Now You See It…

Adam Smith’s ‘invisible hand’: Is it really so invisible?

Published online: Mar 31, 2018 Articles Buzz Shahan, Chief Operating Officer, United Potato Growers of America
Viewed 366 time(s)

America’s founding year of 1776 saw a second event take place, little-heralded at the time, that economists the world over have examined and re-examined, and from which have been drawn key insights into how free-market economies function. It was also the year pioneer economist Adam Smith authored An Inquiry into the Nature and Causes of the Wealth of Nations.

Just as America’s formation forever altered human history, Smith’s observations forever altered economic theory. Diverging from contemporary economic belief of top-down management, Smith’s argument included a methodical discussion of the forces and principles that drive a free-market economy. Most notable are his concepts of the “invisible hand” and rational self-interest. Smith’s invisible hand is a metaphor for how price drives supply toward balance with demand. When oversupply destroys price, supply naturally adjusts downward until price rebounds. When price (margin) gets too high, capital (competition) enters the market, increasing supply, and price subsequently falls. A key component of this is that price tracks the health of the supply/demand balance; no government or local entity need set supply limits. All suppliers must do is observe price and measure it against production cost; this comparison tells them where they are from a profitability standpoint. Supply thus manages itself with price as the invisible hand that slaps the supplier across the face when he gluts the market and stuffs cash into his pocket when he gets it right.     

Smith describes how in a free-market economy, rational, self-interested individuals respond to these supply/demand forces to maintain equitable pricing. Process potato growers do this by acknowledging their mutual interdependence and the need to come together in regional associations for mutual benefit. Those unwilling to acknowledge grower interdependency become irrational, self-interested outliers that inevitably cause a lower price for everyone because no single producer has critical mass sufficient to drive an exceptional deal, although some naively think they can. Price can and will be no greater than the degree to which total supply matches—and does not exceed—demand.

Fresh potato production is no different: Whether in fresh or process potato production, no grower can claim independence from all other growers (suppliers). Grower independence cannot happen because total supply is what it is, and price reflects the value of that total supply as it mates with demand. When fresh market growers overproduce, that overproduction exceeds demand and price declines. When process growers overproduce and provide that overproduction to entities with whom they must negotiate price for next year’s contracted volume, they find that they have weakened their negotiating position. Such is the history of the past five years.

It’s comforting to know that a potato grower’s economic future can be secure. This is accomplished through sharing of market information among interdependent growers—market information that is tracked, gathered, collated and made available by grower cooperatives such as United and local process-grower organizations. Vegetable growers—potatoes are a vegetable—who understand and adhere to Adam Smith’s concepts of the invisible hand and of rational self-interest enjoy economic triumph. In potatoes’ case, this translates into a fair grower return. By recognizing grower interdependence as motivation to work together, fresh produce growers can and do achieve consistent financial strength.

Such people dot the western U.S. These people are fun to be around. They’re always happy to buy lunch, and to explain how growers work together to make success happen.