Sunday, March 11, 2012

A Largely Agreeable Review of Kaushik Basu on the Invisible Hand

Last year, I reviewed a book “Beyond the Invisible Hand” by Kasuhik Basu on Lost Legacy and noted its author had failed to understand Adam Smith’s use of the IH metaphor, which largely compromised Basu’s critique of the problems that support beliefs in the modern invention of Smith’s actual meaning in using the metaphor because Basu accepts the modern invention without realising that neoclassical economics was a victim of its own false beliefs. Now, a critical review of the same book has been posted and I think a few comments are in order.

Oliver Mark Hartwich, a Research Fellow in the Economics Program of the Centre for Independent Studies in Sydney, Australia, reviews Kashik Basu’s Beyond the Invisible Hand: Groundwork for a New Economics, by Kaushik Basu (Princeton University Press, Princeton, NJ, 2011), pp. 273. HERE . Basu’s review was published in Economic Record (Sydney), Vol. 88, No. 280, pp. 156-158, March 2012.

The title’s reference to the ‘invisible hand’ of course refers to Adam Smith’s notion, first proposed in the Wealth of Nations (1776), that individuals pursuing their own interests would also achieve outcomes that are beneficial to society at large.

Basu is careful to point out that Smith’s original idea contained qualifiers and warnings, which were left out by later generations of economists building on the concept of ‘the invisible hand’. This is most welcome since it has become commonplace, both by his admirers and his adversaries, to turn Smith into a caricature of himself. Basu recognises that Smith’s theories were far more elaborate and nuanced than perhaps suggested by the metaphor of the invisible hand.

However, having given this initial disclaimer, Basu falls into the same trap by identifying Smith’s original insight too closely with what neoclassical economics had made of his idea. First of all, it would have been worth a discussion of whether there is not in fact a distinction between self-interest and greed. Throughout Basu’s reflections, the two concepts of self-interest and greed seem almost interchangeable.

Second, and more importantly, Basu takes Smith’s concept of the invisible hand, which is very much an evolutionary concept of a dynamic market economy, and deals with it in a static perspective of equilibrium:

If we have a competitive economy, where all individuals choose freely according to their respective rational self-interest, then (given a few technical conditions) the equilibrium that will arise will be Pareto optimal. With a little bit of investment in algebra, this result can be proved as rigorously as any theorem in mathematics or axiomatic geometry. … This formalization was a major breakthrough in economics. (p. 19)

In this way, a metaphor from the colourful, non-mathematical world of classical economics is used as a synonym for the sterile and technical worldview of neoclassical economics. Poor Adam Smith!

What thus makes Basu’s critique of neoclassical economics odd is that the author himself remains locked in precisely the same methodology. Neoclassical economists frequently attempted to design models to render Smith’s ‘invisible hand’ more precise — arguably destroying its dynamic connotations in the process.

Basu attempts the opposite. In his book, he modifies the models in a way so as to show how Smith’s invisible hand fails to produce socially optimal outcomes. In doing so, he operates in precisely the same kind of equilibrium framework. …

If we want society to progress and economic development to occur, we need to nurture our innate sense of social values — such as altruism, trustworthiness, integrity, and a sense of fair play. And if we do not want the world to be fractured and broken up into oppressors and the oppressed, we should try to inculcate these values across all human beings and not just narrow in-groups, defined by race, religion, or nationality. (p. 119)…

… the author remains lost in the methodological framework of those economists he criticises and he only holds utopian dreaming against the perceived failings of a grossly distorted picture of free market economics.”

Much of Oliver Mark Hartwich critique of Basu’s book I agree with, except I would have been more specific.

Adam Smith’s notion, first proposed in the Wealth of Nations (1776), that individuals pursuing their own interests would also achieve outcomes that are beneficial to society at large.”

This is not what Adam Smith wrote. It is what selected parts of paragraph 9 from Book IV, chapter 2, are massaged to appear him to be saying. Cutting through all the invented implications, Adam Smith’s point was that a specific set of merchants, but not all, because they felt insecure about sending their capital abroad in the “foreign trade of consumption” (detailed in paragraph 6), they preferred to invest in support of “domestick industry” (repeated thrice in paragraph 9), and in so doing they unintentionally added to domestic capital and employment. These were the public benefits mentioned by Adam Smith as an unstated consequence of the simple quantitative rule that the “whole is the sum of its parts”. Note that if the same merchants joined domestic cries for tariff protection and prohibitions, their beneficial actions would turn negative.

This simple, obvious and wholly sensible statement became, in the hands of modern economists (Paul Samuelson, et al), a general and wholly unwarranted assertion that “individuals pursuing their own interests would also achieve outcomes that are beneficial to society at large”. Adam Smith never said that at all. He was far too savvy to make an absurd generalization like that. Whether any individual’s actions when “pursuing their own interests” would have beneficial outcomes for “society at large” would entirely depend on the consequences of their actions. Whether actions motivated by greed (Mandeville, Ayn Rand, and others), were “beneficial” depends on circumstances. Indeed, Smith gives over 70 examples of non-beneficial outcomes for society from the actions of self-interested individuals in Books I, II, and III, of Wealth Of Nations and book IV is a detailed (and "violent") polemic against the self-interest actions of "merchants and manufacturers' that were decidedly non-beneficial for society at large.

In the specific and only case of "an invisible hand" that Smith gives in Wealth Of Nations, paragraph 9 (Book IV, chapter2), he mentions a particular merchant’s “concern for his security” which "led" him to invest domestically, and he used the invisible hand metaphor specifically to refer to that “insecurity” which "led him by an invisible hand” to “promote an end which was no part of his intention”. It was a metaphor, not a general rule, or reference to anything that actually existed. Smith taught that all metaphors “describe in a striking and more interesting manner their objects” (Smith, Lectures on Rhetoric and Belles Lettres”, ([1763 1983, p 29).

The entire edifice of the so-called, invisible-hand mythology has been erected on a mere metaphor, “striking and more interesting” as it is – always the sign of a good metaphor! Kasuhik Basu does not understand that, nor does the majority of the economics profession, none of whom, brilliant as they undoubtedly are, has ever shown that the invisible hand exists – it does not appear as a term in their superb equations. Like Warren Samuels, we should join him in seeking to “Erase the Invisible Hand”, and “elusive and misleading term in economics” (Cambridge University Press, 2011).

Finally, note well, Oliver Mark Hartwich’s last two paragraphs in his review, quoted above, about the utopian dream of designing major changes to how modern economies work, and bear in mind my Saturday Lost Legacy post on Adam Ferguson’s notion of social arrangements and of society at large being “the result of human action, but not the execution of any human design” (from earlier ideas of Oliver Cromwell and Cardinal de Retz).

Labels: ,


Post a Comment

<< Home