ADAM SMITH IS INNOCENT OF MODERN ERRORS OF ATTRIBUTION
Charles Franklin posts (29 October) on Small Businss Trends about a new book by Georgia L. Keohane, Executive Director of the Pershing Square Foundation and a professor at Columbia University HERE
“Innovative Finance Provides the Link Between Capital and the Common Good"
“The philosophy behind the book’s belief in the power of finance stems from the concept of the”visible hand”, a market-based approach that addresses failures with the highly regarded economic principle known as the”invisible hand.” As the book points out, unchecked belief in the “invisible hand” can lead to negative social and environmental consequences. This market failure, however, can be uniquely solved by innovative finance because of the creativity and scale of the finance industry.
To give an example, childhood vaccines are critical in the fight against fatal childhood diseases but are often neglected by interested businesses because of financial risk and concerns for safety. Pharmaceutical companies, like many donors, want to know that their investment will be financially and socially effective. Capital and the Common Good turns these concerns into a question. What if, in addition to grants and donations, vaccines were funded by long-term passive income (such as interest from a low-interest loan, bond or premium payments from micro-insurance customers)?
The answers to this one “What if” question is a book-length journey into the world of innovative finance, where social problems are solved with the creativity and scale of the market’s “invisible hand.”
I wish Georgia Keohane well in her endeavours. I also hope she takes some time to investigate the so-calleded “higly regarded principle” (by whom and where did they get it from?). It certainly did not come from Adam Smith - check it out.
Smith’s example was of a merchant who preferred to invest locally because he did not trust strangers overseas of whom he knew nothing about their probity, or the reliability of their legal systems. His decision had intentional consequences - he added to his feelings of security and earned profits. His motivated intentional actions of investing locally also had unintentional consequences in that he also added his capital to “domestic capital and domestic employment”. These unintended consequences were also public benefits.
However, Adam Smith also wrote many times of the motivated actions by “Merchants and Manufacturers” that also had intentional consequences, but which did not lead to unintended beneficial consequences, such as those Merchants and Manufacters, who pressed governments to impose tariffs on imports to reduce competition, so that they could put up prices.
The distinction in the two exmples is important. Modern economists enhance Adam Smith’s first example of ‘an invisible hand’ leading the merchant unintentionally to cause public benefits into a general ‘law’ that the invisible hand benefits society.
But that is not what Smith said and the example of merchants clamouring (as they do) for import controls to reduce domestic competition and raise domestic prices does not benefit society. It can lead to political tensions between countries, even trade wars, and, in the 18th century to colonial land grabs and inter-European wars.
In the common examples of naval wars and colonial tensions there is no role for a metaphoric benign invisible hand.
Paul Samuelson, the modern economist, went further in 1948; he generalised the ‘invisible hand’ to be about the selfish actions of people in markets that led to social benefits all round. And he attributed this assertion erroneously to Adam Smith, which attribution to Adam Smith stuck in the minds of modern economists, such was the credibility of Samuelson among his 5 million readers because of his credibility as a mathematical genius, for which he won the Nobel Prize.
Georgia Keohane has chance to correct the errors of Samuelson and the majority of modern economists who believe in the myth of the ‘invisible hand’ and associate it with Adam Smith, a wholly innocent victim of their errors of attribution.