THE IMMORTAL ADAM SMITH, PART 5

In my previous post in this series, we saw that Adam Smith’s famous “invisible hand” mechanism in the economic arena will work only if two key conditions are met:

• Condition #1: Owners of capital prefer local markets over more distant ones.

• Condition #2: Owners of capital extract the most value from their capital.

But do either of these two conditions hold in the real world? More specifically, how can we say with any degree of confidence that the owners of capital will, in fact, extract the most value from their capital? As it happens, Adam Smith responds to this key question in the tenth, eleventh, and twelfth paragraphs of Book IV, Chapter 2 of The Wealth of Nations. For Smith, the reason why both conditions above are true is local knowledge:

“What is the species of domestic industry which his capital can employ, and of which the produce is likely to be of the greatest value, every individual, it is evident, can, in his local situation, judge much better than any statesman or lawgiver can do for him.” (WN, IV.ii.10, emphasis added)

In addition, the Scottish philosopher-economist draws from this descriptive observation about local knowledge a normative claim about the outer limits of government power — or what I like to call “Adam Smith’s dire warning”:

“The statesman who should attempt to direct private people in what manner they ought to employ their capitals would not only load himself with a most unnecessary attention, but [would also] assume an authority which could safely be trusted, not only to no single person, but to no council or senate whatever, and which would nowhere be so dangerous as in the hands of a man who had folly and presumption enough to fancy himself fit to exercise it.” (ibid., emphasis added)

In contemporary terms, Adam Smith is making two additional sub-claims in the above passage. One is that people are better judges of their own private interests than the government is. The other is that it is downright “dangerous” — Smith’s word, not mine — when politicians try to tell us what economic activities we can engage in. Wait; what?!? “Dangerous”?!? Why? Stay tuned: I will address this key question in my next post …