By Jonathan B. Wight
A friend recently inquired about Adam Smith’s view on externalities. A much longer post is needed to break apart several important ideas. First, one would need to disentangle the invisible hand concept from market “efficiency.” (See J. Wight, The Treatment of Smith’s Invisible Hand, The Journal of Economic Education 38(3)(2007): 341-358.)
Second, while Smith does not discuss (to my awareness) externalities arising from environmental pollution, he did write that private market transactions could pollute or corrupt one’s mind. Here are two examples, one negative and one positive.
Negative externalities: When market forces lead to an extreme form of labor specialization, people become “stupid and ignorant” and this mental weakening has a deleterious effect on civil society. This is why Smith proposes publicly-funded education as a remedy:
“The man whose whole life is spent in performing a few simple operations, of which the effects are perhaps always the same, or very nearly the same, has no occasion to exert his understanding or to exercise his invention in finding out expedients for removing difficulties which never occur. He naturally loses, therefore, the habit of such exertion, and generally becomes as stupid and ignorant as it is possible for a human creature to become. The torpor of his mind renders him not only incapable of relishing or bearing a part in any rational conversation, but of conceiving any generous, noble, or tender sentiment, and consequently of forming any just judgment concerning many even of the ordinary duties of private life. Of the great and extensive interests of his country he is altogether incapable of judging, and unless very particular pains have been taken to render him otherwise, he is equally incapable of defending his country in war. The uniformity of his stationary life naturally corrupts the courage of his mind, and makes him regard with abhorrence the irregular, uncertain, and adventurous life of a soldier. It corrupts even the activity of his body, and renders him incapable of exerting his strength with vigour and perseverance in any other employment than that to which he has been bred. His dexterity at his own particular trade seems, in this manner, to be acquired at the expense of his intellectual, social, and martial virtues. But in every improved and civilised society this is the state into which the labouring poor, that is, the great body of the people, must necessarily fall, unless government takes some pains to prevent it.” (Wealth of Nations)
This is pretty clear evidence that in Smith’s mind private market transactions can produce deleterious effects for third parties, and that there is a role for government in remedying the situation.
Positive externalities: In The Theory of Moral Sentiments, Smith claims that people make fundamental misjudgments about means and ends (he is a precursor to behavioral economics). In the story of the poor man’s son, we learn that extreme striving and ambition never produce the expected happiness or peace of mind—it is all a psychological “deception.” The beneficiaries of this striving accrue to others, namely society at large—through greater wealth and innovation.
“And it is well that nature imposes upon us in this manner. It is this deception which rouses and keeps in continual motion the industry of mankind. It is this which first prompted them to cultivate the ground, to build houses, to found cities and commonwealths, and to invent and improve all the sciences and arts, which ennoble and embellish human life; which have entirely changed the whole face of the globe, have turned the rude forests of nature into agreeable and fertile plains, and made the trackless and barren ocean a new fund of subsistence, and the great high road of communication to the different nations of the earth.” (The Theory of Moral Sentiments).
No doubt there are other examples of Smith’s awareness of third party effects. See, for example, this blog about relative standing.
[Thanks to Rob Garnett for raising the question.]