MICRO-MACRO

February 26, 2009

Why are the auto companies in trouble? Because individual people are deciding not to buy new cars. Why are the toymakers tanking? Because individual parents are deciding their kids can get as much fun from a handball than from a Hannah Montana. Why do Wal-Mart's profits continue to rise? Because ... well, you know.
It's Adam Smith's Invisible Hand: Millions of individual decisions about production and purchase create collective wealth.
Or, as we've seen lately, the reverse.
Smith, that presumably thrifty Scot whose treatise, An Inquiry into the Nature and Causes of the Wealth of Nations,appeared in 1776 and established the fundamental axioms for classical economic theory, saw that economic life is primarily based on self-interest: "It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner," he wrote, "but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages." Every individual — producer or consumer — "neither intends to promote the public interest, nor knows how much he is promoting it...; he intends only his own gain, and he is led by an invisible hand to promote a gain that was no part of his intention."
Since Smith's time, things have grown a bit larger from the production side: By and large, the butcher is Purdue, the brewer is Budweiser, the baker is Consolidated. But from the consumption side, it is still the individual person or family whose choices guide the economic pantograph.
Smith was not ruthlessly calculating in his assessment of self-interest. Whereas his contemporary Bernard de Mandeville contended that a free market permitted, even necessitated, the exploitation of labor to cut expense and maximize profit, Smith believed that the humane treatment of workers fostered good will among consumers. That is, Smith understood that there were also more human factors involved in making economic decisions.
It is the human dimension of self-interest, as well as sheer calculation, that may be moving America's Invisible Hand today. Dire economic conditions force the reordering of personal priorities, often to the better. In last week's column, I reported that the Redemptorist order of Catholic priests and brothers, having lost much of their endowment in the Madoff debacle, are now compelled to live their vow of poverty — to be poor in fact as well as in spirit.
In other but related senses, that is true for most of us too. Evaporating investments, falling home values, threatened or actual unemployment, and loss of medical benefits are making people re-think what is really in their self-interest. Forced to scale down, many are finding a scaled-down life more attractive than they'd ever imagined. And when multiplied by hundreds of millions, the changes individuals make in their microeconomic life will alter macroeconomic life profoundly for decades to come.
Already you see it: Personal debt, still at 141% of disposable income, is beginning to decline; the savings rate, at .06%, is rising.
As spending beyond their means, which loose credit and soaring home values once made people think was normal, now looks positively unthinkable, those industries which fed upon it — the credit-card companies and the makers of mammoth, inefficient automobiles, among many others — will, or should, contract or even dissolve.
Adam Smith never foresaw John Maynard Keynes; he thought government's role in the economy was to register and protect property, period. But even as formerly free-market economists are now arguing for "necessary" government intervention, it is important to issue a caution: Do not try to arm-wrestle the Invisible Hand. It is ultimately self-defeating to prop up dying industries and institutions. The role of an enlightened government should be to work synergistically with the self- interest of the citizens, whose response to circumstances will chart a new direction for society — to promote a gain that is no part of their intention.