Sunday, August 31, 2008

The 'Indoctrination' of 6-year Old Good Economist

Ike Pigott (‘better communication makes the complex simple’)
Occam’s RazR (‘This site is as much for him as anyone -- to explain things that ought to be explained, explore ideas that keep him up at night, and connect concepts that are just begging to be joined’) HERE:

Invisible Hands

We’re lucky when the teaching moments come to us.

My wife was explaining how she got a discount on milk yesterday. Apparently, the local Walmart and Publix are in a price war over milk which has dropped the price per gallon more than 90 cents. My six-year-old daughter wanted to know why the Walmart checker dropped the price without even being prompted.

“Let’s say you and Ryan are selling cupcakes,” I said. “You are selling them for five dollars, and Ryan is selling them for three. Who makes more money?”
“I do,” she said.

“Okay, now say I have ten dollars (holding up 10 fingers). I can buy two of your cupcakes (spending the fingers), or I can buy three of his and still have a dollar left over (re-spending the fingers). NOW who makes more money?”

“Ryan does.”

“So what do you need to do?”

“Charge three dollars,” she said.

Why is it that Adam Smith’s invisible hand is so difficult to understand? Functional adults deny its existence because it clashes with their ideology, yet a six-year-old gets it in 30 seconds

Well, Ike, I deny the existence of ‘an invisible hand’ and it certainly does not clash with any ‘ideological’ considerations on my part. I am familiar with the works of Adam Smith and know something about his use of the metaphor of ‘an invisible hand’, which he used once in 1759 in The Theory of Moral Sentiments at TMS IV.1.10: p 184, and once in 1776 in Wealth Of Nations (short-title) at: Book IV.ii.9: page 456.

He also, for the record referred to ‘the invisible hand of Jupiter’ in an essay, unpublished in his lifetime, known by its short-title as History of Astronomy, when he described the ‘pusillanimous superstition’ in pagan societies.

In none of these cases was his use of an invisible hand metaphor anything to do with how simple price markets work. Indeed, the operation of market choice is so simple that your charming six-year-old daughter can understand how they work. Congratulations to her.

So why do you complicate the issue by adding a reference to ‘an invisible hand’ as part of your explanation, and which is now part of her formerly clear understanding? What does an invisible hand have to do with the price mechanism?

It certainly wasn’t part of Adam Smiths’ explanation of prices in Books I and II of Wealth Of Nations – he never mentioned invisible hands when doing so.

His use of the metaphor, detailed above, had nothing to do with price signal, markets, or consumer choices. (If you do not have access to either book to hand, email me and I shall send the relevant two chapters as attachments to you for you to consult.)

In the case of ‘Moral Sentiments’ (short title), he was discussing how some people suffer from a ‘deception’; they disregard the utility of an object in favour of its ‘fitness’ of design. They chase after ‘numberless artificial and elegant contrivances for promoting this ease or pleasure’. In doing so they imagine their ownership of such items means that they will possess ‘more means of happiness’, adding that it is important that they feel this way:

And it is well that nature imposes upon us in this manner. It is this deception which rouses and keeps in continual motion the industry of mankind. It is this which first prompted them to cultivate the ground, to build houses, to found cities and commonwealths, and to invent and improve all the sciences and arts, which ennoble and embellish human life; which have entirely changed the whole face of the globe, have turned the rude forests of nature into agreeable and fertile plains, and made the trackless and barren ocean a new fund of subsistence, and the great high road of communication to the different nations of the earth. The earth by these labours of mankind has been obliged to redouble her natural fertility, and to maintain a greater multitude of inhabitants’ (TMS IV.1.8: p 182)

This leads directly to his use of the metaphor of ‘an invisible hand’:

It is to no purpose, that the proud and unfeeling landlord views his extensive fields, and without a thought for the wants of his brethren, in imagination consumes himself the whole harvest that grows upon them. The homely and vulgar proverb, that the eye is larger than the belly, never was more fully verified than with regard to him. The capacity of his stomach bears no proportion to the immensity of his desires, and will receive no more than that of the meanest peasant. The rest he is obliged to distribute among those, who prepare, in the nicest manner, that little which he himself makes use of, among those who fit up the palace in which this little is to be consumed, among those who provide and keep in order all the different baubles and trinkets, which are employed in the oeconomy of greatness; all of whom thus derive from his luxury and caprice, that share of the necessaries of life, which they would in vain have expected from his humanity or his justice. The produce of the soil maintains at all times nearly that number of inhabitants which it is capable of maintaining. The rich only select from the heap what is most precious and agreeable. They consume little more than the poor, and in spite of their natural selfishness and rapacity, though they mean only their own conveniency, though the sole end which they propose from the labours of all the thousands whom they employ, be the gratification of their own vain and insatiable desires, they divide with the poor the produce of all their improvements. They are led by an invisible hand to make nearly the same distribution of the necessaries of life, which would have been made, had the earth been divided into equal portions among all its inhabitants, and thus without intending it, without knowing it, advance the interest of the society, and afford means to the multiplication of the species. When Providence divided the earth among a few lordly masters, it neither forgot nor abandoned those who seemed to have been left out in the partition. These last too enjoy their share of all that it produces. .” (TMS IV.1.20: p 184)

