Wednesday, June 04, 2008

Did Adam Smith Give Monopolists, &c., an Alibi?

Pater Familias HERE, writes:

"Adam Smith wrote about how “an invisible hand” would lead individuals acting in their own interest to advance the interest of society despite “their natural selfishness and rapacity.” Where does morality come from in such a world? Smith’s answer was: sympathy."

Running phrases together to make a point about Adam Smith is dangerous work, dangerous for the integrity of Adam Smith’s ideas as he expressed them.

Adam Smith wrote about how “an invisible hand” would lead individuals acting in their own interest to advance the interest of society despite “their natural selfishness and rapacity.”

The individuals concerned in the invisible hand paragraph (WN IV.ii.9: p 456) are not countering ‘their natural selfishness and rapacity”; they display, as Adam Smith fully explains in the preceding sentences, their risk avoidance which causes them to invest locally rather than abroad, which by the laws of arithmetic – the whole is the sum of the parts – raises domestic investment greater than it would be if more of them overcame their risk avoidance and invested abroad (as a fair number of them did anyway).

Clearly, not all merchants were touched by the invisible hand! Indeed, this was Adam Smith’s main complaint about the mercantile policies that led Britain into colonial adventures in North America and India in the 17th and 18th centuries, of which he was scathing in his critique in Books III and IV of Wealth Of Nations. And the cause of this misallocation of scarce capital? The greater prospect of profits from mercantile policies for those who took the higher risks of indulging in them.

The cause of their investment decisions: local or abroad? The prospective rates of profit in the two activities. Merchants will invest locally, even at lower profits, if they fear the risks, and even here their risk aversion is constrained on the basis of ‘equal or nearly equal profits’ if they invest locally compared to investing abroad (WN IV.ii.6: p 454).

The higher the prospect of profits from colonial trade – a serious British monopoly under the Navigation Acts – the more that local merchants take the risks of participating in it and send their capital abroad, thus reducing their local investments and, ultimately, reducing the national total.

It seems that the risks of the profit motive act as the valve through which this decision is made. It had nothing to do with the general proposition that self-interested merchants are ‘led by an invisible hand’ to do what they would and did do normally.

Adam Smith’s use of a metaphor (a fairly well known and used metaphor in the 18th century) to explain what may be difficult for his readers – most of whom were not trained as economists – was a literary device to comfort those who did not follow the economics; in the hands of 20th century modern economists it has been transformed into a metaphysical, actual entity –sometimes claimed to be the ‘hand of God’ (even that Adam Smith believed it to be so!) – which turns all self interested actions by individuals to be beneficial to society, which is contrary to what Adam Smith asserted.

What an alibi these economists have made the invisible hand explanation into for every shyster, crook, polluter, fraudster, ‘rapacious’, monopolist and manipulative individual that makes any decision whatsoever! Adam Smith certainly did not believe any such nonsense. He gives over 50 instances in Books I and II of Wealth Of Nations (in which he never mentions the invisible hand metaphor once) in which ‘mean and rapacious’ individuals act in a manner which is definitely not in the interests of society.

This goes to show that Pater Familias, relying apparently on Wikipedia, has missed Adam Smith’s central theme in Wealth Of Nations – the outcome depends on the decisions of those who make them, and those who influence them, and the extent to which these decisions choose between frugality and prodigality, productive and unproductive labour, profitable and unprofitable ventures, risky and less risky trade, legal and illegal behaviours, peace and war, trade and colonies, liberal and subsistence wages for the majority of the population, education and ignorance, health and ‘loathsome diseases’, deterrent defence and threatening ventures for trivial ends, infrastructure that facilitates commerce or luxury expenditure for the ‘dignity of the sovereign’, in short, what he takes near on a million words to convey Wealth Of Nations and Moral Sentiments.

Apparently, for many modern economists (but not an icnreasing minority among us), his Labours were in vain.


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