. Meanwhile, the Bush administration, on behalf of its “sponsors” the energy industry, is resisting international action.

    * Reduced labor costs yield increased profits and increased dividends to the stockholders of the corporation. Thus, if workers abroad accept wages that are a fraction of the wages demanded in the United States, then the “responsible” policy of the corporation executives is to re-locate jobs abroad. “Outsourcing.” The consequences to the displace workers, and eventually to the national economy, is devastating. But strictly speaking, that is not the concern of the corporation. Not, that is, unless the government intervenes with tariffs, tax incentives, regulations, and laws.

    * Finally, the tobacco industry, whose corporate responsibility to its stockholders is to maximize profits, successfully marketed its products to the point where half of the US population were smokers. As a result, almost a half million Americans die prematurely each year — more than the total US casualties in World War II. Today, only a fifth of adult Americans are smokers. No thanks to the industry. Once again, government intervention, vigorously and persistently opposed by the tobacco industry, has curtailed marketing and has publicized the health hazards of smoking, saving the health and lives of millions.

We are all quite familiar with these “market failures,” and many more. It is obvious that, in numerous undeniable cases the unregulated free market fails to “make everyone better off,” as Milton Friedman would have us believe. So why, if market failures are so compellingly obvious, should we even bother to mention them? The answer is that our present government is dominated by individuals who behave as if they don’t recognize these malevolent consequences of free markets. So one after another, regulations and laws designed to correct market failures are being dismantled, as government regulatory agencies are staffed with lobbyists and officers from the corporations that these agencies are charged to regulate.

But why do markets fail to produce optimal results for society at large? Railroad tycoon, William Vanderbilt (1856-1938) said it all: “the public be damned, I work for my stockholders.” Moreover individual entrepreneurs and workers also want and strive for what is best for themselves. Indeed, as any neo-classical economist will insist, personal want-satisfactions (e.g., profits) are what drive an economy.

Implicit in market absolutism and libertarianism is the belief that what is best for each individual and each corporation is best for all individuals – in other words, for “society at large.” As President Eisenhower’s Secretary of Defense, Charles Wilson, put it: “What is good for General Motors, is good for the country.” (For a refutation, see my “Good for Each, Bad for All”).

Market absolutism, like “young-earth creationism” and biblical literalism, is a dogma, and thus it is untouched by hard evidence and practical experience. “Market — good; Government — bad. Period! Now don’t confuse us with the facts.”

Those who are not captivated by the dogma of market absolutism (i.e., most of us), know better. We trust the scientists who tell us that pesticides damage the ecosystem, that CFCs erode the ozone in the stratosphere, that the continuing use of fossil fuels is changing the climate. And we know that smoking causes lung cancer and premature death — the cigarette packs tell us so, not because the tobacco companies warn us out of a sense of social responsibility, but because the government requires them to print the warnings.

Government regulation, and laws restricting commercial activity, arise, not from dogma, but through accumulated practical experience and political action. As human institutions they are imperfect, which means, to be sure, that they are sometimes excessive. The appropriate response to “insolence of office” is reform, not abolition of the office — reform through the same processes of practical experience and political action.

As James Galbraith puts it:

A new spirit of pragmatism surely requires that we discard the metaphor of market determinism — whole and entire. No more, let us bow and scrape before that altar. Markets have their place — they are a reasonably open and orderly way to assure the distribution of services and goods. They are not a general formula for the expression of social will and the working out of social problems.

Corporations quite properly work for the stockholders, and private individuals, in their economic activities, work for themselves and their families. But when these corporate interests and private activities cause social harm, who or what is most authorized to act in behalf of society – of all the people?

The solution is the same in all civilized societies: the law and the government that enacts and enforces the law. To be sure, law and government can be despotic and oppressive, and when they are, “it is [the] right, it is [the] duty” of the people “to throw off such government.” (The Declaration of Independence). Such “despotism” surely includes the situation that we face today, as the corporations that should be regulated by government, instead have taken control of the government. However, in liberal democratic countries, law and government, unlike private enterprises, are authorized to act in behalf of the public at large. This, the unregulated free market can not do and must not presume to do.

There is nothing new or startling about these political principles. They are enshrined in our founding documents:

We hold these truths to be self-evident: that all men are created equal; that they are endowed by their Creator with certain unalienable Rights; that among these are Life, Liberty, and the pursuit of Happiness. That, to secure these Rights, Governments are instituted among Men, deriving their just powers from the consent of the governed, That, whenever any Form of Government becomes destructive of these ends, it is the Right of the People to alter or to abolish it, and to institute new Government… (Emphasis added).

And note in the Preamble to the Constitution, these enumerated legitimate functions of government: “… establish Justice, insure domestic Tranquility, provide for the common defence, promote the general Welfare, and secure the Blessings of Liberty to ourselves and our Posterity.”

