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History of Political Economy 21:4
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The butcher, the baker, and the policy-maker:
Adam Smith on public choice, with a reply
by Stigler
Gary M.Anderson
I. Introduction
The paradox [of the Wealth of Nations] is simply this. If self-interest
dominates the majority of men in all commercial undertakings, why
not also in all their political undertakings? Why should legislators
erect “a hundred impertinent obstructions” to the economic behavior
which creates the wealth of nations? Do men calculate in money with
logic and purpose, but calculate in votes with confusion and romance? (Stigler 1982a, 136)
Stigler’s view of the sharp dichotoniy in Smithian economics between
the commercial market and the political realm is widely shared. Since the
nineteenth century, the conventional interpretation has held that Smith vigorously applied positive economic analysis to explain the effects of government intervention in private markets, but only evaluated the political
process which generated government intervention on normative grounds.
Scholars who have defended Smith from the charge that he preached
when he should have analyzed basically share with Stigler the premise of
the existence of an effective dichotomy in Smith’s work between the market and political realms. For example, West (1979) argues that Smith did
not develop a detailed analysis of the political marketplace because he
chose to emphasize a different branch of public choice, the problem of
constitutional choice among different possible institutional regimes.
Winch (1978) attacks Stigler for the very suggestion that Smith’s separation of the economic and political realms was a failure at all, and maintains
that Smith correctly kept economics out of politics. In sum, Stigler’s main
thesis articulates an apparent consensus view held by an otherwise diverse
array of Smithian scholars to the effect that Smith failed to extend economic analysis to political affairs and consequently that The Wealth of
Nations (WN) has little to offer in the way of what is nowadays termed
public choice theory.
Correspondence may be addressed to the author, Department of Economics, California
State University, Northridge CA 91330.
64 1
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History of Political Economy 21 :4 (1989)
The purpose of the present paper is to challenge this interpretation.
While Stigler admits that Smith occasionally assumed political actors to
be self-interested individual maximizers, he emphasizes Smith’s “usual”
tendency to preach instead. Contrary to Stigler, Smith applied the principles of economics to politics vigorously and consistently. Smith frequently employed the model of rational and self-interested behavior to
explain both the origin and consequences of political policies. Like most
other historians of thought, Stigler has unduly neglected the extent to
which Smith consistently pursued a policy that Hirshleifer, Tullock, and
other modern theorists term “economic imperialism”-the generalization
of the principles of economics analysis to problems outside the traditional
domain of market exchange.’ What is today termed “public choice” was
one of Smith’s major analytical interests.
This paper is divided into five sections. Section I1 examines Smith’s use
of?%onomics to explain political behavior generally in WN.Section 111
reassesses some of the major examples offered by Stigler of “failures of
self-interest” in WN.Section IV considers Smith’s analysis of the economics of slavery. Section V provides a summary of the preceding argument
and a conclusion.
11. Is There an Economics of Politics in WN?
One of the most characteristic expressions of modem public choice is
the extension of the model of actors as rational, self-interested wealth
maximizers to the political sector and the determination of public policy.
A large literature has grown up in recent years which argues that many
public policies are in fact designed to generate artificial scarcity rents to
specific interest or pressure groups.* This overall approach has been described as rent-seeking theory and is often claimed to represent a novel
modern development.
Smith was conscious of the rent-seeking origin of much proposed legislation. For example, in concluding Book I he writes:
To widen the market and to narrow the competition, is always the
interest of the dealers. To widen the market may frequently be agreeable enough to the interest of the public; but to narrow the competition must always be against it, and can serve only to enable the
dealers, by raising their profits above what they naturally would be,
to levy, for their own benefit, an absurd tax upon the rest of their
fellow-citizens. The proposal of any new law or regulation of commerce which comes from this order, ought always to be listened to
with great precaution, and ought never to be adopted till after having
1 . For a collection of recent articles on this theme see Radnitzky and Bernholz (1987).
2. See Tollison (1982) for a recent survey of this literature.
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been long and carefully examined, not only with the most scrupulous,
but with the most suspicious attention. It comes from an order of
men, whose interest is never exactly the same with that of the public,
who have generally an interest to deceive and even to oppress the
public, and who accordingly have, upon many occasions, both deceived and oppressed it. (1979, 267)
This passage not only emphasizes the role of economic self-interest on the
part of particular groups in the origin of commercial legislation, it clearly
distinguishes between real and artificial scarcity rents (returns to “widening the market” and “narrowing the market,” respectively) and explains
the role of legislated regulation in restricting competitive entry into markets.
Near the end of Book IV, Chapter 11, in concluding a discussion of
prospects for eliminating the system of internal trade restrictions in Britain,
Smith argues that such restrictions serve well-defined and organized interests and proceeds to elaborate on the process by which legislative restrictions are achieved and maintained by these interest groups:
Were the officers of the army to oppose with the same zeal and unanimity any reduction in the number of forces, with which master
manufacturers set themselves against every law that is likely to increase the number of their rivals in the home market . . . to attempt
to reduce the army would be as dangerous as it has now become to
attempt to diminish in any respect the monopoly which our manufacturers have obtained against us. This monopoly has so much increased the number of some particular tribes of them, that, like an
overgrown standing army, they have become formidable to the government, and upon many occasions intimidate the legislature. The
member of parliament who supports every proposal for strengthening
this monopoly is sure to acquire not only the reputation of understanding trade, but great popularity and influence with an order of
men whose numbers and wealth render them of great importance.
(1979, 471)
Although the sentence that includes the phrase “like an overgrown standing army” is famous, the passage overall has seldom been carefully considered. Smith here goes beyond merely claiming that some legislation
and/or regulation restricting trade will benefit particular interests, by explaining in some detail how such restrictions are supplied across the legislative marketplace. Rent-seeking interest groups reward legislators by
granting them “great popularity and influence with an order of men whose
numbers and wealth render them of great importance”-an implicit reference to wealth transferred to legislators, directly and indirectly-and
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interestingly, are sanctioned by threats of violence (according to additional
lines not quoted here). What emerges is a picture of legislators enacting
laws in order to further their own self-interest. Altogether, while this passage leaves some important questions unaddressed (e.g ., are legislators
actually supplying legislation to the highest bidders, or are they simply
influenced in their behavior at the margin by interest group pressure?), it
also presents the legislature in unambiguous terms as a market for wealth
transfers.
In another passage Smith elaborates on the magnitude of the influence
of rent-seeking on the determination of public policy. While he does not
argue that all government policy is supplied in response to interest group
demand and functions to provide coercive transfers of wealth, the proposition he offers is nevertheless astonishingly radical:
But in the system of laws which has been established for the management of‘our American and West Indian colonies, the interest of our
home-consumer has been sacrificed to that of the producer with a
more extravagant profusion than in all our other commercial regulations. A great empire has been established for the sole purpose of
raising up a nation of consumers who should be obliged to buy from
the shops of our different producers, all the goods with which these
could supply them. For the sake of that little enhancement of price
which this monopoly might afford our producers, the homeconsumers have been burdened with the whole expence of maintaining and defending that empire. ( 1979, 66 1; emphasis added)
This passage, which appears as the penultimate paragraph of Book V,
Chapter VII (i.e., almost as an afterthought), is nothing less than an outline
of an interest-group model of the British Empire. However, this analysis
is seriously incomplete in several respects. Specifically, Smith neither explains why consumers are vulnerable to such exploitation (can’t consumers
lobby in their interests as well as producers?), or why the domestic producer lobby is given transfers in such an inefficient form (why not less
wasteful simple cash s~bsidies?).~
But regardless of these failures of omission, it is hard to imagine a more “Stiglerian” passage in WN.4
111. SmithS Purported Sins against Self-interest
Stigler (1982a) notes numerous instances in which Smith refrained from
“preaching” in the nonmarket realm and applied “cold blooded” economics
3. For a modem discussion of these problems see Demsetz (1982).
4. There is a major difference between Smith’s interest in the economics of politics and
modem public choice: Smith devotes essentially no space to problems of voting and democratic decision making. West (1979, 140-41) suggests that this lack of interest was a
reflection of the extremely limited franchise in eighteenth-century Britain, which was “dem-
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in innovative ways. Moreover, most of Stigler’s specific examples of
Smith’s failure to apply self-interest in the analysis of behavior with sufficient consistency and rigor are themselves hard to challenge. Smith committed a number of economic errors in the course of discussing nonmarket
phenomena, and Stigler lists and correctly describes the most important of
these. However, some of the most important examples Stigler uses to illustrate Smith’s purported tendency to supplant the self-interest model with
ad hoc reasoning are themselves faulty. In several cases, these examples
can be more accurately described as clever applications of what is today
described as the economics of public choice.
Stigler lists four major examples of what he describes as Smith’s tendency to attribute inefficiency to government in the management of resources under its control, in contradiction to the model of rational selfinterested economic behavior. These are listed in the following order in
Stigler 1982a:
1. “Princes, however, have frequently engaged in many other mercantile
projects, and have been willing, like private persons, to mend their
fortunes by becoming adventurers in the common branches of trade.
