Adam Smith was Right

As often happens, economic turmoil begets questions of whether free market thinkers were right or wrong – and whether regulation needs to be increased to preserve the country’s economic integrity. Now, even greater questions need to be asked: should the government be bailing out companies that make bad bets, and if so, who ultimately pays for these bailouts? These questions are ironic, particularly from avowed free marketers, because Adam Smith himself warned about the challenges of capitalism in his conclusion of the mercantile system in 1776:

Consumption is the sole end and purpose of all production; and the interest of the producer ought to be attended to, only so far as it may be necessary for promoting that of the consumer. The maxim is perfectly self-evident, that it would be absurd to attempt to prove it. But in the mercantile system, the interest of the consumer is almost constantly sacrificed to that of the producer; and it seems to consider production, and not consumption, as the ultimate end and object of all industry and commerce.

Today, we find ourselves precisely where Adam Smith said we would be.

The irony of US Taxpayers bailing out banks is that the bailout follows years of the banks insisting – and getting – less banking regulation. This gave banks the ability to branch into other businesses and freedom from oversight of financial derivatives so complex that most bankers don’t even understand what they’re buying and selling. It’s truly appalling that the U.S. Government is bailing out bankers who made outrageous bets and, now get to keep “earning” their six and seven-figure incomes while their banks are in bankruptcy. And what do consumers get? They get to pay for incompetence of these avowed “free marketers” through taxes.

The banks also asked for – and got – a new bankruptcy law that makes it much harder for consumers to discharge debt. This makes it much more lucrative and less risky for banks to extend even more credit to the American consumer. The avowed “free marketers” claimed that the new law benefitted consumers who couldn’t get loans before – and therefore caveat emptor, let the buyer beware – and somehow this was a great way to let individual consumers decide what is best for them. But that is a very naïve view of how marketing and banking work. While not perfect, banks are far better at predicting which consumers are likely to default on a loan or credit card than the individual consumers themselves. Banks have the advantage of being able to model consumer behavior using enormous databases of past consumer behaviors to understand how similar consumers will act in the future. A first-time homebuyer has no experience paying a mortgage, property taxes and upkeep for a home.  So the bank has an overwhelming information advantage over the consumer, yet the new bankruptcy laws put the burden on the consumer. And what happens when the late charges and higher interest rates force homeowners to give up their homes, their down payments and their dreams? The banks take the homes and the US Government bails out the banks. And consumers get to pay again because the avowed “free marketers” got the bankruptcy law they insisted would help the consumers – but didn’t.

Trying to feed alongside the bankers at the trough of public money last week were American automobile companies. The group is led by G. Richard Wagoner, the CEO of General Motors. Mr. Wagoner is the same man who orchestrated his company’s purchase of Hummer in 2000 because he was confident GM had tremendous opportunities to “grow the brand” of a truck that yielded seven miles to the gallon. The same man who has been arguing against raising the US fuel economy standards and fervently fighting the reclassification of light trucks since at least 2001. The same man who, in 2002 when Toyota was experiencing tremendous success with the Prius, stated, “I don't think anybody's got confidence that the economics make any sense,” and then gave us the Hummer H2 – which gets eleven miles to the gallon. Now Mr. Wagoner and executives from Ford and Chrysler are pleading for subsidized loans to make more economical vehicles.

Of course the ultimate irony of all this is that the big three have been making gobs of money selling Americans gas guzzling SUVs over the past decade while their Japanese and European competitors focused on making great cars that are much more fuel efficient. Now the big three want the US taxpayer to subsidize building more fuel efficient cars so they can compete with their Japanese and European competitors – and make money by selling Americans more fuel-efficient cars to replace the SUVs they so happily sold them. So Mr. Wagoner pulls in millions a year over the past decade based on his leadership of (1) buying the Hummer brand, (2) lobbying Congress not to raise gas standards because that would make GM uncompetitive, (3) selling Americans gas guzzling vehicles, then (4) realizing that GM needs to sell Hummer because no consumer would buy a Hummer with gasoline at $4 a gallon, and (5) lobbying Congress for more handouts, because somehow items 1-4 were not his fault. And what do the American consumers get? Gas guzzling vehicles, more polluted air, greater dependence on foreign oil and, ultimately, stuck with the bill for Mr. Wagoner and his avowed “free market” cronies’ highly paid “leadership.”

Adam Smith was right. True capitalism benefits the consumer. But too often, the needs of America’s consumers are almost constantly sacrificed to the needs of America’s producers.