Sunday, August 22, 2010

Three Serious Economists Criticise My Reading of the Metaphor on 'an invisible hand'

Three serious economists commented on my previous post that 'Stiglitz is Right' and their statements are of exceptional interest to the Lost Legacy debate on what Smith meant by 'an invisible hand' on the three times only that he used it. Because their posts were of such high quality, I have reposted them here with my comments for a wider discussion to include those who do not normally read the comments made by correspondents.

Each reader's comment is followed by the response I made in the previous post:

1
Ray

Gavin, Perhaps I am missing something, but you seem to be stretching what Stiglitz said to suit your opinions on Smith's use of the invisible hand metaphor. Where is the "denial of the assertions"? Stiglitz also uses the phrase "it is not actually there" in the preface of his book 'Making Globalization Work', but, he says nothing there that relates to whether Smith intended the invisible hand to be a function of market efficiency. I have read a fair amount of Stiglitz and my interpretation of his position regarding the invisible hand is that it 'is' a force that has influence on the scales... but, a force that has always been manipulated, mainly due to information 'asymmetries'. This is of course at the apex of the work that made him a Nobel laureate. What I have always thought that Stiglitz meant to imply, by the oft used statement: "the invisible hand is often invisible because it's not actually there", is that the hand is being obstructed by stronger forces?


Comment
Ray
Thank you for your comment. I am quoting what Stiglitz said about the invisible hand not being there. He is right in my view about that. I am not endorsing everything he writes about is prescriptions for capitalism.

Smith’s use of ‘an invisible hand’ is quite clearly a metaphor. See above for Smith’s meaning of the use of metaphors in his Lectures on Rhetoric and Belles Lettres ([1762] 1983).

In the WN case, it was about the felt need for the security of his capital. Now, clearly security is invisible to the observer; it is felt by the merchant trader contemplating sending his capital abroad with its associated (for him) risks. This leads him to prefer to invent locally (Smith explains why this is so in the preceding paragraphs – usually not quoted by modern economists (and probably not read by them either)).

The only ‘stronger forces’ that can affect the trader are those that would reduce the ‘risk-aversion’ he feels – in which case he would send is capital (out of sight) abroad. Clearly, many British traders did precisely this. They consequently reduced domestic investment and productive employment in Britain. The invisible hand of insecurity was not operating for them.

Also, bear in mind, 18th-century traders were not operating in competitive markets. Domestically, the economy was riddled with mercantile monopolies (Guilds, Incorporated Towns, protection measures, prohibitions, combination and Settlement acts, etc.) and internationally by similar measures in the colonies and in other European economies, and the Navigation Acts. This makes the linking of the metaphor to ‘competitive markets” (even, via Samuelson’s 19 edition of Economics, to the 20th century’s welfare theorems and perfect competition!).

What else Stiglitz promoted is not my concern in this discussion. He right on the narrow statement he made; that is all I asserted.

Gavin

2
Gavin Kennedy writes: "Smith’s use of the metaphor was not about markets, regulated of otherwise and in none of the three cases that he uses it was it about markets." The quote from the Wealth of Nations is: "As every individual, therefore, endeavours as much as he can both to employ his capital in the support of domestic industry, and so to direct that industry that its produce may be of the greatest value; every individual necessarily labours to render the annual revenue of the society as great as he can. He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. 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." I am puzzled as to why you don't consider that a description of the socially desirable outcome of individually self-interested choice within the context of a market, and left wondering whether you have actually read the book or are merely reporting what someone else says bout it. Perhaps you could explain what you think Smith means.

Comment

David
Thank you for your comment and question.

I am well aware of the part of Adam Smith’s writing of the context in which he makes reference to the metaphor of ‘an invisible hand’. Indeed, I regularly quote and discuss it on Lost Legacy (and in several papers I have written and it is discussed in my book ‘Adam Smith: a moral philosopher and his political economy’, Palgrave, 2008, and in an extended form in the 2nd edition, 2010, Chapter 12). I have read ‘the book’ and his other two references to the metaphor in his Astronomy (1744-50s) and Moral Sentiments.

Modern Economists since Samuelson, Economics, 1948, page 36, have treated that part of Smith’s statement quoted by you (WN, IV.ii.9: p 456) as if he is talking about all individuals, when the context is clear; he talks about some, but not all traders, who consider foreign trade to be too risky and prefer domestic trade. (WN IV.ii.1-9).

The metaphor describes ‘in a more striking and interesting manner’ its object, as I believe Smith meant, which was the security (modern risk-aversion) that ‘led’ such traders to invest locally, and, unstated but clearly linked, had the unintended consequence that domestic output and employment (concerns of Adam Smith) were higher than they otherwise would be. I suggest the arithmetic rule that ‘whole is the sum of its parts’ captures this consequence.

If you insist that the ‘invisible hand’ is real, actual, or has content, you take on a wholly fictitious metaphysical idea (‘the hand of God’ or such like construction), which is theology not economics.

