Thursday, December 08, 2011

Smith is Misunderstood, But What is it That Modern Economists Do Not Understand?

“Whatever Happened to Making an Honest Buck?” “Wall Street Attacks Elizabeth Warren Because She Believes in Capitalism More Than They Do

By Neil H. Buchanan (an economist and legal scholar, a Professor of Law at The George Washington University, and a Senior Fellow at the Taxation Law and Policy Research Institute, Monash), posting in Verdict HERE

Even the most basic economics textbooks carefully recite what is necessary to allow “the invisible hand of the market” (in Adam Smith’s famous, but generally misunderstood, words) to work its magic. Among the conditions necessary, to give us confidence that self-interested trades among buyers and sellers will lead to socially desirable outcomes, is the requirement that both sides are well-informed about the choices they face.”

True, Adam Smith’s singular in use of the metaphor of “an invisible hand” in Wealth Of Nations (WN. IV, ii. Paragraph 9: 456) is “generally misunderstood”. Smith never said anything about “socially desirable outcomes” being “the requirement that both sides are well-informed about the choices they face”.

That is a construction placed on the IH metaphor by modern economists, who invented the “misunderstood” meanings about “invisible hands”. In Adam Smith’s case, he was referring to some, but not all, merchants who were averse to the risks, as they saw them, of sending their capital out of their sight in the "foreign trade of consumption" and preferred to invest in “domestic industry” (he refers to this concern several times in the famous paragraph, though most modern economists and most authors of “most basic economics textbooks” ignore Smith’s carefully worded case, leading up to his use of the IH metaphor.

He was not writing about “the invisible hand of the market” at all. His point was more specific. From their “insecurity”, those merchants invested locally and it was their concern for their capital that led them to choose the domestic market, and Smith's use of the popular (at least in the 17th-18th centuries) metaphor was to “describe” this process in a “more striking and interesting manner”, exactly as Adam Smith taught his students on Rhetoric, then part of the Moral Philosophy degree at Glasgow and other Scottish Universities.

Neil may check for himself (and for his students and readers) Smith’s views on the role of metaphors in: Smith’s “Lectures on Rhetoric and Belles Lettres” ([1762-3] 1983, p 29), or refer to the entry for metaphors in the English Oxford Dictionary.

[Under my self-denying ordinance, I have no views on the subject of Professor Neil Buchanan in Verdict; I only comment on the politics of the country in which I vote, Scotland.]



Blogger Jazmin said...

In my opinion what modern economists don't understand is why Smith feels that both parties should benefit from what is going on with the trade because sometimes one party has to lose a little for the other to gain. Or that this invisible hand idea doesn't make sense because they both can't automatically benefit.

9:30 am  
Blogger Gavin Kennedy said...

Hi Jazmin

Thanks for your comment.

I suggest you consider that both parties in trade (and exchange) may both benefit (gain). They do not gain the same thing, nor do they need to. Traded exchange is not "zero-sum" - why should someone volunteer to lose in a trade?

Someone gives up whatever it is they trade - the cash value may be the same to initiate the exchange and the other person acquires whatever they want to use the cash value for. The need not trade money; they could trade things - kids do it all the time - comics for toys, and such like.

Trade is a non-zero sum game.

None of this has anything whatsoever to do with Adam Smith's use of the metaphor of an invisible hand.


12:58 pm  

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