Tuesday, July 26, 2011

Metaphors Are Not Real

Jeff Carter writes for Business Insider (HERE):

"Behaviorial Economics Isn't Rational"

“True free market economics in the Adam Smith vein has a lot of warts. It’s messy. People make mistakes. Sometimes it takes a bit longer for a market to clear. There are winners and losers. Many will point to things as being unfair. But, it’s the most efficient way to allocate capital and to raise the standard of living for all society. There is no getting around it, people intrinsically weigh opportunity costs/benefits and make utility maximizing decisions for themselves. That’s what makes the world go round. Some people are able to process information quicker than others, are smarter than others, and have more material advantages than others-but that playing field has been with us since the dawn of mankind. There is no way to even it.

The internet has made it possible to have true worldwide markets. It's possible to quickly exchange information and act on it across borders and time. Simply look at the speed at which news travels today versus even ten years ago. It's much faster and more efficient. You don't even need to watch television news anymore, just follow the right people on Twitter. 

Demand curves always slope down. The study concludes, “Adam Smith’s invisible hand may be more powerful than originally thought….it may generate aggregate rationality not only from individual rationality but also from individual irrationality."

There is one big flaw in Jeff Carter's self-satisfied argument: there is no such thing as a general ‘invisible hand’. It’s a metaphor: it has an object, different from itself. The metaphor is only as “powerful” as the “object” it “describes” in “a striking and interesting manner” (Adam Smith: Lectures on Rhetoric and Belles Letters”, [17563] 1983, p 29).

When Adam Smith used the IH metaphor, only twice in his published writings, he was not referring to “demand curves”, market demand, or the price system (see Theory of Moral Sentiments, Part IV 1.10: 184) and Wealth Of Nations Book IV. II. 9: 456). In fact, he never used the IH in relation to markets or competition.

In TMS he referred to “unfeeling” landlords having to feed their servants, retainers, field slaves/ serfs/ tenants from the inevitable necessity of doing so – no food no labour; no labour no food. In WN he referred to some, but clearly not all merchants – Britain’s foreign trade made it a major exporter and importer in the 18th century - whose “insecurity” led them to invest in “domestick industry”, which in consequence, and without their intention, quantitatively increased domestick annual output of the “necessaries, conveniences, and amusements of life” (WN Introduction, p 10), and he considered this outcome contributed to the public good. (It follows, thereby, on this argument that those merchants who engaged in the “foreign trade of consumption” initially, at least, lowered investment in “domestick industry”).

For both of these examples Smith used the metaphor of “an invisible hand” leading them to act in certain ways – in TMS, from the landlord’s following the dictates of their self “deception” and absolute necessity, and in WN, from some merchants reacting to their feelings of “insecurity” to avoid foreign trade. The IH metaphor was not real in itself; the invisible workings of the brains of those landlords and those merchants “led” them to behave as they did. No actual "hands" led them to do anything - metaphors do nothing themselves they are literary imaginations for the real world.

The metaphor expressed these actions “in a more striking and interesting manner”. In Smith’s use it had nothing to do with markets and the price system, etc. The popular notion that it did have such a connection was an invention in modern economics from the 1940s (Paul Samuelson and others).

Whether behavioural economics is “rational” or “irrational” is not addressed by the IH metaphor.

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