Tuesday, September 30, 2008

The Lonely Truth About Invisible Hands

In a welcome change to the majority of commentators on the financial problems of US and UK economies - which are near universally trapped in a market-failure narrative to do with the failings of the 'invisible hand', wrongly attributed to Adam Smith, I open my survey of them with a more accurate assessment that I find in a Blog called the 'Drudge Retort' (HERE):

"The Invisible Hand - Adam Smith

A phrase often quoted and alluded to, it conveys the unintentional benefits stemming from individual's pursuit of their own wants and needs.

The Butcher, the Baker, and the Brewer provide goods and services to each other out of self-interest; the unplanned result of this division of labor is a better standard of living for all three.

There are two important features of Smith's concept of the "invisible hand".
First, Smith was not advocating a social policy (that people should act in their own self interest), but rather was describing an observed economic reality (that people do act in their own interest).

Second, Smith was not claiming that all self-interest has beneficial effects on the community. He did not argue that self-interest is always good; he merely argued against the view that self-interest is necessarily bad. It is worth noting that, upon his death, Smith left much of his personal wealth to charity.

On another level, though, the "invisible hand" refers to the ability of the market to correct for seemingly disastrous situations with no intervention on the part of government or other organizations (although Smith did not, himself, use the term with this meaning in mind).

For example, Smith says, if a product shortage were to occur, that product's price in the market would rise, creating incentive for its production and a reduction in its consumption, eventually curing the shortage. The increased competition among manufacturers and increased supply would also lower the price of the product to its production cost plus a small profit, the "natural price."

Smith believed that while human motives are ultimately out of self interest, the net effect in the free market would tend to benefit society as a whole. This was later adopted as a universal principle by the laissez-faire economists of the 19th century."

It was a pleasure to come across this piece this morning after reading through 229 depressive reports to the contrary last evening.

At least one commentator understands what many top economists do not: the version of the invisible hand which they attribute wrongly to Adam Smith is a stick with which the enemies of markets are using now to beat them in favour of government solutions.



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