They have scarce ever succeeded. The profusion with which the affairs of princes are always managed, renders it almost impossible that
they should. The agents of a prince regard the wealth of their master
as inexhaustible; are careless at which price they buy; are careless at
what price they sell; are careless at what expence they transport his
goods from one place to another.” (Smith 1979, 818-19; cited in Stigler 1982a, 143)
2. “The persons who have the administration of government being generally disposed to reward both themselves and their immediate dependents rather more than enough.” (Smith 1979, 866; cited in Stigler
1982a, 143)
3. In general, monarchies are conducted with “slothful and negligent
profusion ,” and democracies with “thoughtless extravagance,” but
aristocracies such as Venice and Amsterdam have “orderly and par-
ocratic” only in the very limited sense that members of the House of Commons were elected
periodically, although only a small fraction of the adult population was eligible to vote.
Even the “forty-shilling freeholders” who were eligible to vote were not free to express
their unrestrained electoral preferences in anything approaching a modem sense; ballots
were not secret, and most voters either openly sold their votes or pledged them to the
candidates supported by their landlords, as a component of their rent payments (Williams
1970, 498). Because Britain was not a democracy (in the modem sense of unrestricted
franchise with secret ballots), it is understandable that Smith was relatively uninterested in
the analysis of democratic decision making. None of the other European states at the time
were democracies, either (Williams 1970, 22-23). See Anderson and Tollison (1988) for a
more detailed discussion.
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simonious administration.” (Smith 1979, 8 18; cited in Stigler 1982a,
143)
4. The crown lands would be more valuable if they were sold off.
(Smith 1979, 824; cited in Stigler, 1982a, 144)
All of these examples are used by Stigler to illustrate Smithian lapses from
the rigorous application of the assumption of rational self-interest to human behavior. These passages all purportedly show instances of the “failure of individuals to reason correctly” (1982a, 144).
But correct reasoning on the part of economic actors-efficient behavior
with respect to scarce resources-is necessarily optimization subject to
constraints. One of the recurring themes in WN is the role of institutional
constraints in affecting economic behavior. In each of these cases listed by
Stigler the relevant structure of institutional constraints plays a key role.5
In the first-cited passage Smith explains the poor record of governmental
mercantile projects as the consequence of an agent-principal problem arising from the fact that the administrators of such projects are not residual
claimants. He fails to explain why princes are unable to monitor the behavior of their agents in an efficient manner, and as a result his analysis is
incomplete. But this passage does not imply that princes are irrational.
The prince’s revenue may in fact be maximized in a setting where the
managers of the enterprise are non-residual-claimant patronage appointees
(Smith was writing almost a century before civil service reform in Britain)
who can be expected to run a particular enterprise “into the ground” as the
result of incompetent management. All Smith claims is that the survivorship rate for such enterprises tends to be lower than for similar private
firms. Whether valid or not, this is a potentially testable hypothesis, based
on simple microeconomic theory.
The second passage also points to an agent-principal problem by asserting that government employees obtain net rents. Presumably Stigler intends to imply that competition among rational, self-interested actors
should dissipate any net rents; assuming competitive conditions in the market for government jobs, any rents associated with the administration of
government would tend to be competed away. In other words, if government workers are held to earn “rather more than enough,” potential profit
opportunities are remaining unexploited by nongovernment workers who
5. One of the most frequently cited passages in W N concerns the malfeasance among
servants of the East India Company: “It is the system of government, the situation in which
[the servants] are placed, that I mean to censure; not the character of those who have acted
in it. They acted as their situation naturally directed, and they who have clamoured the
loudest against them would, probably, not have acted better themselves” (1979, 641). One
of Smith’s main themes is expressed by this passage. The institutional constraints which
Smith found most interesting in W N were property rights arrangements.
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would otherwise be vigorously seeking government jobs. But does this
imply a failure of self-interest? In the presence of relatively high transaction costs which tend to be associated with political markets, where prices
are usually implicit, net rents may not be fully competed away. Once
again, Smith can be criticized for his failure to outline his underlying
assumptions carefully. But given these simple and plausible assumptions,
his argument is consistent with self-interest.
The third passage is open to criticism on the grounds that Smith failed
to define his argument precisely. (He may have assumed that the average
reader in the last quarter of the eighteenth century would have sufficient
background knowledge to understand without prompting how Venice and
the Dutch Republic differed in major respects from monarchies and “democracies .”) In the “aristocratic republics” mercantile projects established
by the state were ordinarily run for profit by individuals who first purchased a legal monopoly; commonly the state was effectively a co-owner
in such enterprises, receiving a portion of profits of the enterprise over
time.6 (One historian has argued that “[the] Republic of Venice has justly
been compared to a joint-stock company for the exploitation of the E a ~ t . ” ) ~
In contrast, in both monarchies and democracies state enterprises were
ordinarily run by non-residual-claimant public officials who faced incentives which rewarded shirking and the pursuit of their self-interest even
when this was inconsistent with the maximization of net revenue by the
government (see North and Thomas 1973). Smith can be faulted for failing
to explain why governments tended to organize projects as inefficient public enterprises rather than “contracting out” to the private sector; but the
record is clear that they in fact often did so.
In the fourth example criticized by Stigler, Smith’s argument (concerning the crown lands) deserves a closer look. In a page-long discussion at
the end of Book V, Chapter I1 (1979, 824), Smith notes that “all of the
great monarchies of Europe” contain large tracts of land which belong to
the crown, and explains that by pursuing a policy of sale of these lands
those governments could produce a significant additional revenue which
they could then proceed to allocate to repayment of their respective na6. For an account of these arrangements in Venice, particularly the galere da mercato
(state merchant vessels chartered by the private sector), see Braudel (1986, 126). Braudel
later (196) describes the involvement of the “oligarchy” of the United Provinces of Holland
in commercial and industrial enterprises.
7. Brown (1907, 336). Brown continues: “The board of directors was the Senate, the
citizens of Venice the shareholders. The vast majority of the senators were men of business,
engaged actively in traffic, and from them emanated the regulations which governed Venetian commerce-the choice of trade routes, the appointment of consuls, the directions for
the mercantile marine, the imposition of customs, the formation of tariffs.” Thus the aristocratic republic of Venice was less a government in the usual sense of the word, and more
a corporation with some governmental attributes.
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tional debts. He further points out that by following such sales the crown
could expect additional revenue from taxation of the now privately owned
and developed lands; and over the long run such a policy would tend to
increase “the revenue which the crown derives from the duties of customs
and excise, [which following an increased rate of economic development
resulting from the land privatization] would necessarily increase with the
revenue and consumption of the people.” Because of this retarding effect
on economic development (i.e., by holding potentially productive resources off the market) the revenue the crown derives from the crown lands
“though it appears to cost nothing to individuals, in reality costs more to
the society than perhaps any other equal revenue which the crown enjoys”;
it would “be for the interest of the society to replace this revenue to the
crown by some other equal revenue and to divide the lands among the
people, which could not well be done better, perhaps, than by exposing
them to publick sale.” This passage is not a sermon but a simple application
of welfare economics.
Contrary to Stigler’s assertion, Smith does not maintain that the lands
“would be more valuable if they were sold off .” Rather he argues that while
the crown might be relatively indifferent toward the alternatives of selling
the lands now or holding them for potential future sale, society would
benefit from a net gain in efficiency (which the crown could only partially
capture in taxes) resulting from a more rapid sale. Furthermore, a net
social gain could result if the crown earmarked the resulting sales proceeds
to debt retirement by reducing the pressure on capital markets.
The important point to note in this argument is that Smith is not accusing
the crown of myopia in a supposed failure to maximize returns on its
property. He is instead arguing that there is a public goods problem associated with the crown lands: society would be better off if the crown sold
the lands immediately, but the crown has a low incentive to pursue such a
policy because it would be unable to capture the resulting residual. The
absence of incentives for the crown to pursue socially efficient behavior,
and not “stupidity,” is identified as the major explanatory factor.
There is a further interesting aspect to the question of the crown lands
which Stigler overlooks. Smith’s consideration of the problem was not
merely utopian theorizing but had direct bearing on an important issue for
contemporary policy making.
Most of the British crown lands were not in Britain but in America. In
the royal colonies in America and the West Indies title to land lay in the
crown; that is, all land which was not privately owned was crown land.
The history of the British colonies in America was in part a history of the
privatization of the crown lands. In the royal colonies crown lands were
routinely granted to private individuals. Authority to grant land was vested
in the governor, through his royal commission, and in terms laid down by
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his instructions. Ordinarily a quit rent (an annual percentage of the land’s
production, if any) was reserved to the crown. Typically the revenues from
this source were extremely small. The stated intention of the land grants
-was to secure rapid development, and nominal efforts were made to ensure
that lands actually granted did not go to speculators but to individual farmers who would actually develop the land and put it in production. In practice these restrictions were widely evaded, and much of the land granted
went to professional speculators who sold it for profit.
