Socialism and Capitalism Are Quite Different

Andy Logar posts (19 November) in American Thinker HERE

“Socialism's Fundamental Flaws”

“In the Soviet model the state owned the means of production thus all workers were employed by the state -- essentially each working for everyone else, the collective, but not directly for themselves. This was effectively a compulsory altruism which, because not being a primary human drive, introduced a fatal systemic flaw to an economy so bereft of incentives as to engender the famous Russian quip: ‘We pretend to work and they pretend to pay us.’

“As if one were not enough, the second fatal flaw was the elimination of the free market and its replacement by the planned economy -- where supply and demand were in the hands of technocrats and not the invisible hand of free-market capitalism.”

Comment
Be clear, I have no sympathy for the ‘socialism’ practiced in the Soviet Union or elsewhere, of which criticism by Andy Logar I broadly agree, but I have no confidence in his characterization of the pre-Soviet economy as ‘the free market”, nor as replacing “free market capitalism”. It was largely a pre-capitalist continent, dominated by a repressive oligarchy and a semi-feudal countryside.

Stark contrasts between two extreme poles of description, as is usual in such ideological posts, do not help clarity in the argument that Logar’s post purports to make. He even makes an unfortunate and questionable statement in describing the Soviet model of state ownership as: “essentially each working for everyone else, the collective, but not directly for themselves”. It was the French, 18th-century Physiocrat, Mirabeau, who correctly commented that in markets, each individual thinks they work for themselves, but in actuality they ‘work for others’. How true!

In seeking to realise our self-interests we unintentionally serve the self-interests of others in the mediation that necessarily is the voluntary exchange process. No market would function if people tried to work only ‘for themselves’; their voluntary exchange behaviours must necessarily take account of the self-interest of others (see Adam Smith in Book 1, chapter 2, Wealth of Nations: ‘address the self-love of others, not your own’). That is what free markets bring about. In contrast, in Soviet Socialist Systems everybody in fact worked, under direct compulsion, for the State that decides what they and everybody else gets in return. This is the essential difference between markets and socialism.

Turning to Andy Logar’s sentence: “the planned economy -- where supply and demand were in the hands of technocrats and not the invisible hand of free-market capitalism”, we confront another source of Logar’s error.

It was Oscar Lange, the Marxist, pro-Soviet economist-cum-technocrat, who taught at Michigan and Chicago in the 1930s and 1940s, and who penned the notion that what he called the role of Adam Smith’s so-called “invisible hand” in directing market transactions (a wholly invented attribution he learned from an oral tradition in some US universities, as is often exposed on Lost Legacy, viz, there is no actual invisible hand), would be supplanted by the expected, though never realised, superior benefits of a centrally planned economy.

Lange specifically alluded to the invisible hand’s evident failures in the 1930s depression that contrasted allegedly with the far superior prospects of an harmoniously planned socialist economy, then being imposed without harmony by Stalin in Russia, and later on in Poland, in which the planners allegedly replaced the market’s ‘invisible hand’ (see his 1936. “On the Economic Theory of Socialism, Part I.” Review of Economic Studies 4, no. 1: 53–71; 1937 and Part 2, 4, no. 2: 123–142).

Paul Samuelson (Economics: an introduction to economic analysis, 1948, p 36) took up Lange’s challenge to the superiority of capitalism by recasting what Adam Smith actually wrote about ‘an invisible hand’ and invented the general rule that Smith said ‘selfish’ actions unintentionally led to ‘public benefits’, later re-cast as an early prediction of General Equilibrium theory. Unfortunately he attributed that nonsensical myth to Adam Smith, and even more unfortunately, most modern economists believe it, which Lost Legacy fights daily to challenge.

[NB: The ‘selfish’ myth actually came from Bernard Mandeville’s ‘Private Vice, Public Benefits’, Fable of the Bees, 1724 and resurrected by Ayn Rand, and broadcasted in the ‘greed is good’ libel].

In sum, Andy Logar’s pieces in the ‘American Thinker’(?) rightly critiques socialism, without really understanding the difference with capitalism, and, sadly, does not really appreciate Adam Smith’s political economy in Wealth Of Nations, nor his Theory Of Moral Sentiments.

"Moral Magnanimity and Moral Markets": a naive dilemma?

Dwight R. Lee, is professor of economics at Southern Methodist University, has posted (19 July) in the Moral Liberal (HERE):

“The Economics of Caring and Sharing
Free Enterprise Zone” (from The Freeman)

“Market morality can be achieved, according to Adam Smith in The Theory of Moral Sentiments, “by sitting still and doing nothing.” And while markets reward kindness and caring for those with whom we have personal exchanges, the vast majority of the exchanges we benefit from are impersonal; we neither know nor meaningfully care for those on the other side of the exchange.

Comment

Actually, Smith applied this statement about “by sitting still and doing nothing.” to meeting the virtue of Justice.
Similarly, relations within our immediate circle of family and close friends tend to be most personal and close, and then successively diminishing as the people we transact with are further from our immediate circle.
Finally, we most certainly have to be concerned with those we transact with in market exchanges – see WN: I.ii.2: p27: ‘we address ourselves, not to their humanity. But to their self-love ,and never talk to them of our necessities but of their advantages’.

