Welcome to Eureka Street

back to site

Smith’s invisible hand

Humans often have difficulty grasping the concept of scale. There is that queasy feeling we get when we ponder the fact that as an individual we are just one of six billion people in the world, and this world is merely one planet orbiting one sun in a galaxy of billions of stars, in an infinite universe of galaxies.

Most of us get a similar feeling when we think of ‘the world economy’. While mortgages, bills, annual income and the nightmare of tax returns preoccupy much of our economic thought, we trust that the broader economic framework is still out there and in operation. As long as Adam Smith’s invisible hand of market competition delivers our electronic goods from north Asia, our luxuries from continental Europe, and exotic foods, spices and flavours from destinations we are not even aware of, then we are satisfied that all is well in the world economy.

It is the scale of the economy that is daunting. So many trillion dollars are exchanged via computer trading on the New York Stock Exchange. So many ­billions of dollars have been wiped off ­pension funds; all this trading has led to yet another blow-out in the current account deficit. As an individual, none of this is particularly relevant unless it affects you. Apart from a small stir of patriotism, if the Australian unemployment rate is lower than that of the US for the first time in decades, this is irrelevant if you are still one of the six per cent who are unemployed.

To make the world economy more comprehensible we reduce it to a ­catalogue of personalities, in the same way we tend to simplify history. Thus the world economy is made up of figures including Bill Gates, George Soros, Warren Buffet, Donald Trump and the Sultan of Brunei. Apart from the Sultan, they are all conspicuously North American, which leads us to the conclusion that this is where the money is, and surely where the sensible architects of the world economy are to be found.

As rich (and consequently as powerful as these figures are), the real players in the world economy are not individuals, but corporate entities. In the realm of trade in goods and services, corporations ­efficiently harness the talents of individual humans, separating management, control and investment decisions in the pursuit of profit across the globe. In the other main arena of the world economy, the financial markets, investment funds, hedge funds and other vehicles pursue the highest possible returns across world ­markets. Because of the impersonal nature of these corporations and investment vehicles, and the billions of dollars at their disposal, such operations are often shrouded in a veil of mystery. Basically, however, they pursue elementary capitalist theories and lobby governments to reduce impositions upon their freedom to act profitably.

Trade in goods and services is the easiest starting point. Human societies have always traded, and there has been a correlation throughout history between the more successful and long-lasting civilisations and those that operate effective and efficient trading systems. Just as the military expansion of Rome was underpinned by a network of roads and trading routes across the Mediterranean—allowing access to the grains of Egypt, the horses of Arabia and the produce of Gaul and Spain—the dominance of the British in 19th-century Europe was founded on the mercantilist traditions of the navy and on the trade (and exploitation) of colonial resources. This demonstrates another point about capitalist tendencies in the world economy—the pursuit of profit often disregards the interests of others, who are not deemed partners in the system.

According to classical economic theory, trade should benefit all participants in the exchange. People should specialise in the production of goods in which they have a comparative advantage (that is, the alternative production that they forego in specialising is less than that of their trading partner) and trade to obtain goods that they cannot produce at comparative advantage. At an individual level this is why a busy lawyer, even if she owns a lawnmower, may pay someone else to mow her lawn—for she can earn many times the amount charged to mow the grass in the time it would take her to mow. Division of labour is a primary example of trade.

However, nothing is static in economics and the world is not a simple, two-country trading scenario. Over time, comparative advantages change. This has seen the old industrialised nations of the West lose competitiveness in manufacturing, as skill levels and labour costs have increased. This has resulted in shifts in manufacturing dominance from the old world of Europe to the US, to Japan, to India and North Asia, and to the now more timid Asian ‘tiger’ economies. Such shifts are a reflection of the corporate world pursuing the lowest cost to produce a given product.

Since WWII, various international ­economic organisations have been created to manage the international economic framework. From Bretton Woods to the World Trade Organization (WTO), an underlying assumption of these institutions has been that by promoting economic interdependence, co-operation in the economic sphere can help to prevent the escalation of ­disputes into military conflict. At present the most influential institutions are the WTO in establishing trading rules and negotiating reductions in barriers to trade and other distortions, and the World Bank and International Monetary Fund (IMF) in overseeing financial markets.

Not everything goes to plan, however. In the washup from the Asian financial crisis, the World Bank- and IMF-prescribed policies and rescue packages have received substantial criticism, as a flashback to outdated Keynesian-style economics. The WTO has also been under fire for advancing the interests of the US and developed nations with agreements on intellectual property (TRIPS) while dragging its feet on agriculture, the issue of most importance to developing nations. While US farm subsidies and the European Union Common Agricultural Policy continue unimpeded, developing nations face retaliatory action over violations of the TRIPS policy for producing cheap generic pharmaceuticals. This has created significant tension and forced the issue of equality in the access to the benefits of the world economy.

The world economy is not a perfect or polished system. It is a system that has developed through the pressures of necessity and the demands of its users, rather than as a grand vision imposed from above. As most of these users have been corporations based in the developed world, and notably America, and as these groups have effectively lobbied their ­governments for support, it was in the interests of these nations that the international economic architecture was first designed. Other nations have chosen to participate because even with this bias, the benefits of participation in the institutional framework are still attractive.

As the student of economics is taught, economics is the study of equilibria, situations that clear the market, where demand meets supply. However, these points of equilibrium are never static. In the fluctuations of the world economy, the economic analysis describes not a final and unchanging system, but a constant and often reluctant accommodation to change.

Just as the pendulum had been swinging into an era of hands-free government and increasing corporate freedom, several high profile corporate insolvencies in America (ENRON, WorldCom) and our own local collapses (HIH, OneTel, Ansett) have created a political necessity for some government-imposed corporate governance. And in the WTO, the increasingly evident need to assuage developing nations’ disenchantment with the West will encourage the dominant players, notably America, to adopt less wholeheartedly nationalistic negotiating platforms on basic trading rules.

No matter how risky or uncertain the world becomes, the money will still flow around the globe, as long as the returns are there. But don’t worry too much. Just keep an eye on your super fund, watch out that interest rate rises don’t catch you out on your mortgage, hope your company doesn’t relocate overseas in search of cheaper inputs, and be confident that the invisible hand will guide foreign goods to your supermarket shelves and shopping centres.

Whether you like it or not, and despite what the governments of the world tell us, economically we are all world citizens. 

David Ferris is a final year Commerce/Law student at Melbourne University.



submit a comment