Following the Peace of Paris in 1763 large new American territories
were added to the crown lands (Murdoch 1984, 550). A system of land
sales of parts of this acreage which was very similar to the scheme Smith
describes was in fact experimented with between 1765 and 1777. In the
Ceded Islands in the West Indies (Grenada, Dominica, St. Vincent, and
Tobago, all former French possessions ceded to Britain by the Treaty of
Paris) land was sold at public auction. These sales operated under the
direction of the Treasury (Murdoch 1984, 552). At the same time that the
Ceded Islands were auctioned off, crown lands elsewhere continued to be
granted in the traditional fashion; Gipson (1964, 180-84) claims that the
“sugar land” on the islands was expected to attract high prices at auction,
and the Ceded Island policy was basically an experiment in privatization
via auction of crown lands.
This experiment was apparently a qualified success. Between 1765 and
1773 the cumulative gross total proceeds from these sales and leases was
&703,298. There is some evidence that mismanagement and poor organization combined to produce excessively high costs of the sales, but regardless, about 20 percent (or approximately &138,000) was transferred to
the Treasury as net revenue. This experience suggested that a bettermanaged system of crown land sales on a much larger scale might generate
very large revenues. This was apparently the interpretation that the British
government placed on the experience . 8 Unfortunately, the American Revolution intervened before any such policy could be implemented.
Smith’s ties to Charles Townshend have been well documented. The
author of WN served as an advisor to the latter while he was chancellor of
the exchequer during 1766-67 (for a detailed account see Scott 1935). In
this capacity Smith had detailed knowledge of Treasury operations and
very likely became aware of the Ceded Islands auction program. He continued occasional consultations with government officials on various mat8. In February 1774 the Privy Council instructed the governors of nine royal colonies
(Nova Scotia, New Hampshire, New York, Virginia, North Carolina, South Carolina, Georgia, East Florida, and West Florida) to survey, divide into fixed minimum lots, and sell at
a fixed minimum price all lands hitherto ungranted in their provinces (Murdoch 1984, 573).
Although the policy of public auction was intended to be discontinued, sales at a fixed
minimum price might have considerably reduced administrative costs and produced a higher
net revenue.
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ters until at least 1779, so it seems likely that he was also aware of the
Privy Council’s 1774 instruction regarding sale at fixed minimum price
(see note 8 above; Raphael 1985, 27). In other words, Smith may have
been offering positive economic analysis in support of expanding an existing, but experimental, policy.
IV. Slavery and Self-interest
In recent years one of the most controversial areas of research in economic history has been the economics of ~lavery.~
But the economic analysis of the evolution and functioning of slavery was an innovation of Smith,
who appears to have been the first economist to have engaged the problem
of slavery on positive grounds in any detail. His performance in this connection has been criticized as muddled or worse. Was his analysis of slavery another example of his slipping on the deck of the ship of state?
Stigler argues that Smith’s tendency to preach to politicians instead of
conducting positive economic analysis of the origin of public policy got
the better of him in the course of his discussion of slavery; “[if he had
consistently applied the assumption of self-interest] a much more skeptical
eye would have been turned to arguments such as the one that absolute
governments treat slaves more kindly than republican states” (Stigler
1982a, 140). As Stigler relates it, Smith’s proposition sounds ridiculous
and smells of polemical excess. But Stigler actually misinterprets Smith’s
account of these matters. In fact this particular application is one of the
most interesting examples of economic reasoning applied outside the narrow confines of commercial exchange in W N .
The passage appears in Book IV, Chapter VII, Part Second, entitled
“Causes of the Prosperity of New Colonies.” Smith is examining the relative prosperity of French versus English sugar colonies, and claims that
the former are the more prosperous. He explains this difference by reference to two major factors: (1) “the sugar colonies of France are not discouraged, like those of England, from refining their own sugar”; and (2)
“what is of still greater importance, the genius of government naturally
introduces a better management of their negro slaves” (1979, 586). He
maintains that “it is generally allowed” that the management of slaves in
the French colonies is superior to that of English colonies. He proceeds to
offer an explanation for this particular state of affairs (perhaps the only
example in WN of France being compared favorably to England):
The law, so far as it gives some weak protection to the slave against
the violence of his master, is likely to be better executed in a colony
where the government is in a great measure arbitrary, than in one
9. See Gunderson (1976) for a good summary of the important basic arguments in this
recent literature.
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651
where it is altogether free. In every country where the unfortunate
law of slavery is established, the magistrate, when he protects the
slave, intermeddles in some measure in the management of the private property of the master; and, in a free country, where the master
is perhaps either a member of the colony assembly, or an elector of
such a member, he dare not do this but with the greatest caution and
circumspection. The respect which he is obliged to pay to the master,
renders it more difficult for him to protect the slave. But in a country
where the government is in a great measure arbitrary, where it is usual
for the magistrate to intermeddle even in the management of the private property of individuals, and to send them, perhaps, a letter de
cachet if they do not manage it according to his liking, it is much
easier for him to give some protection to the slave; and common humanity naturally disposes him to do so. The protection of the magistrate renders the slave less contemptible in the eyes of his master,
who is thereby induced to consider him with more regard, and to treat
him with more gentleness. (1979, 587)
The same factors that limit a magistrate’s discretion in matters affecting
private property of individuals in democracies, and hence serve as part of
the bulwark of liberty, tend to reduce the protection afforded to the welfare
of slaves (who are simply defined as the private property of their masters). l o
The behavior of magistrates in seeking, ceteris paribus, to protect the
slave from harm is regarded not as an example of irrationality but as a
preference based on “common humanity.” Hence the protection of slaves
by magistrates is presented as “on-the-job” consumption by judges, as a
“good” with a relatively high price-elasticity of demand; if the magistrate
can expect to bear a significant cost as a result of defending the rights of
the slave, the supply of such defense will decline. Magistrates can be
expected to make “humane” decisions regarding slaves as long as they are
able to do so at low cost to themselves.lI Smith’s argument is thus based
10. Smith understood-as many of his contemporaries did not (see Davis 1984, chapter
3)-that a rational slaveowner would invest resources in the care and maintenance of his
valuable capital assets, and that this economic incentive (irrespective of the “altruism” of
masters) would likely generate humane outcomes: “In order that [the slaves] might work
well, it is the interest of their master that they should be fed well and kept in good heart, in
the same manner as it is in his interest that his working cattle should be so” (1979, 939).
However, keeping slaves alive and healthy would still be consistent with gross violations of
their individual rights. It might still sometimes be the case that a master would choose to
“consume” a slave by beating h i d h e r to death or otherwise sacrificing the slave for his
personal “entertainment” and voluntarily bearing the subsequent capital loss. Therefore the
capital market would not necessarily be a sufficient protection for each individual slave.
1 1. Smith’s account of the magistrate’s “maximization problem” in some respects anticipates Tbllock’s modem discussion of the “public goods” characteristics of judicial decision
making. ’hllock argues that although the judge’s decisions generate public goods (or bads),
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on the relative price of altruism. The protection of the magistrate for the
slave is the obverse of the relative insecurity of the master’s property right
in his chattel. Masters tend to “treat [slaves] with more gentleness” because they otherwise will suffer legal penalties imposed by the magistrate,
who exercises charity as a kind of perquisite of office. In short, under a
regime where property rights are more secure and the power of magistrates
is strictly limited, as in England, the utility of slaves will be reduced,
whereas under a different one where property rights (including rights of
slave masters) are attenuated and magistrates enjoy more arbitrary
decision-making power, the utility of slaves may be enhanced. A seemingly “perverse” result-that net human welfare may be increased by the
failure of certain private property rights-follows Smith’s consistent application of simple positive analysis. l 2
Smith also claimed that slave labor was relatively less productive than
he or she receives virtually no benefits (or bears virtually no costs) as a result of those
decisions. The cost to the judge of indulging a “personal ethical system” is therefore very
low (1971, 914). llllock’s argument is predicated on the assumption that judicial independence is protected, either by the institution of lifetime tenure (in the case of federal judges)
or some other means. Such appears to have been the case in France, where the liberty of
opinion (and hence discretionary authority) of the magistrates was strongly protected (Egret
1970, 27).
12. Smith’s close friend and associate Edward Gibbon presented a similar argument at
about the same time, although in a slightly different context. Gibbon claimed that the treatment of slaves in the Roman Empire was much more humane than it had been in the Roman
Republic. He attributed this in part to the restrictions imposed on the slave trade by the
Empire, which drove up the capital value of slaves and increased the incentives of slaveowners to attend more carefully to the maintenance of their (now more valuable) chattels:
“The existence of a slave became an object of greater value, and though his happiness still
depended on the temper and circumstances of the master, the humanity of the latter, instead
of being restrained by fear [of slave revolt], was encouraged by the sense of his own interest” ( 1 909, 1:44).This represented an anticipation of one of Fogel and Engerman’s (1974)
basic arguments by almost two hundred years. But Gibbon also argued that this “progress
of manners” was accelerated by the “virtue of the policy of the emperors”: “the protection
of the laws was extended to the most abject part of mankind. The jurisdiction of life and
death over the slaves, a power long exercised and often abused, was taken out of private
hands, and reserved to the magistrates alone . . . upon a just complaint of intolerable treatment, the injured slave obtained either his deliverance or a less cruel master” (44).
