Sunday, July 19, 2009

A Chicago Version of Adam Smith

Martin Mandelman writes the Mandelman Matters Blog HERE:

17th century economist, Adam Smith, in his treatise “The Wealth of Nations,” based his free market conclusions on the precept that human beings will act in their own self-interest, and by doing so, also be acting in the best interests of the society as a whole. Smith’s famous metaphor, “the invisible hand,” was used to describe the effect of everyone in the marketplace doing what’s best for themselves, and the economic growth that would result. But, time after time, when it comes to investing our own money, we continue to prove that we are flawed beings who are subject to acting out of greed and/or fear, even when it is clearly not in our best interest to do so.

Comment
Martin Mandelman has some way to go before he understands much about Adam Smith.

Skipping over the slip about which century Smith lived in – the 18th, not the 17th – and noting that he did not write a ‘Treatise’ (it was getting close to a 1,000 pages, depending on which edition you put on your shelf; reading it is a distinctly minority activity), nor did he hold to a ‘precept’ that “human beings will act in their own self-interest, and by doing so, also be acting in the best interests of the society as a whole” (emphasis added).

“Smith’s famous metaphor, the invisible hand” wasn’t his at all- it was a rather commonplace metaphor from ancient times (Ovid) and increasingly used from Shakespeare’s time (Macbeth), and in Smith's time appeared in numerous published sermons (several dozen authors have been identified), and also featured in several literary works (Daniel Defoe, Voltaire, Bonet, Robinet, Walpole, and Reeve.

Of course, since the 1950s The Metaphor has become ubiquitous, albeit it re-invented by modern economists to mean something quite different from the Adam Smith born in Kirkcaldy in 1723, though it is stubbornly attributed to him.

For Smith the metaphor of the invisible hand, in the only place he used it in Wealth Of Nations, was NOT “used to describe the effect of everyone in the marketplace doing what’s best for themselves, and the economic growth that would result”.

It was about what some, but by no means all, owners of capital did who were risk-averse regarding investing abroad, even in the colonial trade with North America, and therefore preferred to invest locally where they could see the people with whom they did business, and how this added to domestic capital investment, creating local employment and adding to the annual output of the ‘necessaries, conveniences, and amusements of life’.

Of course, without the others who preferred to invest abroad – their profit rates were higher – Britain’s economy would be negatively affected.

Martin gets to the import of his message: “we continue to prove that we are flawed beings who are subject to acting out of greed and/or fear, even when it is clearly not in our best interest to do so”.

Yes, he is in the advice business. But I wonder how good he is if he quotes Adam Smith for support for his message and gets him so wrong?

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3 Comments:

Blogger Mandelman said...

Hey, hey, hey... first of all, Mandelman (that's me) is not in the "advice business". My 401(k) has long since been reduced to a 201(k). Second of all, I do love the critique of my apparent misunderstandings of Adam Smith.

Now, I have to go back and read it again to make sure I understand what you're saying, and forgiving your criticisms about whether something is or isn't a treatise... I was under the impression that Smith's invisible hand referred to the cumulative impact of each person working in his or her own best interest. I didn't know that others had coined the phrase, and I'm sure there's more that I missed about Smith or got wrong.

My overriding point, if I remember the article's message correctly, is that people don't act rationally and in their own best interest when it comes to investing their money for retirement.

I'm someone who, after losing plenty of money, and studying the market's bottom-line numbers, believes that most of us has too much exposure to market risk.

So, did you like the article otherwise? I'll read your critique and again, go back and fix my article and source you as the impetus behind my learning... I'll even link back to your blog... how's that?

Mandelman

7:52 p.m.  
Blogger Mandelman said...

Oh, and could you send any follow-up comments to mandelman@mac.com, instead of my gmail address? Thanks... and love the rest of your site... Mandelman

7:56 p.m.  
Blogger Gavin Kennedy said...

Hi Mandelman

Thanks for commenting.

Apologies for misdescribing you and for my abrasive tone.

Should you wish to read my paper on "Adam Smith and the Invisible Hand: from metaphor to myth", post this url:
http://www.aier.org/aier/publications/ejw_wat_may09_kennedy.pdf

You are in good company with your ideas on the invisible hand - most of the economics profession believes what you stated about Adam Smith.

The sorry misunderstanding began in Chicago in the 1930s and then spread round the campuses, given the prestige of Samuelson, Friedman, Stigler and their thousands of graduates in the last half of the 20th century and this one.

Lost Legacy is trying to correct these errors.

If anybody comments I shall send them as requested.

Best wishes

Gavin

4:48 p.m.  

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