Government Intervention and the Invisible Hand

The “Invisible Hand” is a concept coined by Adam Smith that is used to define any force – be it social, political, or economic – that brings an unbalanced market back to equilibrium, the point in which the price-to-quantity ratio in any producer-consumer transaction is equitable for both parties. This concept of the invisible hand implies that the economy is self-regulating. Some economists use these inferences as supporting evidence for their argument in favor of a laissez-faire economy. In this type of economy, government intervention would be regarded as unnecessary and detrimental because, as the invisible hand theory suggests, when everyone in a society pursues individual interests, the public good is consequently promoted in a way that is even more effective than if individuals’ initial and primary intent were to procure social wellbeing. However, there is a constraint as to how much power the invisible hand has in equilibrating the economy, whether it is in regards to timeliness, scope of reach, or the extent to which societal wellbeing is increased relative to individual welfare. Therefore, government regulation is necessary to optimize the effect of the invisible hand in regards to some of these facets.

One contingency that is consequential to depending on the invisible hand alone (i.e.: without government regulation) is that the benefit conceded to the public good is not always sufficient. In the case of Wal-Mart’s recent announcement to raise the wages of its employees, this decision, albeit beneficial when compared to the existing standard, is not one that will allow workers to be economically self-sustaining. Wal-Mart’s primary purpose in increasing their minimum wage to at least $9 an hour is to pursue self-interest, specifically to make itself a more worthy competitor in its contest against rivals such as Ikea or Costco, which have provided fairer wages to its employees for years. Wal-Mart has constantly been under fire for not providing decent wages to its workers, many of whom who must depend on government aid such as food stamps and Medicaid to live. Several articles and headlines focusing on Wal-Mart’s recent decision frame the change in such a way that the media over-appraises the company and such that people perceive this change as an act of altruism, when it is more comparably a reparation or a change that should have been enacted long ago. Overdependence on the invisible hand dissuades people from actively petitioning for desired economic reform. Moreover, if Wal-Mart’s employees were to truly benefit from the rise in wages, other amendments would have to be made to the system of labor in place there. Employees at Wal-Mart have admitted that they would not gain much from a rise in wage simply because they are not assigned enough hours of work. Government regulation could have worked in conjunction with the invisible hand and optimized societal benefit by ensuring that Wal-Mart raise its minimum wage sooner and establish a minimum (in addition with the already existing maximum) number of hours that part-time and full-time employees can work.

In contemporary society, time is money. That is why people suffer while the economy is in this transitory period of time in which the invisible hand is shifting it towards a state of equilibrium. Government intervention is the ideal solution at moments such as these because it can work alongside businesses to ameliorate the hardships of underprivileged individuals while the economy fixes itself. Furthermore, the government can call out businesses that abuse time for their own profit. This comment is made with the Ford Pinto scandal in mind. In this incident, the faulty Ford Pinto model was being produced and purchased for nearly four years before lawsuits were filed and the model was recalled. Unfortunately, numerous people were hurt or killed before then due to the design of the car, which although cheap, made the vehicle more susceptible to rear-end-collision engine fires. Despite being made aware of the fault prior to the sales distribution of the car, Ford conducted a cost-benefit analysis from which they used results to claim that producing the defected car and paying for the lawsuits would prove less of a financial burden than paying an additional $11 per car to correct the design flaw. This cost-benefit analysis is an unreliable executive tool for various reasons. First, it is wrong because the optimization of behavior through cost-benefit analysis cannot always be guaranteed given the constraint to Ford’s access to information. Ford will only collect information until the perceived costs of obtaining additional information surpass the perceived benefits and even then, this amount of information may not be enough to make a proper analysis. Second, the cost-benefit analysis is unreliable because it is unethical and goes against the pursuit of social good. One could claim that in this specific incident, the invisible hand did not bring this microcosmic economy back to equilibrium because the plaintiffs (i.e.: the victims of the car accidents or their families) received monetary compensation. The opposing argument exists, however, that equilibrium cannot be achieved in instances such as these because a dollar value can never be accurately placed on a human life. Government intervention is helpful in instances such as these because it can guarantee the incorporation of altruistic intent in businesses policies when there would have only been self-serving motives otherwise.

The final reason for which government regulation is necessary in the economy is that the concept of the invisible hand is based on the assumption that every decision a person makes is rational. Given that individuals are influenced not only by reason, but also by emotions and their surroundings, it is fair to question the efficacy of the invisible hand. There can be instances in which actions that are fueled by self-interest may not amount to societal benefit, but instead result in greed. Under circumstances such as these, the federal government can act as the mediator between self-interest and societal interest and produce a compromise that is fair for all. When it comes to answering the question of whether or not the government has the right to intervene in the regulation of the economy, one must define the purpose of an economy. Many texts describe the economy as the systems through which parties cope with scarcity, but these texts never define the end goal of these series of systems. Using the definition established by the 20th century neoclassical model, we know that the economy is a “collection of profit-maximizing firms and utility-maximizing households” where the primary goals are influenced almost entirely by self-interest. Other definitions, such as that provided by economist Alfred Marshall are a bit more optimistic in that he claims that the economy is an expedient through which poverty can be ameliorated so that people can focus more of their expenditure of resources on luxuries, such as augmenting their ethical and scholastic facilities. Overall, the extent to which the government ought to be involved depends heavily on how the purpose of the economy is described.

