The Moral Compass behind the "Invisible Hand"

While there may be many "technical" causes of the worldwide recession started in 2008, there is one deeper cause that stands out.

In his October 2008 testimony before the US Congress about the “economic tsunami” that was unfolding, Alan Greenspan, Chairman of the US Federal Reserve for 18 years, declared that he was in “shocked disbelief.” He had assumed that “the self-interests of organizations… were such that they were best capable of protecting their own shareholders and their equity.”

He went on to say: 

I found a flaw in the model that I perceived is the critical functioning structure that defines how the world works. The free market did break down. I still do not fully understand why it happened.[1]

What is the flaw in the model? To discover it, let’s first go back to Adam Smith, the 18^th century Scottish moral philosopherand author of “The Wealth of Nations.” This father of capitalist economics stated that the decisions of individual owners to use their capital for their own gain, and of purchasers to buy for their own interests, would somehow be guided by an “invisible hand” to produce the greatest overall prosperity of society:

As every individual… 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.[2]

To me, the flaw is not in the concept of the invisible hand. Rather it is how we have collectively ignored Adam Smith’s moral foundation for how we make our individual choices. He was a moral philosopher even before being a political economist. He believed strongly in moral faculties as the ultimate basis for our thoughts, words, decisions, and actions – which include the individual economic activities that culminate in societal wealth:

They [moral faculties] were set up within us to be the supreme arbiters of all our actions, to superintend [control] all our senses, passions, and appetites, and to judge how far each of them was either to be indulged or restrained. [These] were plainly intended to be the governing principles of human nature; the rules which they prescribe are to be regarded as the commands and laws of the Deity.[3]

By acting according to the dictates of our moral faculties, we necessarily pursue the most effectual means for promoting the happiness of mankind, and may therefore be said, in some sense, to co-operate with the Deity.[4]

Furthermore, he did not see people as inherently self-centered or greedy in their pursuit of life. Rather, we also have an altruistic nature:

How selfish so-ever man may be supposed, there are evidently some principles in his nature, which interest him in the fortune of others, and render their happiness necessary to him, though he derives nothing from it except the pleasure of seeing it.[5]

Thus, Adam Smith depended on an internal, moral regulation of our individual decisions and behaviour – a set of Deity-inspired rules and laws intended to direct our free actions, including economic ones. With these rules in practice, we might say that the invisible hand would be guided by the Divine hand.

Smith never endorsed pursuing personal gain at the expense of others. In fact, he belittled it:

“All for ourselves” and nothing for other people, seems, in every age of the world, to have been the vile maxim of the masters of mankind.[6]

And he scoffed at our adulation of personal riches as life’s goal:

This disposition to admire, and almost to worship, the rich and the powerful, and to despise, or, at least, to neglect persons of poor and mean condition...is…the great and most universal cause of the corruption of our moral sentiments.[7]

While some may find it easy to dismiss these statements as irrelevant piety, they form the basis of Smith’s moral foundation for pursuing individual and societal wealth. The “wisest of the wise” in various cultures have never spoken of individual self-interest or greed as a basis for societal health and prosperity. They offer no prospect that an economy based solely on the pursuit of individual gain can be healthy and beneficial to society long term. As Smith stated:

“All for ourselves” and nothing for other people, seems, in every age of the world, to have been the vile maxim of the masters of mankind.[8]

Greenspan and others are in shocked disbelief because of “a flaw” in their understanding of how the economic world works. Without a moral foundation, turning a market economy loose for each person to pursue his or her “all for myself” interests is much like permissive parents giving the car keys and no curfew to an immature 14-year old with no drivers license: a great deal of harm is likely to occur.