Wednesday, August 25, 2010

A Debate on the Invisible Hand Continues

David Friedman writes:

And I remain puzzled as to how you can believe that the comment about the invisible hand was only about preferring local to foreign investment at nearly equal profits, when Smith both provides another example and says that his comment is true of many other cases as well. Beyond that, I would need a clearer idea of who and what you believe you are disagreeing with to tell to what degree your disagreement is or is not justified.

Gavin responds:

The first part of David’s question (was Smith making a general statement about all individuals are ‘led by an invisible hand’) is answered by reading his text more carefully for context (all references are to the definitive Glasgow Edition of Smith’s Works and Correspondence, published by Oxford University Press and reproduced by Liberty Press):

The contextual theme starts in paragraph 1 and runs through to paragraph 9, pages 452-456, WN Book IV, chapter ii. Merely to take part of paragraph 9 (456), which is the usual format of the popular ‘quotation-only’ references, misses out Adam Smith’s argument about the distortions to what he called ‘natural’ processes were caused by mercantile political economy.

To see why the statement in paragraph 9 links to what preceded it, read paragraph 6 (pp 454-5) and note the consequential importance of the home trade (‘a greater quantity of revenue and employment’):

‘… but a capital employed in the home-trade, it has already been shown, necessarily puts into motion a greater quantity of domestic industry, and it gives revenue and employment to a greater number of inhabitants of that country, than an equal capital employed in the foreign trade of consumption… Upon equal, or only nearly equal profits, therefore, every individual naturally inclines to employ, his capital in the manner in which it is likely to afford the greatest support to domestic industry and to give revenue and employment to the greatest number of people in his own country’ (p 455; emphasis added).

Smith clearly differentiates between the ‘domestic’ and the ‘foreign trade of consumption’ and goes on to refer to ‘every individual who employs his capital in the domestic industry’, which by doing so separates ‘every individual’ he refers to from those other individuals who engage in foreign trade and who do not invest their capital domestically. Capital sent to set up a ‘factory’ in India or a plantation in Virginia does not simultaneously impact positively and equally in domestic investment and output.

The investment of Glasgow tobacco merchants (of whom Smith was very familiar from 1751-64) added to Virginia’s domestic output and employment (including slavery), with some trickle-down to Scottish output and employment in shipping, warehousing, distribution and such like, plus building trades for their Scottish magnificent houses (consumption). Its predominant investment and employment effect was abroad.

Smith sets out his hypothesis, again separating domestic from foreign industry:

‘7. Secondly, every individual who employs his capital in the support of domestick industry, necessarily endeavours to direct that industry, that its produce may be of the greatest value’ (455).

Therefore, it should be clear that Smith in paragraph 9 refers to ‘every individual’ who engaged in domestic investment, but clearly not to those who engaged in foreign investment, because domestic investment did more for domestic revenue and employment than ‘an equal capital employed in the foreign trade of consumption’.

So we find that is perfectly legitimate from what Smith wrote to separate the ‘every individual’ tag from slipping from one specific group of capital investors (those investing locally) from another group investing abroad (Europe and the British Colonies, including India). Repatriated profits, especially on retirement, were mainly spent on splendid country and town houses personal consumption and prodigality, which Smith regarded as less beneficial to domestic capital investment and employment than the successive, regular and short cycles of individual capitals returning three or more times a year domestically (productive), rather than the four of five years (or even longer) they might take for one take in foreign trade. That is why the context is easily missed if Book IV, chapter ii is read hurriedly and if you are already convinced that Smith was making a general statement for all the actions of all individual investors, domestic and foreign when he was being more specific ‘in praise of, so to speak, the domestic investors.

Neoclassical economists who leapt on the ‘hurried’ reading, mainly, I suspect of the quotation separated out of paragraph 9 and not the chapter, such as Paul Samuelson, who take it as a general statement and not as Smith had written and, therefore, intended it.

This brings to the ‘case’ question: ‘he is in this, as, as in so many other cases, led by an invisible hand to promote an end which was no part of his intention’.

First, note in the second sentence of paragraph that the ‘he’, and ‘every individual, therefore, endeavours as much as he can both to employ his capital in support of domestick industry’ (which thereby clearly excludes every other individual who deploys his capital in the foreign trade of consumption and not ‘domestick industry’). Smith is not making a general statement or axiom in this paragraph.

Smith states specifically, ‘ in this case’ – those in ‘support of domestick industry – are ‘led by an invisible hand’ to invest locally. And the object of the metaphor? It is his intention of: ‘only his own security’ (namely ‘his’ aversion to the greater risk of foreign trade, specified in paragraph 6, p 454).

I have already specified what Smith regarded as the purpose of using metaphors: specifically to state ‘in a more striking and interesting manner’ their ‘object’ (his Lectures on Rhetoric and Belles Lettres, 1762: 1983, p 29). And the object that drives individuals to prefer the home trade to foreign trade: the security of their capital!

Now, Smith extends the applicability of the metaphor to other cases, but the same rhetorical ‘rules’ prevail, as for all metaphors (that is what Smith taught his students and has been known since Professor John M. Lothian of the University of Aberdeen, purchased 1978 in a Manor House sale two volumes of ‘Notes of Dr Smith’s Rhetoric Lectures’ (1762) and published them in 1963 (Nelson), which have been widely available from Oxford University Press since 1983.

