David Friedman Replies to the Invisible Hand Debate

(Guest Column from the Comments to Previous post [Some paragraph breaks inserted]):

Smith and the Invisible Hand By David Friedman

You write: "he talks about some, but not all traders, who consider foreign trade to be too risky and prefer domestic trade. " Smith writes: "By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. " As you can see, he is not limiting his point to the preference, at almost equal profits, for domestic over foreign investments. As I already pointed out in a comment, he is also talking about directing one's industry to produce the greatest value. Furthermore, he explicitly says "in this, as in many other cases," thus making it clear that the point is not limited to the narrow case you claim it is. "If you insist that the ‘invisible hand’ is real, actual, or has content," That's a straw man. Nobody I know of, certainly no economist, claims the invisible hand is real.

The point, reinforced elsewhere in the text, is that actions motivated by self-interest result in behavior that is in the general interest. Smith doesn't, of course, have either the modern tools or the ideas of efficiency associated with Marshall, Pareto, and Hicks-Kaldor, but he is making the same point as the efficiency theorem in a much less precise form. "My assertion that the metaphor was not used by Adam Smith in relation to markets is based on the close reading of his uses of it. " And my assertion that it is describing behavior in the context of markets is based on a close reading of the book. Smith makes the same point repeatedly, without that metaphor, as when he writes: "It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest." Absent a market on which they sell food and drink, it would not be in their self-interest to produce it for us.

I’m not sure there is much point to either of us continuing to repeat our arguments on what the invisible hand passage in the Wealth of Nations was about. Following links, I came across a brief summary of your more general views, and thought it worth commenting on. You write (about Smith): “He did not consider it appropriate for society to be run by or for ‘merchants and manufacturers’, and nor did he accept that the rich and powerful, including kings, had the right to oppress with punitive laws I’m not sure who, in this passage, you think you are arguing with. Certainly Smith did not think society should be run by merchants and manufacturers. But his chief complaint against them was that they used the power of government, via tariffs and other interferences in the market, to benefit themselves at the cost of the welfare of the rest of the society. That is the same complaint made by modern supporters of laissez-faire.

Consider the modern literature on regulatory capture, coming largely from Chicago school authors, or the public choice literature explaining the existence of tariffs. You don’t specify what “punitive laws” Smith did not accept and (presumably) you think modern supporters of capitalism do. Smith had harsh words for the punitive laws used to enforce the ban on wool exports--but his opinion on that subject would be shared by modern supporters of free markets.

You write, about Smith: “He did not encourage laissez faire (two words he never used) because he was aware of the limitations of markets and of the usefulness and limitations of the State, and nor did he support leaving the poor without realistic opportunities of sharing in their country’s wealth. In short, Smith’s ideas did not qualify him for the phoney cliché title of the ‘High Priest of Capitalism’ or its ‘Apostle’” It’s true, of course, that Smith was not an anarchist and so did not support complete laissez-faire. But he went further in that direction than most modern supporters.

His comments on schooling, for instance, consider as potentially legitimate a range of alternatives ranging from a completely private system to a degree of state intervention much weaker than current practice in the developed world. Someone who proposed that state intervention be limited to a partial subsidy of schooling--roughly speaking, the pro-state extreme of Smith’s range--would be viewed today, in the U.S. or U.K., as an extreme supporter of laissez-faire. Modern supporters of free markets view a laissez-faire society as the best way of providing the poor with realistic opportunities of sharing in their country’s wealth.

For some (American) evidence for that view, you might take a look at what happened to poverty rates in the postwar period. Prior to the beginning of the War on Poverty they were falling pretty steeply. Since it got fully funded and operational they have been essentially static, going up or down with the general economy. The most successful attack on poverty in modern history, along laissez-faire lines, was the almost unrestricted immigration policy followed by the U.S. prior to the 1920’s. The hostility to immigration in modern welfare states parallels, on a larger scale, Smith’s point about the negative effect of the poor laws on labor mobility. To this reader, your passage quoted above seems to come down to “Smith was in favor of home and motherhood and against the man-eating shark, which shows that he was not a supporter of capitalism--supporters of capitalism being known to oppose home and motherhood and approve of man-eating sharks.” You have the first half right. Perhaps this is too harsh-I haven't read your book, which might be more convincing, and I don't know what "supporters of capitalism" you are attacking. But it is how the passage I quoted comes across to a reader who is both an admirer of Smith and a supporter of laissez-faire.