In his book, Smith, the father of modern economics and the great guru of the free market concept, argued that although an individual entrepreneur always acts in pursuit of his or her personal interest, reaching for personal gain also ends up working in the interest of the whole community. Smith characterized the phenomena as the “invisible hand,” an unintended consequence.
Since his first elucidation, the invisible hand has been a guiding principle for the free market economy all over the world for more than two centuries.
While most economists accept the basic premises of Smith’s argument of an intervention-free environment for business to operate, they disagree on the degree of freedom businesses must have in order to be profitable and to have enough incentive to be in business. Also, many profoundly disagree over how Smith’s invisible hand theory, which is rooted in individual entrepreneurship, has been stretched to include the Mega Corporation.
Those who argue for sensible regulations believe that Smith, a philosopher by education, knew too well that greed is a double-edged sword. Whereas it may be a reason for an enterprising tenor, it can also become an impediment to the greater good of the society if left unfettered.
Therefore, businesses must be regulated to protect the greater societal interest without destroying the entrepreneurial spirit. Hence, while Smith supported a relatively intervention-free business environment, he was by no mean arguing against all regulation.
Furthermore, Smith couldn’t have generously expanded the invisible hand idea from individual person to corporations because the concept of a corporation was only in its infancy in 1776.
The fact of the matter is that, unlike corporate executives, individual entrepreneurs risk their own personal wealth and put their own necks on the line for their businesses. Second, the whole purpose of a corporation is to shield the stockholders (the business owners) from liability. Therefore, the corporations don’t offer a similar “unintended positive consequence” for the society, as individual businesses do.
To get in the mind of Adam Smith, one must understand 18th-century England and the backdrop under which Smith penned his philosophy.
At that time in England, businesses were dominated by hundreds of slaughterhouses, bakeries, shops, banks and trading houses of similar size and strength. Even those businesses advanced by the agricultural and industrial revolutions, such as textile factories and mills, were mostly local and had a similar competitive edge against each other.
Almost all neighborhood shops of Smith’s world, which inspired him to develop his economic commandments, have been long replaced by a few faceless corporate conglomerates with factories in China and Mexico. The ownership of the business, the real focus behind Smith’s invisible hand argument, is as relevant today as derivatives and credit swaps were in 1876.
These ruthless modern day conglomerates tout a regulation-free business environment for the personal benefit of their officers, but not necessarily for the long-term interest of the true owners (the stockholders) of the company. While they are quick to claim success and reap reward, they are often long gone from the company when it fails.
In another words, for corporate executives, heads they win and tails someone else looses.
Fannie Mae, Freddie Mac, Lehman Brothers, Goldman Sachs, AIG, Citibank and the GM and Chrysler automobile companies are only few of the hundreds of recent examples of such a win-lose story.
Smith couldn’t have envisioned the world that we live in today, which is much more complex and globally interdependent, as businesses operate in different countries with variable sets of rules. The cost to support labor laws, environmental policies and standard of living is different in each country, resulting in a different cumulative cost to each society.
Subsequently, it’s simply imprudent to believe that a completely regulation-free environment in one country can produce an intended outcome — the long-term success of the business enterprise.
If anything is to be learned from the current global economic crisis triggered by American bank failures, it is that despite regulation, no country can protect the larger interest of its people all the time.
It’s not the number of regulations that can protect both the interest of the business as well as that of the people. Only a timely, proactive improvement of the system will help prevent the total collapse of the system or at least minimize the effect of the systemic failure from the next economic meltdown.
• Roger Adhikari is a Tracy resident who is a finance and management consultant in Silicon Valley.