The economic concept of ‘demand’ was developed in the 19th century but merging our wants with our needs has its roots in Adam Smith’s Wealth of Nation (1776). He observed that people were highly motivated to improve their own lives, spurring social progress. Yet the mechanics of supply and demand mean that poor people lose out.
Smith believed that self-interest, combined with specialisation from a more complex division of labour, would unleash so much productivity and innovation that even the poorest benefit. He claimed that markets are just because they advantage everyone, giving us permission to pursue our wants irrespective of other people’s needs. Famously he wrote that markets are ‘led by an invisible hand’ though the end of that sentence is less widely cited: ‘to make nearly the same distribution of the necessaries of life, which would have been made had the earth been divided into equal portions among all its inhabitants’
With the benefit of hindsight we know he was wrong. Today’s welfare state only exists because 19th century laissez-faire failed to address extreme poverty. In reality, the market would fill a rich man’s swimming pool before quenching a poor family’s thirst given sufficient disparity in wealth. Smith was right about capitalism’s productivity and innovation, but he was wrong to claim that market outcomes advantage the poorest. He let us off the hook regarding the well-being of others, making selfishness consistent with the common good. This is highly comforting for those who do well, but if something is too good to be true, it usually is.
Markets can be liberating, challenging established hierarchies and empowering people with choices through free exchange. People facing acute need do not participate in this win-win. Markets allocate on price and unequal bargaining power at the heart of every transaction systematically favours the stronger side. Money exerts its own gravity, and tends to mass into fortunes as market prices suck wealth up from the poorest.
On the supply side, all workers sell their produce or their time, but those trading to meet their basic needs are forced sellers. They must accept worse prices and lower wages because they have so little bargaining power. When your children will go hungry or some other need will not be met, you are not just competing with others in the market but also racing against the clock, because needs get worse over time. Those who survive this race to the bottom must tread water – they live to fight another day but are no better off. They cannot afford any advancement, or enjoy any choice, through which the rest of us progress.
A similar dynamic affects those on low incomes even where welfare assures their survival. They spend a far higher proportion of their income on food, water, shelter and energy. There is little left over for any goods and experiences that might improve their lives or enhance their productivity. The better-off spend far more on wants, gaining those enhancements while poor people are left behind and inequality rises.
As well as the gravitational pull of money, redistribution is justified by the price mechanism itself. We understand prices to work on diminishing marginal utility (DMU) – the more of something we have, the less we want more of it. An apple is nice, and I might even enjoy a second. But I’d pay less, the more they kept coming.
Economic orthodoxy resisted the consequences of applying DMU to money, arguing without foundation that money was a special case. That seems deeply self-serving when it merely tells the obvious truth that a pound is worth more to a poor person than to a rich one. As J.K.Galbraith put it: ‘For decades, rigorous theory had always held that the marginal utility of money … did not fall. [That it does] gave resounding support to the redistribution of income’.
Adam Smith proclaimed the justice of market distribution because it improved the lot of the poorest. That is not true. Instead, market prices systematically favour the wealthy and redistribution is both just and maximises well-being. Still, markets are productive, innovative and responsive. We should use them, taxing and regulating where necessary to achieve democratically desirable goals, but recognising that, despite all the propaganda, market outcomes are not just.
* Alastair Bowman is a life-long Lib Dem who chaired Camberwell and Peckham from 2007 to 2010. He now lives in the French Pyrenees.
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19 Comments
The idea that ‘markets don’t work for poor people’ is, because it is a generalisation, false.
Markets work for some poor people. It works for people who are able to sell or use their talents to earn income and works especially for those willing to ‘better themselves’ by gaining skills, qualifications or experience so that their earning potential increases. We all know individuals who started in poverty and have managed to make a comfortable life for themselves and their families, often now owner occupiers who are mortgage free. Markets worked for them.
Of course, markets don’t work for those poor people who are unable or unwilling to work, and for those who have no interest or ability to better themselves to increase their earning power. The market will not meet their economic needs – therefore the state provides benefits that are paid for by taxing everybody else.
