The Betrayal Of Adam Smith

I’ve been thinking about writing something in the wake of Don Arthur’s Nanny and the Libertarians post, but until now I haven’t had the heart.  Discussion threads on posts dealing with such issues always seem instantly to degenerate into a slanging match between, on the one hand, extreme libertarians who think that the magical incantation “markets” is a slam dunk answer to any criticism and that markets always deliver freedom of choice for workers and consumers even when they patently don’t, and on the other hand more left-leaning readers with touching faith in the ability of governments to solve all problems by regulation and who have learned mainstream economic jargon only far enough to label as “market failure” any outcome they personally dislike.

I have little doubt this thread will result in exactly the same frustrating conversation.  The only reason I concluded it was worth venturing onto the topic is that I’ve found a writer who expresses my own thoughts much better than I ever could.  Following is an extract from retired Harvard economics professor David Korten’s 1995 book When Corporations Rule the World.

I should stress at the outset that I disagree strongly with Korten’s extremely negative apocalyptic view of corporate capitalism and globalisation, in that he ignores its extraordinary positive potential for delivering a prosperous future for all especially currently poor countries. Had the Chinese listened naively to Korten’s central message way back in the early 1990s they would never have experienced the explosive growth and delivery of hundreds of millions from extreme poverty that have subsequently occurred. It clearly is possible to restrain the excesses of global corporate capitalism while benefiting from its productive potential, through effective international co-operative regulation.  At least it’s possible as long as we don’t fall for the self-interested spin of the corporate shills who try to convince us that just about any regulation is both illegitimate and destructive. Of course, China itself is, to put it neutrally, a work in progress in these repects.

Nevertheless Korten’s demolition of the more simplistic nostrums of what he calls “corporate libertarianism” is persuasive in my view and worth reproducing here. Korten defines “corporate libertarianism” like this:

In the name of individual freedom, this alliance ¹ advances a doctrine that places the rights and freedoms of corporations ahead of the rights and freedoms of individuals acting through governments to hold corporations accountable to the public good. Their ideological doctrine is perhaps most accurately described as corporate libertarianism, because its consequence is to increase the freedom of corporations at the expense of human freedom. Presented as an economic agenda, it is in truth a governance agenda that systematically transfers power from people and governments to the persona of the corporation and those whose interests align with corporate power.

An extensive extract from a chapter of Korten’s book dealing with the issues that arose in the discussion thread on Don’s post is reproduced below (with a couple of side-notes from me – I think Korten’s views are extreme in some respects but interesting just the same):

Proponents of corporate libertarianism regularly pay homage to Adam Smith as their intellectual patron saint. His writing remains to this day the intellectual foundation of policies advanced in the name of market freedom that are allowing a few hundred corporations to consolidate their control over markets all over the world. See An Economic System Dangerously Out of Control.

Ironically, Smith’s epic work The Wealth of Nations, which was first published in 1776, presents a radical condemnation of business monopolies sustained and protected by the state. Adam Smith’s ideal was a market comprised solely of small buyers and sellers. He showed how the workings of such a market would tend toward a price that provides a fair return to land, labor, and capital, produce a satisfactory outcome for both buyers and sellers, and result in an optimal outcome for society in terms of the allocation of its resources. He made clear, however, that this outcome can result only when no buyer or seller is sufficiently large to influence the market price—a point many who invoke his name prefer not to mention. Such a market implicitly assumes a significant degree of equality in the distribution of economic power—another widely neglected point.

Indeed, Smith was almost fanatical in his opposition to any kind of monopoly power, which he defined as the power of a seller to maintain a price for an indefinite time above its natural price. Indeed, he asserted that trade secrets confer a monopoly advantage and are contrary to the principles of a free market. He would surely have strongly opposed current efforts by market libertarians to strengthen corporate monopoly control of intellectual property rights through the General Agreement on Tariffs and Trade (GATT). The idea that a major corporation might have exclusive control over a lifesaving drug or device and thereby be able to charge whatever the market will bear would have been anathema to him.

Furthermore, Smith did not advocate a market system based on unrestrained greed. He was talking about small farmers and artisans trying to get the best price for their products to provide for themselves and their families. That is self-interest—but it is not greed. Greed is a high paid corporate executive firing 10,000 employees and then rewarding himself with a multimillion dollar bonus for having saved the company so much money. Greed is what the economic system being constructed by the corporate libertarians encourages and rewards.

