Monday, March 19, 2007

Smith's Natural and Market Prices had Nothing to Do with Invisible Body Parts

Indian newspapers are written by educated journalists and contributors. They often refer to Western intellectuals with a familiarity that shows their university syllabi include swathes of work from philosophers, economists and other figures at home to students in North America and Europe. Unfortunately, this includes the Chicago version of Adam Smith and derivatives therefrom.

In today’s Times of India editorial (19 March) I come across these paragraphs in an article about bears running rampant in the stock market:

When the market is overheated, as many analysts believe about the Indian stock market, it is natural that bears will come in to the picture and pull it down.

That is exactly what Adam Smith meant by the invisible hand — the free market would always adjust to a stable equilibrium. Or to use the laws of physics: What goes up must come down.”

See what I mean?: ‘the free market would always adjust to a stable equilibrium’. And, apparently, this is ‘exactly what Adam Smith meant by the invisible hand’!

Exactly where did he write that he ‘meant’ anything remotely like this assertion? Certainly not in either Moral Sentiments or Wealth Of Nations. He explained in Book I of Wealth of Nations how market prices would oscillate around the notional ‘natural price’ – the price at which the contributors to its costs of production received their full value – and how market price deviations from natural price signalled whether to supply more or less of their contributions (land, labour and capital). But he said nothing about ‘adjusting to a stable equilibrium’. Market prices were actual prices, natural prices were coincident with factor costs, not real, and nothing he said in Book I was to do with financial instruments or share prices.

Moreover, he wrote of ‘an invisible hand’ in Book IV in the context of the consequences of human motivation – risk aversion – and not in relation to market prices. That was added by the neoclassical economists of Chicago and their epigones who spread across the world’s campuses armed with notions about Adam Smith bearing no relation to the Adam Smith from Kirkcaldy.

Sometimes a little knowledge is dangerous to truth and accuracy, both valued among credible journalists.


Blogger Kip & Alisha said...

Smith's natural price was actually "the natural price to which the market price is always gravitating." You are referencing the labor theory of value, which states that the intrinsic value of a commodity is determined by the cost of the labor input in the production of the commodity (labor wages)

5:21 pm  

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