Whether free markets provide a ‘just’ outcome depends on your definition of ‘just’. Is it just that ‘he who does not work, neither shall he eat’ ? That is the outcome of free markets, but was also enshrined in the Constitution of the former USSR.
Smith said a lot of things and taking one bit of what he said on its own is not a sensible idea. Smith also said that when 2 or more businesses got together the result would be ‘a conspiracy against the public’. He also said, effectively, that the market couldn’t regulate itself and ‘the government should hold the ring’.
In other words he didn’t support unregulated free markets.
So you’ve set up an aunt Sally to knock down.
I’d generally agree with the arguments in the OP but I’d put it that the markets per se, at least in the short term, aren’t the problem for most people. The exception would be those who are incapable of participating in the market for reasons of physical or mental disability.
The problem of inequality is cumulative. The costs of living are lower at the same time as the opportunities for income are higher for those who have somehow managed to acquire more than the rest. Those who have wealth can use the asset value of that to borrow money far more cheaply than those who don’t have any. Those who own their own houses can live for free in them whereas those who don’t have to pay rent. Those who own more houses and more land are rent receivers rather than rent payers. The game of Monopoly is quite accurate in this respect.
So it’s relatively much easier to make more money once you have something to start with. Just like you’re much more likely to win a game of Monopoly if you start off well. The Duke of Westminster famously quipped that the best way to get rich was to have a direct ancestor who was a friend of William the Conqueror. Many a true word is spoken in jest! The process of the rich getting richer while the rest struggle along has been happening at least since 1066.
Thank you for you comments.
@ Brenda
You are describing people in a welfare state that probably contributed significantly to their success. People need some discretionary income before they can take advantage of the choices the market provides. Unequal bargaining power at the heart of every transaction systematically advantages the strong, making market prices unjust.
@ Mick
People hold different views about market justice, which helps shape their politics. Some oppose intervention and redistribution because ‘a rising tide lifts all boats’, and ‘wealth trickles down’. Smith’s ‘invisible hand’ is the most famous metaphor in economics because it falsely gave generations an easy shorthand to dismiss injustice. Moreover the distinction between wants and needs is important. Subsuming them into ‘demand’ gives gizmos the same investment priority as technology to save the planet, if equally profitable. It also explains, for example, why the NHS can work (something so valuable can be free at the point of use only because it is a need that very few want).
@ Martin
I completely agree. As Roy Jenkins used to say: the market should be our servant, not our master. We should use it to create an enabling society in which all are encouraged to fulfil their potential. It could make us richer as well as happier.
Alastair – thank you for such a very lucid piece. You have managed to set out what I have always suspected but have never been able to argue (I have never studied economics). Thank you. Please write more about this! And I will try to remember the end of Adam Smith’s sentence.
But markets DO work for poor people. Poor people in Britain today have much, much, much, much better standard of living than even rich people did in, say, 1900 — and that is as a result of markets.
In reality, the market would fill a rich man’s swimming pool before quenching a poor family’s thirst given sufficient disparity in wealth.
This isn’t true. There is more profit in providing water for poor people than in filling the swiming pools of the rich, for the simple reason that there are orders of magnitude mosre por people than rich people, and they all need to drive, while there are very few rich people with swimming pools that need to be filled. So the market, being interested in profit, will optimise for supplying drinking water to poor people (and indeed to non-poor people) because, due to scale, that is where the majority of the profits are to be found.
You should read The Constitution of Liberty.
@ John
Thanks for your appreciative comments. Since you ask, my novel Creative Destruction explores the difference between wants and needs and the social context of capitalism more generally. Increasing numbers do not feel the system is working for them, and we need a more inclusive economics to reverse that trend. My previous post argued that controlling inflation using taxes instead of interest rates would be fairer, more effective, and reduce the national debt. My next (and last for now) may be more controversial, arguing that free trade only benefits the tyrants.
“Poor people in Britain today have much, much, much, much better standard of living than even rich people did in, say, 1900 — and that is as a result of markets.”