Smith had a strong dislike for both governments and corporations. He viewed government primarily as instruments for extracting taxes to subsidize elites and for intervening in the market to protect monopoly. In his words, “Civil government, so far as it is instituted for the security of property, is in reality instituted for the defence of the rich against the poor, or of those who have some property against those who have none at all.” Smith made no mention of government intervention to set and enforce minimum social, health, worker safety, and environmental standards in the common interest—to protect the poor against the rich. We can imagine that given the experience of his day the possibility never occurred to him.

The theory of market economics, as contrasted to free market ideology, specifies a number of basic conditions needed for a market to set prices efficiently in the public interest. The greater the violation of these conditions, the less efficient the market system. Most basic is the condition that markets must be competitive. I recall the professor in my elementary economics course using the example of a market comprised of small wheat farmers selling to small grain millers to illustrate the idea of perfect market competition. Today, four companies—Conagra, ADM Milling, Cargill, and Pillsbury—mill nearly 60 percent of all flour produced in the United States, and two of them—Conagra and Cargill—control 50 percent of grain exports.

In the real world of unregulated markets, successful players get larger and in many instances use the resulting economic power to drive or buy out weaker players to gain control of ever larger shares of the market. In other instances “competitors” collude through cartels or strategic alliances to increase profits by setting market prices above the level of optimal efficiency. The larger individual and more collusive market players become, the more difficult it is for newcomers and small independent firms to survive, the more monopolistic and less competitive the market becomes, and the more political power the biggest firms wield behind demands for concessions from governments that allow them to externalize ever more of their costs to the community.

Given this reality, one might expect the economic rationalists to be outspoken in arguing for the need to restrict mergers and acquisitions and break up monopolistic firms to restore the conditions of a competitive market. More often they argue exactly the opposite position—that to “compete” in today’s global markets firms must merge into ever larger combinations. In other words, they espouse a theory that assumes small firms and advocate policies that strengthen monopoly.

Another basic condition of efficient market allocation is that the full costs of production must be born by the producer and be included in the producer’s selling price. Economists call it cost internalization. This condition is so basic to market theory that it is rarely disputed even by the most doctrinaire of free market ideologues. If some portion of the cost of producing a product are borne by third parties who in no way participate in or benefit from the transaction, then economists say the costs have been externalized and the price of the product is distorted accordingly. Another way of putting it is that every externalized cost involves privatizing a gain and socializing its associated costs onto the community.

Externalized costs don’t go away—they are simply ignored by those who benefit from making the decisions that result in others incurring them. For example, when a forest products corporation obtains rights to clear-cut Forest Service land at give away prices and leaves behind a devastated habitat, the company reaps the immediate profit and the society bears the long term cost. When logging companies are contracted by the Mitsubishi Corporation to cut the forests of the Penan tribes people of Sarawak the corporation bears no cost for devastating native culture and ways of life.

Similarly, Dow Chemical externalizes production costs when it dumps wastes without adequate treatment, thus passing the resulting costs of air, water and soil pollution onto the community in the form of additional health costs, discomfort, lost working days, a need to buy bottled water, and the cost of cleaning up what has been contaminated. Walmart externalizes costs when it buys from Chinese contractors who pay their workers too little to maintain their basic physical and mental health or fail to maintain adequate worker safety standards and then dismiss without compensation those workers who are injured.((However you can’t take this argument too far. The Ricardian comparative advantage poorer countries enjoy includes lower wage and related costs. While it is undoubtedly immoral for major corporations to take their operations to places where workers are paid below subsistence wages to work in extreme dangerous conditions, it’s equally immoral to deny poor countries the opportunity to utilise their comparative advantages to pull themselves out of poverty. If corporations were only permitted to invest in places that paid first world wages and offered first world conditions then poor nations would forever remain poor.  Some degree of trade-off and compromise is unavoidable, a proposition Korten’s moral absolutism simply ignores. ~KP))

When the seller retains the benefit of the externalized cost, this represents an unearned profit—an important source of market inefficiency. Passing the benefit to the buyer in the form of a lower price creates still another source of inefficiency by encouraging forms of consumption that use finite resources inefficiently. For example, the more the environmental and social costs of producing and driving an automobile are externalized, the more automobiles people buy and the more they drive them. Urban sprawl increases, more of our productive lands are paved over, more pollutants are released, petroleum reserves are depleted more rapidly, and voters favor highway construction over public transportation, sidewalks, and bicycle paths.

Yet rather than demanding that costs be fully internalized, the corporate libertarians are active advocates of eliminating government regulation, pointing to potential cost savings for consumers and ignoring the social and environmental consequences. Similarly they advise localities in need of employment that they must become more internationally competitive in attracting investors by offering them more favorable conditions, i.e., more opportunities to externalize their costs through various subsidies, low cost labor, lax environmental regulations, and tax breaks.