Disregarding (i.e., not caring) about those we directly transact with leads to poorer or no bargains. The anonymity begins beyond the immediate partner transactions – we care less about them because we do not know, nor need to know, of them – and so on along supply and demand chains beyond those with whom we directly transact, which is a creditable, as well as necessary condition, for complex transactions amidst modern opulence (and was true in Smith’s day too).

Dwight R. Lee:
Since these impersonal exchanges create enormous benefits from outcomes that emerge without conscious direction, people seldom give much thought to those benefits or the market morality on which they depend. Of course people do think about markets occasionally, but when they do it is seldom with appreciation for the benefits they are receiving. More often than not people think about markets when they are being inconvenienced by the market discipline—the requirements “imposed” on us, for example, in return for income—that makes their benefits possible. Few of us connect such discipline to the far greater benefits we receive as a consequence, particularly when we see others who appear to be reaping great rewards from the very discipline that is apparently making us so much worse off. Under these circumstances it is easy to conclude that we are imposed on unnecessarily by the greed of others. How easy it is to also believe there is something immoral with an economic system that not only tolerates greed but also rewards it.

Comment
It is forgetful of the history of what “worse off‘ meant compared to the societies our predecessors lived in for many millennia before the ‘Age of Commerce’ that Smith analysed that makes it too easy to write about today’s economic system “that is apparently making us so much worse off.’ Compared to what – Somalia, rural China, India, Brazil, North Korea?
Moreover, since when was “an economic system that not only tolerates greed but also rewards it” something new and unprecedented in the history of the human societies, right up to now? The vast majority of the history has often had no choice but to ‘tolerate’ the vile rulers of mankind since long before ‘market morality’ was introduced.

Dwight R. Lee:
“When economists make the case for what they see as the most impressive feature of markets, they typically do so with the aid of Adam Smith in a way that reinforces the view that markets at best lack morality. Smith understood and appreciated magnanimous morality, as any reader of The Theory of Moral Sentiments, his first book, knows. But this would not be known to someone who knew only Smith’s “invisible hand” argument for markets in The Wealth of Nations'.

Comment
Given that “someone who knew only Smith’s “invisible hand” argument for markets in The Wealth of Nations” is living under an illusion, cruelly spread by modern economists, who saw this myth as the ‘advantage’ of capitalism over socialism during the Cold War decades (Samuelson, 1948, et al) and, ironically, by Marxists (Oscar Lange, 1946) as a convenient though false criticism of markets. The myths of the ‘invisible hand of the market”, which Adam Smith never articulated in Wealth Of Nations, nor in Moral Sentiments”, because, as we show endlessly on Lost Legacy, Smith had no such “argument”. It was “invented’ and popularized from-mid 20th century, but not in 1759, nor in 1776.

Dwight R. Lee:
“The advantage of markets, according to Smith, is that by pursuing their own interests in the marketplace, people unintentionally do more to promote the public interest (the interest of no one in particular) than if it had been their intention to do so. [GK: Agreed] This argument ignores every requirement for magnanimous morality, and the way economists phrase the argument makes it easy for people to conclude erroneously that the argument for the market rules out the more personal caring and sharing in which our personal relationships are rooted.”

Comment
Only if Adam Smith’s notion of “self-interest” elides into “selfishness”, which he consistently condemned as “licentious” and “wholly pernicious” referring to Bernard Mandeville, 1724i, n Moral Sentiments (TMS IV.ii.4.6: 308, etc.,) and popularized by Geko’s script writer in “Wall Street” and numerous modern economists and media people almost everyday.

Dwight R. Lee:
“Calls for a more moral marketplace — sometimes referred to as capitalism with a human face—are invariably motivated by the hope of substituting the instinctive morality of the small group for the morality of impersonal markets. …

… The primary advantage of markets is that they provide each of us with the information and motivation to share with literally millions of people, without caring for them.

Comment
Apart from the naïve reliance on “small group morality” of early hunter-gather societies as a model for the future, Professor Lee should add to the moral balance sheet the anthropological data of the death rates inside those small groups and with their neighbours was higher by far than that of what we regard as the very violent wars and urban murder rates experienced in the 20th century among males, not to mention the incidence rape and forced cohabitation among captured women in the very violent ‘wars’ of “small groups. There is no reason to believe that the 21st century (so far) has managed to approach the comparison death rates of the ‘small group’ societies of all previous millennia before capitalism.

Incidentally, these early societies were truly anonymous in every sense in their lack of knowledge or acquaintance of distant neighbouring other ‘small – even large – groups’, living hundreds of miles away across a continent, and were completely ignorant of other “anonymous” groups in distant continents. For example, when those small tribes left Africa and some walked over the generations to what we call Australia, they became ‘unknown’ and truly ‘anonymous’ years until Dutch and Chinese explorers found them for over 60,000 years later.