A few points:
1) Rich people always had somewhere decent to live in 1900. Many poor people in 2025 either have very substandard accommodation or nothing at all.
2) Rich people usually had servants in 1900 so didn’t actually need automatic washing machines!
3) The positive changes that have come about in the last 100 years or so are largely the result of technological improvements. Probably some of them can be attributed to the private sector but the big leaps have been the result of wartime government expenditure.
You only need to look at the commercial aircraft that we had in in 1950 compared to just over a decade previously. They were quite a step up. Since then the progress has been far slower. The war brought big improvements in Radar and all kinds of electronics.
The internet is another example of government involvement.
To suggest that a person renting an overcrowded and expensive flat in the basement of what was once a spacious Victorian or Edwardian family home has a “much, much, much, much better standard of living” (rather too many “muchs” in there methinks!”) because the current occupant has a mobile phone, whereas the original owner occupant didn’t, doesn’t sound too convincing !
@ Alastair,
“My previous post argued that controlling inflation using taxes instead of interest rates would be fairer, more effective, and reduce the national debt.”
The economy used to be regulated this way. It all changed with the advent of monetarism which metamorphised into what is misleadingly termed New Keynesianism. The usual abbreviation of NK should be understood as Not Keynesianism. I’m not sure that even monetarism is an accurate description. It’s more like interest-rate-ism.
Whether it would reduce the National Debt is impossible to say. The National Debt is best understood, and should be understood, as the difference between all the ££ that have ever been spent into existence by the government and what has ever been received back in taxes.
The mainstream doesn’t accept this definition even though it would actually increase the figure for the ND.
So what has happened to the difference? Some £ notes may have been burnt in front of beggars by Bullingdon Boys but it the main it represents all the savings that users of the currency wish to make.
So unless and until the Government finds a way to control how much anyone else wishes to save it can’t control its debt level. It can only try to influence it.
1) Rich people always had somewhere decent to live in 1900. Many poor people in 2025 either have very substandard accommodation or nothing at all.
A poor person’s dwelling in 2025 is far superior to a rich person’s dwelling in 1900. It has better insulation, it has decent heating, it has a refrigerator and a freezer, it has gas or electric hobs and ovens rather than open fires or wood stoves to cook on, it has electric lighting rather than having to use candles, and speaking of candles the furniture is far more fireproof, the list goes on and on and on.
2) Rich people usually had servants in 1900 so didn’t actually need automatic washing machines!
But when washing machines became available they moved away from servants, didn’t they? So washing machines must be better than servants. Even if only because they are cheaper, leaving more money for other things.
3) The positive changes that have come about in the last 100 years or so are largely the result of technological improvements. Probably some of them can be attributed to the private sector but the big leaps have been the result of wartime government expenditure.
No, technological improvements in themselves don’t improve anyone’s life. What improves people’s lives is the productisation of technological improvements, and that only happens because markets make it possible to make a profit by making and selling products that utilise technological achievements.
I would say Dav is roughly correct: Thanks to markets, even people living in what we’d consider poverty to day have better standards of living than most of the population had 100 years ago (I’m not sure I’d extend the comparison to the ‘rich’ though). @Peter: somewhere decent to live in 1900 would have meant a house that was draughty, had no central heating, electricity or gas, heated by a coal fire in one room, with bed bugs and other insects all around, and if you were in a town, extraordinary levels of pollution. If you were a working man, you’d probably be at work 10-12 hours a day, 6 days a week. The food available was very limited in variety, with healthy food very hard to obtain (not that most people even knew what healthy food was). Medical care was basically, if you got ill, you either died or if you recovered it was thanks to your own body fighting the disease off. Do you really want to claim that poor people today have a worse standard of living than that?
@ Dav and Simon
I completely agree that markets are productive and innovative, but they did not end the terrible poverty of the 19th century. Instead, the Liberals introduced sickness and unemployment benefit along with old age pensions, and liberals like Keynes and Beveridge built the post-war welfare state. Markets can make us rich enough to tackle poverty, but it needs political action to make it happen.