Smith does not identify any other of the ‘many other cases’ in Wealth Of Nations, but he does identify one other use of the metaphor in Moral Sentiments (1759) and we can see the same format used by Smith of this metaphor. In TMS book IV, chapter 2, p 184, he refers to ‘the proud and unfeeling landlord’ who ‘without a thought for his brethren’ nevertheless is ‘led an invisible hand to make nearly the same distribution of the necessaries of life, which would have been made, had the earth been divided into equal proportions among all it inhabitants and this without intending it and without knowing it, advance the interests of society, and afford the means to the multiplication of the species’ (TMS IV. i.10, p 184-5).

Two common features to these two cases of the use of the same metaphor of ‘an invisible hand’: the agents concerned (the proud and unfeeling landlord’ and the ‘individual’ who invests in the home market) do not intend to promote the public interest and nor do they know about the consequences of their actions.

They are motivated to do what they do by distinct causes: the landlord must distribute ‘his’ food from ‘his’ fields to ‘his’ serfs, because, self-evidently, he had no choice but to do so. Without subsistence they would starve and the basis of his self-opinionated ‘greatness’ would perish (the invisible hand was his absolute necessity to share some of his food resources to continue to bask in his power and greatness, and this had the effect of ‘advancing the interests of society’ and the ‘multiplication of the species’); and the home trade investor driven by his perception of the comparative greater ‘insecurity’ of investing abroad to invest at home instead. In doing so, he increases domestic investment and employment, without this being his intention or even thinking about it. The whole is the sum of its parts. He pursues profit on his capital, not national advantage.

I suggest that Smith demonstrated the powerful use of a metaphor to explain in ‘a more striking and interesting manner’ the unintended consequences of individual motivation in both cases.

That there are numerous other cases where unintended consequences can be demonstrated is most likely. A French Physiocrat (I think it was Mirabeau) remarked that ‘individuals think they are working for themselves but in reality they were working for everyone else’. If we could examine what motivates each individual, we could identify the object of whatever metaphor we used to describe what they actually did.

The third question about just who am I criticizing is fair enough.
I have been tracking the explosive use of the metaphor as its own object seen in the oft stated assertion that there is an invisible hand of the ‘market, supply and demand’, a theorem, a paradigm, and which somehow led to social optima and equilibrium, which, allegedly was first stated by Adam Smith, and so on.

Originally, I found this attention strange, because I had found no references by others to Smith’s use of the invisible hand when he was alive (though the metaphor was extremely well used in the 17th-18th centuries in theology and literary fiction), nor much notice of his uses taken until the last fourth of the 19th century. In the 1920s and 1930s the invisible hand (focusing on versions of selfishness/self interest leading to social maxima in output or welfare) began to appear in isolation (Pigou, Knight, Chicago oral tradition, Lange) and, after Paul Samuelson’s Economics: an introductory analysis (1948; 19 editions and 4½ million sold) appeared, the references – and the myths - became endemic (I can send you my paper ‘Paul Samuelson and the Origins of the Modern Myth of the Invisible hand’ if you send me an email address:

This 20 May to 3 June, I began posting on Lost Legacy modern attributions of the invisible hand myths to Adam Smith in textbooks, but I was interrupted by illness and hospitalization from continuing until, probably, late September. You can look through the archives for examples; some titles appear below:

20 May: John Lindauer, Economics: a modern view, 1977, W. B. Saunders Company, p.12
21 May: Elbert V. Bowden, Economics: the science of common sense, 1974, South-Western Publishing Co. p. 405.
22 May: James F. Willis and Martin L. Primack. 1977. Explorations in Economics, Houghton Mifflin and Company
23 May: Edwin Mansfield: Economics: principles, problems, decisions, 1974. Norton & Co. New York, pp 16-18
24 May: Richard B. McKenzie and Gordon Tullock, Modern Political Economy: an introduction to economics, 1978, p. 111-12. McGraw-Hill, New York.
25 May: William Baumol and A. S. Binder, 1979. Economics: principles and policy, pp 593, 599, 806-7, Harcourt Bruce Jovanovich, New York
26 May: David Begg, Stanley Fisher and Roger Dornbush Economics (1984) New York: McGraw-Hill (British Edition of a popular US text)
29 May: George Reisman [1990] 1996. Capitalism: a treatise on economics, Ottawa, Illinois, Jameson Books
1 June: Alec Cairncross, 1944. An Introduction to Economics, London: Butterworth & Co
2 June: H. A. Silverman, [1922], 5th: 1928; 11th: 1940; 16th 1964. The Substance of Economics: for the student and the general reader, London: Pitman & Sons Ltd.
3 June: Edwin G. Dolan (with the collaboration of David E. Lindsey), 1977. Basic Economics. Hinsdale, Illinois: The Dryden Press.
You may respond with a post as long as you need, which shall be posted unedited in full (email my adress above)



Blogger Far de la Banya said...

The debate about invisible hand is now actuall... with the crisis. But... this hand help really the people, or only some rich people?

Best regards from Catalonia,

7:52 a.m.  

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