Today, their descendant children can see on television all the affairs of the otherwise “anonymous” children of those their ancestors left behind.

A Tale of Two Bottles

Dennis Behreandt writes in Moral Liberal HERE:

‘Congressman Paul Ryan Sips Wine, Liberals Are Outraged’

‘As a result, to paraphrase Adam Smith, though in each case the people engaged in any given transaction only seek to improve their own lots in life, the “invisible hand” of the economy works through these transactions to improve the lives of countless others.’

Comment
Before this paragraph, Dennis Behreandt writes a brilliant dissection of the moral outrage of fellow diners, one of them an economist, no less, who are outraged that Congressman Paul Ryan (GK: Who is he?) and two friends consumee two bottles of imported French wine at $350 a bottle while there are poor people in the USA not present at the restaurant. But the ‘outraged’ economist and her partner are also present in the restaurant! (But drinking water though presumably eating the expensive food).

I have no quarrel with Dennis Behreandt’s dissection of the economics of the purchase of expensive imported wine – a classic reminder of the real benefits to society of such production processes and trade between countries.

However, I balk at the assertion – wrapped in a ‘paraphrase’ – that the “invisible hand” of the economy works through these transactions to improve the lives of countless others.’ Economies work to that end, not ‘invisible hands’!

Also, that is not what Adam Smith actually said. In his single example in which he used the metaphor of ‘an invisible hand’ in Wealth Of Nations (see Book IV, chapter ii, paragraphs 1-9, pp 452-6), he described how some, but not all, merchant traders preferred to invest locally in ‘domestick industry’ rather than send their capital abroad in the ‘foreign trade of consumption’ and that it was their ‘concern for their own security’ (today we call it their ‘risk aversion’) that led them to do so. That insecurity was the object of ‘an invisible hand’ leading them to act thus!

Now metaphors, taught Smith, are used to ‘describe in a more striking and interesting manner’ their objects (i.e, what they are metaphorically representing). It was their ‘insecurity’ that led them to invest locally, not the ‘economy’ that ‘led them’, because multiple motives are at work on individuals in an economy - not everybody is ‘insecure’ to the same degree and many of them do engage in foreign trade (hence, the French wine bottles in fancy in DC restaurant at $340 a bottle).

The economy exists and ‘insecurity’ exists in the perceptions of the insecure merchants – THERE IS NO ‘INVISIBLE HAND’ IN THE ECONOMY. To assert that there is an invisible hand misreads Smith’s meaning.

It is also nonsensical of Smith’s meaning because the economy consists of myriad people, not all of them sharing the same ‘insecurity’ of the example provided by Smith! Many merchants did and do invest abroad, despite the insecurity felt by some others. What ‘invisible hand’ leads them to contradictory actions? Where is the term for the invisible hand in any of the equations of the mathematical models of modern economists?

Merchants, of all kinds, act from many motives not because of invisible hands but from their noting the very visible prices that are absolutely necessary (and, indeed, absoliutely sufficient) for a market to form and do its work.

There is no mystical invisible hand at work. It is not the ‘hand of god’, etc., that drives markets. Prices are sufficient, and Adam Smith outlined a plausible analysis of how prices work in an economy (albeit wrapped in the fairly cumbersome language of ‘natural’ and ‘market’ prices) through ‘supply’ and ‘effectual demand’ in Books I and II of Wealth Of Nations, without mentioning anything about ‘invisible hands’.

Most modern economists dismiss concerns about their misrepresentation of Adam Smith’s use of the invisible hand metaphor. They have adopted an invented ‘useful’ meaning to the restricted meaning that Smith applied, and they ignore not only what metaphors mean, but also what Smith actually confirmed in Book IV of Wealth Of Nations and what was the role of metaphors in literate English (and ancient Latin and Greek) in his Lectures on Rhetoric and Belles Lettres, [1763], 1983, p 29).

But still, read Dennis Behreandt’s interesting piece (follow the link). It does not need a myth about invisible hands to be an excellent exhibit for the benefit of markets.

A Serious Scholar Disagrees

Over at the excellent Anti-Dismal Blog, Paul Walker raises important criticisms of my Monday post this week on Lost Legacy, (HERE):

“The neoclassical model”

‘When discussing The Emergence of Capitalist Economics II at the Adam Smith's Lost Legacy blog, Gavin Kennedy writes
[...] we are treated to an account of the usual Ricardian corn model, regarded by some economists as illustrative of the inner workings of a capitalist economy, upon which the seeds of the profession’s love affair with models were planted in 1817.

YHT also link Adam Smith to the problems with which the corn model is lined up to discuss and which the late 19th-century mathematical school went on to separate economics even further from the real world, leading to the fantasies of General Equilibrium and much of microeconomics as we know it today.’

