On the objective-functions of firms and consumers
February 22, 2024
What should people in business maximize? Thelmo Vargas-Madrigal gives a brief tour of famous thinkers who have tried to answer that question and picks his winners and losers.
What should people in business maximize? Thelmo Vargas-Madrigal gives a brief tour of famous thinkers who have tried to answer that question and picks his winners and losers.
Editor's Note: This post can be found in Spanish translation here.
In 1962 Milton Friedman published Capitalism & Freedom dedicated to Janet and David and their contemporaries who must carry the torch of liberty on its next lap. In it, he wrote that
In 1962 Milton Friedman published Capitalism & Freedom dedicated to Janet and David and their contemporaries who must carry the torch of liberty on its next lap. In it, he wrote that
there is one and only one social responsibility of business—to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition, without deception or fraud.
Aware that this opinion could be considered subversive, Friedman added:
If business do have a social responsibility other than making maximum profits for stockholders, how are they to know what it is? Can self-selected private individuals decide what the social interest is? (…) If businessmen are civil servants rather than the employees of their stockholders then in a democracy they will, sooner or later, be chosen by the public techniques of election and appointment.
Of course, stockholders are be free to use their resources in every legitimate purpose of their choosing.
Friedman found it appropriate to substantiate the above opinion with Adam Smith’s famous phrase in An Inquiry into the Nature and Causes of the Wealth of Nations, that an entrepreneur operating under the rules of a competitive market is
led by an invisible hand to promote an end which was no part of his intention (…) By pursuing his own interest, he frequently promotes that of society more effectively than when he really intends to promote it.
To this, Smith had added two important considerations:
Every man, as long as he does not violate the laws of justice, is left perfectly free to pursue his own interest his own way, and to bring both his industry and capital into competition with those of any other man, or order of men.
I have never known much good done by those who affected to trade for the public good.
On the other side of the road, Karl Marx, writing some decades after Adam Smith, wrote that the capitalistic bourgeoisie
put an end to all feudal, patriarchal, idyllic relations (…) and has left remaining no other nexus between man and man than naked self-interest, than callous ‘cash payment’. It has drowned the most heavenly ecstasies of religious fervour, of chivalrous enthusiasm, of philistine sentimentalism, in the icy water of egotistical calculation. It has resolved personal worth into exchange value, and in place of the numberless indefeasible chartered freedoms, has set up that single, unconscionable freedom — Free Trade. In one word, for exploitation, veiled by religious and political illusions, it has substituted naked, shameless, direct, brutal exploitation
(Karl Marxand Friederich Engels The Communist Manifest, 1848).
Capitalism and free trade were, in Marx’s view, synonymous with egotistical, exploitative self-interest. And alienating.
The less you eat, drink, buy books, go to the theatre or to balls, or to the pub, and the less you think, love theorize, sing, paint, fence, etc., the more you will be able to save and the greater will become your treasure which neither moth nor rust will corrupt--your capital. The less you are, the less you express your life, the more you have (…) Everything which the political economist takes from you in life and in humanity, he replaces for you in money and in wealth.”
(Karl Marx, Economic & Philosophic Manuscripts, 1844).
Marx turned out to be wrong. Entrepreneurs do have other goals besides profit maximization at any cost. In a competitive market firms cannot be exploitative because if they were to charge unduly high prices for their products, or pay low wages to their employees, they soon will end up without buyers and without employees.
As far as consumers are concerned, Adam Smith made it clear that
Every man is rich or poor according to the degree in which he can afford to enjoy the necessaries, conveniences, and amusements of human life”. And, “it is not for its own sake that men desire money, but for the sake of what they can purchase with it.
In The Theory of Moral Sentiments, which Smith published before his Wealth of Nations (and continued to revise for the rest of his life), he had introduced the idea of the Impartial Spectator, an imagined person, or arbiter, whose approbation or disapproval makes up our awareness of the nature of our own conduct, and who indicates what in one’s conduct constitutes “fair play”, and what a violation of it, which the Impartial Spectator cannot admit.
Man naturally desires, not only to be loved, but to be lovely; or to be that thing which is the natural and proper object of love. He naturally dreads, not only to be hated, but to be hateful; or to be that thing which is the natural and proper object of hatred. He desires, not only praise, but praiseworthiness; or to be that thing which, though it should be praised by nobody, is, however, the natural and proper object of praise. He dreads, not only blame, but blame-worthiness; or to be that thing which, though it should be blamed by nobody, is, however, the natural and proper object of blame.
In contrast, a somewhat incoherent Marx, who in 1844 wrote “the less you eat, drink, buy books,…”, four years later stated that
The bourgeoisie, during its rule of scarce one hundred years, has created more massive and more colossal productive forces than have all preceding generations together. Subjection of Nature’s forces to man, machinery, application of chemistry to industry and agriculture, steam-navigation, railways, electric telegraphs, clearing of whole continents for cultivation, canalisation of rivers, whole populations conjured out of the ground – what earlier century had even a presentiment that such productive forces slumbered in the lap of social labour?
(Karl Marx and Friedrick Engels, The Communist Manifest, 1848).
Who had a presentiment that the productive forces of “free competition, accompanied by a social and political constitution adapted in it” slumbered in the lap of social labour? Adam Smith was well aware of that phenomenon and its causation. In fact, in The Theory of Moral Sentiments he had written that men’s pursuit of wealth is the force
which first prompted them to cultivate the ground, to build houses, to found cities and commonwealths, and to invent and improve all the sciences and arts, which ennoble and embellish human life; which have entirely changed the whole face of the globe, have turned the rude forests of nature into agreeable and fertile plains, and made the trackless and barren ocean a new fund of subsistence, and the great high road of communication to the different nations of the earth. The earth by these labours of mankind has been obliged to redouble her natural fertility, and to maintain a greater multitude of inhabitant.
For public-policy purposes, history has shown that Karl Marx was inconsistent and wrong, and Adam Smith right and inspiring.
More from Thelmo Vargas-Madrigal:
Adam Smith on Taxation/ Ideas de Adam Smith en Materia Impositiva
Adam Smith on Fiscal Policy/ Adam Smith y Política Fiscal
More from Thelmo Vargas-Madrigal:
Adam Smith on Taxation/ Ideas de Adam Smith en Materia Impositiva
Adam Smith on Fiscal Policy/ Adam Smith y Política Fiscal