Wednesday, March 27, 2013

Is the Invisible Hand Self-Interest?

Primal Rambler” writes on Rampage Liberty HERE 

For those unfamiliar with the invisible hand, it’s a metaphor popularized by Adam Smith in the mid 18th century for how free markets are guided (not controlled).  The invisible hand is an individuals’ self interest. The theory being pushed is that in a free market people’s self interest is channeled into socially desireable ends.
Your mileage on the theory may vary, but it’s worth considering.“It’s not from the benevolence of the butcher, the
brewer, or the baker that we expect our dinner, but
from their regard for their own interest (Adam Smith, “Wealth of Nations”).
Primal Rambler is obviously confident that he knows what Adam Smith meant when he used the metaphor only once of “an invisible hand” in Wealth Of Nations (book IV).  
His juxtaposition of the assertion that “The invisible hand is an individuals’ self interest”, supposedly from Book IV ,with the statement about how one obtains one’s dinner from the “butcher, the brewer, and the baker” in Book I, reveals his source is from misrepresentations by modern economists and not from what Adam Smith was writing about on self interest. 
The same erroneous linkage is made regularly by senior economists, such as David Friedman on Lost Legacy (see Lost Legacy: June 2006; August 2011; and etc.). 
Friedman wriggles out of his errors of linking the two passages, to his satisfaction, by asserting the linkage is not a general statement, which denies the generality of the claimed statement and ignores the real and rich meaning of Smith’s paragraph about the ‘butcher, brewer and baker’. ‘Primal Rambler’ makes the same erroneous generalization.
For a start, if Smith had been so careless as to assert as a general statement that “The invisible hand is an individuals’ self interest”, he would have contradicted a great deal of his meaning in Wealth Of Nations.
First, because Smith knew that self-interest motivated all the actions of individuals across society, some parts of which led to unintended consequences that were actually of negative benefit to those who were affected by such actions, such as consumers who faced increased prices from the self-interested clamour for tariff protection and prohibitions of imports by “merchants and manufacturers”.  This would have made his political economy self-contradictory, which is why he opposed all monopolistic behaviours that consequentially led to restricting competition among suppliers and the narrowing of markets. And these were  certainly not examples of an “invisible hand” channeling “self-interest” into “socially desireable ends”. 
They are examples of “self-interest” leading to undesireable consequences, and once we have exceptions to general statements, they are no longer true. Hence, the assertion of Primal Rambler that by his use of the IH metaphor Smith meant self-interest is false. In fact, Smith never linked self-interest to the IH metaphor, or to markets, or to price theory, and so on.  Moreover in the circumstances of the 18th-century where he did use in Book IV, it was hardly about “competitive markets”.
Second, the “butcher, brewer, and baker” example was not about an individual’s self-interest in isolation; it described the appropriate conduct of negotiations between the self-interested readers and the self-interested suppliers of their meat, drink and bread for their dinners through the mutual mediation of their individual self-interests. The jointly agreed price of the items for one’s dinner was summarised by Smith:
But man has almost constant occasion for the help of his brethren, and it is in vain for him to expect it from their benevolence only.  He will be more likely to prevail if he can interest their self–love in his favour, and shew them that it is for their own advantage to do for him what he requires of them. Whoever offers to another a bargain of any kind, proposes to do this. Give me that which I want, and you shall have this which you want, is the meaning of every such offer; and it is in this manner that we obtain from one another the far greater part of those good offices which we stand in need of. It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self–love, and never talk to them of our own necessities but of their advantages” ((Book 1, chapter 2, paragraph 2).
The absolute mediation of self-interest is clearly stated in that paragraph.  Yes, self-interest draws the butcher, brewer, and baker to labour to produce items for sale in the market, and self-interest draws potential customers to visit the market in search of the ingredients for their dinners, as commonly found in the 18th century.  But one’s self-interest does not determine the price of those ingredients, because both buyers and sellers have views on what that agreed single price should be.  Smith advised readers to “address” themselves not to the seller’s humanity, but to their “self-love and never talk to them of our own necessities but of their advantages” in setting a price acceptable to buyers.  Those engaged in commercial negotiations will recognize the validity of Smith’s observations.
If prices were solely decided by sellers, and buyers had to accept the sellers’ prices, the self-interests of sellers would drive prices above competitive prices towards extortionate monopoly prices.  This too definitely would not be a case of self-interest channeling prices “into socially desireable ends”.
It is usually at this point that modern economists try to corer the cracks in their generalisation of self-interests driving “socially desirable” ends, by claiming they are only talking of “competitive” situations, not the commonplace markets that have always existed.  But exceptions show the assertion is erroneous as written, especially by ideologues and mis- interpretations of the “butcher, brewer, baker” example.


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