Gibbon’s book was published on 20 February, W N on 9 March 1776. But a letter from
Hume to Smith (1 April 1776) appears to recommend Gibbon’s book to the latter; the
earliest correspondence surviving between Gibbon and Smith is dated 26 November 1777
(see Mossner and Ross 1977, 187, 228). Therefore it seems possible that the two similar
arguments about slavery were in fact coincidental parallel developments.
Was Gibbon right? Some historians have argued that the end of Roman imperial expansion after the time of Augustus caused the supply of slaves to shrink, raising the price of
slaves and therefore raising the cost generated by ill-treatment of them (see Finley 1980,
128, for a summary). Jones (1956) claims that slave prices multiplied eightfold between the
fourth century B.C. and the second century A.D., making this argument more plausible. In
other words, the extension of the protection of laws to “the most abject part of mankind”
could have simply amounted to a legal acknowledgment of the increased capital value of
slaves.
Anderson
The butcher, the baker, and the policy maker
653
free labor (1979, 587), another “failure of self-interest” according to Stigler (1982a, 137). But in this case Smith both stated his hypothesis in
testable terms and offered an empirical “test.” This was not in WN, but in
his 1762-63 Lectures on Jurisprudence (w>.This evidence involves the
Scottish colliers and salters.I3 By Scottish law (the act of 1606), workers
in and about coal mines and salt pans (which were closely connected),
were bound to the mines for life.I4 The same act imposed a wage ceiling
on the colliers. l5 If colliers left their master’s colliery or salt works without
permission, they could be reclaimed by him within a year and a day of
leaving, and punished as thieves; a new employer who refused to surrender
them within twenty-four hours was liable to a penalty of El00 Scots (Ashton and Sykes 1967,71-72).
Smith argues that the performance and wages of free laborers in Scotland employed in different but similar occupations can be compared with
the performance and wages of the “enslaved” colliers in a sort of natural
experiment.l 6 After arguing that colliers could be compared to plowmen
and ditch-diggers in terms of the difficulty of the work and the skill required, Smith claims that while the former free laborers earn a “mean rate”
of 6 pence per day, a collier “whose work is mere labour such as any man
who can handle the pick will learn by a very short practice” can expect to
earn between 2 and 3 shillings per day (between 24 and 36 pence) (1978,
192). He attributes this “slave premium” to the need to pay more to a slave
than to a free man in order to motivate him to work efficiently; masters are
willing to pay these higher wages rather than simply hire free laborers for
lower wages because of their “love of domination”; i.e., slaves are a con13. Viner ( 1965, 1 15) expresses wonder over the fact that Smith did not even mention
the bondage of the coal miners in WN. However, he also implies that Smith only paid scant
attention to the phenomenon in fJ,whereas Smith actually devoted lecture time equivalent
to about three pages (191-92, 453) on two separate occasions, in 1763 and again in 1766.
Furthermore, the Scottish slave system is mentioned explicitly in the Early Drufr ofPurr of
the Wealth of Nurions, which was (probably) written in 1763 (1978, 579). This discussion
was eventually edited out sometime before 1776. Might Smith have dropped this topic from
publication to avoid annoying his Scottish coal-mine-owning friends?
14. Parents could sell their children into bondage, and individuals fourteen and over
could sell themselves (see Viner 1965, 109). The owners were restricted from selling their
chattels singly but could transfer them to a new owner as part of a package which included
the mine itself (Smith 1978, 191).
15. No master could legally offer as “earnest” a sum greater than 20 marks, a rule ostensibly intended to prevent new potential employers from “seducing” colliers from their masters (Ashton and Sykes 1967, 72).
16. However, Smith’s account of these facts was probably not strictly accurate. For example, there is evidence of considerable mobility among colliers in Scotland. Colliers who
succeeded in evading their former masters for more than a year and a day were free and
clear. Runaway colliers were common and appear to have had little trouble finding new
employment. Also, by the eighteenth century laborers entering the industry sometimes successfully stipulated that they should not become serfs as a result of their employment; free
colliers seem to have often worked alongside serfs (Ashton and Sykes 1967, 77).
654
History of Political Economy 21 :4 ( I 989)
sumption good. Nef (1932, 190-91) is skeptical that Scottish colliers actually earned higher wages than did free English colliers when the wages
are computed on a comparable basis, but given the validity of Smith’s
account of the facts, his argument is plausible.17 The major problem with
Smith’s presentation of evidence is that he fails to control for other possibly
significant factors. (He may have been the first “economic imperialist,” but
he was not the first econometrician.)
Finally, Smith deserves credit for confronting the one major problem
area least explored by the modem economics of slavery: emancipation. *
He offers an explanation for the emancipation of slaves in Scotland, England, France, and Spain in the late Middle Ages. Although he alludes to
this argument in WN (1979, 390), it is presented in detail in W.There he
argues that the emancipation of the slaves was a by-product of the competition between the king and the (Catholic) clergy on the one hand and
the barons on the other; the former pursued emancipation as a means of
reducing the power of the latter. The clergy
therefore promoted greatly the emancipation of villains, and discouraged as much as lay in their power the authority of the great men over
them. The king’s interest tended also to promote the same thing. . . .
The king’s courts, on this account, were very favourable to all claims
of the villains, and on every occasion endeavoured to lessen the authority of the landlord over them. (1978, 188)
A crucial caveat is in order here: the villeins (or “villains”), whom Smith
also refers to (in the same passage) as “slaves,” were not slaves in the same
sense, as, say, were slaves in the antebellum American South. The major
economically relevant difference was that explicit capital markets did not
exist across which villeins were openly bought and sold. But the villeins
were subjected to compulsory labor, were villeins by birth, and while not
marketed independently, were commonly transferred along with the estate
17. Viner (1965, 116) cites R. H.Campbell’s account of the experience of the Scottish
Carron Company as “strong support” for Smith’s position with respect to the relative productivity of slaves. The company found it profitable to import colliers from England on a
free-contract basis at premium wages over the Newcastle rates and with especially favorable
working facilities provided, because the English colliers were more efficient, better disciplined, and more loyal than the Scottish bound workers. Smith was a friend of John Roebuck, one of the partners of the firm (Viner 1965, 22 n. 16).
18. Even the “new economic historians” (e.g., Lebergott 1984, 212) typically ascribe
the abolition of slavery to ideological factors. Exceptions are Fogel and Engerman (1974),
who argue that the capital loss experienced by the Northern states as a result of the slave
emancipation laws of the early nineteenth century was very small (making moral superiority
cheap), and Anderson, Rowley, and Tollison (1988), who argue that the ban on slave importation into the United States after 1808 was motivated by the economic interests of
domestic slave-breeders.
Anderson
The butcher, the baker, and the policy maker
655
of their residence. The institutional arrangements connected with the feudal system were decidedly different from the other major examples of
compulsory labor Smith was acquainted with (in ancient Greece and
Rome), but the basic characteristics of those different systems were sufficiently similar to make his description of the villeins as slaves reasonable.
The precise nature of villeinage is still a matter of controversy among
modem historians.l 9
Extending the basic argument, elsewhere Smith argues that in countries
where the combined power of the church and the king was great, slavery
had been abolished, and where it was relatively weak (e.g., in Poland,
Germany, Bohemia, and Russia) it continued to survive (1978, 189). He
concludes: “The circumstances which have made slavery be abolished in
the comer of Europe in which it now is are peculiar to it, and which
happening to concur at the same time have brought about that change”
(1978, 187). Ideology plays no role in this argument, only cold-blooded
self-interest on the part of competing power blocs.20
V.
Conclusion
Contrary to the widely held belief that Smith failed to apply his model
of rational self-interest to political behavior or to the origin of particular
government economic policies, the economic analysis of politics was a
major recurring theme in WN.Politics was analyzed as a marketplace, in
which policies result from self-interested competition among rational actors.
As applied to specific topics, Smith’s economic analysis was not always
based on completely valid empirical premises, although this paper has
19. Few modem students of either slavery or feudalism describe villeinage as a form of
slavery. In fact, some go so far as to maintain that feudal society was essentially contractual.
For example, Muller (1963, 68-69) writes: “the feudal system was the antithesis of Oriental
despotism. The essential principle of rule was contract, not God-given right or dominion; it
was an embryonic form of social contract on which later political theory would be based.”
He proceeds to argue that various rights and liberties were extended by custom to serfs in
return for their services.
