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Adam Smith (1723-1790), considered by many to be the father of modern political economics, is most famously know for his theory on how economies are influenced by the “invisible hand” of the market. According to Smith’s theory, free markets are capable of naturally regulating themselves as market participants (consumers and businesses) maximize their own self interests as they compete for scarce resources.
Maximizing Self Interest
“It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.” ~Adam Smith
This notion is an important part of the invisible hand theory. According to Adam Smith, consumers and business who act out of self interest are actually doing what is best for the economy. How is this possible? Think about it this way. Acme Corporation is in business to make a profit. In order to maximize their own self interest, they must sell more widgets than their competitors. To do this, their widgets must provide the best value to their customers. Mr. Jones is a consumer who is looking to buy a widget. It is in his self interest to find a widget that provides the best value for his family. In the end, both Acme Corporation and Mr. Jones have helped each other by doing what is best for themselves. Acme Corporation helped Mr. Jones acquire a great widget at a great price. Mr. Jones helped Acme Corporation make a profit.
Weeding out Weak Companies
We live in a world of “too big to fail”, stimulus packages, and bailouts. But is this all really necessary? According to Adam Smith’s invisible hand theory, a struggling economy is capable of correcting itself. When a weak company fails or dissolves, it leaves room for a new company or existing strong company to expand and fill the void. Let’s take the General Motors bailout for example. If the US government allowed GM to fail, consumers would still continue to buy cars. If they couldn’t buy them from GM, they could purchase them from other stronger car manufacturers. With increased sales, the other car manufacturers would need to expand by hiring more workers or build additional plants to fulfill the increase in orders.
“I have never known much good done by those who affected to trade for the public good.” ~Adam Smith
Adam Smith believed that interference by outside forces such as federal regulation can hinder and even damage an economy’s ability to thrive. According to the invisible hand theory, an economy is capable of functioning properly on its own without intervention from an outside force. In every market interaction, there are always two or more individuals, companies, or entities competing for scarce resources such as raw materials, customers, and other resources. The problem is that when the government makes a move to stimulate a struggling portion of the economy it artificially boosts the performance of one while damaging the opportunities of another. Going back to the example of the General Motors bailout, GM was struggling due to poor management and weak product lines. However, this gave GM a strong foundation to withstand the crumbling economy while other car manufacturers were left to fend for themselves.
Opposition to the Invisible Hand
“The reason that the invisible hand often seems invisible is that it is often not there” ~Joseph E. Stiglitz~
There are many critics that oppose parts or the entirety of Smith’s theory. Simply taking into account the US governments aggressive role in current economic downturn is evidence of such. Some argue that individuals and corporations working only toward self interest cause corruption and greed which damages the natural flow of markets. Some economist dismiss Smith’s theory stating that the economic principle is outdated and only valid in simple economies such as those seen during 18th century in America. While others support the invisible hand theory but support the use of the federal government as a governing body and life support system during economic recessions.
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