Profitable Business: Adam Smith’s Moral Assessment

Many who hear the name “Adam Smith” imagine a zealous, unnuanced defender of free markets. In fact, Smith was a careful student of business, markets, and associated institutions. He freely acknowledged their limits while expressing optimism about their capacity to improve human lives.

Popular opinion today is more pessimistic. Studies suggest that the “default [popular] view of profits is zero-sum.”[i] Indeed, many believe that far from improving lives by creating employment, trade, and consumption opportunities, profitable firms worsen lives by taking from others. This view is erroneous when it comes to most firms. Smith’s work can be seen as a corrective.

Smith asked, what makes one society wealthier than another? Since wealth is not “mere money,” but what it can buy—including life’s essentials—Smith knew the question to be ultimately about what provides the material conditions for human happiness or misery. "Every man," says Smith in The Wealth of Nations (Bk. I, Ch. V), “is rich or poor according to the degree in which he can afford to enjoy the necessaries, conveniencies [sic], and amusements of human life.”  Smith’s answer to his question: Trade, specialization, and the division of labor. 

A Smithian will generally see trade as a vehicle for improving lives by creating consumer and producer surplus. When Bill trades with Jane, Bill gains value and, remarkably, so does Jane. Market exchange is typically not zero-sum, but win-win. Suppose Bill pays Jane, a business owner, $15 for a shirt, but he was willing to pay $30. If he is right about the shirt’s value for him, he gains the equivalent of $15 in value (consumer surplus). And if Jane was willing to sell the shirt for $5 but sells it for $15, she gains $10 in value (producer surplus), for a net surplus of $25 between the two. Millions of such exchanges happen in our world every day—or, perhaps, every minute. Imagine the value created.

Smith recognized that humanity benefits greatly from not only trade but also productive processes that involve specialization and the division of labor. Individuals and firms specialize when they focus on performing single tasks or a small set of tasks. The division of labor takes root when workers control particular steps in productive processes. Workers become more skilled, tasks take less time, and innovation is spurred.  When production becomes more efficient as a result, this creates more and better goods and further opportunities for surplus-increasing exchange.

Strikingly, firms and markets benefit humanity even when—often, precisely because—individuals and groups pursue their self-interested ends. Although Smith mentions the “invisible hand” only once in An Inquiry into the Nature and Causes of the Wealth of Nations (a full title worth remembering), the metaphor is justly famous.[ii] The “invisible hand” is individuals’ pursuit of their self-interest that guides human cooperation from the bottom up, yielding economic and social benefits for others. This pursuit is fueled by concern for oneself and one’s family: two interests, central to a life well-lived, that most market participants seek to secure not selfishly but (merely) self-interestedly. Self-interested businesses create a “stock” of goods, traders facilitate its “flow” in the economy, and the resultant gains from trade redound to the benefit of many, including people whom members of the firms do not know and will never meet.

For these reasons, Smith was rightly confident in the power of markets to enhance human welfare. Critics have argued, however, that markets have various costs distinct from their welfare effects. For example, prominent theorists such as G. A. Cohen claim that market actors are characteristically greedy; and popular sources convey a similar message.[iii] Hollywood films, for instance, often portray businesspersons negatively. Our movies include more figures like the infamously greedy Gordon Gekko from Wall Street than the ordinary businesspersons on whom our civilization critically depends. Far less often do films shine a spotlight on the (far more common) businessperson who puts in an honest day’s work, day after day, year after year, benefiting their family, firm, and customers.[iv] If Hollywood is getting the public to see profit-making as a greedy, zero-sum process, it's very often doing so based on anomalous, cherry-picked cases.

Smith was incisively aware of not only the benefits but also the costs of firms and markets. He knew that there are greedy businesspersons—just as there are greedy people in government, Hollywood, and elsewhere who lust after power, status, and money—and that these persons' pursuits corrupt their characters even while, in some cases, spurring them to be productive in ways that create opportunities for others. Smith knew that markets sometimes include knaves, rule-breakers, and worse. He knew that firms collude with one another and with governments, setting back the interests of rival firms and consumers alike. “People of the same trade seldom meet together, even for merriment and diversion,” says Smith in The Wealth of Nations (Bk. I, Ch. X), but when they do “the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.” Smith accordingly saw a role for governments in combating collusion and regulating powerful monopolies. He also knew, and realistically pointed out, that some firms make and sell trinkets that are worthless or even bad for consumers.

Ever the realist about firms and markets, Smith also took pains to show how some market arrangements cause employees to suffer. In his famous discussion of the division of labor in a pin factory, Smith observes that even if, for instance, having workers spend hours each day straightening wire for pins greatly increases firm productivity, this work can be monotonous and degrading. Smith also cautioned against the pursuit of wealth for the wrong reasons. Discussing the “poor man’s son, whom heaven in its anger has visited with ambition[,]” Smith emphasizes in The Theory of Moral Sentiments (Part IV, Ch. I) that a desire to acquire wealth can be justified and beneficial, but only within limits. For it would be a mistake to treat wealth-getting as an ultimate human good, as those who become wealthy often realize only afterward that wealth is insufficient (even if in some degree necessary) to secure human happiness.

Yet, for all of Smith’s realism about the costs of markets, which are, after all, human institutions subject to ordinary human limits, Smith made powerfully clear how a system of political economy with free and fair exchange, specialization, and the division of labor can massively improve human lives. What we get in Smith is not a utopian view of profitable business, but a humane and realistic assessment of the power of firms and the markets in which they operate to do good in the world. Indeed, adherents of diverse political and economic views who carefully study Smith’s writings recognize his views of markets and profitable firms as “deeply humane.”[v] As well as anyone before him or since, Smith showed why we all benefit from trade, specialization, and the division of labor.

It’s time to correct the misconception of profitable firms as selfish expropriators. Most firms instead consist of people who add value to their communities and customers (e.g., us) while working to improve their own and their families’ lives. We should not blame them but offer gratitude and praise.[vi]

Endnotes:
[i] Amit Bhattacharjee, Jason Dana, and Jonathan Baron (2017) ,"Anti-Profit Beliefs: How People Neglect the Societal Benefits of Profit", Journal of Personality and Social Psychology 113(5): 671-696: 671 (abstract). The authors, who conducted seven studies, report: “Our first two studies find that while the majority of our subjects exhibited anti-profit beliefs, there was ample heterogeneity across individuals, with a small minority exhibiting pro-profit beliefs” (691).
[ii] The Wealth of Nations (Bk. IV, Ch. II).
[iii] G. A. Cohen (2009), Why Not Socialism? Princeton: Princeton University Press.
[iv] For illuminating discussion of this and other issues, see James R. Otteson (2019), Honorable Business: A Framework for Business in a Just and Humane Society, Oxford: Oxford University Press.
[v] Elizabeth Anderson (2017), Private Government: How Employers Rule Our Lives (and Why We Don’t Talk about It), Princeton University Press, p. 22.
[vi] I am grateful to James Otteson for his generous feedback on this essay and his exemplary scholarship on Smithian political economy. I also thank Daniel Cummings for comments and Adam Gjesdal and Mario Ivan-Juarez for discussion of Smith’s views.



Related Links:

Steven Horwitz, Adam Smith on the Labor Theory of Value
Michael Munger, Division of Labor, Part 1