Bibliography

Ashraf N., Camerer C.F., Loewenstein G. “Adam Smith, Behavioral Economist.” Journal of Economic Perspectives—Volume 19, Number 3—Summer 2005—Pages 131-145. http://www.cmu.edu/dietrich/sds/docs/loewenstein/AdamSmith.pdf (accessed April 2, 2015).

Federal Reserve Bank of St. Louis. “The Role of Self-Interest and Competition in a Market Economy – The Economic Lowdown Podcast Series, Episode 3.” Federal Reserve Bank of St. Louis Webs site. https://www.stlouisfed.org/education/economic-lowdown-podcast-series/episode-3-the-role-of-self-interest-and-competition-in-a-market-economy (accessed April 2, 2015).

Krugman, Paul. “Walmart’s Visible Hand.” The New York Times.March 2, 2015. http://www.nytimes.com/2015/03/02/opinion/paul-krugman-walmarts-visible-hand.html?_r=2 (accessed March 31, 2015).

Samuelson, Paul A. “Chapter 7: Economic Behavior and Rationality.” Economics: An Introductory Analysis. http://www.ase.tufts.edu/gdae/pubs/te/mic/3e/mic_3e_ch7.pdf (accessed April 1, 2015).

Tabuchi, Hiroko. “Walmart Raising Wage to at Least $9.” The New York Times. February 19, 2015. http://www.nytimes.com/2015/02/20/business/walmart-raising-wage-to-at-least-9-dollars.html (accessed March 31, 2015).

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Government Intervention and the Invisible Hand

2 thoughts on “Government Intervention and the Invisible Hand

  1. Hi Nicole. You are tackling some very complex questions here. Recall that Adam Smith’s “Invisible Hand” is a theoretical concept, and has never actually been demonstrated in practice. It is acceptable to say that liberal capitalism strives for minimal government interference, and there was until after the Great Depression. Since that time, government has regulated, provided social programs for the disadvantaged, and subsidized specific industries to keep them viable (farming, for example).

    For your Walmart example, Smith would have said that employees have the right to work wherever they can earn the highest wage given their skill set. Unfortunately, demographics doesn’t always permit such behavior. There are many midwestern towns where Walmart may be the only unskilled employer, and that limits the options of residents. Smith would have suggested that these people relocate to a place where they had choices. We all know that is easier said than done.

    One of the reasons the government regulates is to encourage businesses to behave ethically. Your Ford Pinto case is a good example of unethical behavior, although the stated reason that a cost-benefit analysis drove their decision is unlikely. Ford could not have known how many Pintos would be hit from behind so they were missing one half of their cost equation. More likely, this was a story that was fabricated once lawsuits were filed.

    Regarding your broader topic, I believe that Adam Smith’s vision did not anticipate the existence of abject poverty nor did it anticipate a rapidly growing income inequality gap. You might want to look at some summaries of Thomas Piketty’s recent book, “Capitalism in the 21st Century” for an explanation of why the gap is growing and what can be done about it. The sum total of government programs and regulations to slow the growth of the income gap has had little impact since the second half of the 20th Century. At the high end of the income spectrum, government policy and regulation is clearly inadequate to maintain some kind of control (without killing motivation). At the low end, the failures of government programs and policies have led sociologists to propose that poverty may not be an economic condition, but instead a cultural condition.

    I’ll be curious to see where you go with these very important ideas.

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    1. Hi, Mr. Backon. Thank you for taking the time to read my blog post and comment on its content! Although I see where you are coming from with some of your points, I will have to politely disagree with some of your contentions. First, I acknowledge that, as you said, the “Invisible Hand” is an abstract concept. However, Smith describes it as one that’s effects can be observed in tangible ways such as through the economical forces like Walmart’s raise in wage. Or at least that was the idea I was trying to get across in my post.

      Instead of suggesting that under-appreciated employees relocate to a place where their employer can pay them a wage equivalent to their skill set, Adam Smith may suggest that they remain where they are. In place of relocating, former employees from Walmart could boycott the store and lobby for some of Walmart’s competitors such as Costco to establish more stores in the Midwest. This shift, representing the work of the Invisible Hand, is a force that would eventually bring the employer market back to equilibrium because Walmart would be compelled to raise it wages to be at par with it’s rival Costco.

      In regards to my assertion about government intervention in the economy being necessary to incite ethical business behavior, I collected my information from an internal report, “Fatalities Associated with Crash-Induced Fuel Leakage and Fires,” that shows the cost-benefit analysis that was conducted prior to the filing of the Ford Pinto lawsuit. It was an analysis the company was required to do by the National Highway Traffic Safety Administration (NHTSA) before distributing and selling this particular model car. As for the bemusing numbers that were used in the analysis, such as the estimate of 180 deaths and 180 burns that consumers would suffer as a result of not fixing the fault in the car model, I do not know how those numbers were contrived.

      I will definitely make sure to look at summaries for Piketty’s book. I’ve actually been reading two books, The Truly Disadvantaged by William J. Wilson and American Apartheid by Douglass S. Massey and Nancy A. Denton, that explore and dissect these concepts regarding the failure of public policy to ameliorate poverty and the “culture-of-poverty.” I will be writing about these very ideas in my upcoming blog posts.

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