In raw terms, a free market is one where the prices for goods and services are determined by the forces of supply and demand without intervention from any external agency, such as a government or a monopoly. Although free markets have existed since one human first started trading with another, it was not until the 18th century that their mechanics were subjected to serious academic scrutiny. The most important free-market theoretician of his age was the Scottish economist, Adam Smith.
Smith (1723–90) was a moral philosopher and logician by training, and was heavily influenced by Enlightenment thought. His most famous work, An Inquiry into the Nature and Causes of the Wealth of Nations appeared in 1776 and contained many of his most important ideas, including that of the ‘invisible hand’, which he claimed guides the free market. It is, he suggested, the unseen force that ensures free-market economic activity is coordinated notwithstanding the absence of a centralized, organizing agent. To put it another way, the market provides those goods and services that society requires most efficiently when left to its own devices.
Writing at a time when mercantilism (see here) still held significant sway, Smith’s ideas were striking. He contended that the free market is driven towards optimum distribution by self-interest – the suppliers’ desire for enrichment through sales and the consumers’ desire to enjoy particular goods and services. Thus, suppliers will provide for consumers that they do not necessarily know or have goodwill towards, and similarly consumers will gravitate towards suppliers with whom they have no personal connection. Smith described the situation like this:
Every individual necessarily labours to render the annual revenue of the society as great as he can. Generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it . . . by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.
Smith did see some instances where government intervention was desirable – such as in the provision of health and education, where he feared supply might falter in the hands of private enterprise – but his idea of the ‘invisible hand’ has been pivotal to the intellectual establishment of modern, free-market economics.