Friday, July 15, 2005

Nothing Mysterious About Markets

From today’s Times: Trade needs that moral dimension by Graham Searjeant, Financial Editor, 15 July 2005:

“In the Age of Enlightenment Adam Smith showed how an “invisible hand” of competitive markets translates the pursuit of individual self interest into the common good. But that applies strictly to the best use of resources to create wealth.”

Adam Smith said nothing of the kind. The metaphor from Shakespeare (Macbeth: 3.2: 47: ‘thy bloody and invisible hand’), that he used only three times in three publications (‘History of Astronomy’; ‘Moral Sentiments’ and ‘Wealth of Nations’), had no direct connection to competitive markets. That it is continually linked, as in Graham Searjeant’s article, is testimony to the extent that Adam Smith’s legacy has been usurped by academe and journalists for purposes he never intended.

Smith’s use of the invisible hand metaphor was about human motivation and the unintended outcomes that could follow, sometimes benign but other times not. That pagan superstition ('History of Astronomy') used the ‘invisible hand of Jupiter’ (the Roman god) to explain the mysteries of life was not about markets; that Feudal lords('Moral Sentiments') distributed food, etc., to their retainers and serfs to produce nearly the same distribution by an invisible hand as would have happened had the land been equally divided, was not about markets, and nor was the fact that because local merchants ('Wealth of Nations'), led by an invisible hand, preferred to use their capital locally rather than in distant lands, about markets.

Smith’s writings on markets and the relationship between ‘market’ and ‘natural’ prices (supply and demand) are in a separate chapter in ‘Wealth of Nations’ to his single reference to an invisible hand. It could as easily be argued that when a firm dumps toxic chemicals in the river it is led by an invisible hand to cause something it did not intend, and so on. Smith spent many pages in ‘Wealth of Nations’ denouncing the activities of ‘merchants and manufacturers’ whose self interests brought about monopolies, restricted supplies and higher prices.

Using the invisible hand as Graham Searjeant does to say that Smith: ‘showed how an “invisible hand” of competitive markets translates the pursuit of individual self interest into the common good’ is a travesty of his themes. The self-interested actions of polluters, thieves, rogues and corrupt officials debase the morality of markets. As we do not know which people in competitive markets are in which group (benign or malign) until after the event, we cannot ascribe a general law of approval to their motives and the common good.

Markets are composed of people, acting in concert, but not necessarily in tune, and there is nothing miraculous or invisible about their outcomes (modern economists have bled dry the vibrant, local markets of Smith’s “Wealth of Nations” in their mathematical abstractions). Smith wrote clearly and showed how prices tended to gravitate towards their natural prices. There was nothing invisible in this process and it needed no metaphor.

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