![]() But as the late economist Abba Lerner once remarked, the main problem confronting the poor is that they have too little money. Of course, when millions of voters feel the pinch of rapidly rising prices, politicians find it hard to stand idly by. Economists opposed suspending the gas tax because doing so would make the economic pie smaller. But adopting inefficient policies is never the best way to help people in financial distress.Įfficiency is important because any policy that enlarges the economic pie necessarily lets everyone have a bigger slice than before. The stated aim of their proposal was to ease the financial burden of sharply higher gasoline prices. In such cases, the simplest solution is to discourage consumption by taxing it.ĭoing so would not only raise revenue to pay for public services it would also make the allocation of society’s resources more efficient hence economists’ almost universal dismay when Senators John McCain and Hillary Rodham Clinton recently proposed eliminating the federal tax on gasoline for the summer. That simple example captures the classic breakdown in the invisible hand when a product’s market price doesn’t reflect all its relevant social costs and benefits. But because each gallon of gasoline also generates external pollution costs, the total cost of that last gallon produced is higher than its value to consumers. ![]() As before, market forces cause production to expand until the seller’s direct cost for the last unit sold is exactly the value of that unit to the buyer. Producing an extra gallon of gasoline, for example, generates not just additional costs to producers, but also pollution costs that fall on others. The production and consumption of many other goods, however, generate costs or benefits that fall on people besides buyers and sellers. If the costs incurred directly by sellers are the only relevant costs of expanding potato production, and if the benefits to potato buyers are the only relevant benefits, the invisible hand gets things just right. The market reaches equilibrium when the cost of producing the last pound is exactly equal to its value. Profit-seeking sellers are willing to offer an additional pound of potatoes for sale whenever the benefit of doing so as measured by what buyers are willing to pay is enough to cover the cost of production. Consider the market for potatoes: in it, production and consumption are determined by millions of separate cost-benefit calculations. It’s helpful to look more closely at why the invisible hand works so well in many ordinary markets. But prices often diverge from cost and value and, in those cases, taxes can actually help steer resources toward more highly valued uses. When market prices convey accurate signals of cost and value, the invisible hand promotes the common good. Smith’s more nuanced position supports a different view of taxes. The problem, according to this view, is that taxes distort the price signals through which the invisible hand guides resources to their best destinations. If you believe, with Smith’s modern disciples, that unfettered pursuit of self-interest always promotes society’s interests, you probably view all taxes as a regrettable evil necessary to pay for roads and national security, but also an unwelcome drag on economic efficiency. This understanding has important implications for economic policy in general, and for the recent presidential campaign dust-up about gasoline taxes in particular. In short, Smith understood that the invisible hand is often benign, but not always. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it.” It says that this owner “is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.” It continues: “Nor is it always the worse for the society that it was no part of it. On the contrary, the relevant quotation from his “Wealth of Nations,” which describes a profit-seeking business owner, is far more circumspect. Yet Smith himself was under no such illusion. In their account, Smith’s assertion was that purely selfish individuals are led by an invisible hand to produce the greatest good for all. ADAM SMITH’S modern disciples are far more enthusiastic about his celebrated invisible-hand idea than he ever was.
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