Thursday, March 13, 2008

A Serious Debate on the Invisible Hand

On a forum for historians of economic thought, I am engaged with several distinguished scholars in a mini-debate on the meaning that Adam Smith attached to the metaphor of 'an invisible hand', which regular readers of Lost Legacy will know exercises my energies and efforts from time-to-time.

I am pleased with this development because it means I am addressing serious people (not the usual media-light commentators who merely repeat what they were taught or read elsewhere in the media). We can assume safely that they are familiar with Adam Smith's work and have read his books. Therefore, if I can influence them to re-read what they already know - and which other readers to read out of interest - perhaps the isolated position that I am in as a defender of Adam Smith's Legacy may become less lonely.

Below is a contribution to a debate from the distinguished Professor Patrick Gunning, Professor of Economics, College of Business Feng Chia University 100 Wenhwa Rd, Taichung Taiwan and my comments. Professor Gunning writes:

‘I would refer to the following passage in WON:

"But the annual revenue of every society is always precisely equal to the exchangeable value of the whole annual produce of its industry, or rather is precisely the same thing with that exchangeable value. As every individual, therefore, endeavours as much as he can both to employ his capital in the support of domestic industry, and so to direct that industry that its produce may be of the greatest value; every individual necessarily labours to render the annual revenue of the society as great as he can. He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. By preferring the support of domestic 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 wors e for the 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. I have never known much good done by those who affected to trade for the public good. It is an affectation, indeed, not very common among merchants, and very few words need be employed in dissuading them from it.
" Book 4, chapter 2.

In light of the brewer statement (i.e., the butcher, brewer and baker statement -- Book 1, chapter 2), and other statements about self interest in WON, it seems to me that this invisible hand statement can be transferred seamlessly to the domestic economy without compromising Smith's intended meaning. Thus, it seems to me that attacks on the traditional view of Smith's meaning of the invisible hand (e.g., that it is mythology) are misguided and possibly wishful." Pat Gunning

Professor Gunning quotes part of Adam Smith’s Chapter 2 of Book IV only. I offer below a summary build-up to the famous extract that Professor Gunning selects. It is my case that the extract must be read in the context in which Adam Smith wrote it:

WN: Chapter II on 'an invisible hand': Taking each numbered paragraph up to the famous metaphor:

1 Restraints upon importation - increase monopolies in home market

2 Protected home monopolies encourage protected industries at expense of other
domestic industries - overall the benefits or otherwise not 'evident'.

3 General industry limited by the capital of society - no regulation can
increase society's capital; can only divert it.

4 Individuals seek most advantageous employment - this serves his
interests, but is also advantageous to society.

5 Merchants prefer home trade provided they can obtain 'ordinary, or not a
great deal less', profit, and consequently supports domestic industry.

6 [long paragraph] Merchants prefer 'upon equal of nearly equal
profits' [elsewhere in Book IV Adam Smith shows colonial trade was more
profitable than domestic trade] the 'home' trade to 'foreign' trade of
consumption, and to 'carrying trade' (shipping). Explains in detail why
home trade preferred (explicitly: lower risks of domestic versus foreign
trading); knows local people 'better', knows laws better. Repeats (twice) the condition for preferring domestic trade on 'same or nearly the same
profits, and 'saves himself the risk and trouble of exportation'.

7 Individuals who support domestic industry necessarily direct
industry to produce greatest value.

8 Individuals will seek to increase profits and directs capital to the
industry likely to produce greatest profit.

9 Individuals [for reasons explained earlier] in supporting domestic industry for the 'greatest value' to their own capital, necessarily raise
society's annual value. He does not intend to promote society's interests, only his own. 'Intending' his own 'security' [risk avoidance] he 'intends his own gain' and [same sentence] 'he is in this, as in many other case, led by and invisible hand to promote an end which was no part
of his intention'.

Adam Smith’s supporting argument is deep in the context of the home versus foreign trade, and ‘his security’ (risk avoidance) is even mentioned in the sentence that contains the metaphor of the invisible hand.

The risk-avoidance issue is of major relevance to Adam Smith’s use of the metaphor; the context is not en passant to its use.

The consequence is simple arithmetic: if parts of industry strive to make their profits larger from individual motivations, then it follows that the whole-industry profits are larger. The whole is the sum of its parts (arithmetic law).


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