Paul Walker: I find myself asking, if GE and much of microeconomics is just a bunch of fantasies, how did we come to these fantasies? If we assume, as economists normally do, that those like Ricardo, J S Mill, Marshall, Jevons, Menger, Walras, Knight and many others, who developed the neoclassical model were not stupid, then why does neoclassical economics look the way it does, there has to be a reason. Ether I'm wrong and all these economists were just morons as many critics seems to suggest or they were rationally attempting to answer some question. So, if neoclassical economics is the answer, what was the question? This is something those who just want to complain about microeconomics don’t ever seem to ask. And even less answer.’

Comment
Fair enough, but I would suggest, humbly, that Paul misses my point (I cannot speak for other critics of neoclassical economics).

It is not that the neoclassical models were wrong, given their assumptions, or that their designers were ‘just morons’. Far from it; they were among the brightest minds of their respective generations. It’s just that they were asking the wrong questions. Their work (and it was hard work) was to ask how a perfectly competitive economy worked abstracted from all human distractions that could not be incorporated in the models.

This was the reverse error that shaped the thinking of the old classical mercantile political economists, whom Smith severely criticised in WN. Specifically, they ignored in their speculations about the damaging roles of imports, that the common politics of all of Britain’s nation state trading partners was one imbued by the existence of ‘jealousy of trade’, linked to the dynastic insecurities of the monarchical governments in Europe (within which primogeniture both fed and projected their insecurities).

Monarch’s proved title to their vast properties and income by primogeniture and others challenged their title through normal changing events in passing generations. Mercantile political economy did not create jealousy of trade; it was jealousy of trade (for all its reasons) that created mercantile political economy. Each nation was ‘threatened’ by every other nation, and the mercantile state threatened ever other nation, forming and dissolving temporary alliances to suit events.

Here the search for proofs of perfect competition reached their final success in the proof of General Equilibrium; but the mathematical world it identified corresponded to no known – or knowable –world in which human beings did or could exist.

‘Paul Walker’: 'I would argue there are two possible answers to my question: one theoretical, the other empirical.'

‘From the theoretical side as has been pointed out by Demsetz (1982, 1988a and 1995) the fundamental preoccupation of neoclassical economists is with the market and the price system and hence little, or no, attention gets paid to either the firm or the consumer as separate, significant, economic entities. Firms and consumers existed as handmaidens to the price system.’

In Demsetz's view the interest in the price system, culminating in the "perfect competition" model, has its intellectual origins in the eighteenth-century debate between free traders and mercantilists. Butler (2007: 25-6) briefly sums up mercantilism in the following way:

[...] it measured national wealth in terms of a country's stock of gold and silver. Importing goods from abroad was seen as damaging because it meant that this supposed wealth must be given up to pay for them; exporting goods was seen as good because these precious metals came back. Trade benefited only the seller, not the buyer; and one nation could get richer only if others got poorer. On the basis of this view, a vast edifice of controls was erected in order to prevent the nation's wealth draining away - taxes on imports, subsidies to exporters and protection for domestic industries. [...] Indeed, all commerce was looked upon with suspicion and the culture of protectionism pervaded the domestic economy too. Cities prevented artisans from other towns moving in to ply their trade; manufacturers and merchants petitioned the king for protective monopolies; labour saving devices such as the new stocking-frame were banned as a threat to existing producers.

The free trade versus mercantilism debate was, to a large degree, about the proper scope of government in the economy and the model it gave rise to reflects this. The question implicitly at the centre of the debate was, Is central planning necessary to avoid the problems of a chaotic economic system? The mercantilists would (surely) answer "yes" but Adam Smith famously answered "no".

‘Smith [ ... ] realised that social harmony would emerge naturally as human beings struggled to find ways to live and work with each other. Freedom and self-interest need not lead to chaos, but - as if guided by an 'invisible hand' [GK: Smith never used the IH as a simile] - would produce order and concord. They would also bring about the most efficient possible use of resources. As free people struck bargains with others - solely in order to better their own condition - the nation's land, capital, skills, knowledge, time, enterprise and inventiveness would be drawn automatically and inevitably to the ends and purposes that people valued most highly. Thus the maintenance of a prospering social order did not require the continued supervision of kings and ministers. It would grow organically as a product of human nature. (Butler 2007: 27-8.)'

GK Comments: Butler imposes a somewhat idealist gloss on Smith’s more down-to-earth realism about the ‘prospering social order’. Sure, the social order did not require ‘the continued supervision of kings and ministers’ and noted that their ‘continued supervision’ was a drag on prosperity, but neither did he consider that ‘natural liberty’ was necessary or sufficient for progress towards opulence (as he told Dr. Quesnay in WN); in fact the saw the reforms he recommended on their own merits and not as some sort of economy-wide imperative.

I would also suggest that the sentence: ‘As free people struck bargains with others - solely in order to better their own condition - the nation's land, capital, skills, knowledge, time, enterprise and inventiveness would be drawn automatically and inevitably to the ends and purposes that people valued most highly’ puts a modern gloss on Smith’s thinking; his objectives were much more localised to the world as he knew it. He was not in the prophesising business. And ‘the ends and purposes that people valued most highly’ leaves much scope for modern market distortions (Bubbles, False Accounting, Cartels, Scarcity Manipulations, Pollution, etc.) that may also serve private-ends intentionally, but may also have unintentional social disbenefits.