Regardless of the absence of well-developed capital markets for villeins, they were also
valuable assets to their lords; the emergence of the customary extension of rights and liberties Muller describes was economically rational on the part of feudal lords. As economic
development progressed and following the labor supply shock of the Black Death in the
fourteenth century, the villeins became relatively more valuable to their “owners ,” and their
treatment improved further (Hirschleifer 1987, 1 10-1 1).
20. This is similar to the argument developed by Ekelund and Tollison (1981, 67-70)
that the gradual decline of domestic trade restrictions and the significant deregulation of the
economy in the seventeenth and eighteenth centuries in England was a by-product of the
competition between Parliament and the monarchy for the right to operate the national
system of economic regulation.
656
History of Political Economy 21 :4 (1989)
argued that the available evidence often tends to support his interpretation
of the facts. However, even if he had simply invented the major facts in
each of these cases in order to illustrate his argument, the analysis would
still constitute an innovative extension of economics beyond the boundaries of ordinary market exchange. The bold application of price theory was
important in its own right, independent of the validity of the particular
applications.
This bears directly on the question of Smith’s originality. Recently
Rashid (1985) has argued that substantial portions of Smith’s free-trade
doctrine, as well as certain major applications of the analysis of the effects
of trade restrictions (e.g., the internal corn trade, 13-17), were not very
original and had been presented in a similar form by earlier writers. He
leaves open the question of whether this similarity was due to coincidence
or actual plagiarism. Grampp (1952) had already demonstrated that in fact
many of the so-called mercantilist writers were strong advocates of free
domestic markets, favoring policies similar to those espoused by Smith.
Clearly this suggests that Smith’s claim to originality is fairly weak to the
extent that his economic analysis of the effects of trade restrictions is considered to be his major contribution.
But WN went much further than merely analyzing the effects of restrictions on market exchange: Smith diligently extended economic reasoning
to the origin of such restrictions. He even tried to explain the growth of
the British Empire as a by-product of the rent-seeking of producer interest
groups who wanted to extend the size and scope of their monopoly privileges! Much of this “rent-seeking analysis” in WN is flawed and fails to
address important aspects of the problems associated with the political
marketplace in a precise and rigorous fashion. Nevertheless, Smith’s economic perspective on public policy making was both innovative and original.
Smith is vulnerable to Stigler’s claim of the “paradox of WN” in one
important sense, though. Smith was willing to extend the assumption of
self-interest to the realm of the determination of public policy, but not the
“invisible hand.” Why, if in the ordinary commercial marketplace individuals are “led by an invisible hand . . . [to promote the interest] of society”
(1979, 456), is not the same thing true in political markets? Why do competitive ordinary markets produce efficient outcomes, while competitive
political markets produce “a hundred impertinent obstructions”?
Despite this limitation, his achievement was impressive. It also dropped
from sight after Smith’s death. Neither his self-proclaimed followers (like
Dugald Stewart) nor later classical economists (most importantly Ricardo,
Senior, and Mill) furthered Smith’s efforts to extend economics beyond
simple commerce to political decision making, the role of ideas, religion,
Anderson
*
The butcher, the baker, and the policy maker
657
or any other major nontraditional subject matter.*’ If Smith gave birth to
public choice, it failed to survive its infancy. This mystery deserves attention from historians of economic thought.
Thanks to David Levy, William Shughart 11, Robert Tollison, Gordon Tullock, and two
anonymous readers for useful comments on earlier drafts. The usual caveat applies.
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Press.
ADAM SMITH AND PUBLIC CHOICE: A REPLY TO ANDERSON
George J. Stigler
In my essay on Adam Smith’s treatment of political questions (Stigler
1982) I argued that he did not consistently apply economic logic (rational
behavior) to the political scene. The Wealth of Nations has many recognitions of self-interest acting efficiently in legislation and politics but also
many and important failures to analyze political phenomena in these terms.
Gary M. Anderson (HOPE, this issue) apparently believes (1) that these
failures to use economic logic are fewer and less important than I assert,
and (2) that some of the more important alleged failures were actually
economically rational, so I, not Smith, erred.
Anderson’s statement is discursive and imprecise, and I shall not attempt
to deal with it in detail. Consider these examples:
1. He begins with Smith’s well-known condemnation of the self-serving
manufacturers and merchants. He ignores the passage, which comes
only a page before that which he quotes, where Smith asserts the
identity of interests of landlords and laborers with that of society.
2. To counter a few of the examples I proposed to illustrate Smith’s
failures of political analysis, Anderson uses analyses of principalagent problems, public goods, or transaction costs to justify Smith’s
positions. This could be labeled defense by anachronism.
There can be no dispute over the facts that Smith made correct and
perceptive analyses at some points but failed to do so on other points. The
Correspondence may be addressed to the author, Center for the Study of the Economy and
the State, University of Chicago, 1101 East 58th Street, Chicago IL 60637.
What Did Smith Mean by the Invisible Hand?
Author(s): William D. Grampp
Source: The Journal of Political Economy, Vol. 108, No. 3 (June 2000), pp. 441-465
Published by: The University of Chicago Press
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http://www.jstor.org
What Did Smith Mean by the Invisible Hand?
William D. Grampp
University of Chicago
The invisible hand is not a power that makes the good of one the
good of all, and it is not any of a number of other things it is said to
be. It is simply the inducement a merchant has to keep his capital at
home, thereby increasing the domestic capital stock and enhancing military power, both of which are in the public interest and
neither of which he intended. Smith’s exposition discloses how his
rhetorical sallies could disfigure his economics, confuse his argument for free trade, and make him play fast and loose with facts
and the ideas of others.
If classical economics were ever given a musical setting—unlikely
but not inconceivable, an oratorio perhaps, subsidized by a cunning
National Endowment for the Arts—the title surely would be Three
First Words, and they would be ‘‘an invisible hand.’’ The composition
would open with plainsong, which is in keeping with the apparent
simplicity of the words, and would end in dissonance, and that is in
keeping with the diverse and contradictory ways the words have been
interpreted.
They must be the most familiar of all of the words that Smith
wrote, certainly the most familiar to people who have read more
about than by him. If the attention the invisible hand has gotten is
For reading my paper and their comments, I am grateful to Ronald H. Coase,
Robert V. Eagly, William M. Landes, Anna Pellanda, Joseph J. Persky, Richard A.
Posner, Carlos Rodrı́guez-Braun, George Rosen, Sherwin Rosen, William R. Waters,
two anonymous referees, and, primus inter pares, Warren J. Samuels, who has long
been interested in the question, has thought much about it, and will, I trust, someday
publish his ideas. But neither he nor the others named here are responsible for the
way I have used their kind assistance.
[Journal of Political Economy, 2000, vol. 108, no. 3]
2000 by the University of Chicago. All rights reserved. 0022-3808/2000/10803-0002$02.50
441
442
journal of political economy
a measure of its importance, it is indeed important. But that is not
always a reliable measure.
In my interpretation, the invisible hand is more interesting than
it is important. It is a part of an argument for free trade that is astute
in several places, is shrewd in a few, specious in some, and in its
entirety makes one believe Smith adapted his discourse as much to
the misconceptions of his readers as to the truths he wanted them
to hold. Or, briefly, the argument shows Smith could be the buncombe artist as well as the professor. Another reason the invisible
hand is interesting is that it has become a rhetorical device in the
polemics over economic policy, used more often than not as a pejorative to dismiss a simple-minded (or any other kind of) belief in
the market. Still another reason is that there is little or no support
in what Smith wrote that can substantiate the interpretations it has
been given, thus offering another example of how the words of a
great man can mean different things to his readers and can be made
into something that he himself would not recognize.
In saying it is more interesting than important, I simply mean it
does not have a principal place in the Wealth of Nations or even a
salient place. It is related to his ideas about domestic capital, and
they are important, but they do not stand or fall with it. It also has
a place in the leading proposition of Smith’s economic policy, which
is that defense is more important than wealth. But, again, the proposition does not rest on the invisible hand and can do without it.
While much, although not all, of what has been said about it by
its interpreters is related to ideas that are in the Wealth of Nations,
somewhere or other, they are not (with a single exception) ideas
that Smith himself made a part of it when he wrote about the invisible hand.
Does what he said matter? It should. If what he meant by the invisible hand is misunderstood, then what it is mistakenly said to mean
may be misunderstood also. For example, to interpret the invisible
hand as the price mechanism, which it is not, is likely to make one
overlook the numerous reservations Smith had about the price
mechanism or what he called the simple system of natural liberty,
which, on examination, is seen to be neither simple nor systematic
and is by no means meant for all markets. There is an account below
of the numerous measures of intervention that Smith favored. It
should give pause to the advocates of a market economy who invoke
the authority of Smith to support their advocacy. There are better
arguments for it. But this should not please the opponents of the
market. The exceptions Smith took to it cannot be brought together
in a systematic and convincing statement that argues against it. Particular exceptions can be used and have been. In the extended de-
the invisible hand
443
bate from 1815 to 1846 over the British Corn Laws, the protectionists
cited Smith’s statement that there should be a duty on an imported
good that competed with a domestically produced good subject to
a tax. The protectionists were defeated, and the laws were repealed.
