Tuesday, April 27, 2010

Paul Samuelson and the Invention of the Invisible Hand





Gavin Kennedy

Bernard M. Villegas writes (25 April) in mb.com HERE

‘The pitfalls of mathematical economics’

‘The pioneer in the "mathematization" of economics in the last century was the late Paul S. Samuelson who died last December 2009 at the age of 94. As reported by Michael Weinstein in The New York Times (December 14, 2009), quoting another Nobel laureate in economics, Robert Solow (who was one of the readers of my doctoral dissertation at Harvard): When economists "sit down with a piece of paper to calculate or analyze something, you would have to say that no one was more important in providing the tools they use and the ideas that they employ than Paul Samuelson."

Shortly after his death, an article appeared in the Financial Times authored by Stephanie Flanders entitled "Nobel laureate who turned economics from scattered thoughts to science dies." According to Flanders, Samuelson spent a large part of his career organizing scattered thoughts on economic theories since at least the time of Adam Smith in the 18th Century: "Welfare economics, the theories of consumption, capital accumulation, economic growth, finance and international trade all became subject to his rigorous 'picking and arranging'. It is difficult to name an important postwar debate in economics in which Samuelson did not play a role. He once boasted: 'My finger has been in every pie.' "

This work of systematization started with the doctoral dissertation at Harvard entitled The Foundations of Economic Analysis which he submitted in 1941 when he was only 19 years old. The dissertation contained only a few pages full of mathematical formulas. As Samuelson himself wrote: "To a person of analytical ability, perceptive enough to realise that mathematical equipment was a powerful sword in economics, the world of economics was his or her oyster in 1935. The terrain was strewn with beautiful theorems begging to be picked up and arranged in unified order." Through his pioneering work, economics began to comply with the definition of a "science", i.e. an organized body of demonstrated truths. Before this effort of systematic organization of theories, economics was known as political economy, a branch of philosophy. In fact, the first practitioners of economics such as Adam Smith, David Ricardo, and even Karl Marx were, strictly speaking, moral or social philosophers rather than economists in the present sense of the word

I am tidying up a paper at present, ‘Paul Samuelson and the Modern Economics of the Invisible hand’, and this post by Bernard M. Villegas on Paul Samuelson who died in December 2009, aged 94, is apposite in that it partly covers ground in my paper. Its main point about possible limitations of mathematics is put well and you should follow the link to read all of it.

The quotation from Stephanie Flanders of the FT and BBC (familiar to tv viewers since the General Election) that Samuelson spent much time ‘organizing scattered thoughts on economic theories since at least the time of Adam Smith in the 18th Century’ is revealing (I read a similar one recently).

Among the scattered thoughts was that of Adam Smith, in particular about ‘an invisible hand’, which I discuss in my paper, following Samuelson’s treatment of the metaphor through 19 editions of his popular text, Economics: an introductory treatment (1948: McGraw-Hill) which over 62 years sold 4½ million copies in 40 languages, earning the undisputed title of the best selling economics textbook of all time.

Samuelson’s Economics reached so many students and their tutors (with many of the former becoming tutors themselves in campuses all over the world) that I suggest that he was the source for the modern version of the metaphor of ‘an invisible hand’, which is now ubiquitous and thoroughly entrenched in the discipline.

However, Samuelson relied on the ‘scattered thoughts’ of his tutors’ in his undergraduate years at Chicago (he graduated in 1935 and went to Harvard for his PhD), which is clearly seen in his paragraph on Adam Smith in the first edition of Economics (1948):

‘Even Adam Smith, the canny Scot whose monumental book “Wealth of Nations (1776), represents the beginning of modern economics or political economy – even he was so thrilled by the recognition of order in the economic system that he proclaimed the mystical principle of the “invisible hand”: that each individual in pursuing only his own selfish good was led, as if by an invisible hand, to achieve the best good of all, so that any interference with free competition by government was almost certain to be injurious. This unguarded conclusion has done almost as much good as harm in the past century and a half, especially since too often it is all that some of our leading citizens remember 30 years later, of their college course in economics. Actually much of the praise of perfect competition is beside the mark.’

We know these are ‘scattered thoughts’ and that Samuelson did not get them from Wealth Of Nations because there is no evidence that Adam Smith was ‘thrilled’ about recognising ‘order’ (there is no mention of this in Wealth Of Nations, or anywhere else) and that he did not ‘proclaim’ the ‘mystical principle of the “invisible hand”. He buried it without comment in the middle of his book and did not discuss it anywhere else in Wealth Of Nations. If it had been enough to become ‘thrilled’ at the thought, he would have placed it nearer the front of the book when he discusses markets, supply and demand, competition, capital formation and money.

Smith did not write: ‘that each individual in pursuing only his own selfish good was led, as if by an invisible hand’. For Smith ‘self interest’ did not elide into ‘selfishness’ – quite the reverse! – and the metaphor was not written ‘as if by an invisible hand’ (a simile). There was no ‘as if’ about it.

From these errors, Samuelson went onto to construct a version of the invisible-hand that had no connection to Adam Smith. Its mathematics, eventually, were impressive by the 19th edition (2010): General Equilibrium, Pareto Optimality, Nash Equilibrium (Prisoner’s Dilemma), and the contribution of ethical interventions to mitigate the misdistribution of income (Samuelson was a 'centrist' not a fundamentalist).

For Smith, the reference to the invisible hand was metaphorical, and he applied it to a case where some, but not all, merchants chose to invest locally and not abroad from their concerns about the security of their capital, which on the simple arithmetical count from the ‘whole is the sum of its parts' led to higher domestic output and employment than otherwise would be the case. Smith considered this to be advantageous to the public good. That’s all.

The object of the metaphor of ‘an invisible hand’ was the risk-aversion (modern idea) of certain individuals leading them to behaviours with a public-good outcome. It’s hardly the greatest idea ever known to mankind.

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