Freeman

ARTICLE

Liberty and the Domain of Self-Interest

Markets Channel Self-Interest to Serve All of Society

NOVEMBER 01, 1996 by STEVEN HORWITZ

One of the most frequent charges leveled at those of us who support free-market capitalism is that our ideas are just an ideological cover for a defense of naked self-interest. By supporting the right of owners to dispose of their property as they see fit and their right to keep the profits they might make by doing so, the charge goes, we are defending the anti-social selfishness of those owners. By implication, we are opposing the rights of the masses to receive a living wage or fair prices. On this view, the selfish, greedy search for profits is responsible for poverty, crass commercialism, and the general decline of society. The world would be better off if we all acted more altruistically and more out of concern with others’ welfare than with our own—and if we won’t do it, the state should. The pro-capitalist perspective is ruled out of the discussion because it defends immoral self-interest.

So what are we to do? I suggest that the best way to respond to these charges is not to debate the merits of self-interest in the abstract, but to examine the relationship between the organization of society and the benefits or damage created by self-interest. Empirically, does society work better or worse when self-interest is given freer reign? In what sorts of social groups will self-interest work or not work? These are questions that can be addressed by economics, sociology, political science, law, and, of course, history. They are theoretical and empirical issues, not just philosophical or moral ones. I propose that we should defend self-interest on the grounds that, at least in the large heterogeneous world of an advanced nation (what F. A. Hayek called the Great Society), self-interest works. Economic and social institutions that give self-interest greater latitude simply produce more wealth and lead to longer and higher quality lives.

Kinds of Societies

Let us distinguish face-to-face groups from anonymous or Great societies. In face-to-face groups, all or most of the members know each other individually, and generally have shared preferences and goals. People can coordinate their plans through ordinary face-to-face processes, like talking to each other. Examples of such groups would be tribal groups of an earlier era, families today, small firms, sports teams, college fraternities and sororities, armies, and perhaps religious organizations. Each participant knows a lot about the others. In almost all of them, not coincidentally, the needs of the group dominate the needs or wants of the individual.

By contrast, these features are absent from the anonymous society. In the anonymous society, we know only a very few of the other participants at all well. Preferences and goals are quite heterogeneous. Social coordination requires anonymous and abstract processes, such as the market. Examples of anonymous social groups abound: virtually every regional economy on the planet, as well as some other large organizations, such as big firms and much of what happens on the Internet. In anonymous social groups, individuals know little concrete information about one another. Almost all such groups, not coincidentally, are based (or work better when they are based) upon the primacy of the individual over the group.

This notion of interplay among group size, knowledge of the other, and self-interest is not new. In fact we can trace it back to Adam Smith. Consider his explanation for why we need to rely on self-interest:

 

In civilized society [man] stands at all times in need of the co-operation and assistance of great multitudes, while his whole life is scarce sufficient to gain the friendship of a few persons. . . . [M]an has almost constant occasion for the help of his brethren, and it is in vain for him to expect it from their benevolence only. He will be more likely to prevail if he can interest their self-love in his favour, and show them that it is for their own advantage to do for him what he requires of them. . . . It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, 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.[1]

Note that Smith’s explanation is not about any moral failing or the like. Rather, it is simply a fact that altruism won’t work, because we don’t know enough other people, and implicitly don’t know enough about them, to be able to determine what it is that they want and what they can provide for us (not to mention how best to produce either). A world run purely on benevolence just isn’t feasible, so we must rely on self-interest to get the job done in an indirect way. The key, though, is that for Smith, the value of self-interest derives from the structure of the society.

Why is that? In the face-to-face world, we can, to a large degree, act selflessly because we know what the interests of others likely are and what the interest of the whole group might be. The adequacy of our knowledge is made possible by the simplicity of the social structure. In a small, homogeneous group, the range of preferences is probably narrow, as are the resources at the group’s disposal. The economic problem (determining what to do and how to do it) is not overly complex and can be solved through face-to-face processes.

In a hunter/gatherer group, for example, the elders understand how everyone fits into the scheme of things. When the tribal elders say go catch fish today, they speak from knowledge of how this decision will benefit the group as a whole. Or take a sports team: the head coach of a successful hockey or baseball team assigns each player a role on the basis of his knowledge of how and why the person playing that role benefits the team as a whole. The players (and hunters) cooperate, because the hierarchical system works. Of course military examples might be cited as well.

Acting in one’s narrow self-interest, in these situations, is gauche or downright anti-social. The athlete who puts himself above the team is usually (although less so than in years past) rewarded with a spot on the bench. In a family, putting yourself above the group is considered a sign of immaturity. In the military, or a tribal clan, putting yourself ahead of the group can mean not just your own death, but the death of the group. To go your own way in such groups is to invite the destruction of the whole group by upsetting the delicate web of relationships that defines it and makes its survival possible.