A victory for free trade and a defeat for a free trader?
I should like to propose a way to get things straight about Smith
or anyone else. It is to begin by distinguishing between (a) what the
author actually said, (b) what is implied by what he said, (c) what
can reasonably be inferred from it, (d) what we may conjecture he
meant, (e) what he conceivably could have meant, and ( f ) what it
would be convenient to believe he meant. The next step is to stay
as close as possible to points a and b, to know that about point c the
operative word is ‘‘reasonably,’’ and to move as far as point d only
when all else fails or never at all. Distinctions e and f are left to those
who, to paraphrase George Stigler, make the study of the history of
economic ideas a work of the imagination.
These are steps along the straight and narrow, and they lead to
the Grand Rule, grand in purpose, grand in simplicity: Get it right
or leave it out. A counsel of perfection, possibly, and one this paper
may not itself satisfy despite the effort to make it do so. Those who
do not care for the counsel have excused themselves by saying that
the celebrated words of a celebrated man often are used to mean
something different from what he meant by them. Just so. But would
not the reader be better served if he were placed on the alert and
told, ‘‘Consider how the market is guided by ‘an invisible hand,’ to
use the celebrated words of Adam Smith, although he himself did
not use them that way and believed the market needed some guidance’’?
In the Wealth of Nations, Smith writes of an invisible hand in the
course of describing a particular condition that may or may not be
present in a transaction on a competitive market. The condition is
that in which a man who intends to benefit only himself in a particular way may, in the act of procuring that benefit, produce a benefit
of a different kind for everyone including himself. A merchant who
instead of engaging in foreign trade engages in domestic trade—
where his capital is more secure and no less profitable—contributes
to the defense of the nation. He does so because he adds to domestic
capital; it is a source of military power, and that power is a benefit
to everyone including the merchant. This interpretation of the invisible hand is explained in Section II where the passage in which Smith
uses the celebrated words is given at length.
There is also an invisible hand in the Theory of Moral Sentiments,
where it means something different, and there is another in the Essay
on Astronomy where it has still another meaning. That meaning is
444
journal of political economy
repeated in the Essay on Physics and is assigned to ‘‘invisible beings.’’
The hands and the being which are outside of the Wealth of Nations
are described in Section III. The invisible hand of the Theory of Moral
Sentiments is little noticed. Neither is the book itself, although the
readers it presently has are earnest and ingenious. The invisible
hand and being of the essays are rarely noticed. Not so the invisible
hand of the Wealth of Nations. It has received its full measure of attention and more. There are nine different interpretations of it that I
have seen (which cannot be all of them), and there is a tenth. I
would call it my own if I believed, as I cannot, that it never has occurred to anyone else since 1776.
I
About the other nine.
1. The most common seems to be that the invisible hand is the
feature or property of the market that makes the self-seeking of each
person work to the benefit of others as well as of himself, ‘‘others’’
being variously indicated as society, the public, everyone, other people, or just someone else. This interpretation implies Smith believed
that a society of self-interested people who conducted their economic affairs on the market would be a society that is mutually beneficial, prosperous, and harmonious (Cropsey 1979, p. 173; Sugden
1986, p. 2).
Neither the interpretation nor what it implies is warranted by what
Smith said. He did, to be sure, say the self-seeking of men could
increase the wealth of the nation and in so doing could contribute
to defense, a contribution that is in the public interest, and he said
this in the chapter that describes the invisible hand. But he also said,
in the same chapter, that self-seeking adds to the wealth of the nation only if it is done in competitive markets and that the public
benefits only when the additional wealth is kept within the country.
These two conditions are not always present. Moreover, according
to Smith, men do not always act in their own interest. They can be
mistaken about what it is (as when they are not as thrifty as they
should be). When they know their interest they can be mistaken
about what will best serve it (as when they overestimate the chance
of success in an occupation). Or they may not consult their interest
at all (as when the pursuit of pleasure drives them to ruin) (Wealth
of Nations, pp. 346, 123, 907).
In summary, Smith did not say that a man who acts in his own
interest is led by an invisible hand to act also in the interest of others.
Nevertheless, the notion that he did say this is held by many, and
some are in high places. The editors of The New Palgrave Dictionary
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of Economics, in the introduction to their collection of articles that
are related to the invisible hand and published separately under that
title (Eatwell, Milgate, and Newman 1989, p. xi), say this (some of
it in their words, some in the words of Smith):
Although he mentioned it only twice, Adam Smith introduced into the language of economics a metaphor as powerful as any used before or since: the invisible hand. The
meaning that Smith imparted to the phrase remains much
the same today. Every individual, acting solely in the pursuit
of private gain, is ‘‘led by an invisible hand to promote an
end which was no part of his intention’’ (Wealth of Nations,
1776, Book IV, Part II), that end being ‘‘the publick interest.’’
The reader is invited to contrast this with the passage from the
Wealth of Nations that is in Section II below (entirely in Smith’s own
words of course).
The Palgrave collection includes, most suitably, the article on the
‘‘Invisible Hand’’ from the Dictionary itself (Vaughan 1987), and the
meaning that article assigns to the idea (which is interpretation 3
below) does not agree with what the editors of the collection say or
with what Smith said or with what in the Dictionary entry on Smith
is said to be the meaning of the invisible hand (which comes within
interpretation 2) (Skinner 1987, 4:365).
2. An interpretation almost as common as the preceding but considerably refined is that the invisible hand is the price mechanism,
a force that brings all markets together into a state of grand harmony, or general equilibrium, and directs the economy in a way that
maximizes the wealth of the nation (Grampp 1948, p. 334; Gordon
1968, 8:548; Hahn 1982; Coase 1994, pp. 82–83).
Smith did say a buyer and a seller, each acting for himself and
himself alone, come together to exchange on terms that are satisfactory to both (Wealth of Nations, pp. 26–27). That implies an equilibrium condition of course. Whether or not it is a condition that maximizes wealth is another matter. It is if the buyer and seller exchange
on a competitive market and it is not if they restrict trade. So the
fact that self-interested behavior eventuates in a price mechanism is
not evidence that the behavior is in ‘‘the public interest,’’ which, in
the passage about the invisible hand (hundreds of pages away),
means an increase in the domestic wealth of the nation. Still, the
idea that voluntary transactions bring about mutually satisfactory results does imply markets can guide themselves. That implication is
made explicit in Smith’s explanation of how market prices adjust
themselves to natural (long-run equilibrium) prices. This, in turn,
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implies markets do not have to be controlled by government. That
implication is made explicit in Smith’s explanation of why laws
against forestalling and engrossing are either useless or mischievous
(pp. 74, 532–34).
However, these ideas about the price mechanism (none of which
Smith held in an unqualified form) have nothing to do with the
invisible hand. It is self-interest operating in the fortunate circumstance in which a merchant finds that keeping his capital at home
is profitable, the consequence of which is to increase the ability of
the nation to defend its people (including the merchant). That is
different from what directs markets. There each man knows that if
he is to get what he wants he must pay what is asked. He may not
be aware that he is participating in the optimal allocation of resources and distribution of output and that he is one among the
many who are doing their bit to demonstrate the First Fundamental Theorem of Welfare Economics: if all individuals and firms are
price takers, competitive equilibrium is Pareto optimal. The theorem is said to ‘‘trace back’’ to the invisible hand (Feldman 1987,
4:889). It does not but does trace to other of Smith’s ideas about
markets.
3. The Neo-Austrians interpret the invisible hand as a ‘‘metaphor’’
for ‘‘the principle by which a beneficial social order emerged as the
unintended consequence of individal human actions’’ (Vaughan
1987, 2:997). This resembles the preceding interpretation, the invisible hand as the price mechanism. But it is not altogether the same
if, in addition to offering a teleology of the market, it means the
invisible hand also explains how a social order can originate and
take form from the behavior of individuals acting independently of
each other and without any intention of creating a relationship
among themselves that is to the advantage of all of them.
How Smith’s conception of the economy resembles and how it
differs from that of Ludwig von Mises, Friedrich von Hayek, and
others of that school is an interesting question. Inquiry into it could
have the unexpected consequence of revealing that Smith was not
as loyal to the simple system of natural liberty as the Austrians are.
However that may be, the inquiry is not likely to reveal any connection between the invisible hand and the idea that the market comes
into being as the unintended and unexpected consequence of the
independent behavior of people. True, the invisible hand does have
a consequence that is unintended, but the consequence is not a beneficial social order. It is a benefit that, while important, is of a lesser
order. It is to contribute to the defense of the nation. It is nothing
so complex and so grand as the social order or the price mechanism
within it.
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447
The second and third interpretations come together in the new
theory of the firm. The result is an example of how a misunderstanding of the invisible hand can bring in its wake a misunderstanding of other ideas of Smith, in this instance his idea, or bundle
of ideas, about the market. A cardinal feature of the new theory is
that the market cannot do everything. If it could there would be no
firms. But there are firms. Smith, according to one statement of the
theory, did not recognize the division of authority between the firm
and the market and believed the market could do all (Williamson
1994). He did not, actually, as a reading of what he said about it
makes plain. Indeed, he did not believe the market could do as
much as the new theory of the firm says it can do.
