Sunday, October 05, 2008

Invisible Hand Distortions Again

J. R. Nyquist writes (3 october) in Geopolitical HERE:

Political Blame and the Myth of Government-Sponsored Salvation’

According to Adam Smith’s notion of the “invisible hand,” financial selfishness (a.k.a. greed) is a positive force in a free economy. In one of the most celebrated passages in Smith’s book, An Inquiry Into the Nature and Cause of the Wealth of Nations, we read: “[the businessman] 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 worse 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.”

J. R. Nyquist has not only changed the meaning of Adam Smith’s passage in Wealth Of Nations (WN IV.ii.9-10: p 456), he has also hidden the context to which the passage refers. It may be ‘one of the most celebrated passages’; it is also to most misrepresented.

Selectively quoting some sentence only a reader gets, and it is intended that he gets, a wholly misleading meaning of Adam Smith’s views. Taken as quoted, the reader assumes Smith is describing a general condition of market-based economies and the conduct of a businessman.

Self interest is not selfishness. That was a view of Bernard Mandeville (1724) in ‘Fable of the Bees: Private Vice, Public Virtue’, not Adam Smith in Wealth Of Nations (1776). Smith was not talking about ‘businessmen’ going about their daily activities in markets; he was talking about traders deciding whether to supply the locality or to engage in foreign trade (to the British colonies in North America).

Some traders engaged in shipping exports and imports because of the higher profits from the monopoly status Britain held in its colonies, backed by the Navigation Acts and the protection of the Royal Navy (though the Atlantic was a dangerous, risky place, as nobody controlled the weather).

Others, a majority, were risk-averse; they preferred the certainties of local trade, they trusted the legal system, knew the individual traders they dealt with, and their capital turned-over more quickly. It was their estimate of the risks involved in the two different activities that led them to trade locally. In doing so, they added to local capital investment which made the local activity larger than it would have been if the foreign trade of consumption and domestic trade were perceived as risk-equal.

This conclusion followed from the ‘whole is the sum of its parts’ – more parts meant a greater whole by the laws of arithmetic. For those readers who did not follow the economic analysis he used the metaphor of ‘an invisible hand’, but the metaphor added nothing of substance to his analysis of the consequences of risk aversion

Subsequently, over a hundred years later in fact, and then on a mass scale from mid-20th century, the metaphor has been elevated to a general principle, despite it not having that role in Smith's theoriy of markets Wealth Of Nations.

It has become a popular justification for the false notion that ‘merchants and manufacturers’, elided into modern ‘businessmen’, can act selfishly and still create social benefits. What a multitude of anti-social ‘crimes’ that such a notion covers up. Never mind pollution, fraud, monopolies, restrictive trade practices, and conspiracies to cartels, and such like; it’s OK, because Adam Smith said so – but he didn’t!



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