Paul Walker:

‘For Smith, markets are the most prominent mechanism for solving the problems of coordination and motivation that arise with interdependencies of specialisation and the division of labour. Market institutions leave individuals free to pursue self-interested behaviour, but guide their choices by the prices they pay and receive. For economists, the 200 years following Smith involved a search for conditions under which the price system would not descend into chaos.’

[GK Comments: Smith also recognised that other factors guided individuals; indeed, that was the actual point that he made about the ‘invisible hand’: some but not all merchants were led (‘by an invisible hand’) in the form of their insecurity about the evident risks of foreign trade to invest in ‘domestick industry’ and suggested, but did not identify, many other examples of similar non-price driven behaviour (WN Book IV.ii. 1-9).] Smith was no single-track ideologue.]

'The formal (neoclassical) model that arose from this search abstracts completely from any form of centralised control in the economy. [For Adam Smith this would be an abstraction too far. Smith knew of the importance of institutions to the proper functioning of the market economy.] It is a model delineated by "perfect decentralisation". Decentralised insomuch as authority plays no role in coordinating resources, the price system does the work. Note that the neoclassical model is often described as one of "perfect competition" and one reason that the emphasis on the firm and the household diminished as the model developed was that the neoclassicals placed a growing emphases on the concept of market competition and thus less emphases was given to firms and households. As McNulty (1984: 240) explains "[t]he 'perfection' of the concept of competition, beginning with the work of A. A. Cournot and ending with that of Frank Knight, which was at the heart of the development of economics as a science during the nineteenth and early twentieth centuries, led on the one hand to an increasingly rigorous analytical treatment of market processes and on the other hand to an increasingly passive role for the firm." For Knight "[p]erfect competition is conditioned by the existence of a set of assumptions, the most important of which are the following: (1) "a perfect market for productive services [ ... ], that is, uniform prices over the whole field" (1921[a], 316); (2) complete rationality and perfect knowledge by free and independent individuals; (3) "perfect mobility in all economic adjustments, no cost involved in movements or changes" (1921[b], 77); (4) "virtually instantaneous and costless" exchange of commodities (1921[b],78); (5) "perfect, continuous, costless intercommunication between all individual members of the society" (1921[b], 78); (6) perfect divisibility of commodities; and (7) "an indefinitely large number of competing organizations, each of the most efficient size" (1921[a], 316)." (Marchionatti 2003: 58)'.

[GK Comments: agreed. Paul deploys and ample illustration of the neoclassical abstraction. A step forward for the perfection of the model and a clear step away from reality.]

Paul Walker comments:
Again, authority, be it in the form of a government or a firm or a household, plays no role in coordinating resources. The only parameters guiding decision making are those given within the model - tastes and technologies - and those determined impersonally on markets - prices. All parameters are outside the control of any of the economic agents and this effectively deprives all forms of authority a role in allocation. Thus the neoclassical model gives a set of sufficient conditions under which the price system alone can achieve equilibrium.

Foss and Klein (2005: 6-7) argue that there is the possibility of an empirical reason for the way the neoclassical model considers the production side of the economy, at least. In short, the relative unimportance of the firm. Until relatively recently firms were simply not a large part of the economy. So treating firms as if they were all small may have been a reasonable approximation to a large section of the economy of the time. But they also point out that such an explanation is not wholly convincing. Large firms have existed since at least the time of Adam Smith and the classical economists knew this. Mokyr (2002: 122-3) summarises manufacturing in the U.K. before the Industrial Revolution by noting that,

[...] large plants were not entirely unknown before the Industrial Revolution. For instance, Pollard (1968) in his classic work on the rise of the factory, mentions three large British plants, each employing more than 500 employees before 1750. Perhaps the most ``modern" of all industries was silk throwing. The silk mills in Derby built by Thomas Lombe in 1718 employed 300 workers and were located in a five-story building. After Lombe's patent expired, large mills patterned after his were built in other places as well. Equally famous was the Crowley ironworks, established in 1682 in Stourbridge in the Midlands (not far from Birmingham), which at its peak employed 800 employees. [...] In textiles, supervised workshops production could be found before 1770 in the Devon woollen industry and in calico printing (Chapman 1974).

Also chartered companies were well known as witnessed by Adam Smith's negative assessment of chartered companies in general and the East India Company in particular, contained in the Wealth of Nations.'

[GK Comments: agreed. (Caveat: Smith did not condemn all ‘joint-stock companies; he found them workable when they operated in ordered sectors, such as banking and insurance, but he did object to those founded by Royal Charter for foreign trade, especially in India where the London directors’ control was week to non-existent, mostly because of the distance – a year or more each way by sea).