4. Then there is the assertion, expressed clearly, forcefully, and
with total conviction, that the invisible hand is competition and as
such is a power for good because competition is good. It compels
people (coerces them, actually) to use their resources wisely, their
income sensibly, and, by so doing, to promote the public interest.
Of this, it is asserted, ‘‘there is absolutely no question’’ (Rosenberg
1979, p. 24).
Smith did not in fact say the invisible hand is competition. Neither
did he imply it. He did say competition is the friend of good management; he said monopoly is the foe of parsimony; and he said parsimony is the immediate cause of an increase of the capital stock
(Wealth of Nations, pp. 163–64, 612, 337). But he did not say these
things in the course of describing the invisible hand and he did not
say the invisible hand is present in all competitive markets or in all
conduct that is directed by self-interest. The invisible hand guides
a merchant only when circumstances induce him to keep his capital
at home. To be noticed as well is Smith’s belief that competition,
while it can do much, cannot do everything, cannot, for example,
provide for the defense of the nation. That he said ‘‘defense . . . is
of much more importance than opulence’’ there truly can be no
question (pp. 464–65).
5. There is the no-nonsense view, far down the conceptual and
linguistic ladder, that the invisible hand is simply the mutual advantage there is in exchange (Knight 1947, p. 377).
The view is understandable. Smith did say exchange yields a benefit to both buyers and sellers as did a number of writers before him,
Cicero among them (from whom Smith could have and may have
also gotten an idea or two about the benefits of the division of labor
and of material welfare) (Cicero 44 bc, ii, 3, 4; North 1691, p. 13;
Wealth of Nations, pp. 26–27). They did not attribute the benefit to
an invisible power. Nor did Smith. He attributed it to the wisdom
that is common to men. They know the butcher and the baker do
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not act out of benevolence when they provide the necessaries of life.
But the wisdom is not dispensed by an invisible hand and has no
place in Smith’s account of it.
6. A novel and recent view is that the invisible hand is not a beneficial force at all and that it did not have a favorable connotation
for Smith. The invisible hand may have been meant as a joke (Rothschild 1994).
The interpretation is unusual because it draws for support on the
three writings in which Smith used the words and because it claims
that what the term means in any one of them is consistent with what
it means in the others (the risible hand). The interpretation is certainly correct in saying the invisible hand has a pejorative connotation in the Essay on Astronomy. But that cannot be said about its meaning in the Theory of Moral Sentiments. There, even though it is
associated with behavior of which Smith disapproves, it meliorates
that behavior. Moreover, the two works are quite different from the
Wealth of Nations, as well as from each other, and there are no
grounds for imputing the meaning in either of them to that in the
Wealth of Nations, where it has a favorable connotation (along with
the self-interest in which it has its origin).
7. Another novel and recent interpretation is that the invisible
hand is the process by which men acquire the knowledge, skills, and
habits that guide them in buying and selling, the consequence being
that they maximize their wealth and presumably that of the nation
as well. This interpretation comes from evolutionary psychology
(Cosmides and Tooby 1994).
This view assigns a beneficial quality to the invisible hand, and
that of course is what Smith said it has. He also said that behavior
directed by self-interest could be efficient and in the public interest.
He said moreover that the division of labor, ‘‘from which so many
advantages are derived, evolved slowly as the consequence of the
propensity to truck, barter, and exchange’’ (Wealth of Nations, p. 25).
All of this is consistent with the interpretation. But Smith also said
the propensity might be a natural endowment or, more probably,
the product of the faculty of reasoning, and that implies it is not
behavior which undergoes evolutionary development.
What tells even more against this interpretation is that Smith nowhere says the invisible hand is the outcome of an evolutionary process; nor does he say anything from which such an interpretation
can be inferred. This is not to say there is no factual basis for the
statement that market skills evolve over time and as they do markets
become more efficient, resources are used more productively, and
income is spent more effectively. These things may be quite true.
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449
But they have nothing to do with the invisible hand of the Wealth of
Nations (or that of other of Smith’s writings).
8. At the upper reach of the conceptual scale there is the interpretation of the invisible hand as the prime mover, fons et origo, omniscient monitor, or final cause of economic and all behavior. The
four are not conceptually the same, of course, but are used here as
if they were and to mean the invisible hand is a beneficent power
beyond the will of man—a providential force that is a part of the
natural order (Viner 1927, p. 207; 1968, 14:324; Spiegel 1979; Evensky 1993).
The interpretation resembles, in some ways, what the invisible
hand actually is in the Theory of Moral Sentiments. To make it this in
the Wealth of Nations calls for a suspension of belief or for ignoring
what Jacob Viner called ‘‘a substantial measure of irreconcilable divergence’’ between the two books. In the Wealth of Nations the invisible hand leads to a beneficial outcome, as this interpretation quite
correctly states, but it does so only in particular circumstances. To
believe this means the invisible hand is a providential force calls for
assuming, first, that providence has made men self-interested (endowed perhaps with the propensity to truck and barter) and, second,
that self-interested behavior is always beneficial. If Smith believed
the first assumption when he wrote the Wealth of Nations, he kept it
to himself. That he did not make the second is clear from the account he gives of behavior—self-interested and other—that is not
in the public interest. The great difference between the invisible
hand of the Theory of Moral Sentiments and of the Wealth of Nations is
described in Section III.
9. The invisible hand is a force that contributes to the security of
the nation by retarding the export of capital. So runs this, the ninth
and the most interesting of the interpretations (Persky 1989). It is
so for these reasons: (i) It begins with the passage in the Wealth of
Nations in which Smith actually uses the words. (ii) It notices what
the invisible hand specifically does, which is to reduce the export of
capital. (iii) It relates the geographic allocation of wealth—between
what is held at home and what is held abroad—to the importance
Smith placed on domestic employment and output, a matter of considerable consequence as explained in Section II of this paper. (iv)
It notices that what Smith said about the invisible hand was meant
to answer an anticipated objection to free trade. (v) Finally, because
one is grateful for small gifts as well as large, it calls the invisible
hand a simile (which Webster and Fowler give us reason to think it
could be) instead of calling it a metaphor as others have done so
often as to make one sigh and sink.
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Yet for all of its merit, the interpretation is incomplete. It does
not explain the ‘‘security’’ the invisible hand provides. Is the capital
it keeps at home more advantageous to the nation than capital that
is exported because more capital at home means more employment
at home? Smith says that. But what does this signify: that domestic
employment is the objective of policy and that other objectives are
subordinate to it? Hardly, since Smith’s statement is made in a chapter that advocates free trade. What then did he mean by ‘‘security’’?
The plausible answer, as argued below, is that capital at home, being
safer than capital abroad, is a resource on which the nation can draw
for its defense.
In sum, the invisible hand has been interpreted to mean: (1) the
force that makes the interest of one the interest of others, (2) the
price mechanism, (3) a figure for the idea of unintended consequences, (4) competition, (5) the mutual advantage in exchange,
(6) a joke, (7) an evolutionary process, (8) providence, and (9) the
force that restrains the export of capital.
II
Consider now what Smith himself said about it—his ‘‘interpretation.’’ Consider the passage in the Wealth of Nations in which he expressly wrote about the invisible hand and consider also the relation
of what he said there to what in other passages he said about the
wealth of the nation, about defense, and about the way self-interest
affects the two.
There is only one reference to the invisible hand in the Wealth of
Nations. It is in chapter ii (‘‘Of Restraints upon the Importation from
Foreign Countries of Such Goods as Can Be Produced at Home’’)
of book IV (‘‘Of Systems of Political Oeconomy’’). The setting of
the invisible hand, the circumstance in which it is present, is the
fortuitous and fortunate consistency there can be, but not always is,
between the particular interest of one person and the quite different
but compatible interest of everyone. A merchant makes a transaction
that increases his wealth, that being in his interest obviously, and
the transaction does not reduce the wealth of others, but in all likelihood increases it, that being in their interest. He keeps his additional
capital at home, and that is in the interest of everyone including the
merchant himself. The reason why that is in the interest of everyone
is that domestic wealth is a resource on which the nation can draw
to defend itself. The fact that the merchant in serving himself in
one way serves everyone, including himself, in another way is something he had no intention of doing and was not aware of doing.
In the language of today’s economics, defense is a public good
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451
and depends, in part, on the stock of domestic capital. There are
certain transactions that increase that stock. The increase is a positive externality which the transactions yield, and it contributes to
the actual or potential quantity of the public good. The people who
engage in such transactions do not intend to contribute to defense
and do not know they do. Nevertheless they do. Their conduct shows
that what is good for one person in one way can be good for everyone
in another way. The invisible hand then is self-interest operating in
this circumstance, the circumstance in which a private transaction
yields a positive externality that augments a public good.
