Adam Smith, Milton Friedman and the Social Responsibility of Business

Over the next couple of weeks, we’ve asked our writers (and guests) to respond to the question” What is the Social Responsibility of Business?”  Please comment away or contact us if you’d like to offer an opinion.

Adam Smith, an 18th century economist and author of The Wealth of Nations, is often viewed as the father of modern capitalism. Smith’s three main underlying concepts were the “invisible hand,” that individuals pursuing their own best self-interest would result in the greatest overall good to society, and that levels and kinds of goods and services in the market should be determined by the free market alone (i.e., not by government).

The first notion, that of the invisible hand, suggests that people essentially vote with their dollars. If we want a society with nothing but solar energy and organic food, we’d all go out and buy those things and not buy GMO or factory-farmed foods or coal-fired energy. This invisible hand would guide the suppliers in the marketplace to provide those goods and services for us, and there would be no such thing as coal power or GMO food.

The second notion, that an individual seeking his/her own best self-interest is actually the best thing that the person can do for society, indicated Smith’s belief that, given sufficient motivation for personal gain, each person would work hard, and as a result, society as a whole would benefit with more jobs, more competition, and better quality goods and services.

The third notion effectively just means that government should stay out of the market, and limit their role to police.

Smith is often held up by modern conservatives as a hero of capitalism and freedom, and a reason that subsidies for things like solar and wind power should not exist. Smith acknowledged the concept of externalities and other free market breakdowns, but didn’t really address them as a major challenge to society. Smith can be forgiven: when he was alive, there were less than one billion people on the planet, and the concept of externalities (mercury emissions, DDT, polychlorinated biphenols, stillbirths, cancer, and other disease caused by, but not paid for by, a business seeking its own self-interest) would have been foreign even to the most progressive economist.

Milton Friedman, a modern disciple of Adam Smith, is now often championed by conservatives for furthering Smith’s line of thinking, with perhaps his most famous quote underscoring the concept of the social responsibility of business from a conservative point of view:

“There is one and only one social responsibility of business — to use its resources and engage in activities designed to increase its profits.”

It’s a line that is often repeated by conservatives as a defense against claims that companies should be doing more. The challenges with this line of thinking, of course, is that single-minded focus on profit maximization is what led to the creation of bundled mortgage backed securities that led to the housing bubble that virtually melted down the global economy in 2008 (and realistically, to pretty much every speculative bubble in economic history). Friedman did eventually go on to add, “So long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.” And of course, deception and fraud can be defined in many ways.  (Friedman was also fervently against privatization of jails and openly supportive of the legalization of drugs, which is often overlooked by conservatives).

The main challenge to this Smith-Friedman version of reality is that it can never be so simple.

Corporations doing business create side effects, and if they are not responsible for those side effects, the whole free market system breaks down. It’s factory farms using antibiotics for their own gain (faster fattening of animals to bring to market) and causing antibiotic resistant bacteria that is now a public menace. It’s pesticide use that is killing honeybees and causing a decline in pollination for other farmers. It’s coal plants that produce mercury emissions and cause birth defects and respiratory ailments. The list can go on and on and on.

Smith, to his credit, at least acknowledged it. Joseph Stiglitz, a modern Nobel Prize winning Economist, said, “Whenever there are externalities–where the actions of an individual have impacts on others for which they do not pay, or for which they are not compensated–markets will not work well.”

Conversely, Friedman, according to the otherwise conservative Motley Fool Stock Advisor, had it dead wrong with his quote on profit being the only social responsibility of business. The Fool suggests that, as opposed to Friedman’s singular vision, investors take the long view, rather than focusing on quarterly reports, in part because quarterly reports give companies incentives to finagle and fudge on their responsibility to society for openness, corporate citizenship, and well, social responsibility.

Follow Scott Cooney on twitter and read his writings at the Inspired Economist.

