Tuesday, June 09, 2009

Markets and Panglossian Invisible Hands

John Markley writes “Review of Economics for Real People” at ‘Suite 101HERE

Gene Callahan Provides an Excellent Introduction to Basic Economics”

“Next, Callahan expands from a single person to a group, bringing in the essential subject of exchange. With exchange come concepts such as specialization, division of labor, and comparative advantage. He also explains how market prices provide information that guides buyers and sellers and makes coordination possible without centralized direction of control, creating the famous “Invisible Hand” of Adam Smith

A promising announcement for educating people about economics, then the inevitable kick in the tail that invents a metaphor into a concept, and spreads the mystical ‘non-explanation’ about how markets work.

The myth about Adam Smith and his use of a metaphor in three quite different circumstances and adds to the substitution of science by mumbo-jumbo’.

Variously, users of the metaphor credit it with semi-conscious powers (quite good for a disembodied invisible hand), affecting all transactions indiscriminately, even when the participants pursue selfish and evil ends – a sort of utopia dominated by naïve optimism, associated with Panglossian ideas, sometimes related to religious ideas about God’s providence.

In the economic theory of general equilibrium – finally proven mathematically in the 1950s – exponents often drift off the mathematics and resort to the metaphor of the invisible hand, which is fine, of course. After all, the metaphor was quite popular in literature in the 18th century (and from long before in classical times), but it often was to do with murderous scenes, interventions by the gods and God, and mysterious things that ‘go bang in the night’.

But it was not Adam Smith’s allusion, particularly. Three references in a million words – none of them to do with how markets work – makes its use and attribution somewhat of an exaggeration, convenient may be, because it gives the prestigious gloss of a renowned figure in the history of economics to a pure. modern theory of an imaginary world without real humans present, but also dangerous, as recent events show leading to a financial crisis.

Remember the context (always remember context!) in the 1930s when Chicago University faculty introduced their oral allusion to the economy being guided by an ‘invisible hand’. This was the decade of the twin scourges of National Socialism and Soviet Communism coinciding with the Great Depression. Capitalism was under challenge and the notion of a superiority of the market dominated USA guided by the peaceful, amazing, and pacifistic “Adam Smith’s invisible hand”, unlike the state-managed systems of Germany and Russia, guided by the bloody fists of Gauleiters and Commissars, was attractive to nationals and refugee immigrants together.

Fast forward to the late 1940s, and Oscar Lange and Paul Samuelson, both from Chicago in the 1930s, each introduced the invisible hand, linked by name to Adam Smith into the literature of economics. Samuelson’s economics 101 textbook, Economics, published in 1948 and then through 18 editions, and translations, became an educational phenomenon across campuses worldwide. Its Keynesian macro-economics exuded confidence in capitalism and markets and responded to the needs of the West during the Cold War years with the Soviet Union.

Hardly noticed too, was the item on page 36 (1st edition), proclaiming, if cautiously to be sure, the metaphor of the invisible hand, which also spread across the discipline and took on a life of it own as each instructor interpreted it to suit. By the end of the century, the invisible hand, transformed from a metaphor into a ‘theory’, ‘ a concept’, even a ‘paradigm’, and was generally believed to be embedded in Wealth Of Nations and to be central to Adam Smith’s analysis of how markets work.

Few economists ever bothered to read Wealth Of Nations for themselves and to see how and where Smith used the metaphor, and in what context. They were taught, and believed, that Smith gave it a major role in markets, and because they were confined to the quotation in which he talks generally of ‘every individual’ seeking to make use of his capital to maximise his profit and how this produces the best result for society, they repeat the connection with disciple-like intensity whenever anybody challenges this interpretation.

Armed with these certainties, they accord to markets powers and consequences which they never had: the power to produce the ‘best of all possible worlds’ irrespective of the intentions, or the limited goals, of entrepreneurs and corporations. Some capitalist econoimies work better than others; some cannot even get started.

Currently, in the present crisis, scores of former-disciples of the invisible hand are rejecting markets (and Adam Smith) with the haste of those woken up to the crash of their illusions and what they have been taught and taught themselves.

