Thursday, November 03, 2005

Invisible Hand no 26

In this week’s New Statesman (UK) Patrick Hoskins, financial editor of The Times reveals scandals in the financial services industry.

Read the article at (subscription): http://www.newstatesman.com/nssubsfilter.php3?newTemplate=NSArticle_Economy&newDisplayURN=200511070016


Patrick Hosking’s case against the mess in financial services is fairly compelling. However, his inclusion of comments about Adam Smith’s views in the article is quite unfortunate:

“Bankers, insurers and investment professionals wax happily about the near-mystical way that individual choices, though selfish in themselves, lead collectively to the best of all possible worlds.

Yet it is in the financial services industry, above all other sectors of the economy, where Adam Smith's "invisible hand" goes wonky.”

Whatever bankers, insurers and investment professionals may ‘wax happily’ about the ‘near mystical way’ of markets, that was never a view attributable to Adam Smith. True, it is a fairly common interpretation of Smith’s views but not one based on his writings, either in ‘The Theory of Moral Sentiments’ (1759), nor in his better known, but not more important, “Wealth of Nations” (1776).

There is nothing ‘mysterious, ‘mystical’ or ‘miraculous about Smith’s analysis of markets. Indeed, the invisible hand, mentioned only once in “Wealth of Nations” (WN VI.ii.9: p. 456) was not about markets, but about a special case of human motivations assisting domestic economic growth. There is no theory of invisible hands in Adam Smith (it was Shakespeare’s metaphor actually: Macbeth 3:2).

On numerous occasions in “Wealth of Nations” he rails against the perfidious proclivities of ‘merchants and manufacturers’ to monopolise, rig supply, raise prices and cheat consumers. Smith’s markets are not ‘wonky’; the people in them were, and some clearly still are.

Self-interest in Smith’s accounts does not automatically lead to the ‘best of all possible worlds’ – it can and does often produces worse outcomes. He warned that selfish players have to be watched with vigilance and the best form of vigilance is open competition, the application of law and the firm remedies of justice. This is why he never advocated laissez faire. If the law in financial markets is lacking, that is not reason to score cheap points against Adam Smith and his legacy.

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