And yet, the dogma of the ruling elites would ordain that we put all these founding principles aside, and in matters of public interest and social welfare, “let the market decide.”

These individuals have the nerve to call themselves “conservatives.”

Dr. Ernest Partridge is a consultant, writer and lecturer in the field of Environmental Ethics and Public Policy. He has taught Philosophy at the University of California, and in Utah, Colorado and Wisconsin and is the co-editor of The Crisis Papers. His e-mail is: Read other articles by Ernest, or visit Ernest's website.

11 comments on this article so far ...

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  1. Darrin Knode said on June 20th, 2007 at 6:30am #

    There are far too many fallacies, asssumptions, and intentional misrepresentations within this garbage pail of an article to address them all without writing too much for a response to an article, so I will focus upon two items within your list of market “failures”. Tobacco industry (your opposition to a right to ones own body) and outsourcing (your inability to properly access the effect to our economy of tariffs and protectionism)

    Tobacco industry:
    Your assumption that your supposedly benevolent actions of the state to restrict the right of people to use a drug is quite telling and extremely hypocritical of one who writes fro a site which attempts to market itself as supportive of peace and justice. How is it peaceful to force your moral and medical views of what is right and healthy upon people by making thier choice to use a drug more expensive? How is it just to interfere with the right to ones own body?

    Outsourcing :
    What you view as “devestating” is not in the slightest… unless you consider allowing domestic business to survive in the world market and superior prices available to consumer and the subsequent increase in standards of living… “devestating”. All of these restrictions on the market hurt domestic jobs more than the outsourcing you fear. Domestic restrictions and price caps and minimum wages FORCE domestic businesses to outsource to other nations in order to compete… in order to stay alive. Additionally domestic businesses, when protected from foriegn competition, become wasteful, inefficient, and allow the quality of production to lax. This is nowhere more obvious than in the domestic steel industry whose union push for protection from foriegn comeptition virtually eliminated the industry within the united states… while raising steel prices which hurt construction and ultimately are reflected in rising costs across the board.

  2. David A. Smith said on June 20th, 2007 at 7:50am #

    Would like to see your comments on the other half of the equation. Yes, government has a responsibility to promote a social polity that promotes a responsible market system. But it is a mistake to think that the present market system is anything like a “free” market. Moneyed interests have manipulated the government to create laws that favor the current market system, from laws establishing corporations as legal entities to tax breaks to patents to regulatory groups, etc. We won’t see the government become an effective tool for the amelioration of the harm that our current economic system causes until control of the government is taken away from those who also run the economic system. I’m afraid I don’t see that happening any time soon.

  3. Aaron said on June 20th, 2007 at 5:36pm #

    A prime example of the fallacy of “free market” enterprise, and the so-called benefits of privatization- the current U.S health care system! It is a sad fact that Americans pay far more for less when it comes to health care- in fact the U.S was rated # 37 in health care, beaten senseless by most of “left” Europe. Yup, that invisible hand sure is working. Working to send the average American into indentured servitude…. with a 10,000.0 $ bill just to see a doctor and get your hand stitched up when you cut it doing yard work, or slicing it open in a nice cushy minimum wage service sector job, since all the good jobs got outsourced. White collar is next on the chopping block to be outsourced, and it’s already hapenning. There’ll be a lot more converts to socialism when what’s left of the middle class (how dare they try to organize themselves in the 60’s and 70’s!!!) finally gets hollowed out, those hungry dogs at the top will be licking their chops at all the money they can get out of the upper-middle class. And so it will go until one day you’ll wake up and realize that you live in a third world country, lucky to be indentured to a “benevolent” corporatocracy, or maybe even a nice dictatorship (will have to get a little rough with the people when they get out of sorts about having to settle for a lower quality of life you know?)

  4. Deadbeat said on June 20th, 2007 at 11:10pm #

    Racism help to promote the notion of the “Free” market and the conditions that allowed the rise of Ronald Reagan. While these conservative intellectuals are few in number they would never have been able to enter the corridors of government if they were no white privilege that help to build their base of support. Reagan racism was how he was able to “win” over the “Reagan” Democrats that pushed him into office. The ideology of the “free” market was embraced by whites because they felt since they have white privilege they would be the beneficiaries while those “blacks on welfare” was dragging the nation down. So they too wanted to see government “cut”.

    Well it didn’t happen that way. Yep they cut social programs used by everyone — white and black. And cut taxes for the rich — meaning they get to keep the spoils of capitalism that naturally maldistributes wealth. And increase government spending on the military that also maldistributes wealth to the top. While increasing tax burdens on workers – yet another way to maldistribute wealth.

