Monday, February 07, 2011

Adam Smith On Markets And Their Regulation

One benefit of enforced “rest” from having a prolonged cold, now reinforced by anti-biotic doses, is the time it creates for some idle thinking, in this case, about Lost Legacy. Looking back over several years, I can follow the development of my narrative against the prevailing practice in modern economics of misrepresenting Adam Smith’s use of the IH metaphor. Over recent time, particularly when responding to the recent challenges from Daniel Klein and David Freidman (for which I thank them for their scholarly approach to discourse among colleagues, and which Jeff Traubman reminds us, is proper in the Republic of Letters).

What occurs to me is my need to focus more on the attempted applications of the IH metaphor in Adam Smith’s name to how markets work, rather than focus on the alleged use by Smith of the IH metaphor as some kind of allusion by him for market processes, to supply and demand, and for the inevitable benefits they contribute to social harmony, even to General Equilibrium, in stark contrast to the highly restricted use Smith had in mind of the purely “domestik” quantitative increase in the “annual revenue and employment”, as some merchants chose to avoid their perceived risks of “foreign” trade.

This also applies to those who associate the IH metaphor working as and within “perfect competition”, and modern “capitalism”, and even as of divine origin.

I think I shall try to take on the applications of the IH metaphor as they are presented by modern commentators, and show that there is no role in economics for a mysterious, non-defined (nor definable) term in their arguments – it never appears in the mathematics of GE, ironically its strongest exponents.

If proponents of the IH metaphor reject the evidence in Adam Smith’s texts (History of Astronomy, 1995, post-h; Moral Sentiments, 1759; Wealth Of Nations, 1776, but he defines metaphors in his Lectures on Rhetoric, 1762-3, 1983, post-h), then let us take the challenge to them to explain what the IH metaphor brings to the party – so to speak – in their modern examples.

My broad case can be summed: it brings nothing at all.

So let me start with today’s offering:

Ted Sprauge post in McGill Daily (HERE) (and also Blogs HERE

Adam Smith in the traditional market: Deconstructing the Indonesian pasar”

“Today the chicken seller doesn’t budge: 27,000 rupiah (roughly $3) each. He won’t even shave a thousand rupiah for a seasoned bargainer. Demand is high on the eve of the Chinese New Year. Recognizing that he has the upper hand, the chicken seller is winning this centuries-old competition between buyers and sellers. Adam Smith’s “invisible” hand penetrates deep even in this medieval market. Nothing escapes the clutch of the law of supply and demand.”

“Foreigners might think them to be “native,” “traditional,” a way of life to be preserved, but if you ask everyone there, they would want things to be improved. A rat-infested pasar is not something to be proud of. Adam Smith’s “invisible” hand cannot possibly untangle this mess. A firm, directed hand, and one which is visible to the people, is needed, and it shou
ld be the hands of those petty traders and housewives – rough, scaly, dark, from years of peddling, hawking, and handling food.”

Ted Sprauge describes a scene that is replicated in many places all over the world. I have attended colourful street markets in Singapore, Kuala Lumpur, Shanghai, Hong Kong, Cape Town, Istanbul, Suez, and Aden, and their modern remnants in Leeds, London, Bergerac, Castillion, Paris, Edinburgh, and Glasgow.

Sprague turns a fine phrase: “Nothing escapes the clutch of the law of supply and demand”. Yes, and Smith made a similar point about the effectual demand for black cloth on a day of mourning at a funeral.

But what he did not do was link this example to the IH metaphor. His explanation of markets was fully explained in Wealth Of Nations without the IH metaphor in the “centuries-old competition between buyers and sellers.”

The subjective social pressures of proper appearance in black as a guest at a funeral fuelled the effectual demand for black cloth, even as an arm- or hat-band, if not a coat. No ‘invisible hand’ was needed to prompt the buying of black cloth; the `IH metaphor’ is redundant in this context.

What does it do? Lead mourners to go out and buy black cloth? The felt social obligation is sufficient, certainly among the principal mourners (family, close friends). Similarly with the effectual demand for chicken, where the “Demand is high on the eve of the Chinese New Year”, as is demand for Haggis, even a nominal spoonful, in Scotland around 25 January (birthday of Robert Burns).

Sprague rightly notes that “Adam Smith’s “invisible” hand cannot possibly untangle this mess”, because “A rat-infested pasar [market] is not something to be proud of”. First I would answer why is it that street markets in Britain are not “rat infested (as was very visible when I visited one selling fish and chickens in Singapore)? Then I would ask, why do most developed markets in Europe and North America (and Singapore!) conform to the ‘big box’ type for retail sales?

Yes, it was and is connected to the rise in per capita incomes from “medieval” conditions. In fact, ‘big box’ selling it seen by some as a threat to city centre small shops, from the perceived lower market prices of the Tesco, Safeways, Wall Mart, Sainsbury, and Waitrose operations.

Ted, from a developed economy’s perspective, abandons his faith in the “invisible hand”, which never existed in the role he assigned to it, and plumps for “A firm, directed hand, and one which is visible to the people” which “needed”. I only comment: beware of what you wish for.

History shows that the gradual regulation of the “medieval” street markets across Europe (at first resisted by the merchants) proved a dubious long-term benefit for consumers. Remember, regulations, licences and such like, are administered by inspectors, who as a rule expand any set of regulations over time by a large amount, and certainly did so in Britain.

These regulations formed the basis for Queen Elizabeth’s mercantile laws, the side-effects of which legalized town monopolies of tradesmen (Guilds, Apprentices, and such like) by devolving their administration and enforcement to the tradesmen, supposedly to be regulated. Smith had plenty to say about these unintended malign consequences in Wealth Of Nations.

The first cry for ‘laissez-faire’ came from a French town-merchant speaking on behalf of merchants – not consumers – against the even more regulated town markets of France.

Rising per capita incomes among the lowest paid and poorest majority from economic development inexorably resolves the awesome problem of ‘rat infestation’ of street markets. Western tourism, ironically, tends to keep them as places to visit (in between spending sprees in place like Singapore’s Orange Road's big-brand retail emporia – I tried my first Apple in a computer shop there in the 1980s).

Ted Sprauge, perhaps, should look closer at Adam Smith’s use of the IH metaphor before considering it as relevant to an Indonesian pasar, interesting as his report was.

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