Paul Walker:
A more precise, and more defendable, version of the argument would be that the large, vertically integrated and diversified firm was not empirically important until recently. Thus analysing anonymous "firms" may not have been a bad approximation to the empirical realities of the time. As an approximation to "anonymous firm" production - that is, fully price-decentralised production - consider the case of rife manufacture in Birmingham, England in the 1860s,

[o]f the 5800 people engaged in this manufacture within the borough's boundaries in 1861 the majority worked within a small district round St Mary's Church. [...] The reason for the high degree of localization is not difficult to discover. The manufacture of guns, as of jewellery, was carried on by a large number of makers who specialized on particular processes, and this method of organization involved the frequent transport of parts from one workshop to another.

The master gun-maker-the entrepreneur-seldom possessed a factory or workshop. [...] Usually he owned merely a warehouse in the gun quarter, and his function was to acquire semi-finished parts and to give these out to specialized craftsmen, who undertook the assembly and finishing of the gun. He purchased materials from the barrel-makers, lock-makers, sight-stampers, trigger-makers, ramrod-forgers, gun-furniture makers, and, if he were engaged in the military branch, from bayonet-forgers. All of these were independent manufacturers executing the orders of several master gun- makers. [...] Once the parts had been purchased from the "material-makers," as they were called, the next task was to hand them out to a long succession of "setters-up," each of whom performed a specific operation in connection with the assembly and finishing of the gun. To name only a few, there were those who pre-pared the front sight and lump end of the barrels; the jiggers, who attended to the breech end; the stockers, who let in the barrel and lock and shaped the stock; the barrel-strippers, who prepared the gun for rifling and proof; the hardeners, polishers, borers and riflers, engravers, browners, and finally the lock-freers, who adjusted the working parts. (Allen (1929: 56-7 and 116-7), quoted in Stigler (1951: 192-3).)
Such a method of production would be a guide to the way production would take place under a functioning version the neoclassical model of the "firm".

[GK Comments: agreed.]

Paul Walker:
‘Thus whether we see the neoclassical model as a set of conditions under which the price system alone can prevent decent into chaos, more formally conditions under which equilibrium can be achieved, or as an approximation to a large section of the economy of the time, the neoclassical model makes more sense than many of its detractors would permit.’

GK Comments: To paraphrase Smith: there is a ‘lot of ruin’ possible in a market system (and long before it ceases to function effectively) which does not require to be in equilibrium to avoid ‘chaos’ because ‘chaos’ is not the opposite of equilibrium, nor a necessary consequence. Degrees of imperfection are tolerable in real world markets; they characterise them. In fact, also, given the world we live in, they are normal.

Demanding perfection in markets is an act of faith, not an assurance of science. The study of real-world markets, and the politics of societies that impinge on markets and non-market provision, is more required than class-room illusions of perfectionism, and worse, that new scores of students leave believing that the perfection-paradigm has value as policy, even though it applies nowhere and never has.

The details that Paul provides in the course of his rebuttal are infinitely more interesting and relevant to the real world than the equilibrium models developed since Smith.

Mercantile political economy persisted in basic forms long after Wealth Of Nations. Having lost one empire after 1776-83, Britain continued its mercantile policies in a second empire in India, Caribbean, Canada, Africa, Australasia, and the Pacific (until after the second world war) and its mercantile instincts continue, post-colonialism, in the protectionism in the EU and WTO. The state’s role Britain, and all other major economies, shows that all countries are more state capitalist than they are anywhere near perfectly competitive.

'Price Gouging' Is Never Invisible

Stanley Robinson of
 Princeton, Mo. writes to Kansas City.Com HERE:

“Price gouge warning counter to principles”

“Once again, Missouri Attorney General, Chris Koster, stymies the workings of free market capitalism. According to a statement on his official website, he and all the government forces he can rally will be on guard “against price-gouging following the devastating tornado in Joplin.”



Evidently, Koster is unfamiliar with the central tenet of Adam Smith’s “invisible hand” theory of commerce. A shortage of goods or service in one location will cause a rapid rise in its price, and the result will be an inflow to rebalance the market. Disruptions in a free market will self-correct — or so it is said. Only an advocate of wet-nurse government would approve of such socialistic restraint undertaken by our attorney general. I thought unfettered capitalism and small, unobtrusive government is the default position of the Republican Party.”


Comment
A fairly typical response to the surge in prices for repairs and comforts after an act of nature, is for prices per unit of things to rise, which is commonly called (in the USA) ‘price gouging’, meaning exploitation of those in need (including sometimes of those desperate for tickets to an event).

Modern economists, and those influenced by them, can try to explain what is happening by referring to supply an demand analysis. So far so good. But then sometimes, the basic economics of supply and demand attracts the kind of mysticism shown by Stanley Robinson in his letter.

Not satisfied with explaining how markets work through very visible prices (try to think of a market working where prices are invisible!), Stanley Robinson, like too many others, introduces what he asserts is ‘the central tenet of Adam Smith’s “invisible hand” theory of commerce’ which he suggest is ‘unfamiliar’ to the Missouri Attorney General, Chris Koster.

