RICHARD HAUSEMANN AND THE INVISIBLE HAND

RICARDO HAUSMANN posts (31 October) on Project Syndicate (the world’s opinion page} HERE

Ricardo Hausmann, is a former minister of planning of Venezuela and former Chief Economist of the Inter-American Development Bank.
He is also Professor of the Practice of Economic Development at Harvard University, where he is the Director of the Center for International Development, writes: 

“Of course, private-private coordination has been the essence of economics for the past 250 years. While Adam Smith started us on the optimistic belief that an invisible hand would take care of most coordination issues, in the intervening period economists discovered all sorts of market failures, informational imperfections, and incentive problems, which have given rise to rules, regulations, and other forms of government and societal intervention. This year’s Nobel Prize in Economic Sciences was granted to Oliver Hart and Bengt Holmström for their contribution to understanding contracts, a fundamental device for private-private coordination.

But much less attention has been devoted to public-public coordination. This is surprising, because anyone who has worked in government knows that coordinating the public and private sectors to address a particular issue, while often complicated, is a cakewalk compared to the problem of herding the cats that constitute the panoply of government agencies.

The reason for this difficulty is the other side of Smith’s invisible hand. In the private sector, the market mechanism provides the elements of a self-organizing system, thanks to three interconnected structures: the price system, the profit motive, and capital markets. In the public sector, this mechanism is either non-existent or significantly different and less efficient.

COMMENT

Richard Houseman did not get his view that “Adam Smith started us on the optimistic belief that an invisible hand would take care of most coordination issues” from anything that Adam Smith wrote. Housman got that ideas from economists educated as undergraduates by Paul Samuelson's textbook, Economics, (1948) who told them about Adam Smith believing that his example of a merchant, who invested his capital domestically because he did not trust unknown foreigners with his capital. By investing locally he sought to benefit his own interests but, unbeknown to him, by arithmetically adding to domestic capital locally he also unintentionally benefitted others. 

Smith said nothing about it would “take care of most co-ordination issues”. That assertion is a modern gloss put on it by modern, 20th-century, economists, and subsequently believed by Richard Houseman in Venezuela.

The market failures that Richard Housman speaks of were known to Adam Smith, who often commented in his Wealth of Nations on the perfidious behaviour of “merchants and manufacturers” in 18th-century markets. However, he said nothing about “an invisible hand” ‘co-ordinating markets’.

Moreover, from the time when Adam Smith used the metaphor of “an invisible hand”, once only in Wealth of Nations, in 1776, it was just over 100 years later in the 1870s  that some English economists at Cambridge re-discovered his use of the invisible hand and applied it generally to the whole economy. Once Paul Samuelson praised it as such another 70 years later in 1948, the myth of Smith’s ‘invisible hand” grew into a universal belief.

Richard Housman should reflect a moment on these facts and re-consider his passion for his untrue beliefs.