Adam Smith, Milton Friedman and the Social Responsibility of Business

Adam Smith, an 18th century economist and author of The Wealth of Nations, is often viewed as the father of modern capitalism. Smith's three main underlying concepts were the "invisible hand," that individuals pursuing their own best self-interest would result in the greatest overall good to society, and that levels and kinds of goods and services in the market should be determined by the free market alone (i.e., not by government).

The first notion, that of the invisible hand, suggests that people essentially vote with their dollars. If we want a society with nothing but solar energy and organic food, we'd all go out and buy those things and not buy GMO or factory-farmed foods or coal-fired energy. This invisible hand would guide the suppliers in the marketplace to provide those goods and services for us, and there would be no such thing as coal power or GMO food.

The second notion, that an individual seeking his/her own best self-interest is actually the best thing that the person can do for society, indicated Smith's belief that, given sufficient motivation for personal gain, each person would work hard, and as a result, society as a whole would benefit with more jobs, more competition, and better quality goods and services.

The third notion effectively just means that government should stay out of the market, and limit their role to police.

Smith is often held up by modern conservatives as a hero of capitalism and freedom, and a reason that subsidies for things like solar and wind power should not exist. Smith acknowledged the concept of externalities and other free market breakdowns, but didn't really address them as a major challenge to society. Smith can be forgiven: when he was alive, there were less than one billion people on the planet, and the concept of externalities (mercury emissions, DDT, polychlorinated biphenols, stillbirths, cancer, and other disease caused by, but not paid for by, a business seeking its own self-interest) would have been foreign even to the most progressive economist.

Milton Friedman, a modern disciple of Adam Smith, is now often championed by conservatives for furthering Smith's line of thinking, with perhaps his most famous quote underscoring the concept of the social responsibility of business from a conservative point of view:

"There is one and only one social responsibility of business -- to use its resources and engage in activities designed to increase its profits."

It's a line that is often repeated by conservatives as a defense against claims that companies should be doing more. The challenges with this line of thinking, of course, is that single-minded focus on profit maximization is what led to the creation of bundled mortgage backed securities that led to the housing bubble that virtually melted down the global economy in 2008 (and realistically, to pretty much every speculative bubble in economic history). Friedman did eventually go on to add, "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." And of course, deception and fraud can be defined in many ways.  (Friedman was also fervently against privatization of jails and openly supportive of the legalization of drugs, which is often overlooked by conservatives).

The main challenge to this Smith-Friedman version of reality is that it can never be so simple.

Corporations doing business create side effects, and if they are not responsible for those side effects, the whole free market system breaks down. It's factory farms using antibiotics for their own gain (faster fattening of animals to bring to market) and causing antibiotic resistant bacteria that is now a public menace. It's pesticide use that is killing honeybees and causing a decline in pollination for other farmers. It's coal plants that produce mercury emissions and cause birth defects and respiratory ailments. The list can go on and on and on.

Smith, to his credit, at least acknowledged it. Joseph Stiglitz, a modern Nobel Prize winning Economist, said, "Whenever there are externalities--where the actions of an individual have impacts on others for which they do not pay, or for which they are not compensated--markets will not work well."

Conversely, Friedman, according to the otherwise conservative Motley Fool Stock Advisor, had it dead wrong with his quote on profit being the only social responsibility of business. The Fool suggests that, as opposed to Friedman's singular vision, investors take the long view, rather than focusing on quarterly reports, in part because quarterly reports give companies incentives to finagle and fudge on their responsibility to society for openness, corporate citizenship, and well, social responsibility.

Follow Scott Cooney on twitter and read his writings at the Inspired Economist.

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