Yet, if the went back to Wealth Of Nations and actually read the whole chapter, or even paragraphs 1 to 9 of Chapter 2, Book IV, they would see, perhaps for the first time, that Adam Smith fully explains the behaviours of some – NOT all – traders by their degree of risk avoidance in their decision to invest locally or in foreign trade with the British colonies in North America, or the European continent. Their actions are driven by their ‘own security’; those less insecure than others engaged in foreign trade and those more insecure than others engaged in local trade.

In what way are they ‘led by an invisible hand’ to do what their degree of insecurity compels them to do anyway? I have never had a direct answer to that question in all the years of the Lost Legacy Blog.

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Blogger Paul Walker said...

"Fast forward to the late 1940s, and Oscar Lange and Paul Samuelson, both from Chicago in the 1930s, "

To be fair, Paul Samuelson graduated from the University of Chicago in 1935 and pursued graduate study in economics at Harvard University, where he received the master's degree in 1936 and the doctorate in 1941. In 1940 he joined the faculty of the Massachusetts Institute of Technology.

An undergraduate degree isn't exactly what I would have referred to as "from Chicago in the 1930s"

And Oscar Lange was a market socialist arguing on the socialist side of the Socialist Calculation Debate. Not exactly what you think of when you say "Chicago School".

8:33 am  
Blogger Gavin Kennedy said...

It was Samuelson who remembered the talk about the invisible hand at Chicago. It was an oral tradition. 1935 and the years before were in the 1930s. The presumption must be that faculty continued speaking in lectures and tutorials of the invisibl hand.

It was in the late 1940s that the invisible hand began to appear in the literature (Lange in 1946 and Samuelson in 1948).

We may note too that Hayek took up the invisible hand as an early manifestation of his own work on 'spontaneous order'.

In the 1950s, graduates of MIT, Chicago and elsewhere, picked up on the spreading gospel of The Metaphor.

I mentioned both Lange and Samuelson were 'from Chicago'. There is much written about the Chicago School (I read a book about it last year), but it is clear there were several strands to the faculty from the 1920s.

Stigler and Friedman were prominent exponents of the attributed role of Adam Smith to the post-War experiences of capitalism compared to socialism.

Lange was schooled in neoclassical marginal analysis and applied it to socialist planning, but that was not my point.

I hope this clears up whatever it is we disagree about. The Metaphor crept, then swept, into economics discourse in the 1950s from its roots in the 1930s, mainly in Chicago and from its graduates.

11:46 am  
Blogger michael webster said...


Wasn't Ed Chamberlain doing primitive experiments in auctions around the 1950's at Harvard?

This experiment showed that pure mingling around in markets, without an auction mechanism, didn't produce trades as predicted by the supply/demand theory.

Vernon Smith then shows that if you add an auction device, and people have fixed reservations bids- that auction mark clears in a way predicted by supply/demand curves.

But the auction device is not an invisible hand, and if you want to unpack the assumptions which allow the auction device to work, you will find many visible conventions.

I just point this out to show the alternative history of economics.

4:15 am  
Blogger Gavin Kennedy said...


There were many experimental projects in the last quarter of the 20th century.

I remember Fouraker and Seigel (I think that's right; McGraw Hill book) on oligopoly pricing, plus auctioning (since Cournot, 19th century). Of course, Vernon Smith's work too, and others.

Setting reservation prices depends on a whole range of influences, not just price and quantity (incomes, taste, alternative goods and availability, etc.).

Where 'an invisible hand' fits into this array is not clear, as implied in the IH attributed 'theory'. The IH is an empty set.

In my reply to Klein (EcoJournal Watch, forthcoming in September) I shall address these unnecessary fantasies to 'explain' (i.e., obfuscate) explanations of how markets work.

6:28 am  
Blogger Seth said...

Which work from Lange are you referring to? I haven't been able to find any written in 1946 nor have I found any in which the invisible hand is mentioned.

10:59 am  
Blogger Seth said...

Which work from Lange are you referring to? I haven't been able to find any written in 1946 nor have I found any in which the invisible hand is mentioned.

11:06 am  

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