FROM PAUL SAMUELSON TO THE WORLD BANK

Kaushik Basu, Senior Vice President and Chief Economist of the World Bank, is Professor of Economics at Cornell University. HERE 

Extract (October 17, 2015) from a conference at Columbia University honoring Joseph Stiglitz for a half-century of teaching. HERE 

“Stiglitz’s Sticky Prices”

WASHINGTON, DC – For a long time, the assumption underlying  much of mainstream 
economics was that the invisible hand worked its magic seamlessly. Prices moved smoothly
up as demand outpaced supply and rushed back down when the tables were turned, 
keeping markets in equilibrium.

To be sure, many observers realized the truth was actually quite different – that prices, and wages and interest rates in particular, were often sticky, and that this sometimes prevented markets from clearing. In labor markets, this meant unemployed workers facing prolonged job searches. But the response by others in the field was that what their colleagues described as “unemployment” did not truly exist; it was voluntary, the result of stubborn workers refusing to accept the going wage.

Among those who recognized the reality of involuntary unemployment were John Maynard Keynes and Arthur Lewis, who incorporated it into his model of dual economies, in which urban wages do not respond to labor-supply gluts and remain above what rural workers earn. Both Keynes and Lewis used the stickiness of prices extensively in their work. But even for them, the concept was only an assumption; they never managed to explain why wages and interest rates so often resisted the pressures of supply and demand.

Columbia University’s Joseph Stiglitz, who celebrates 50 years of teaching this year, solved the puzzle. In a series of innovative papers, Stiglitz picked up some elementary facts about the economy that lay strewn about like jigsaw pieces, put them together, and proved why some prices were naturally sticky, thereby creating market inefficiencies and thwarting the functioning of the invisible hand. In Stiglitz’s words, the invisible hand “is invisible at least in part because it is not there.”

Comment

The first sentence exposes the fallacy prevalent in mainstream economics:

“For a long time, the assumption underlying  much of mainstream economics was that the invisible hand worked its magic seamlessly.”

Check Kaushik Basu’s language: “the invisible hand worked its magic seamlessly”. But that was a myth largely created in modern times by Paul Samuelson in his popular textbook, Economics: and introductory analysis, 1948, from its 19 editions with 5 million sales, plus an active second-hand market. (See: G. Kennedy. 2010. Paul Samuelson and the Invention of the Modern Economics of the Invisible hand. History of of Economic Ideas, XVIII 2010/3. pp 105-119).

Stiglitz broke cover and announced “the invisible hand is invisible at least in part because it is not there.” The modern profession has taken little notice of Stiglitz’s announcement, nor the empirical evidence whereas the empirical evidence of Samuelson’s role in spreading the myth of a “magical” invisible hand is conclusive, and can be shown in a graph of mentions of the "invisible hand", published by me when I discussed the myth of the “invisible hand post-Paul Samuelson in my paper, Kennedy, G. 2010 “The Myth of the Invisible Hand – A View From The Trenches” Gavin Kennedy (Heriot-Watt University, Edinburgh) (readers seeking a copy of this paper, please contact me at: gavink9@gmail.com).

The data upon which the graph in the above paper was published was prepared by kind Dan Hirschman, a post-graduate PhD student from data from: Warren Samuels, (with the assistance of Marianne F. Johnson, William H. Perry). 2011. Erasing the Invisible Hand: Essays of an Elusive and Misunderstood Concept in Economics, New York. Cambridge University Press. 

The graph shows the spectacular rise in modern mentions of the “invisible hand”. Samuels reported that “Incomplete data for materials published in the English language – principally, but not solely, economic writings – suggest that between 1816 and 1938, the average annual level of writings in which the “invisible hand” appeared was very low”, confirming my assertion from library searches. Thereafter, writes Warren Samuels, “from roughly 1942 through 1974, the average annual level of writings doubled; from 1975 through 1979, it roughly doubled again; and between 1980 -1989, it was approximately 6.5 times higher than it had been during 1942 through to 1974. Between 1990 and 1998, the average annual level was a little more than eight times that of the 1942-1974 level and slightly more than 20 percent higher than the 1980-1989 level. During 2000-2006, the average annual level seems to have receded to a level slightly more than 60 per cent of the 1990- 1999 level, the highest level reached so far” (Warren Samuels, 2011, 18-19).

Kaushik Basu, at the World Bank, has access to considerable data collection resources which he could mobilse to follow the trajectory of mentions of the invisible hand in both the scholarly press and the public media, from those associating the "invisible hand" with market economies, since Paul Samuelson's 1948 assertions about Adam Smith's alleged meaning when he used of the now famous metaphor, which was  ignored while he was alive and afterwards hardly commented upon for a 100 years and more after he died in 1790. From 1875 the myth of the invisible hand's so-called "magical" (indeed "miraculous") powers took root in Cambridge (England). Once Paul Samuelson got hold of the wrong-end of the stick, it spread out from MIT and conquered the Academy and the modern media.
It has done much to confuse Smith's modest use of the now famous metaphor with a wholly invented interpretation of it by late 19th and early 20th century economists and it is now embedded in folk lore, even among most Nobel Prize winners.