Friday, December 05, 2008

Invisible Hand Myths in Melbourne

Toby Norgate writes in The Age (Melbourne), Business Day, HERE.

Dogs are barking for some reform

Commentators have suggested recently that because of the fallibility of investors the markets should turn to merit regulation. But making regulators merit assessors will not work. As with the old Soviet Union, governments (and regulators) can never be as efficient or effective as Adam Smith's invisible hand of the market.”

Governments and regulators can never be as efficient or effective as markets, for sure, but Adam Smith never had “an invisible hand of the market”, either as a theory or as a metaphor even.

He covered his theory of markets in Books I and II of Wealth Of Nations without a single mention of an invisible hand. Strange that. He mentioned the metaphor of an invisible hand only once and it is found in Book IV of Wealth Of Nations (WN IV.ii.9: p 456; Canaan, p 423), and it wasn’t about markets.

It was about the risk avoidance of some merchants in their not trading with the British colonies in America (meanwhile, of course, many others did engage in the risky Atlantic trade, being less risk averse).

How come the metaphor was promoted from the mid-20th century to a ‘theory’, ‘concept’, ‘paradigm’ even, of markets under the name of Adam Smith?

Briefly, some modern theorists found what they considered to be most significant, namely that they could show a mathematical model of an economy that was in general equilibrium, first mooted in 1871 and finally was ‘proven’ in the late 1940s.

Paul Samuelson, one of the searchers and the author of one of the most successful textbooks on economics, introduced his readers to an alleged Adam Smith’s invisible hand in the midst of markets, guiding the players to harmonious market equilibrium. Read by tens of thousands of students, many of whom went on to lecturing across the United States and the UK, the myth of the invisible hand gained credibility (without a shred of evidence that Adam Smith wrote anything to justify his inclusion, or his collusion, in the myth).

Meanwhile, in Chicago, many latched onto the invisible hand as ‘pure propaganda’ against Soviet planners and social democrats who preached and enforced State management of their economies. Among the luminaries of Chicago, Milton Friedman, a great proselytiser for free markets, liberty, and smaller state structures, taught invisible hand, laissez-faire economics, as if it was in the tradition of Adam Smith. Several Nobel Prize winners (among them George Stigler) added their lustre to the spread of the myth, until it became a dominan belief among economists, media commentators, and politicians.

Hence, to find the myth propagated in the Age in Melbourne in 2008 is hardly surprising. But it is still a myth and contrary to Adam Smith’s use of a lonely metaphor en passant of something completely different.



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