Friday, May 20, 2011

Professor Boettke: what Exactly Do Invisible Hands Do?

Peter Boettke in Coordination Problem writes HERE

‘What Does the Market Process Do?’

Dick Cornuelle was a student of Mises before Rothbard, before Sennholz, before Kirzner. He also devoted his work to a wider audience, and to a field not traditionally studied by economists. But he was a market process theorist and he did emphasize the adaptive efficiency of the market economy.

Consider the following from Dick Cornuelle's De-Managing America (1975):

‘The economic process is usually explained in terms of profit motivation and competitive discipline, so we get the impression that the process communicates instructions like "Work hard and don't waste anything." But Adam Smith's invisible hand does much more than stimulate effort and penalize waste. It works as a master arranger or harmonizer of diverse human effort and it works without control. The invisible hand that coordinates the economic process holds neither a carrot nor a stick. It is a signaling hand, important mainly for the kind of directions it provides and the way it communicates them.’

The free economic process shows each participant how to find his own way into a useful position in the larger mosaic. ... The way this happens in practice is illuminated by the concept of feedback ... (pp. 85-86)’

I have read Peter Boettk’s Blog for many years, so my critical remarks of his praise for Dick Cornuelle's ‘De-Managing America’ are not intentionally derisory on what I regard as sheer mysticism by Dick Cornuelle's attempt to explain either or both, the process or the outcomes of markets at work. ‘Adam Smith's invisible hand’ (IH) supposedly explains everything, yet it explains nothing. It certainly was not given this role by Adam Smith himself. He used the invisible hand metaphor for much more limited purposes and his use did not obviously have anything much to do with markets.

If the IH really works as ‘a master arranger or harmonizer of diverse human effort and without control’, how or what did ‘it’ do exactly?

In Moral Sentiments, the context in which Smith applied the IH metaphor referred to the behaviour of ‘proud and unfeeling’ landlords when they allocated part of the harvests produced on their land by and to, variously, serfs, slaves, villains, labourers (and later tenants). This covers a very long period of history, since whenever ‘Providence divided the earth among a few lordly masters’ (TMS, IV.1.10:184), which, in Smith’s stadial sequence, was long before commercial society and even nascent markets.

The object of the IH metaphor on this occasion in TMS was identified by Smith as the cause of them feeding their dependents – the plain fact that they had no choice but to do so – labourers and their families had to be fed, otherwise the labourers could not work the fields that secured the ‘greatness’ of their lordly masters, and this was ensured only because of the mutual dependence of the labourers on their lordly masters and the dependence of the lordly masters on their labourers. It had nothing to do with markets – in fact their mutual dependence was based on the very real likelihood of violence, fuelled by the ‘natural selfishness and rapacity’ of ‘the rich’ (Moral Sentiments, IV.1.10: 184-5).

The second example of Smith’s use of the IH metaphor in Wealth Of Nations, which Cornuelle directly, and Boettke indirectly, claim: ‘coordinates the economic process’, holding ‘neither a carrot nor a stick’, but it is ‘a signalling hand, important mainly for the kind of directions it provides and the way it communicates them’. This use is also far from what Adam Smith wrote in Wealth Of Nations as its role. Pointedly, its ‘object’, is also far from a ‘market decision’, as opposed to a decision in a market environment – 18th-century protectionist Britain.

On this occasion, the IH metaphor was applied by Smith to a particular sub-set of merchants in protection-ridden Britain. One subset of merchants traded exclusively and ‘domestickly’ in Britain, and another sub-set traded exclusively in the ‘foreign trade of consumption’. Another sub-set, while inclined to join in foreign trade, recoiled from it because of their concerns for the security of their capital. Smith discusses the causes of the security concerns of these merchants from paragraphs 1 to 8 in pages 452-55) before he uses the IH metaphor (WN IV.ii.9:456). He comments: ‘In the home trade' [the domestic-only merchant] knows better ‘the character and situation of the persons whom he trusts, and if he should be deceived, he knows better the laws of the country from which he must seek redress' (WM IV.ii.6: 454), and Smith observes, correctly, that ‘a capital employed in the home trade ... necessarily puts into motion a greater quantity of domestic industry and gives revenue to a greater number of inhabitants of the country, than an equal capital employed in the foreign trade of consumption’ [which is not exactly high-level maths!].

Smith goes on, (mentioning the impact on ‘domestick industry 3 times more), to make his famous observation on the role of an invisible hand:

By preferring the support of domestick to that of foreign industry, he intends only his own security and by directing that industry 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 and end which was no part of his intention’ (IV.ii.10: 456).

Now, all metaphors have specific objects, which they describe ‘in a more striking and interesting manner’ (see Adam Smith, Lectures in Rhetoric and Belles Lettres, [1763] 1983, page 29), and the object of the IH metaphor in Wealth Of Nations is not that it ‘coordinates the economic process’, holding ‘neither a carrot nor a stick’, nor that it is ‘a signalling hand, important mainly for the kind of directions it provides and the way it communicates them’.

That is wholly an invention from the 20th century, albeit plausible if a 20th-century author wishes to invent that role for it (with of course a clear identification of the intended object by the 20th-century author) - but it is not what Adam Smith wrote in Wealth Of Nations and should not be applied to his use in the 18th century. Smith, on both occasions, in TMS and WN, identified the objects of the IH metaphor and they are eminently plausible, and help us understand the role of their objects in the process in which they operated.

But that cannot be said of the 20th-century inventions; nobody bothers to explain how the use of the IH metaphors helps us understand the working of markets. In fact, they obfuscate our understanding, creating allusions to something mysterious, indeed, ‘miraculous’, about markets (yes, even ‘the hand of God’ is sometimes applied).

Smith knew how markets worked (he showed how in Books I and II of Wealth Of Nations – without mentioning anything about ‘invisible hands’ - , but nobody, to my knowledge has explained what the modern version of ‘an invisible hand’ actually does, yet the profession, including the followers of Mises, seem to apply it in a mystical form, making modern pretentions to being a science somewhat laughable.

It was necessity that led ‘proud and unfeeling lordly masters’ to feed their dependent labourers – that necessity was the IH; it was what economists call their risk-aversion from what Smith called ‘their insecurity’ that led some, but not, all merchant traders to invest their capital locally, thus unintentionally adding to local ‘domestick’ revenue and employment – their insecurity was the invisible hand (you cannot see 'necessity' or 'insecurity' but you can see market signals at work through very visible prices, as we teach from Economic 101 to Doctorates.

I urge Peter Boettke to consider an ‘Emporer is naked’ moment on the modern use of the IH metaphor and answer the question: what does the Market Process do?’ - without using a 20th-century empty metaphor of its required object.

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Blogger Michael Kruse said...

Maybe we need to make clear that when it comes to understanding economics and economic history, invisible hands are the devil's workshop. ;-)

2:49 am  

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