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. Samuelson and others asserted that it was elated to markets, without a scrap of textual evidence – its is not mentioned in Books I and II of WN, which deal in detail with the workings of markets. Also, his use of it was hardly mentioned by political economists, while Smith was alive, nor for long after he died. Strange for a cardinal principle?

Gavin

3
Gavin. I think you are missing the point of what Stiglitz is saying. In my view he isn't saying I have read Adam Smith and understand what he wrote and how and when he used the idea of the invisible hand. From what I have read of Stiglitz I see on real understanding of Smith. What I think he is saying, in short, is "I hate markets". Stiglitz's understanding of markets and "market failure" is a neoclassical understanding. He believes in the,and uses a a benchmark for market failure, the fundamental theorems of welfare economics and as I have noted before, Mark Blaug argues that Smith's notion of markets has noting to do with these theorems. When Stiglitz says the invisible hand doesn't exist, he is saying that it is not there in terms of the neoclassical model, ie there are market failures and thus we need government actions to correct these.
By Paul Walker on Stiglitz is Right on 22/08/10

Comment
Paul
I am commenting on Stiglitz's sentence, ending in the 'invisible hand is not there', nothing else. That statement in my view is correct. The metaphor as used by Adam Smith was a metaphor, as taught by Smith to his students attending his Lecture in Rhetoric and Belles Letters ([1762] 1983, p 29), which represent 'in a more striking and interesting manner', it's object. Modern economists, including neoclassical and Miseian economists, treat Smith's use of the metaphor of the invisible hand as it own object, i.e., they assert that it exists - there is an invisible hand! Whatever else it is, it is not its own object, as Adam Smith understood, taught his students, and meant by it.

That is my point in quoting Stiglitz (whose other ideas I may not agree with).
Gavin

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6 Comments:

Blogger David Friedman said...

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.

9:49 p.m.  
Blogger David Friedman said...

(Your software does not appear to allow long comments, so I am posting this in several pieces)

(part I)

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.

10:53 p.m.  
Blogger David Friedman said...

(Part II)

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.

10:56 p.m.  
Blogger David Friedman said...

(Part II)

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.

(continued in part 3)

10:57 p.m.  
Blogger David Friedman said...

(part 3)

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.

10:58 p.m.  
Blogger r l love said...

Gavin,

As it turns out, Wiki has a quote from Stiglitz that further explains his position on this very issue:

"The Nobel Prize-winning economist Joseph E. Stiglitz, says: "the reason that the invisible hand often seems invisible is that it is often not there."[10][11] "Stiglitz explains his position:"

"Adam Smith, the father of modern economics, is often cited as arguing for the "invisible hand" and free markets: firms, in the pursuit of profits, are led, as if by an invisible hand, to do what is best for the world. But unlike his followers, Adam Smith was aware of some of the limitations of free markets, and research since then has further clarified why free markets, by themselves, often do not lead to what is best. As I put it in my new book, Making Globalization Work, the reason that the invisible hand often seems invisible is that it is often not there."

"Whenever there are "externalities"—where the actions of an individual have impacts on others for which they do not pay, or for which they are not compensated—markets will not work well. Some of the important instances have long understood environmental externalities. Markets, by themselves, produce too much pollution. Markets, by themselves, also produce too little basic research. (The government was responsible for financing most of the important scientific breakthroughs, including the internet and the first telegraph line, and many bio-tech advances.)"

"But recent research has shown that these externalities are pervasive, whenever there is imperfect information or imperfect risk markets—that is always."

"Government plays an important role in banking and securities regulation, and a host of other areas: some regulation is required to make markets work. Government is needed, almost all would agree, at a minimum to enforce contracts and property rights."

"The real debate today is about finding the right balance between the market and government (and the third "sector"—non-governmental non-profit organizations.) Both are needed. They can each complement each other. This balance differs from time to time and place to place.[11]"
------------------------------

So, it seems that Dr. Stiglitz 'does' consider the invisible hand metaphor to imply that by "free markets", and by, the "pursuit of profits, [firms] are led, as if by an invisible hand, to do what is best for the world".

In other words, you are using a quote from his writing out of context to align his position with your own. There is a subtle deceit involved here because the title suggests ('Stiglitz is Right') that Stiglitz is endorsing your position on what A. Smith meant by the 'invisible hand'... when, Dr. Stiglitz is suggesting nothing of the sort. Then you repeatedly distance yourself from his other views as if this distancing validates the quote taken out of context. Please explain.

I am also curious about how you get around the obvious fact that the very paragraph containing the invisible hand metaphor ( see David's comment) begins with, and repeats, the term: "every individual". Which, you argue, actually means: "some" ("traders", "merchants") in a variety of ways? There is not a 'way' though, to transform the word 'every'... to mean 'some'.

Ray L Love

11:20 p.m.  

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