I do not know about what the Missouri Attorney General, Chris Koster is familiar with or not (I am certainly not familiar with the politics of his tribe, Republicans or Democrats, nor am I interested, as I do not vote in Missouri). But I can say that I too am unfamiliar with what Stanley Robinson calls ‘the central tenet of Adam Smith’s “invisible hand” theory of commerce’.

It certainly is not discussed as such by Adam Smith in his Theory of Moral Sentiments (1759) or in his ‘Wealth Of Nations (1776), or, in fact, in anything else he wrote in his lifetime. In short, Adam Smith had no central tenet of commerce involving anything other than visible prices in his ‘theory of commerce’.

So why does Stanley Robinson claim, incorrectly that Adam Smith had such a ‘central tenet’?

Because, of course, Stanley Robinson has picked up the association from an invented assertion by modern economists (Paul Samuelson, among others) in the post war years as an answer to the then claims of the Soviet Union that their national state planning was superior to the anarchy of the ‘free markets’ of the West. Having a so called ‘invisible hand’ on its side supposedly helped Western markets outperform Soviet Planning, but it was the market system that achieved this result decade after decade, and it did so without Soviet- style tyranny and without an 'invisible hand'!

And ‘price gouging’ is fully explained without resort to ‘miracles’ and ‘invisible hands’ and any other mumbo jumbo. ‘Price gouging’ is very visible, as are its alternatives, such a rationing (the 'rules' for rationing are published - of the enforcers that implement the rules are very visible.

The end result is always the same – shortages, with some people going without – we can’t all go to the same concert, or all get the same tarpaulin, or whatever. That’s life. If you prefer rationing, get to the back of the queue.

What Does the Modern Invisible Hand Add to Visible Prices in Markets?

Lisa Szefel writes (28 February) a review, in Cutting Edge (HERE), “The Age of Fracture: An Intellectual of America and the Twentieth Century”, of The Age of Fracture by Daniel T. Rodgers. Harvard, 2011:

“Rodgers argues that in the 1940s and 1950s, social scientists and political philosophers established the terms of the debate on a range of issues concerning the self and society, obligations and justice, morality and destiny. To these postwar intellectuals, ideas had severe consequences, contexts and nature constricted human action, and history loomed very large indeed. While the turmoil and chaos of the 1960s caused tremors, it was not until the quakes of oil embargoes, unemployment, and inflation in the 1970s, that fault lines in this ideological consensus emerged. Into this breach, a lexicon of microeconomic principles, which had been forming for decades in libertarian circles that stressed agency, contingency, and reason emerged, promising solutions to seemingly intractable problems of disco-era stagflation. Instead of focusing on property and production, workers and owners, these economists celebrated instead the slight of (an invisible) hand that produced wealth and fostered the virtues of competition.”

Comment
At least Daniel T. Rogers does not ascribe the “invisible hand” doctrine invented by post-war Modern economists to Adam Smith.

But that does not save that doctrine, while welcomed by Lost Legacy, from critical scrutiny. It moves the criticism to another level, including asking of what does the so-called invisible hand contribute to the known workings of the market.

Among these long known working is the irreducible fact that market transactions are signaled and negotiated by very visible prices. Indeed, markets cannot work without that visibility.

So what then does an imagined invisible hand bring to the known workings of markets?

The silence and obfuscation from proponents of the modern invisible hand doctrine in not answering the question is itself a condemnation of the doctrine, which ought to be embarrassing to its proponents, many of whom are in the highest ranks of the discipline.

Adam Smith On Markets And Their Regulation

One benefit of enforced “rest” from having a prolonged cold, now reinforced by anti-biotic doses, is the time it creates for some idle thinking, in this case, about Lost Legacy. Looking back over several years, I can follow the development of my narrative against the prevailing practice in modern economics of misrepresenting Adam Smith’s use of the IH metaphor. Over recent time, particularly when responding to the recent challenges from Daniel Klein and David Freidman (for which I thank them for their scholarly approach to discourse among colleagues, and which Jeff Traubman reminds us, is proper in the Republic of Letters).

What occurs to me is my need to focus more on the attempted applications of the IH metaphor in Adam Smith’s name to how markets work, rather than focus on the alleged use by Smith of the IH metaphor as some kind of allusion by him for market processes, to supply and demand, and for the inevitable benefits they contribute to social harmony, even to General Equilibrium, in stark contrast to the highly restricted use Smith had in mind of the purely “domestik” quantitative increase in the “annual revenue and employment”, as some merchants chose to avoid their perceived risks of “foreign” trade.

This also applies to those who associate the IH metaphor working as and within “perfect competition”, and modern “capitalism”, and even as of divine origin.

I think I shall try to take on the applications of the IH metaphor as they are presented by modern commentators, and show that there is no role in economics for a mysterious, non-defined (nor definable) term in their arguments – it never appears in the mathematics of GE, ironically its strongest exponents.