Market forces create substantial pressure on business to decrease costs and increase profits by increasing efficiency. The corporate rationalists fail to mention that one way firms increase their “efficiency” is to externalize more of their costs. The more powerful the firm, the greater its ability to take this course. As ecological economist Neva Goodwin has observed, “…power is largely what externalities are about. What’s the point of having power, if you can’t use it to externalize your costs—to make them fall on someone else?” When corporate libertarians promote practices that allow corporations and wealthy investors to socialize their costs and privatize their gains, they reveal their fidelity to a political interest rather than to economic principles.

A third condition basic to the market theories of Adam Smith, but rarely noted by corporate libertarians—is that capital is locally or nationally rooted and its owners are directly involved in its management. Adam Smith made quite explicit in The Wealth of Nations his assumption that capital would be rooted in place in the locality where its owner lived. He made it clear that this condition is critical to enabling the invisible hand of the market to translate the pursuit of self-interest into optimal public benefit. Indeed, the following is the only sentence in the entire text in he made reference to the invisible hand.

By preferring the support of domestic 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.

 The circumstance that Adam Smith believed induced the individual to invest locally, was the inability to supervise his capital when employed far from his home. In the current age of instant communications by phone, fax, and computer, and twenty-four hour air travel to anywhere in the world that circumstance no longer endures. However, the advantage to the community and the larger society of productive investment being locally owned remains. Local investment is more likely to remain in place and is more easily held to local standards.((I should stress that I strongly disagree with Korten’s simplistic condemnation of global capital markets, although the  still unfolding consequences of the GFC starkly indicate that they do require effective local and international regulation which is clearly by no means easy to achieve (Australia seems to have done better than most). Alan Kohler’s article Too Fat to Fail a couple of days ago is interesting in this regard, although Kohler evinces an extraordinary faith in “markets” to manage optimally a major shrinkage in the reach and size of global banking. ~ KP))

Smith was also quite explicit that optimal market efficiency depends on the owners of capital being directly involved in its management—the owner managed enterprise. One could also argue that implicitly he favored worker owned enterprises, as in his ideal small firm owner, manager, and worker were one and the same person.

Thus Smith’s vision of an efficient market was one comprised of small, owner-managed enterprises located in the communities in which the owners reside, share in the community’s values, and have a personal stake in its future. It is a market that bears little in common with a globalized economy dominated by massive corporations without local or national allegiance managed by transient professionals who are removed from real owners by layers of investment institutions and holding companies.

Economist Neva Goodwin, who heads the Global Development and Environment Institute at Tufts University suggests that the neoclassical school of economics, with which many of the most vocal proponents of corporate libertarianism are identified, may be roughly characterized as the political economy of Adam Smith minus the political analysis of Karl Marx.

The classical political economy of Adam Smith was a much broader, more humane subject than the economics that is taught in universities today. . . . For at least a century it has been virtually taboo to talk about economic power in the capitalist context; that was a communist (Marxist) idea. The concept of class was similarly banned from discussion.

Adam Smith was as acutely aware of issues of power and class as he was of the dynamics of competitive markets. However, the neoclassical economists and the neomarxist economists bifurcated his holistic perspective on the political economy, one taking those portions of the analysis that favored the owners of property and the other those that favored those who sell their labor. Thus, the neoclassical economists left out Smith’s considerations of the destructive role of power and class. And the neomarxists left out the beneficial functions of the market. Both advanced social experiments embodying a partial vision of society on a massive scale and with disastrous consequence.

In Praise of Competitive Markets

When the necessary conditions are met the market is a powerful and efficient mechanisms for allocating resources. What we now have is not a market economy. It is increasingly a command economy centrally planned and managed by the world’s largest corporations to maximize financial returns to top managers and the wealthiest shareholders at the expense of the rest of society. If the corporate libertarians were to bear serious allegiance to market principles and human rights, they would be calling for policies aimed at achieving the conditions in which markets function in a democratic fashion in the public interest. They would be calling for measures to end subsidies and preferential treatment for large corporations, to break up corporate monopolies, encourage the distribution of property ownership, internalize social and environmental costs, root capital in place, secure the rights of workers to the just fruits of their labor, and limit opportunities to obtain extravagant individual incomes far greater than their productive contribution.

Corporate libertarianism is not about creating the market conditions that market theory argues will result in optimizing the public interest. It is not about the public interest at all. It is about defending and institutionalizing the right of the economically powerful to do best serves their immediate interests without public accountability for the consequences. It places power in institutions that are blind to issues of equity and environmental balance.

1. of economic rationalists, market liberals and members of the corporate class[↩]