Tuesday, July 21, 2009

A Welcome Step to Appreciating the Role of The Metaphor

Lawrance G. Lux write his Blog by the same name HERE:

Hole in One Golf’

“I have always believed in Adam Smith’s Invisible Hand, but not in the manner most cited; reread the previous paragraph, and ask whether the fiscal deficit as described is not a failure of a universal turn to that Invisible Hand. The award of Tax benefits without universal application negates the operation of the market, and the dysfunction of fiscal balance comes from the loss of guidance from that Hand

Follow the link for the rest of this interesting side-light on the invisible hand, which takes its meaning on it own terms. However, even on these terms it is partly contradicted by the context in which Adam Smith introduced the metaphor.

What Lawrence appears to be saying is that he considers the invisible hand has only operating effectively in a free and competitive market, with minimal or no government, and certainly no government intervention on the scale presently practised in western ‘capitalist’ countries today, for example, the current fiscal deficit.

This implies – near to the truth – that the invisible hand was a metaphor for people reacting to social signals to behave in certain specified ways, such as in Moral Sentiments (TMS IV.i.10: 184) where rich landlords, reacting to the obvious need to feed, clothe, and shelter their labourers (and their families), would provide them with sufficient subsistence (no doubt, widely interpreted by the landlords retainer’s and overseers) to do so. The landlords could do not other, because without subsistence, the farm labourers would not last the winter, and who would prepare, plant, and harvest next season?

In the Wealth Of Nations the invisible hand was a metaphor for some local merchant traders deploying their capital locally to hire labour (creating employment) and to produce ‘the annual output of the necessaries, conveniences, and amusements of life’ and profits, which Adam Smith considered to be the real wealth of a society. The whole annual output is the sum of its contributory parts, hence the more that local merchant traders acted in this manner, the higher would be a county’s annual output. In this case, what behavioural signals prompted some, but definitely not all of them to behave in this manner?

From the commercial society, their motives included the profits they could make which replaced the capital they deployed, and the wages they paid to labourers to transform capital into output by the application of labour. Out of their revenues, after paying all their costs, they earned income, which was either consumed, hopefully frugally but in some cases it was spent in prodigality, and they invested in new rounds of transforming capital into new revenues ('the great wheel of circulation').

Here, most people read the 9th paragraph of the chapter (WN IV.ii.9: 456) too quickly. They forget the other social signals to all, not just some, merchant traders, who divided into two particular sets particularly. Individual merchant traders vary in their attitudes to risk – no investment round is absolutely certain to provide a return on their capital.

Merchant traders, who, considering their options and assessing whether to invest locally or to send their capital abroad, are swayed by the prospect of profits counter-balanced by their assessment of the risks of sending their capital out of their sight, to strange lands that may have different customs, uncertain local laws when deciding commercial disputes, and operated by people whose characters and reliability they know little or nothing about.

The different estimates of risk lead to two sets: those who are risk averse, and choose the home trade, and those who are risk neutral who choose the foreign trade, swayed by prospective higher profits.

Smith mentions, specifically, that the home trader who ‘intends only his security’ thereby invests locally ‘intending only his own gain’.

The foreign trade likewise ‘intends only his own gain’ but is relaxed about his security. The fact that the home trader, in consequence of this risk aversion, benefits home output and employment is the object of the metaphor of an invisible hand (which is all that most economists read from this passage) and which is related to the other fact that the foreign trader is not ‘led by an invisible hand’.

In short, the invisible hand is a metaphor for known behavioural social reactions to signals and it is not a prediction of how markets work to produce harmony or to result necessarily in beneficial results for society as a whole. Call this the neoclassical fallacy.

It seems to me that Lawrance G. Lux is close to understanding Adam Smith’s meaning behind his deployment of the metaphor of an invisible hand.

That some economists have made the metaphor into a theological interpretation of behaviours, that most regard it as somehow miraculous, and many have become immune to appreciate what is clearly staring them in the face, is far more mysterious a contagion of minds of many in our profession.

I remain optimistic that patient explanation will prevail in due course. So, I thank Lawrence for inciting this message on Lost Legacy.



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