<iThe National Debt is best understood, and should be understood, as the difference between all the ££ that have ever been spent into existence by the government and what has ever been received back in taxes.
That’s not true; this is looking at the national debt only in nominal terms. But the lenders who buy government bonds expect a real, not just a nominal, return on their investment. If the government were to immediately print enough money to pay off all its debts, then it could claim that the ‘national debt’ had been wiped out and nominally, that would be the case; however, the holders of the bonds would have been paid in a currency that had suddenly been so debased as to be practically worthless.
The result would be an instant bond strike, so that the government could no longer borrow any money at any price, until it could exercise sufficient fiscal discipline, for a sufficient period, to convince lenders that it would not ever do the same thing again; and even when people began to lend to it again the interest rates demanded would be ruinous.
Actually, markets in the 19th century did help poor people: The standard of living even of the poor was much higher in 1900 than it was in 1800. Check out this article: https://www.econlib.org/library/Enc/IndustrialRevolutionandtheStandardofLiving.html. Note this quote: No economist today seriously disputes the fact that the industrial revolution began the transformation that has led to extraordinarily high (compared with the rest of human history) living standards for ordinary people throughout the market industrial economies. (I know it says, industrial revolution, not markets, but the industrial revolution was largely driven by the market)
The thing is, markets over time tend to raise the overall standard of living, which helps everyone equally. People think that doesn’t help the poor because we insist on using the 60%-of-median-income definition of poverty. That definition means that if the standard of living of everyone (including the poor) doubles, we still claim poverty is just as bad – which if you think about it is absurd.
What markets don’t (usually) do is systematically redistribute income in favour of the poor, so the poor end up with a higher income relative to everyone else. You do need Government action (such as welfare benefits) to do that, and I’m not disagreeing with you there.
@ Simon
Industrialisation was driven by the market allocating capital to new and evolving technologies, which benefited from scientific curiosity, permissive politics, military competition … and the creation of corporations and limited liability to make capital more willing. The Corn Laws and imperialism increased real wages by driving down the cost of staples and raw materials, incorporating many more poor people into our supply chain when we once supplied our own wheat and textiles.
For people without assets, the labour market and their resulting wage is fundamental. Unless there is a labour shortage, some will go without work and many more will fear it, bidding down wages to subsistence for those without the skills to earn a premium.
@Alastair: The Corn Laws decreased real wages by driving up the cost of staples.
A “free” market economy is good for innovation and productivity, but favours gross inequality. We can contrast the US and Europe. The US military-industrial complex has delivered market leadership in technology, while the comparatively state-interventionist EU has lagged. But the “free” market US economy has also created a divided, unhealthy, and angry nation, whereas the “constrained” EU economy has been better at restricting poverty and preserving civilisation.
Which is the winning strategy?
I fear Trump has taught us that, for all the agonised blustering from his opponents, what works best for the US is ruthless self-interest and the wilful abandonment of alliances and constraints. The tariffs may sound comical, but the strategy is working. The UK and the EU have knuckled under.
The third world lobby has long agitated for “Fair Trade, Not Aid”, pointing out that what really keeps them poor is unequal trading relationships, whereby Western capitalism extorts minimal prices from third world mining and agricultural suppliers. But “Fair Trade” is a myth. Trade rules are set by the strong. What Trump has done with tariffs is to put Europe and Britain into a similar position to the third world – Weak patsies, who can be screwed with impunity.
Do we like that? Of course not. Should we pretend it isn’t happening? No. Can we expect the next US Democrat president, if any, to roll back Trump’s tariffs? Probably not. Will retaliation work? Unlikely.
Sorry, I don’t have any good answers – but we should recognise reality.
@ Peter
You are right, of course, I should have said Repeal of the Corn Laws.
@ David
I agree that trade is critical. I’ve just posted a piece on using the trade system to promote democracy and human rights.
Interesting post and discussion, trade and markets should exist to benefit all. Some will benefit more than others. Progressive policies will adjust the distribution of goods and services so that fairness and other social and environmental issues are addressed.