Thursday, May 24, 2007

Call For Comments on Smith's 'Invisible Hand'

It has long been my view that ‘invisible hand’ explanations are redundant in Wealth Of Nations and Moral Sentiments because the instances they refer to are fully explained by Smith as a natural outcome from human behaviours.

That invisible hand explanations have become in the second half of the 20th century elevated into ‘principles’ or ‘theories’ of markets has more to do with an apparent need of Chicago-influenced neoclassical economists to sanctify their partial and general equilibrium models and is unfortunate, but they do not correspond to anything implied in Smith (he did not develop theories of perfect competition as we know of them today), nor did he write about capitalism (a word invented in 1854).

I have prepared a paper for the History of Economics Society 34th annual meeting, this year taking place at GMU, Fairfax, Virginia from 8 to 11 June. My paper is called: ‘Adam Smith’s Invisible Hand: from metaphor to myth’. It is in draft form at present.

I was reading a my chapter from my manscript for a new book on Adam Smith today (aiming to have a final manuscript for the published by the end of June) and I noted a few paragraphs indirectly related to the invisible hand debate, which sum up a theme running through my HES paper and I thought readers may be interested in reading them (hopefully, also commenting if so minded).

I quote the famous paragraph mentioning the metaphor first, followed by some full quotations from later chapters in Wealth Of Nations that provide a perfectly clear explanation of behaviours related to the famous paragraph that do not mention anything about ‘an invisible hand’. The omission is so glaring that my assertion that the ‘invisible hand’ explanation of behaviours are redundant is a sounder explanation of the metaphor than attributions to it by some economists nearly two hundred years later.

Here is the famous paragraph (Smith’s only reference to ‘an invisible hand’ in Wealth Of Nations:

‘By preferring the support of domestick to that of foreign industry, he intends only his own security; and 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. Nor is it always the worse for society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it.’ (WN IV.ii.9: p 456)

Compare this mystical explanation with ‘an invisible hand’ to how Smith explains what is going on in mercantile commerce five chapters later in Wealth Of Nations, which fully explains the process by which unintentional actions have unintended outcomes beneficial for society without mentioning, or implying, that ‘an invisible hand’ was at work:

‘The mercantile stock of every country, it has been shewn in the second book, naturally seeks, if one may say so, the employment most advantageous to that country. If it is employed in the carrying trade, the country to which it belongs becomes the emporium of the goods of all countries whose trade that stock carries on. But the owner of that stock necessarily wishes to dispose of as great a part of those goods as he can at home. He thereby saves himself the trouble, risk, and expence, of exportation, and he will upon that account be glad to sell them at home, not only for a much smaller price, but with somewhat a smaller profit than he might expect to make by sending them abroad. He naturally, therefore, endeavours as much as he can to turn his carrying trade into a foreign trade of consumption. If his stock again is employed in a foreign trade of consumption, he will, for the same reason, be glad to dispose of at home as great a part as he can of the home goods, which he collects in order to export to some foreign market, and he will thus endeavour, as much as he can, to turn his foreign trade of consumption into a home trade. The mercantile stock of every country naturally courts in this manner the near, and shuns the distant employment; naturally courts the employment in which the returns are frequent, and shuns that in which they are distant and slow; naturally courts the employment in which it can maintain the greatest quantity of productive labour in the country to which it belongs, or in which its owner resides, and shuns that in which it can maintain there the smallest quantity. It naturally courts the employment which in ordinary cases is most advantageous, and shuns that which in ordinary cases is least advantageous to that country.’ (WN IV.vii.c.86: p 628-9)

Smith continues in this vein because distant trade is ‘as necessary for the welfare of the society as a near one’. How then does it occur naturally that ‘some stock should be withdrawn from advantageous employment locally to distant locations where it is less advantageous? The answer is fully explained in the model from Book II (and not by the metaphor of ‘an invisible hand’), namely the higher profits obtainable in distance trade (scarcer capital is employed in distant than local trade, raising the market rate of profit above its natural rate), motivate individuals to overcome their risk aversions.

‘It is thus that the private interests and passions of individuals naturally dispose them to turn their stock towards employments which in ordinary cases are most advantageous to the society. But if from this natural preference they should turn too much of it towards those employments, the fall of profit in them and the rise of it in all others immediately dispose them to alter this faulty distribution. Without any intervention of law, therefore, the private interests and passions of men naturally lead them to divide and distribute the stock of every society, among all the different employments carried on it, as nearly as possible in the proportion which is most agreeable to the interests of the whole society.’ (WN IV.vii.c.88: p 630)

Again, he makes no mention of the metaphor of ‘an invisible hand’. There is no need for anything remotely mystical or literary about market incentives. The natural workings of markets are fully sufficient to explain what happens.

[If you have comments pro or contra, please send them to: gavin{AT] adamsmithslostlegacy DOT [com} and I shall forward in due course a copy of my paper. Thanks.]

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