In summary, having explained exactly why the rich landlord from the products of his farms feeds the labouring farmers and their families (he can’t eat it all himself), Adam Smith uses a common 18th-century literary metaphor to support his contentions.

How necessary is the metaphor? The inescapable fact is that if the landlord didn’t distribute the surplus food, above what he and his immediate family consume for themselves, the labourers would starve and there would be nobody around in the Spring to work his lands (they would not last the Winter without subsistence, clothing and shelter), and the rich landlord’s life style would terminate. In other words landlords can do no other. The invisible hand metaphor adds nothing to the necessities of self-preservation.

In Wealth Of Nations (short title) he uses the metaphor of ‘an invisible hand’ after he has explained completely why some wholesale merchants prefer the home trade to engaging in the riskier foreign trade:

First, every individual endeavours to employ his capital as near home as he can, and consequently as much as he can in the support of domestic industry; provided always that he can thereby obtain the ordinary, or not a great deal less than the ordinary profits of stock.

Thus, upon equal or nearly equal profits, every wholesale merchant naturally prefers the home-trade to the foreign trade of consumption, and the foreign trade of consumption to the carrying trade. In the home-trade his capital is never so long out of his sight as it frequently is in the foreign trade of consumption. He can know better the character and situation of the persons whom he trusts, and if he should happen to be deceived, he knows better the laws of the country from which he must seek redress. In the carrying trade, the capital of the merchant is, as it were, divided between two foreign countries, and no part of it is ever necessarily brought home, or placed under his own immediate view and command
.” (WN IV.ii.5-6: p 454)


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.” (WN IV.ii.9: p 456)

Again, Smith first explains the circumstances that lead some merchants to prefer the domestic trade to foreign trade, which boils down to their fears for the security of their capital (or in modern parlance, their risk-avoidance) – ‘he intends only his own security’ – and to the extent that many individuals react in this manner, the quantity of local capital will be greater and, therefore, the total output domestically will be greater.

This follows from a law of arithmetic that the whole is the sum of its parts – the more numerous the parts, the greater the whole. It is at this point that he uses the metaphor of an invisible hand, though anybody who reads the earlier passages will get the importance of his explanation without it. The invisible hand adds nothing to the correctness of Smith’s earlier analysis.

Yet, Ike accuses ‘functional adults’ of finding the invisible hand of being “so difficult to understand”. Is he sure that he is attacking the correct targets?

I completely understand Adam Smith’s explanations of the ‘mechanism’ by which the rich landlord feeds the poor labourers working for him and maintains their subsistence sufficient for them to maintain families and bring up their children - the next generation’s farm labourers, household retainers and body guards.

I also understand the psychological pressures that induce some merchants from their risk-avoidance to invest locally rather than abroad.

What I don’t understand is why Ike (and many, many others) think the metaphor of an invisible hand adds anything to our understanding of these processes.

Moreover, I cannot fathom why Ike (and many, many others, including distinguished economists) believe it is necessary to extend the use of the metaphor of an invisible hand to Adam Smith’s theory of markets, the derivation of prices, the working of competition and capital accumulation.

Adam Smith never suggested that the metaphor had wider use, nor did he link it to any other element of his analyses in moral philosophy not political economy.

I’m with his daughter age 6 in this exercise. She didn’t mention anything about an invisible hand either. She got the answer correct from the data given to her. Smart kid.

I hope she was not confused later by Ike introducing her to ‘an invisible hand’ as a dubious explanation for what she already knew from the data. That’s no way for her to turn into a ‘functional adult’.


Blogger Ike said...

Thanks for your clarification.

9:26 pm  
Blogger Gavin Kennedy said...

Hi Ike

Thank you for coming back and commenting. The longer explanation on your Blog was also fine, and I don't wish to quibble over minor points.

I have known young students at university who would muddle their answers if asked the same standard of question as your 6-year old. Impressive of her.

Best regards

4:35 pm  

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