FREE MARKETS AND UTILITY: ADAM SMITH:Free Trade and Utility: David Ricardo

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Business Ethics MGT610

LESSON 17

FREE MARKETS AND UTILITY: ADAM SMITH

Smith's utilitarian argument is most commonly criticized for making what some call unrealistic

arguments. First, Smith assumes that no one seller can control the price of a good. Though this

may have been true at one time, today many industries are monopolized to some extent.

Second, Smith assumes that the manufacturer will pay for all the resources used to produce a

product, but when a manufacturer uses water and pollutes it without cleaning it, for example,

someone else must pay to do so. Third, Smith assumes that humans are motivated only by a

natural, self-interested desire for profit. This, say his critics, is clearly false. Many humans are

concerned for others and act to help others, constraining their own self-interest. Market

systems, say Smith's critics, make humans selfish and make us think that the profit motive is

natural.

One especially influential critic of Smith was John Maynard Keynes. Keynes argued that

government intervention was necessary because there is a mismatch between aggregate supply

and demand, which inevitably leads to a contraction of supply. Government, according to

Keynes, can influence the propensity to save, which lowers aggregate demand and creates

unemployment. Government can prevent excess savings through its influence on interest rates,

and it can influence interest rates by regulating the money supply. The higher the supply of

money, the lower the rate at which it is lent. Second, government can directly affect the amount

of money households have available to them by raising or lowering taxes. Third, government

spending can close any gap between aggregate demand and aggregate supply by taking up the

slack in demand from households and businesses. Keynes' arguments became less convincing

after the stagflation of the 1970s, though. It has been replaced by a post-Keynesian school of

thought, which argues for even more governmental intervention in the market.

Social Darwinists had a different take on the utilitarian justification for free markets. They

argued that economic competition produced human progress. If governments were to interfere

in this process, they would also unintentionally be impeding human progress. Weak firms must

be weeded out by competition, they claim. The basic problem underlying the views of the

social Darwinist, however, is the fundamental normative assumption that survival of the fittest

means survival of the best. That is, whatever results from the workings of nature is necessarily

good. The fallacy, which modern authors call the naturalistic fallacy, implies, of course, that

whatever happens naturally is always for the best.

Free Trade and Utility: David Ricardo

Adam Smith's major work, the Wealth of Nations, in fact, was primarily aimed at showing the

benefits of free trade. There he wrote:

It is the maxim of every prudent master of a family never to attempt to make at

home what it will cost him more to make than to buy. The tailor does not make his

own shoes but buys them from the shoemaker... What is prudence in the conduct of

every family can scarce be folly in that of a great kingdom. If a foreign country can

supply us with a commodity cheaper than we ourselves can make it, better buy it of

them with some part of the produce of our own industry, employed in a way in

which we have some advantage.

Adam Smith's point here is simple. Like individuals, countries differ in their ability to produce

goods. One country can produce a good more cheaply than another and it is then said to have

Business Ethics MGT610

an "absolute advantage" in producing that good. These cost differences may be based on

differences in labor costs and skills, climate, technology, equipment, land, or natural resources.

Suppose that because of these differences, our nation can make one product for less than a

foreign nation can, and suppose the foreign nation can make some other product for less than

we can. Then clearly it would be best for both nations to specialize in making the product each

has an "absolute advantage" in producing, and to trade it for what the other country has an

"absolute advantage" in producing. It was Ricardo's genius to realize that both countries could

benefit from specialization and trade even though one can make everything more cheaply than

the other. Specialization increases the total output of goods countries produce, and through

trade all countries can share in this added bounty.

Ricardo's ingenious argument has been hailed as the single "most important" and "most

meaningful" economic discovery ever made. Some have said it is the most "surprising" and

"counterintuitive" concept in economics. It is, without a doubt, the most important concept in

international trade theory today and is at the heart of the most significant economic arguments

people propose today when they argue in favor of globalization. Ricardo makes a number of

simplifying assumptions that clearly do not hold in the real world, such as that there are only

two countries making only two products with only a fixed number of workers. But these are

merely simplifying assumptions Ricardo made to get his point across more easily and Ricardo's

conclusion could still be proved without these assumptions.

There are other assumptions, however, that are not so easy to get around. First, Ricardo

assumes that the resources used to produce goods (labor, equipment, factories, etc.) do not

move from one country to another. Yet today multinational companies can, and easily do, move

their productive capital from one country to another. Second, Ricardo assumes that each

country's production costs are constant and do not decline as countries expand their production

or as they acquire new technology.

Third, Ricardo assumes that workers can easily and unreservedly move from one industry to

another. Yet when a company closes down because it cannot compete with imports from

another country that has a comparative advantage in those goods, the company's workers are

laid off, suffer heavy costs, need retraining, and often cannot find comparable jobs.

Finally, and perhaps most importantly, Ricardo ignores international rule setters. International

trade inevitably leads to disagreements and conflicts, and so countries must agree to abide by

some set of rules and rule-setters.

Marx and Justice: Criticizing Markets and Trade

Karl Marx offers the most critical view of modern private property and free market institutions.

Marx claims that free-market capitalism necessarily produces extremes of inequality. Since

capitalist systems offer only two sources of incomeowning the means of production and

selling one's laborworkers cannot produce anything without the owner of the productive

forces. But owners do not pay the full value of the workers' labor; they pay workers what they

need to subsist, keeping the rest for themselves and gradually becoming wealthier as a result.

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