The Wealth of Nations

by Adam Smith

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In The Wealth of Nations, does Smith overlook any potential problems with the free-market system?

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While Smith's work was foundational for the discipline of economics, technology and business practices have changed radically over the past few centuries.

Free markets depend on symmetry of information. A consumer who wishes to buy a dozen eggs and can find out the prices at which local farmers are offering eggs will seek out the lowest-priced eggs, causing downward pressure on the price of eggs until the price is close to the cost of production. Contemporary algorithms for pricing of airline seats, or many other products sold over the internet, can vary prices depending on customer's presumed income and level of interest in the product, making it difficult for customers to discover and compare prices. This information asymmetry can lead to artificial pricing.

Next, Smith did not analyze "network effects." Companies such as Netflix and Amazon draw in customers because they already have a wide range of products, and this large customer base makes them attractive to vendors (and able to dictate terms to vendors), which in turn attracts more customers. This leads to de facto monopolies, making "free markets" noncompetitive and even monopolistic.

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There are many possible problems with the free market system that Smith does not point out in this book.  I will discuss two of them here.

First, Smith does not discuss the problem of what economists call "negative externalities."  In Smith's vision, companies compete ruthlessly to make profits and this helps society.  However, think about what can happen due to competition.  Companies may cut corners as they try to compete.  They might, for example, stop disposing carefully of their hazardous waste and, instead, dump it in ways that harm other people or the environment.  Smith does not contemplate these sorts of harms that can come from competition.

Second, Smith does not foresee that firms would tend to get bigger and bigger and stifle competition.  In Smith's day, firms were small things with a few employees.  Today, there are huge firms which do not really have much in the way of competition (think of cable companies).  These companies are able to concentrate wealth in the hands of a few rather than distributing it to the many in the way Smith anticipated.

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