  5. stephen said on June 21st, 2007 at 12:43am #

    in reply to darrin

    actually, your tobacco argument falls apart by misrepresenting what he said. you said “restrict the right” and “force” medical advice… yet you are completely allowed, if you are of legal age, to purchase cigarettes. you have the *right to choose* to ignore the warnings. but they are there for you, in case you want to take them seriously. most of us do. you don’t have to though. that’s your choice. warning some guy that sticking his head in a microwave might cause harm to his brain is not violent, nor is it restrictive. it’s not even interference. it’s a warning.

  6. Mulga Mumblebrain said on June 21st, 2007 at 2:09am #

    Market Fundamentalism is a cancerous system. Like a neoplasm it is most malignant when most undifferentiated, hence the ‘one size fits all’ policies inflicted by those High Malignancies the IMF, World Bank and WTO, on their Poor World victims. The link between Smith and Malthus is clear too, from policies that decimate public health and education in the Poor World, and the Market Fundamentalist dogma that puts BigPharma’s profits before the lives of AIDS victims in Africa and elsewhere. Market Fundamentalism is the precise antithesis of democracy, power instead accruing either, depending on your taste in labels, to the rich ie a plutocracy, or to the worst people in society, ie a kakistocracy. Usually the two groups are, more or less, congruent. The current wave of neo-liberal Market Terror has its roots in the disappearance of the socialist alternative. With the threat, however flawed, of the Soviet Union gone and China reverting to capitalism, the Masters have been free to return the world to a neo-feudal state. Workers everywhere are being treated more and more as serfs. No Market Capitalist society ever reformed peacefully. All social amelioration was granted, grudgingly, out of fear of the proles. It is now all being taken back. Unless the rule of that parasitic caste whose religion is Market Fundamentalism is ended, they will immiserise 90% of humanity, probably exterminating billions through war, disease, starvation and malign neglect. It’s their idea of a solution to the world’s ecological crisis. The odds of this liberation occuring are infinitessimal, as the Bosses are quite capable of destroying the world rather than surrendering their privileges.

  7. Jeremy Wells said on June 23rd, 2007 at 12:51am #

    Abstract theory of the “market” degenerates into mind-controlling propaganda. This babble is designed to facilitate the exploitation of working people and the rape of the economic resources of the planet.

    Replace the word “privatization” with “steal” or “loot” and you will understand everything you need to know. The federal government has been largely “privatized” as has the military with the use of “contractors” and mercenaries. War is now unashemedly driven for corporate greedand profit, despite all the “reasons” for war.

    Global warming, war, mass poverty, mass migrations, etc. cannot be “reformed” or but must be ended.
    Global capitalism, organized by U.S. hegemony, must be ended if humanity is
    to survival.

    Read daily the World Socialist Web Site


  8. jsalvati said on June 23rd, 2007 at 3:37am #

    It is quite disingenuous to call free-market fundamentalism “the dogma of the ruling elites.” Few politicians would even qualify as moderate libertarians (don’t even think about referring to the president as a market oriented person). Although market fundamentalists do exist, I think you are wrong to characterize all libertarians, especially the academic libertarian crowd, as market fundamentalists. Most libertarians with some economics knowledge recognize the existence of market failures (not sure why you kept that in quotes), and often willing to use the government to fix those market failures, but usually in more market oriented ways.

    I also think you misunderstand Robert Smith, his point isn’t that the free market as it exists now will fix all problems, but that establishing other property rights will help fix environmental problems (I have heard of Robert Smith before, but it’s all in your quote). The theme that many environmental problems come from insufficient property rights is common among libertarians. What he is discussing is the difference between “command and control” regulation and market based regulation. For example, a market based regulatory solution global warming would be to establish either a tax on green-house gas (GHG) emissions or have the government auction off permits for GHG emissions. A “command and control” solution would be for the government to set specific limits on how much GHG emissions individual polluters can release. Libertarians are much more likely to support the first type than the second type, although I (and I consider myself libertarian) would acknowledge limits on market based regulations. Market based solutions exist for many environmental problems, everything from fish stock depletion to ozone depletion, and you will find that market based solutions are often regarded as better and easier solutions to environmental problems command and control regulations for many problems by economists.

  9. jsalvati said on June 23rd, 2007 at 4:12am #

    hmm, sorry I meant that I had *not* heard of Robert Smith before.

  10. Letter to Dissenting Voice « Good Morning, Economics said on June 23rd, 2007 at 4:42am #

    […] 2007 in letter to the editor by jsalvati Here is a letter to the editor I wrote in response to this article over at Dissenting Voice:  I am writing to respond to Ernest Partridge’s June 20th […]

  11. Carol said on May 27th, 2009 at 5:42am #