Sunday, October 26, 2008

A Reader Comments and I Concur

Michael Webster, reader of Lost Legacy, introduced the thinking behind the modern economists’ ‘theory of an invisible hand’, which they incorrectly call Adam Smith’s theory (see his comment on Friday’s post “The Invisible Hand Gang” below).

I have stated these origins of the modern ‘invisible hand’ notion many times on Lost Legacy and therefore I agree with Michael Webster. I read John McMillan’s Reinventing the Bazaar’ a year or so ago and found: a) it is an exciting and readable voyage through the world of markets - all those market minded commentators keeping their heads down at present should read it; and b) McMillan’s account of the invisible hand’s transformation from commonplace literary metaphor in mid-18th century into its mythical 20th-century status is accurate, though now well beyond its originators intentions.

Arrow and Debreu’s works are of theoretical interest only, but of little consequence for much else. Diminishing returns is no longer in pole position; increasing returns has moved up the starting order; exogenous growth theory left unexplained major components of growth; endogenous growth theory brings disequilibrium into the heart of the old equations, and, of course, the enormous change in the role of governments since the late 19th century and their expenditures as a proportion of GDP has added new dimensions inside market economies, not least from the role of politicians, or as Smith might have put it, from legislators and those who influence them.

True, Smith wrote (WN IV.ii.9: p 456) in the case of some merchants (not all!), that ‘only’ for their ‘own security’ – a.k.a, risk avoidance – they would prefer to invest their capital locally, as many did (increasing the domestic investment), rather than risk the greater uncertainties of sending it abroad, especially across the North Atlantic, despite which many individuals continued to trade abroad (hence reducing the amount of capital that could have been invested locally). The net sum added/detracted from domestic investment, and the metaphor was intended for those 18th-century readers who could not follow Smith’s argument, despite which too many seem unable to udnerstand it today after two hunred years plus of advances in economics.

From this sole example, which applies ‘in many other cases’ (Smith doesn’t state if by ‘many’ he meant a large number or a significant proportion), yet the ‘worshippers' of the metaphor of the invisible hand, i.e., what ‘most classical market economists think’, extend it to all cases.

Michael Webster asserts:

Whether or not Adam Smith had the insight about prices and an invisible hand is going to be largely irrelevant to them.”

They may believe, of course, what they wish, but the consequences of purveying an untruth that corrupts what Adam Smith was teaching about the role of markets is unhelpful when policy makers discuss markets. We may also note here that Adam Smith (at least not the one born in Kirkcaldy in 1723) did not bless markets with quasi-religious ‘pusillanimous superstition’ (there is a large literature by senior economists purporting to find godly apparitions in competitive markets).

Those who inject ‘invisible hands’ (even ‘feet’ too!) over-egg their ‘theories’ of markets as ‘promoting ends’ (social benefits) whatever the motivations, intentions, and behaviours of market makers, which we know to be false by the numerous of cases of fraud, pollution, monopolies, cartels, dangerous products and practices that regularly surface and, as now, occasionally cause massive crises of confidence.

Adam Smith was never a proponent of laissez-faire. His support for Natural Liberty transcended commercial societies – natural law theory applied to all societies as a standard of conduct – but he gave instances in Wealth Of Nations for example where interventions were justified to restrain ‘injudicious’ banking behaviours that threatened greater disasters socially:

To restrain private people, it may be said, from receiving in payment the promissory notes of a banker, for any sum whether great or small, when they themselves are willing to receive them, or to restrain a banker from issuing such notes, when all his neighbours are willing to accept of them, is a manifest violation of that natural liberty which it is the proper business of law not to infringe, but to support. Such regulations may, no doubt, be considered as in some respects a violation of natural liberty. But those exertions of the natural liberty of a few individuals, which might endanger the security of the whole society, are, and ought to be, restrained by the laws of all governments, of the most free as well as of the most despotical. The obligation of building party walls, in order to prevent the communication of fire, is a violation of natural liberty exactly of the same kind with the regulations of the banking trade which are here proposed.”

(WN II.ii.94: p 324: read Book II, chapter 2, of Wealth Of Nations, which is instructive for resisting extremist rants about market infallibilities, such as quasi-religious beliefs in invisible hands.)

Adam Smith was never an ideologue about markets, nor about human behaviour (for evidence of the latter see his Moral Sentiments; see also my recent Adam Smith: a moral philosopher and his political economy, 2008, Palgrave Macmillan).

Invisible hand myths are propaganda, not science. They undermine the credibility of competitive markets and give succour to the enemies of markets, who call for ever tighter state-imposed regulations and the triumph of politicians over myriads of market decisions, despite Adam Smith’s clear warning:

The statesman who should attempt to direct private people in what manner they ought to employ their capitals would not only load himself with a most unnecessary attention, but assume an authority which could safely be trusted, not only to no single person, but to no council or senate whatever, and which would nowhere be so dangerous as in the hands of a man who had folly and presumption enough to fancy himself fit to exercise it.” (WN IV.ii.10: p 456)

The problem is that the mythical theory of the invisible hand, which Smith never countenanced as part of his theory of markets (Book I and II of Wealth Of Nations), discredits his more important warnings about ‘statesmen’ legislating (i.e., governments, planning commissions, and such like) to assume an authority for which they are incapable of exercising, all because ‘modern economists’ have lauded the invisible hand for purposes which Smith never endorsed. Unwittingly, they encourage those who would ram anti-market propaganda down their throats and silence the intellectual and practical case for markets.

The circled wagons of market economies are now under legislative pressure (election campaigns and failing governments in the US and UK) from a revived Left, the forces of which lurk restlessly just beyond the light of our campfires. They have been given a new breath of life by incompetence, recklessness, and self-interested selfishness (there's nothing ‘enlightened’ about them at all) by those who were complicit in the myth of the invisible hand and those who fell asleep when supposed to be on guard duty.



Blogger michael webster said...

Great last paragraph Gavin!

I agree with much of what you have to see and would also recommend the reader to re-read Reinventing the Bazaar: A Natural History of Markets for the breadth of examples of how prices convey information, and more importantly when market prices fail.

It is important these days to remind ourselves what marvelous collection devices markets can be, when properly set up.

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