Sunday, December 12, 2010

A Blogger is Perplexed

“Dave” posts on Flatland Rescue Blog (HERE) and writes the following. He seems to be a nice guy, modest too (he’s probably a computer genius). He raises some interesting questions:

‘The Invisible Hand.


No discussion about Adam Smith would be complete without a reference to his famous phrase, “the invisible hand”. I was surprised that the term did not figure more prominently in the book. I only found it once:

'As every individual, therefore, endeavors 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 labors 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. (Smith, 1776)

To me, this concept makes sense, but there is plenty of evidence to the contrary in recent history. I would like to think that, despite the seemingly irrational behavior of people, their general tendency to look out for their own best interest will work for the best in society at large. Then I see an event like the sub-prime loan disaster that almost takes down the country’s economy. The people who took out those loans knew that they could not pay the bills. The lenders who made the loans knew that the default rate would be sky high. Somehow, actions taken in self-interest did not benefit the society at large. Perhaps it is a case of the old adage, “If something sounds too good to be true, it probably isn’t.” Adam Smith was a professor of moral philosophy and a Scotsman. As such, he was likely accustomed to ordinary folk with the sense to know what was in their best interest.’


Comment
See what I mean?

Now let’s treat his questions (asked or implied) helpfully. He deserves answers, which in the normal case he would not get from a modern economist, who would waffle to hide the gaps in their story-book fiction of the so-called “invisible hand’. “Dave” deserves better.

I would ask all users of this paragraph who genuinely want to establish what Smith means by this statement, to consider what lies behind the words ‘every individyal”. Most jump from there to assume that “every individual” means just that; that he is about to make a general statement in the paragraph respecting every single person all the time and link it to his use of the metaphor of “an invisible hand”. But was he?

Now, in a sense he was, but only in the context of the paragraph, and the eight proceeding it, Smith is speaking about those individuals who are the subject of the first nine paragraphs of chapter 2, in Book IV, in which the subject is the behaviour of a specific group of individuals, namely those who prefer to invest in “domestick industry” (Smith’s spelling) rather than in “foreign trade”. Clearly, the paragraph is not about every individual in the whole set of possible individuals.

The distinction is not a mere quibble. There are at least two sets of individuals beside the subject of the paragraph (those who specifically prefer to avoid foreign trade), namely those individuals who prefer to invest abroad (in Europe or the colonies) of which there was a high number, and those individuals who invest at home in “domestick industry” (another high number) for other reasons, besides those (an unspecified number) who are concerned about the security of their capital (many investors of capital at home do so for reasons of habit, scale, and opportunity, and such like, who do not think of sending their capital abroad (local tradesmen, butchers, bakers, and candlestick-makers, and such like). For them too, each “individual necessarily labors to render the annual revenue of the society as great as he can”. This is an inevitable consequence of their actions, whatever their motives besides their “insecurity”.

Generally, too, for them “indeed”, each of such individuals “neither intends to promote the public interest, nor knows how much he is promoting it.” But for the third group – those whose “insecurity’ about investing abroad, that is, THE SUBJECT OF THE EIGHT PARAGRAPHS, which specifically prefer “the support of domestic to that of foreign industry”, which is specifically mentioned eleven times (WN IV ii.1: 452; ii.2: 453; ii.5: 454; ii.6: 454 and 455: 5 times; ii.7: 455; ii.9: 456: twice).

In short this sub-group, within the three sub-groups of merchants, unambiguously, is the subject and the object of the “invisible hand” metaphor.

Modern economists, conveniently for their invented meaning of Adam Smith’s use of the metaphor of an invisible hand, have leapt from Smith’s subject – the actual object of Smith’s use of the metaphor (and remember: according to Adam Smith’s teaching in his Lectures On Rhetoric and Belles Lettres, , Monday, November 29, 1762, p 29, [Oxford University Press, 1983]: “of what is called the tropes and figures of speech”:

In every metaphor there must be an allusion betwixt on object and an other… it is evident that none of these metaphors can have any beauty unless it can be so adapted that it gives the due strength of expression to the object to be described and at the same time does this in a more striking and interesting manner” (p 29).

Could Smith be clearer? Why then did modern economists disregard his clear meaning and smother the “beauty” of his use of the IH metaphor, with nonsense about “social harmony”, “magical” properties, and ultimately, with the “historical travesty” (Blaug) that Smith was an early founder of what became the mathematics of the fundamental welfare theorem? (See my paper: “Paul Samuelson and the Modern Invention of the Invisible Hand”, Journal of the History of Economic Ideas, 2010, no. 3).

“Dave” is right to be perplexed: “To me, this concept makes sense, but there is plenty of evidence to the contrary in recent history.” It has been plausible since Samuelson’s presentation of it in his text, Economics: an introductory analysis, 1948 (McGraw-Hill) and it has spread widely in the last 50 years (whereas it was hardly commented on in the previous 150 year!). It has been and is lauded by top economists, including Nobel prize-winners.

Events, however, hoisted them on their own petards, as “Dave” suspects. The sooner they accept their embarrassment and go back to the actual text in Wealth Of Nations, the better they will feel.

Moreover, read Smith's passage carefully, and note what he was asserting: not that this unintentional outcome was a 'miraculous' general harmony of the 'best good of society', nor even about market, but that the necessary consequence that the larger each individual's output, the larger was society's 'annual revenue and employment' - in short, the whole is the sum of its parts (hardly worthy of it being a truly great mathematical innovation: the ancient Greeks and Arabs knew this millennia ago). Smith regarded the quantitative total of revenue and employment as a 'public good', particular for labouring people, which said nothing about the actual distribution between the orders of society.

I hope “Dave” continues his search for sense in what economists' assert, including why Smith only mentions it once in Wealth Of Nations, though modern economists claim it is his most important idea. It certainly is a beautiful metaphor for its object - the insecurity felt by some, but not all merchants.

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2 Comments:

Blogger Dave Schoeff said...

Dr. Kennedy
Thanks very much for your interesting comments. My little blog post came out of a series of reflections written on “The Great Books of Business”. My classmates and I spent 2 weeks on the Wealth of Nations. Obviously we didn’t get very far, but it was certainly better than simply scanning a Wikipedia article or swallowing Samuelson’s distillation. I read Book1 and Book 4.

I’m compelled to agree with your observations on the beauty of Smith’s metaphors. The IH passage is certainly typical of many eloquent sections in the two books I read. Your explanation makes good sense, and I never realized that so many had taken such license with the Hand metaphor over the years. Very interesting.

Your comment is certainly the most thoughtful I’ve seen in ages. Thanks very much for taking time to illuminate this famous passage.

2:47 am  
Blogger Gavin Kennedy said...

Dave

Good fortune with your studies. Reading the original texts is always the best way to learn what an author meant.

In economics this is so important regarding Adam Smith.

Gavin

10:51 am  

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