This interpretation incorporates four ideas of Smith: (1) Defense
is an objective of economic policy, which means that a measure of
policy must not be judged by its effect on wealth alone. (2) Wealth
is one of the resources on which the nation draws in order to defend
itself (its men, their skills, and their martial spirit being the others),
and the amount of its wealth that is held domestically is more secure,
hence is more important for defense, than the wealth that is held
abroad. (3) The acquisitive behavior of individuals may contribute
to defense if that behavior is competitive and only if it is. (4) People
who engage in acquisitive and competitive behavior do not intend
to benefit everyone, nor do they know they do.
The evidence that Smith held these ideas and an explanation of
them follow.
1. That he believed defense should be an objective of economic
policy he made clear when he said the government should encourage—by protective duties, regulation, and possibly by bounties and
premiums—the manufacture of goods needed for defense such as
gunpowder and sailcloth. He also made the point clear when he said
the government should increase the size of the merchant marine by
protective duties and other measures that reduce the competition
of foreign shipping. He made himself as clear as possible when he
justified the Navigation Acts. He acknowledged they reduced efficiency, hence made the national wealth less than it otherwise would
be, yet (he said) they were among the wisest measures of policy ever
enacted because ‘‘defense . . . is of much more importance than
opulence.’’ He said this in the chapter that describes the invisible
hand (Wealth of Nations, pp. 463, 523, 464–65).
2. That defense depends on the wealth of the nation Smith implied when he said that ‘‘the great expense of fire arms gives an
evident advantage to the nation which can best afford that expense’’
(p. 708). This is said in chapter 1 of book V, which is about the three
major functions of government: defense, justice, and public works
(the first of which is described at greater length than the others).
The description, there and elsewhere, reveals his considerable
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knowledge of military history, together with his keen interest in military affairs, military men, and the martial spirit—an interest, one
gathers from the recent biography, although it does not expressly
say so, that made him behave like a field marshal manqué and a man
with a bee in his bonnet about the martial spirit (Ross 1995, pp.
316–17). His particular worry, or one of them, was that the lower
orders were lacking in it; another was that the middling orders did
not have as much as they should. He advocated that both be trained,
each in its own way, so that each would acquire the courage and
spirit that are appropriate to a man (Wealth of Nations, pp. 787–88).
A piece of drollery about this side of Smith is the comment he made
on the subsidy given to the theater of ancient Greece. He disparaged
it, not because it supported an activity that should support itself, but
because it paid men more to attend the theater than to serve in the
army.
In his account of the invisible hand Smith emphasized the domestic as distinct from the total stock of wealth and did so because he
believed defense depended mainly on the domestic stock. Yet free
trade, the impartial reader would (correctly) suppose, implies the
free movement of capital and the export of some of it. The danger
of capital’s being exported (if it is a danger) is unfounded, he says.
The invisible hand keeps it at home. That is the beneficial end it
promotes and is the only end he explicitly names. What the others
are, if there are others, is not stated. He said the individual who uses
his capital in domestic, competitive trade rather than in foreign
trade and uses it in the most profitable way ‘‘is in this, as in many
other cases, led by an invisible hand to promote an end which was
no part of his intention’’ (p. 456).
Does the word ‘‘cases’’ mean there are transactions, other than
placing capital in competitive domestic trade, that add to domestic
wealth and to defense? Or does ‘‘cases’’ mean that transactions that
place capital in domestic trade contribute to something other than
defense, for example, to what he calls elsewhere the ‘‘greatness’’ of
the nation? Or does the word have all three meanings?
Smith, in his observation about firearms, made no distinction between wealth held at home and wealth held abroad. One would suppose that British assets held in foreign countries could be of military
value to Britain. They could in fact have that value, Smith said elsewhere in a passage that disparaged the mercantilists and their belief
that a favorable balance of trade has military value because it induces
an inflow of specie that can be used in time of war. Wrong, Smith
said. If specie is needed for military purposes it can be obtained by
an export surplus. That of course is what a favorable balance of trade
is and is just what the mercantilists meant. The inconsistency is one
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453
of several mistakes Smith made in writing about the mercantilists;
the largest and probably the least recognized was to say they believed
money was wealth (pp. 440–41).
As Smith called particular attention to the domestic portion of
the wealth of the nation, so he did to the domestic portion of employment, industry, and trade, each of which is related to defense.
Why the domestic portions were important he explained or indicated in several ways. Capital that is kept at home is more secure
than capital that is sent abroad and held there. He did not say, but
one reasonably may infer, that domestic capital is more ‘‘secure’’ in
the sense that it can more surely be called on to support defense
than can capital held abroad. He expressly said domestic ‘‘industry
. . . necessary for the defense of the country’’ should be ‘‘encouraged.’’ The most secure of all capital is land, he said. It is unlike the
capital of a merchant which can be moved from place to place and
sent abroad as he wishes. Domestic trade is superior to foreign because domestic trade gives twice the encouragement to industry that
foreign trade gives and also receives its returns more quickly (pp.
463, 377–78, 426, 368). That employment itself is important is selfevident since it, along with the capital stock, determines the wealth
of the nation. Why Smith made domestic employment the center of
his attention must be left to inference. Mine is simply that the men
of Britain who are working in Britain could with less difficulty be
called on to defend it than the British who lived abroad (as the
American Revolution demonstrated).
3. That the acquisitive behavior of men adds to the national wealth
only when they act competitively is implied by Smith in his statement
(again in the chapter that refers to the invisible hand) that what
adds to the capital of one person or one trade does not add to the
capital of the nation if the market in which capital increases is a
market that is protected from foreign competition (p. 453).
4. That a man who accumulates capital may, without knowing or
intending to, act in ‘‘the public interest’’ (for which one may read
‘‘defense’’) is an idea Smith adumbrates at the beginning of the
celebrated chapter and brings into full light a few pages on, where
he writes of the man, his capital, and the invisible hand:
But the annual revenue of every society is always precisely
equal to the exchangeable value of the whole annual produce of its industry, or rather is precisely the same thing
with that exchangeable value. As every individual, therefore, endeavors as much as he can both to employ his capital in the support of domestick industry and so to direct
that industry that its produce may be of the greatest value;
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every individual necessarily labors to render the annual revenue of the society as great as he can. He generally, indeed,
neither intends to promote the publick interest, nor knows
how much he is promoting it. By preferring the support of
domestick to that of foreign industry, he 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. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest
he frequently promotes that of the society more effectually
than when he really intends to promote it. I have never
known much good done by those who affected to trade for
the publick good. It is an affectation, indeed, not very common among merchants, and very few words need be employed in dissuading them from it. [P. 456]
At this point the thoughtful reader may demur and wonder if what
Smith said about the invisible hand can reasonably be interpreted
to mean it promotes defense. He does not use the word defense;
what he expressly says is that the invisible hand increases domestic
capital.
The question is asked by an anonymous and learned referee of
this paper who says an argument can be made that the invisible hand
is primarily about the accumulation of domestic capital, not about
defense, although (he continues) what is favorable to domestic capital would also, in Smith’s view, be favorable to defense. Consistent
with this argument, as the referee properly observes, is that Smith,
a paragraph or two before he referred to the invisible hand, summarized what he had explained at length in his chapter on capital,
namely that domestic trade, because it adds more to domestic capital
and employment, is superior to foreign trade.
However, there is more. Smith, in the earlier paragraph, did not
attribute the increase in domestic capital and employment to the
invisible hand but to simple self-interest, unguided and unassisted.
The decision of a man to keep his capital at home rather than
abroad has economic consequences with which the man could not
be unaware. He knows he will employ more workers at home than
he would if he sent his capital abroad and he knows that more will
be produced at home because his capital is there. What he does not
know, according to Smith, is that by doing what he does he may add
to the nation’s power.
In the chapter on capital, Smith said ‘‘the riches, and so far as
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power depends on riches, the power of every country, must be in
proportion to its annual produce.’’ He continues: ‘‘the great object
of the political oeconomy of every country, is to encrease the riches
and the power of that country.’’ He did not say that power depends
only on the riches that a country keeps at home, but he did clearly
imply that riches at home were a more secure source of power than
riches held abroad (p. 426).
The riches of the nation, then, are the product of self-conscious,
self-interested effort. The power of the nation, including its military
power, is a consequence, unintended but fortunate, of this effort
and is the work of the invisible hand.
That is not all. The chapter on capital is polemical and argues
against the fostering of exports by subsidies or other means. No need
to, Smith said. Merchants will engage in foreign trade when it is
more profitable than domestic trade, and the latter (he is at pains
to show) has its advantages. They are so considerable that the reader
might wonder whether domestic trade should be fostered. That
would be a perverse conclusion to draw from the discourse of a free
trader. The merchant, when in competition with others, will place
his capital where it adds most to the nation’s wealth, and he does
not have to be told where that is. He will keep it at home as long
as it is as profitable as it would be abroad. At hom...