In the Great Society, however, things are radically different. Here, we know very few people very well and this makes it ineffective for us to act selflessly. Those we know well are such a small proportion of the people we directly interact with, to say nothing of those with whom we interact indirectly, that the task of determining others’ or the general interest is hopelessly beyond our capabilities. When we think of interaction in anonymous societies, we might be tempted to only think of direct interaction: those whom we meet face to face in an ordinary day. Yet we interact indirectly with countless others, most of whom are not aware of their relationship with us, nor ours with them. Leonard Read’s classic article I, Pencil makes this point as simply and effectively as anyone ever has.[2]

The variety and sheer number of others in the Great Society makes intentional altruism very difficult to practice. What does it mean to act in the best interest of others? How do we know and what do we do? Thus self-interest is the solution by default. But, we must still interact with those around us, even if we don’t know them personally. We cannot simply go blindly through the world ignoring others, just because we can’t act directly in their interest. We need to form some expectation as to others’ behavior. Thus anonymity poses some different problems for us than does the face-to-face world. Where face-to-face conversation could coordinate all our plans in that world, it won’t suffice in the anonymous world of the Great Society. There are too many people we would need to talk to. The question now is: how do we channel self-interest into beneficial results?

Coordination in Anonymity: Markets and Self-Interest

Here is where the market comes in. The institutions of the market allow for self-interest to be channeled in ways that serve the interests of the society as a whole. As Smith pointed out: the lure of profit encourages entrepreneurs to produce the goods that people want, and to produce them as economically as possible. In the Great Society, signals from profits and losses substitute for the direct knowledge available in the face-to-face world.

The development and use of market prices is key to the coordinative role of the market. As Hayek pointed out so carefully 50 years ago, prices convey knowledge.[3] That is, market prices enable us to overcome our limited knowledge of others by serving as a symbol, a substitute, for the vast amount of detailed knowledge we would need to acquire to know what others wanted. Prices are more than just numbers. They are more like words that convey meanings to those who make use of them.

Prices that are permitted to move freely as people buy and sell, or refrain from buying or selling, reflect the knowledge and preferences of market participants. When I buy a quart of milk at the store, I am not only satisfying my own thirst but also sending a signal to others in the market about what I want and what I’m willing to give up to get it. Market exchanges are a form of communication, and as such, they enable us to overcome the knowledge limitations that are inherent in anonymous societies.[4] Others in the milk market don’t, can’t, and don’t need to, know exactly what’s in my head. They don’t even need to know who I am. When I buy that quart of milk, I am providing them with a condensation, or a crystallization, of the information they do need in order to know what to produce and what to charge for it.

On the other side of the ledger, milk producers have to watch the prices they pay for the inputs into milk production. If plastic bottles get more expensive, that will perhaps prompt them to switch to paper cartons. The prices of inputs provide information not only about what to produce, but about how best to produce things. Of course the milk I buy at the store is for my own personal consumption, but a local restaurateur might buy milk, or other products at the grocery store, to use in her dishes, using the same kind of milk I consume directly as an input into restaurant production. The interconnections of the marketplace are vast indeed. The self-interest of producers and consumers leads both groups to find the most cost-efficient ways of finding what they want to buy and producing what they want to sell.

Prices enable us to calculate profit and loss, perhaps the most powerful bridge between self-interest and social well-being. A restaurant that produces and sells meals that are more valuable than the combination of inputs used in producing them will make a profit, while a restaurant that fails in this regard will incur losses. Profits and losses link the self-interest of producers to the public interest by steering owners of capital to use their resources in ways that increase their value. A successful producer has created value and has benefited society by increasing the value of the total stock of resources. As the economist William Hutt once wrote, profits are proof of social service.[5] An entrepreneur who makes a profit in the marketplace has benefited others by giving them something they wanted more than alternative uses of the resources.

Self-Interest as a Virtue

Despite this argument we continue to hear moral condemnations of self-interested behavior. Sacrifice and altruism are said to be our highest calling. Economic activity is deemed to be beneath the truly virtuous activities, such as providing charity, creating art or music, or pursuing pure science. Why this condemnation of the driving force of the market and, by implication, all of the benefits that the market brings with it?

My guess is that people who condemn self-interest generally don’t understand the factual connection between self-interest and social benefits. Explaining that connection is the real contribution of economics. The connection matters not just for how we understand the social world, but for how we morally appraise actions within that world. Those who condemn self-interested behavior as anti-social should make an effort to understand what the social effects of such behavior really are, beyond those intended by the actor.

