Sunday, November 16, 2008

Self Interest and Selfishness

Simon Caulkin, management editor, writes in The Observer (UK), 16 November, HERE:

Guess what? Self-interest is bad for the economy

Self-interest as the driver that, like an invisible hand, permits individuals acting on their own behalf to benefit society as a whole goes back to Adam Smith. But Smith at least realised the drastic inequities it would cause and proposed measures, including progressive taxes, to mitigate the worst effects. No such caution has been in evidence since the 1960s as the concept has become the central belief around which all Anglo-American corporate governance, and thence management as a whole, revolves.

“Not so in economics, whose central tenets - rational agents, the invisible hand, efficient markets - derive from economic work done in the 1950s and 1960s, 'which with hindsight looks more like propaganda against communism than plausible science. In reality, markets are not efficient, humans tend to be over-focused on the short term and blind in the long term, and errors get multiplied, ultimately leading to collective irrationality, panic and crashes. Free markets are wild markets' - for which classical economics has no framework of understanding.

“It's an error to think that management, or even economics, can ever be a 'hard' science, not least because of their self-fulfilling premises. That doesn't mean they are unworthy of study and understanding. On the contrary. But, as Greenspan sorrowfully acknowledges, the first step on that path is to bow to empirical observation and stop trying to prove the Earth is the centre of the universe

Simon Caulkin confuses self interest universally benefiting everyone unintentionally, as an idea of Adam Smith’s (he asserts that the idea ‘goes back’ to him), when in fact Smith gave an instance of this happening when merchants preferred to invest their capital locally rather than send it abroad (Wealth Of Nations IV.ii.9: p456).

He also said this happened in many other instances, but he did not say this was a universal consequence of all individuals pursuing their self interest, ‘enlightened’ or otherwise.

Smith had a fine sense of history and he knew the difference between self interest and selfishness. In fact, he gives over 70 other instances in the Books I, II, and III of Wealth Of Nations where individuals exercising their the self interest had consequences that were anything but beneficial to society as a whole.

The merchants above were activated by their risk avoidance; they didn’t need an invisible hand to lead them to avert avoid adding to their risks. Smith used the metaphor as a literary device, not as an instrument of social behaviour.

The belief that there were invisible hands ensuring that thereby anything done by corporate bodies benefits society was “more like propaganda against communism than plausible science” is half right, though ‘communism’ was not the target; it was more positive than that. It was propaganda, alright, but not just by corporate-minded economists in favour of their clients being given a free hand to do whatever they wanted; it was also, and mainly, an attempt by mainstream economists to legitimise their mathematical models of general equilibrium.

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Blogger curiouscat said...

My understanding of Smith was that the most effective strategy was to regulate the market to attempt to create an environment where the invisible hand was effective. Therefore you obviously must prevent collusion. You obviously must regulate negative externalities. You obviously must encourage a market somewhat similar to perfect competition (because it is based on the argument of a system with perfect competition where the invisible hand drives benefit from individual players pursuing their interests).

As you explain in your blog the failure to understand the overall system of ideas expressed by Adam Smith leads people today to go off in crazy directions and claim that such ideas are based on Smith when they are not.

11:56 pm  

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