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What does the following quote from The Wealth of Nations suggest about the merits of a free-market system?
“People of the same trade seldom meet together even for merriment and diversion, but the conversation ends in a conspiracy against the public or contrivance to raise prices” (Adam Smith, 1776, book 10, chapter 8).
Quick answer:
Adam Smith's quote highlights the tendency for individuals in the same trade to conspire to raise prices, which harms consumers through price collusion. However, Smith argues that government should not facilitate or prevent such meetings, as free-market competition naturally undermines conspiracies. In competitive markets, price collusion is difficult, ensuring fair pricing. Smith believes the free market, not government intervention, best regulates prices, preventing monopolistic practices and benefiting consumers.
Many critics of the free-market economy quote this particular excerpt from The Wealth of the Nations to show that their ideas correspond with those of the great Adam Smith. Unfortunately, it's often the case that such critics then conveniently omit what Smith goes on to say in the very same chapter:
It is impossible indeed to prevent such meetings, by any law which either could be executed, or would be consistent with liberty and justice. But though the law cannot hinder people of the same trade from sometimes assembling together, it ought to do nothing to facilitate such assemblies; much less to render them necessary.
In other words, governments shouldn't frame laws that actively prevent businessmen from conspiring against the public through price cartels, price-fixing, or other such measures. Nor, for that matter, should they be in the business of making it easier for them to do so by...
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devising regulations that protect producers involved in such conspiracies.
In Smith's view, then, the only way that businesses can succeed in any kind of "conspiracy against the public" is if they are given protection by government regulation. If not, then the pressures of market competition will ensure that conspiring businesses involved in price-fixing will be undermined by their competitors.
In short, it's the free market that is best placed to end any such conspiracies, not the intervention of government, however well meaning. When all is said and done, it is the market that decides prices, not government intervention and not the price-fixing activities of businesses involved in a conspiracy against the public.
In The Wealth of Nations, Adam Smith writes,
“People of the same trade seldom meet together even for merriment and diversion, but the conversation ends in a conspiracy against the public or contrivance to raise prices.”
By this, he means that when people who have the same occupation get together, even when they get together to socialize, they discuss their jobs and ability to act in unison to raise prices to the disadvantage of the public consumer.
To simplify, Adam Smith is saying that whenever bakers or tailors, as examples, get together, even if they are spending time socially, they end up talking about what they each charge customers for a loaf of bread or to hem a dress. As a result of their discussion, they mutually agree to maintain prices at roughly the same level.
In modern terms, this is referred to as price collusion or price fixing. The Federal Trade Commission describes price fixing as
an agreement (written, verbal, or inferred from conduct) among competitors that raises, lowers, or stabilizes prices or competitive terms.
Adam Smith is arguing against price collusion. However, collusion is really only possible in a monopoly, duopoly, or oligopoly. In a monopoly, one person or entity controls all the supply of a product or service. A duopoly is characterized by the operation of two primary suppliers of goods or services. An oligopoly refers to a situation in which a few large corporations supply the goods or services.
When there are a sufficient number of competitors in the industry, it becomes extremely difficult to fix prices. In a competitive situation, the free-market system allocates resources and prices properly. As Smith says,
The price of monopoly is upon every occasion the highest which can be got. The natural price, or the price of free competition, on the contrary, is the lowest which can be taken, not upon every occasion indeed, but for any considerable time together.
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