Scott Cooney, Principal of and author of Build a Green Small Business: Profitable Ways to Become an Ecopreneur (McGraw-Hill, November 2008), is also a serial ecopreneur who has started and grown several green businesses and consulted several other green startups. He co-founded the ReDirect Guide, a green business directory, in Salt Lake City, UT. He greened his home in Salt Lake City, including xeriscaping, an organic orchard, extra natural fiber insulation, a 1.8kW solar PV array, on-demand hot water, energy star appliances, and natural paints. He is a vegetarian, an avid cyclist, ultimate frisbee player, and surfer, and currently lives in the sunny Mission district of San Francisco. Scott is working on his second book, a look at microeconomics in the green sector.In June 2010, Scott launched, a sustainability consulting firm dedicated to providing solutions to common business problems by leveraging the power of the triple bottom line. Focused exclusively on small business, GBO's mission is to facilitate the creation and success of small, green businesses.

6 responses

  1. This is an excellent post. Friedman’s point of view on CSR has been the most prevalent argument against CSR. It’s important to view his ideas (and Adam Smith’s) in context and understand both sides. Businesses are, inherently, ways of building profit and, as long as they stay within the legal guidelines, they will continue to do so. However, if the products or services these businesses create cause collateral damage, it’s their responsibility to find ways to lessen or eradicate any damage. Society cannot change the way businesses run, if they have any power to change at all. However, if society and businesses find common ground, change can be made – and that is CSR.

  2. You must remember, Adam Smith was also a social philosopher. I’d imagine he expected people, acting in their own self interest, to behave in a moral and just fashion. The Wealth of Nations did not consider unethical or fraudulent behavior by individuals as a given in a capitalist system.
    Similarly, corporations can act as good citizens or exploit the law to create negative externalities in the name of profits.
    Economics is a social science that, in order to be explained, has to make many assumptions. Perfect Information is one assumption that is required in order to derive the supply and demand curve. But Perfect Information is impossible.
    This is where free market economics fail: People believe that many assumptions to economic models can exist in reality and use these to justify behavior. Which leads to the need for regulation and CSR.

  3. What both Smith & Friedman point out is that the court system is in place to force civil and or criminal penalties to those who commit harm. Smith & Friedman were 100% correct.
    Any time the government steps in & artificially regulates the market through feel good utopian ideals styled legislation, it harms the market. This can be seen in every industry that is regulated, which is every industry. The cost of compliance with these regulations increases the cost of goods & services across the board, PLUS it affects the ability of competition to have the same entry point, thereby artificially reducing competition.
    For a group of people to think they can presume all the externalities of a market, then centrally plan what is best for that sociaety based upon their limited understanding of an infinate possiblility of externalities is narcissistic at best.

    1. Huh? I’m not sure how the leap is made from “increasing profits” to shortsightedness, finagling and fudging. Reads a bit like isogesis to me. It is not news that people can quote Friedman and then debase themselves with unwholesome business practices of which he would never approve. That does not make Friedman or his ideas unwholesome. None of Friedman’s detractors take on his argument that CSR is merely a ruse for spending someone else’s money.

    2. A core issue in my MBA program was the intersection of business-society-government. A major role in government vis a vis business (as Friedmann even acknowledged) to ensure business was conducted in the open without deception or fraud. “ much money as posibble while conforming to the rules of society, both those embodied in law and those embodied in ethical custom.”

      Society demands – as it has from the earliest times that no one member can injure of other members. If you have something dangerous on your property and it escapes to injure, kill or diminish the value or enjoyment of others on theirs or public space you are financially accountable. The example from anglo saxon England was mr. Brown’s bull. It escaped and damaged property and killed a man. Mr Brown had to pay wier geld and the bull was destroyed. Mr. Brown knew a bull is dangerous and had a duty to ensure that it did not get loose and cause trouble. Hence clean air & water act; noise ordinances & speed limits and so on.

      Friedman would never have supported unregulated and invisible derivatives or naked CDSs.

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