PARETO WHEN CONSTRUCTING HIS WELFARE THEOREMS MISUNDERSTOOD ADAM SMITH

Stephen Gordon (16 May), professor of economics at Université Laval posts HERE “When in doubt, just send cash”

It starts, as so much does, with Adam Smith. Smith’s best-known contribution to economic thought is the “invisible hand” metaphor: socially-desirable outcomes could be achieved not by conscious, collective effort, but by the pursuit of individual self-interest. You don’t need a central planner to identify and enforce who should do what and who should get what: the public interest would be achieved as an unintended by-product of unco-ordinated individual decisions, “as if by an invisible hand.”

COMMENT

Smith’s observation in which he used the metaphor of “an invisible hand” has nothing to with “ Pareto’s First Welfare Theorem”. He simply opined the view that a merchant who was reluctant to invest his capital abroad faced avoidable risks to his capital while it was out of his immediate control and sight. Instead, he could take the available option and invest it locally. In so doing his motivation was an action that was less risky than sending it abroad. 

Now that intended motivated action also had an unintended consequence in that his action added his capital to “domestic revenue and employment”. This was an unintended benefit to the domestic economy and those in it. The “invisible hand metaphor” did not describe the unintended consequence; it described the motivated intended action (without the motivate intended action there would be no unintended consequence) that caused the unintended consequence. 

The distinction is important: Motivation (usually invisible to others) causes the Action that Causes the unintended consequence (which unintended consequence may be benign or malign). Asserting that an invisible hand, distinct from the motivated action causes the unintended consequence is to assert that some mystical force in economics, separate from the motivated action, causes the unintended consequence is to descend to mysticism. 

Competition is Adam Smith was a process occuring in real time separating the motivated actions of real people. Modern competition theory describes the eventual outomes of Smithian competetion and this applies to modern theories of the outcomes of competition, including the Welfare Theorems of, and following, Pareto. 

The mathematisation of modern economics has further clouded the different meanings of economics as a Smithian process versus those of post-Pareto descriptions of end-states. Mark Blaug (Economic  Theory in Retrospect) wrote of the differences between Smith and Pareto, and I had the privilege of discussing these differences with Mark some years back during a seminar we both attended.

Stephen Gordon may benefit from reading Mark Blaug’s book and journal articles and realising there is a distinction between the two approaches.