Friday, October 16, 2009

Spare Us From the Invisible Hand

Patrick Kilbride writes in Chamber Post HERE:

“Free People, Free Minds, Free Markets”

‘In the 18th-century, Adam Smith left us with the indelible image of markets producing desirable social outcomes through the work of an "invisible hand." ’

In an otherwise neat argument for both liberty and free markets, Patrick Kilbride spoils his case with modern nonsense about Adam Smith and his use of the metaphor of “an invisible hand”.

Smith did not use the metaphor when explaining either how markets work generally (Books I and II, Wealth Of Nations) or how some, but not all, merchant traders preferred to invest locally following their concerns about the higher risks of investing abroad or in shipping (Book IV.ii, Wealth Of Nations).

In fact, a close reading of the only place in Wealth Of Nations where he used the metaphor of an invisible hand, shows that he first explains in detail the circumstances leading some, but not all, merchant traders to behave as they did (paragraphs 1 to 8, chapter 2, Book IV), and only then deploys the metaphor for the consequences of their specific behaviour (“intending their own security”), conforming to the arithmetic rule that the whole (the national annual output of wealth, including local employment) is the sum of its parts – the more merchant traders who are risk averse, despite the high profits from foreign and colonial trade, the greater the total annual wealth, including domestic employment.

Modern economists have invented a whole new meaning to Smith’s singular use of the metaphor, giving it the characteristics of a “law” of markets, though it was never stated as such by Adam Smith.

The modern invented meaning is commonly taught in first year economics courses and textbooks, and such is the effect of it on modern economists, it is extremely difficult to dislodge it – they seldom actually read Wealth Of Nations or even the relevant paragraphs (1 thru 8) and, by relying on a truncated extract from paragraph 9 only, they remain solidly convinced that Adam Smith explicitly stated what their tutors told them he wrote.

This gives succour to hostile critics of markets who throw the “invisible hand” back at them (“invisible fist” or, as seen recently, “invisible middle finger”, and such like). But there is no actual “invisible hand”, it does not exist and never did. The metaphor is just that, a metaphor, and one that was popular in literature, sermons, and poems in the 17th and 18th centuries – I have a list of 59 examples of its uses, besides Smith’s.

Mathematicians called it into being when “proving” that general equilibrium in an imaginary market, loaded with assumptions that removed all semblances of real world economies, was a theoretical possibility (Debreu, Arrow). Others (Samuelson, Freidman) and among them propagandists against Soviet communist planning, used the metaphor to good effect – Stalin needed the gulags to enforce planning, but free markets had an “invisible hand” that did its work without menace.

Editors of Time, Newsweek, Wall Street Journal, Financial Times and assorted media journalists loved the “invisible hand”, Nobel Prize winners sang it praises, and the epigones believed in its miraculous powers with the passionate certainties of Jihadists.

Worse, the invisible hand became an alibi of last resort, flaunted all round as if it existed. When it “failed”, the invisible hand was dumped among wails and the gnashing of teeth in wholesale “confessionals” (Alan Greenspan).

Markets suddenly became naked – they always were naked, but the veil of the invisible hand obscured their nakedness. It never was the answer to everything that could go awry in the normal condition of disequilibrium in all economies, much of it excited to crises by public policy interventions by legislators and those who influenced them.

Smith was right about them and the damage they could inflict – fortunately “there is a lot of ruin” in an economy, as he might have put it in another context...

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