Because the immediate motivation of much economic activity is self-interest, such activity is not thought to be as noble as art or science. However, if it is true that self-interested activity in the market creates value and benefits others, then why isn’t it as noble as these other human endeavors? Why are the acts of inspired creativity that invented and marketed the personal computer, or even Velcro, any less noble than the creation of art or music or the pursuit of science? All of those activities benefit others and are driven by the creator’s urge to produce. The only difference is that entrepreneurs are frequently explicitly and overtly driven by a particular type of self-interest, namely financial. But why does it matter what the motivation is, if the results are beneficial? Why do we care so much about why people do things instead of the results they produce? Would the personal computer be any more important or more useful had it been invented by monks seeking to serve others, rather than by business people and engineers seeking profit and the satisfaction of intellectual curiosity?

One of the important unintended consequences of self-interest in the market is an increase in the pleasantness of social interaction. For example, if you call a mail-order company like L.L. Bean to buy something, order takers are normally helpful and treat you with respect. Most restaurants will go out of their way to prepare your food the way you want it. Neither the phone sales clerk nor the waitress knows you as a person, but she treats you with a civility not all that much different than she would treat a friend she cared about. Now it’s true that workers are acting this way because it’s in their self-interest to do so—they lose profits if they lose customers. But who cares? Isn’t this a better way to interact than a world where markets and the self-interest in civility are absent? Customer service in Eastern Europe and the former Soviet Union was largely nonexistent, and is only now emerging with the turn toward markets.

The Limits of Self-Interest

My defense of self-interest in the marketplace is not a blind defense of self-interest at all times and in all places. I’d like to discuss two settings where self-interested behavior is not to be praised.

The first is perhaps the most important. Self-interest, including and especially that of business owners, can do great damage when it works its way through the political process. In the mixed economies that characterize virtually the entire world these days, people have two broad ways of increasing their individual wealth (outside of direct theft): they can operate in the market arena and try to profit by voluntary exchange, or they can operate in the political arena and try to profit by subsidies or restrictions on their competitors. Both of those options involve self-interested behavior, yet the consequences are dramatically different. Market competition channels the self-interested struggle for profits toward producing what people want and producing it efficiently. When firms pursue self-interest through political action, they seek to benefit themselves by preventing the socially beneficial communication process of market exchange and competition from having full force.

Acting on one’s self-interest by using the state to coerce others is anti-social behavior. It negates the social benefits which derive from market competition and it prevents the socializing and civilizing process of interdependence which grows out of that competition. The greater coarseness and lack of civility we see in political discourse these days is precisely because wealth-seeking through politics is more important than ever before. The political process is a zero-sum game exactly in the way the market is not. In politics, my gain is someone else’s loss: dollars for my spending program require more taxes or funds taken from other programs. In the market, my gain means creating wealth, a positive-sum game. In politics, either you win or you lose. In market exchanges, both sides win.

The other area where self-interest is problematic is in the bits and pieces of the face-to-face world that exist all around us: families, firms, teams, friends, churches and synagogues. A family remains a bubble of face-to-face interaction embedded in the larger world of anonymity. The same for our places of work and worship and our circles of friends. Some free marketeers, particularly those influenced exclusively by economics or by Ayn Rand, leap to the conclusion that self-interest is always the way to go. Well, it isn’t. There is nothing unlibertarian about sacrificing for one’s family, or taking on an assignment at work that one really doesn’t want but will serve the firm’s interest. In these face-to-face domains, we have to play by the appropriate set of rules. Self-interest belongs in only those areas where it generates beneficial consequences and is ultimately a socializing form of behavior. Where self-interest is anti-social, such as politics in the mixed economy or in any of the face-to-face domains mentioned, it does not belong.

Conclusion

Those who vigorously defend the free market should not be uncritical defenders of self-interest. Self-interest is morally praiseworthy in those areas where it unintentionally produces consequences that benefit others. Where self-interest is either inappropriate (the family, firm, or house of worship) or anti-social (political wealth transfers), we should condemn it. As the dominant cultural forces continue to rail against self-interest in almost all of its forms, and never pause to consider where altruism works and where it simply doesn’t, we need to be ever vigilant about defending self-interest where appropriate. Misunderstanding the role—and limits—of self-interest can lead to political and economic disaster.


1.   Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (Chicago: University of Chicago Press, 1976), p. 18.

2.   Leonard Read, I, Pencil, reprinted in Free Market Economics: A Basic Reader, compiled by Bettina Bien Greaves (Irvington-on-Hudson, N.Y.: Foundation for Economic Education, 1975).

3.   F. A. Hayek, The Use of Knowledge in Society, reprinted in Individualism and Economic Order (Chicago: University of Chicago Press, 1948).

4.   See Steven Horwitz, Monetary Exchange as an Extra-Linguistic Social Communication Process, Review of Social Economy, 50(2), Summer 1992.

5.   W. H. Hutt, The Keynesian Episode (Indianapolis, Ind.: Liberty Press), p. 76.

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November 1996

ABOUT

STEVEN HORWITZ

Steven Horwitz is the Charles A. Dana Professor of Economics at St. Lawrence University and the author of Microfoundations and Macroeconomics: An Austrian Perspective, now in paperback.

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