Thursday, May 01, 2008

Joseph Stiglitz Correct About Invisible Hands 'Theory'

On a strange source, at least to my taste (HERE) I found this interesting quotation from Joseph Stiglitz:

Adam Smith was aware of some of the limitations of free markets, and research since then has further clarified why free markets, by themselves, often do not lead to what is best. As I put it in my new book, Making Globalization Work, the reason that the invisible hand often seems invisible is that it is often not there. …Whenever there are “externalities”—where the actions of an individual have impacts on others for which they do not pay or for which they are not compensated—markets will not work well. Some of the important instances have been long understood—environmental externalities. Markets, by themselves, will produce too much pollution. Markets, by themselves, will also produce too little basic research.’

Comment
Yes, it is an excellent statement on the invisible hand. It makes the point made on Lost Legacy, almost weekly, in some context or other from the world’s media. Stiglitz realises the truth about the myth of the invisible hand has it has evolved among economists, some of them Nobel Prize winners, and repeated endlessly by graduates and readers of articles resorting to ‘invisible hand explanations’ for almost anything to do with markets.

It is used by those who claim to be advocates of freer trade, those opposed to freer trade (a stick with which to beat ‘conservatives’), those of a religious disposition when ‘explaining’ market phenomena or God’s role in society, and those, who bereft of allowing their explanations to stand on their own and be judged as such (politicians and journalists), resort to hijacking Adam Smith’s name to give their cases a hallowed-like aura that places them safely beyond deep waters where they might sink without such branding.

Joseph Stiglitz is right to a point (and deserves credit for that alone). I would go the extra length to suggest that if the actual use by Adam Smith of the metaphor of an ‘invisible hand’, which he used once only in Moral Sentiments and once only in Wealth Of Nations and on neither occasion was he referring to markets, is considered by Joseph Stiglitz in their context he would not have to modify the assumptions about its wide and extreme use by pointing out that externalities make a difference to its alleged universal benefits.

It was never intended to be interpreted as it has been since mid-20th century by neoclassical economists. As a literary metaphor it was in wide circulation in the 18th century and was used by Adam Smith after he carefully and fully explained the contexts to which it referred.

Consider what would have happened if rich landlords (Moral Sentiments) had not allowed their servile retainers, bondsmen and tenants sufficient to prolong their working lives and nurture their children? The landlords’ wealth depended on the preparing, planting, nurturing and harvesting the crops upon which their wealth was based, which required labourers to do the work.

Today this is called a ‘no brainer’. Smith called up the metaphor of an invisible hand in a synonymous role. It was not a ‘theory’, ‘a concept’, a ‘paradigm shift’, or something mystical and mysterious, as some have suggested. It was a metaphor: the rich landlords had no choice and didn’t need to think much about it before doing what they had to do.

In the case of the traders who were risk averse about investing abroad and preferred to invest locally – providing there profits were ‘nearly the same’ or ‘not much less’ from doing so (clearly large amounts of capital was sent to the British colonies in North America despite ‘an invisible hand’ at work) – and that this local investment added to the amount of local investment made by traders who did not consider the option of sending it abroad, it followed by the laws of arithmetic that the amount invested locally would be larger than otherwise.

The arithmetical whole is the sum of its parts! What role does ‘an invisible hand’ play in these circumstances other than as a simple metaphor? I suggest none. If this was more widely appreciated, it would not be necessary for Joseph Stiglitz (and so many others) to clarify with wriggle room something that Adam Smith and his first century’s many readers knew perfectly well, and was unnecessarily confused for his second century’s fewer readers (but for its many readers of out of context ‘invisible hand’ quotations, and for many more detached misleading assertions).

That Stiglitz recognises this and publishes it is to some extent encouraging.

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