In September of 2007 I was working on a blog about the kinds of problems that companies inevitably encounter when their underlying technologies, competitors or business models change. I wanted to make the point that any company, no matter how powerful its position, will likely get in trouble when the environment in which it once flourished changes significantly. While searching for the right words to convey the notion that the marketplace is much more powerful than any one company or industry, I came across and ended up using the concept of the invisible hand.
And that is when I first started learning about Adam Smith, the 18th century Scottish philosopher and economist, who is generally considered the father of free-market, free-trade capitalism. Smith coined the metaphor of the invisible hand in The Wealth of Nations and other writings. He used it to indicate that, “in a free market, an individual pursuing his own self-interests tends to also promote the good of his community as a whole,” and that "the free market, while appearing chaotic and unrestrained, is actually guided to produce the right results by this so-called invisible hand."
The more I read about Adam Smith, the more impressed I became with his life and his work. For years, many thought that Smith had been advocating a right wing ideological approach to open markets, reflecting a kind of survival of the fittest competition in which anything goes. As I discovered, nothing could be further from the truth.
Adam Smith was a very moral man. While The Wealth of Nations is his opus magnum, he wrote a number of other books, including The Theory of Moral Sentiments, where he argued that sympathy, the human ability to have a strong feeling of concern for another person, is required to achieve socially beneficial results.
I find his balanced approach to capitalism compelling. On one side is the fierce competition and self-interest inherent in open, free markets. On the other is the supportive community behavior and sympathy found in well functioning human societies. I strongly feel that this approach, which balances the interests of the individual with the interests of society, is the right path that capitalism must take, especially as we look to get over the present financial crisis and try to avoid similar such harsh crises in the future.
These are my opinions as a private citizen, not the views of a professional economist who has thought hard about the issues involved and can comment in far more depth than I am able to.
But then, a few weeks ago, I was really happy to read a couple of articles by Harvard economist Amartya Sen which expressed a similar point of view about capitalism: Adam Smith’s market never stood alone, an opinion piece in the March 10 Financial Times; and a longer article on the same themes, Capitalism Beyond the Crisis in the March 26 issue of The New York Review of Books.
Amartya Sen is a world renowned economist who was awarded the Nobel Prize in Economics in 1998. He is currently a professor at Harvard, having been previously in the faculties at Cambridge and Oxford universities, the London School of Economics and the universities of Delhi and Jadavpur.
In these articles, Professor Sen writes that the global economic crisis that keeps gathering speed at a frightening rate is forcing us to question the nature of capitalism and the need for change.
“Do we really need a “new capitalism”, carrying, in some significant way, the capitalist banner, rather than a non-monolithic economic system that draws on a variety of institutions chosen pragmatically and values that we can defend with reason?”, he asks, in the FT piece and then adds:
“This is not only the question we face today, but I would argue it is also the question that the founder of modern economics, Adam Smith, in effect asked in the 18th century, even as he presented his pioneering analysis of the working of the market economy.”
“What exactly is capitalism?,” he continues. “The standard definition seems to take reliance on markets for economic transactions as a necessary qualification for an economy to be seen as capitalist. In a similar way, dependence on the profit motive, and on individual entitlements based on private ownership, are seen as archetypal features of capitalism. However, if these are necessary requirements, are the economic systems we currently have, for example, in Europe and America, genuinely capitalist? All the affluent countries in the world – those in Europe, as well as the US, Canada, Japan, Singapore, South Korea, Taiwan, Australia and others – have depended for some time on transactions that occur largely outside the markets, such as unemployment benefits, public pensions and other features of social security, and the public provision of school education and healthcare.”
Professor Sen observes that in affluent countries, where it has been most successful, capitalism is pragmatic, not ideologically pure, and that this pragmatism goes back to the days of Adam Smith.
“It is often overlooked that Smith did not take the pure market mechanism to be a free-standing performer of excellence, nor did he take the profit motive to be all that is needed . . . People seek trade because of self-interest – nothing more is needed, as Smith discussed in a statement that has been quoted again and again explaining why bakers, brewers, butchers and consumers seek trade. However an economy needs other values and commitments such as mutual trust and confidence to work efficiently.”
In a capitalist system, mistrust and lack of confidence in others have far-reaching consequences and have greatly contributed to generating the financial crisis and making the recovery so difficult, he explains.
For years, a number of top economists, including former Federal Reserve Chairman Alan Greenspan claimed that derivatives and other financial instruments have been extraordinarily useful in distributing risks, thus lessening the need for regulating the increasingly complex financial markets. Professor Sen disagrees. He believes that what we have in fact distributed is obligations and responsibilities, not risk:
“There were, in fact, very good reasons for mistrust and the breakdown of assurance that contributed to the crisis today. The obligations and responsibilities associated with transactions have in recent years become much harder to trace thanks to the rapid development of secondary markets involving derivatives and other financial instruments . . . A subprime lender who misled a borrower into taking unwise risks could pass off the financial instruments to other parties remote from the original transaction. The need for supervision and regulation has become much stronger over recent years. And yet the supervisory role of the government in the US in particular has been, over the same period, sharply curtailed, fed by an increasing belief in the self-regulatory nature of the market economy. Precisely as the need for state surveillance has grown, the provision of the needed supervision has shrunk.”
His closing paragraph in the FT opinion piece succinctly argues that capitalism should be viewed, not in ideological terms, as extremists from the right and left claim, but as a pragmatic framework for addressing the very complex problems our society faces:
“The economic difficulties of today do not, I would argue, call for some “new capitalism”, but they do demand an open-minded understanding of older ideas about the reach and limits of the market economy. What is needed above all is a clear-headed appreciation of how different institutions work, along with an understanding of how a variety of organisations – from the market to the institutions of state – can together contribute to producing a more decent economic world.”