Saturday, April 26, 2014

TIM ASKS: "ISN'T IT TIME FOR THE TRUTH ABOUT THE "INVISIBLE HAND' TO HAVE 'SUNK IN"?

Tim Worstall posts on Forbes (25 April) HERE
This Is What Adam Smith Meant By Invisible Hand”
“Please do note that Smith wasn’t saying (not at all in the book but most certainly not in the invisible hand phrase) that all markets all the time markets leads to the optimal society.  Nor was he trying to say that there’s not a place for reasonable government action, often to make markets work better. Rather, he was making one simple point about where people prefer to invest.
Judged by the Goldman Sachs spiderweb, savers have embraced a little bit more investment tourism this side of the world’s financial crises, but home bias still rules when it comes to stock markets.
We estimate that over the last decade, domestic holdings of broadly-defined domestic equity in developed markets (DM) have gone from around 81% to 76%, and from 90% to 88% in emerging markets (EM). This ‘home bias’ is visible not only in equities, but also in debt securities and other assets.Which is a little odd, given the benefits of diversification and the spread of portfolio optimisation theory. Particularly as passive investing has gained in popularity and it has become much easier to move capital across borders: why not take some cheap country risk?
The answer being that people don’t really like taking country risk. Here’s Smith:
“First, every individual endeavours to employ his capital as near home as he can, and consequently as much as he can in the support of domestic industry; provided always that he can thereby obtain the ordinary, or not a great deal less than the ordinary profits of stock. (WN IV.2.6: p 452-6)
“Thus, upon equal or nearly equal profits, every wholesale merchant naturally prefers the home-trade to the foreign trade of consumption, and the foreign trade of consumption to the carrying trade. In the home-trade his capital is never so long out of his sight as it frequently is in the foreign trade of consumption. He can know better the character and situation of the persons whom he trusts, and if he should happen to be deceived, he knows better the laws of the country from which he must seek redress.”
As ever with Smith there’s a lot more of that before we come to his conclusion:
“By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner 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 an end which was no part of his intention.”
That is, the answer to Alphaville’s question is in the one  piece of Smith that everyone knows, that invisible hand, 
but which almost everyone gets wrong. It’s not about markets nor their joys, it’s purely and simply about the 
fact that people prefer to invest at home rather than entrusting their fortunes to some swarthy Johnny Foreigner.
Publication of Wealth of Nations was 238 years ago. Isn’t it time all of this sunk in?”
Comment
Tim Worsthall is good, isn’t he. He also writes daily on the Addam Smith Institute’s  “Pin Factory Blog” (http://www.adamsmith.org). HIGHLY RECOMMENDED.  
Readers, like me, may not agree with every policy conclusion Tim comments upon )I agree with most!) but you are guaranteed an excellently expressed daily read. 

I hope Lost Legacy is beginning to get through about the modern myth of the “invisible hand” to Adam Smithian scholars here and in the international community.

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