If proponents of the IH metaphor reject the evidence in Adam Smith’s texts (History of Astronomy, 1995, post-h; Moral Sentiments, 1759; Wealth Of Nations, 1776, but he defines metaphors in his Lectures on Rhetoric, 1762-3, 1983, post-h), then let us take the challenge to them to explain what the IH metaphor brings to the party – so to speak – in their modern examples.

My broad case can be summed: it brings nothing at all.

So let me start with today’s offering:

Ted Sprauge post in McGill Daily (HERE) (and also Blogs HERE

“Adam Smith in the traditional market: Deconstructing the Indonesian pasar”

“Today the chicken seller doesn’t budge: 27,000 rupiah (roughly $3) each. He won’t even shave a thousand rupiah for a seasoned bargainer. Demand is high on the eve of the Chinese New Year. Recognizing that he has the upper hand, the chicken seller is winning this centuries-old competition between buyers and sellers. Adam Smith’s “invisible” hand penetrates deep even in this medieval market. Nothing escapes the clutch of the law of supply and demand.”
 …

“Foreigners might think them to be “native,” “traditional,” a way of life to be preserved, but if you ask everyone there, they would want things to be improved. A rat-infested pasar is not something to be proud of. Adam Smith’s “invisible” hand cannot possibly untangle this mess. A firm, directed hand, and one which is visible to the people, is needed, and it should be the hands of those petty traders and housewives – rough, scaly, dark, from years of peddling, hawking, and handling food.”

Comment
Ted Sprauge describes a scene that is replicated in many places all over the world. I have attended colourful street markets in Singapore, Kuala Lumpur, Shanghai, Hong Kong, Cape Town, Istanbul, Suez, and Aden, and their modern remnants in Leeds, London, Bergerac, Castillion, Paris, Edinburgh, and Glasgow.

Sprague turns a fine phrase: “Nothing escapes the clutch of the law of supply and demand”. Yes, and Smith made a similar point about the effectual demand for black cloth on a day of mourning at a funeral.

But what he did not do was link this example to the IH metaphor. His explanation of markets was fully explained in Wealth Of Nations without the IH metaphor in the “centuries-old competition between buyers and sellers.”

The subjective social pressures of proper appearance in black as a guest at a funeral fuelled the effectual demand for black cloth, even as an arm- or hat-band, if not a coat. No ‘invisible hand’ was needed to prompt the buying of black cloth; the `IH metaphor’ is redundant in this context.

What does it do? Lead mourners to go out and buy black cloth? The felt social obligation is sufficient, certainly among the principal mourners (family, close friends). Similarly with the effectual demand for chicken, where the “Demand is high on the eve of the Chinese New Year”, as is demand for Haggis, even a nominal spoonful, in Scotland around 25 January (birthday of Robert Burns).

Sprague rightly notes that “Adam Smith’s “invisible” hand cannot possibly untangle this mess”, because “A rat-infested pasar [market] is not something to be proud of”. First I would answer why is it that street markets in Britain are not “rat infested (as was very visible when I visited one selling fish and chickens in Singapore)? Then I would ask, why do most developed markets in Europe and North America (and Singapore!) conform to the ‘big box’ type for retail sales?

Yes, it was and is connected to the rise in per capita incomes from “medieval” conditions. In fact, ‘big box’ selling it seen by some as a threat to city centre small shops, from the perceived lower market prices of the Tesco, Safeways, Wall Mart, Sainsbury, and Waitrose operations.

Ted, from a developed economy’s perspective, abandons his faith in the “invisible hand”, which never existed in the role he assigned to it, and plumps for “A firm, directed hand, and one which is visible to the people” which “needed”. I only comment: beware of what you wish for.

History shows that the gradual regulation of the “medieval” street markets across Europe (at first resisted by the merchants) proved a dubious long-term benefit for consumers. Remember, regulations, licences and such like, are administered by inspectors, who as a rule expand any set of regulations over time by a large amount, and certainly did so in Britain.

These regulations formed the basis for Queen Elizabeth’s mercantile laws, the side-effects of which legalized town monopolies of tradesmen (Guilds, Apprentices, and such like) by devolving their administration and enforcement to the tradesmen, supposedly to be regulated. Smith had plenty to say about these unintended malign consequences in Wealth Of Nations.

The first cry for ‘laissez-faire’ came from a French town-merchant speaking on behalf of merchants – not consumers – against the even more regulated town markets of France.

Rising per capita incomes among the lowest paid and poorest majority from economic development inexorably resolves the awesome problem of ‘rat infestation’ of street markets. Western tourism, ironically, tends to keep them as places to visit (in between spending sprees in place like Singapore’s Orange Road's big-brand retail emporia – I tried my first Apple in a computer shop there in the 1980s).

Ted Sprauge, perhaps, should look closer at Adam Smith’s use of the IH metaphor before considering it as relevant to an Indonesian pasar, interesting as his report was.

A Debate About Polanyi and Exchange

Dan Hirschman responds to my invitation to post his comments on my Blog Post (below) and his response is posted in full:

Thank you for your comments and your criticism! I will respond in this comment and think more carefully about those issues I don't address.

First, I want to assert (to make sure I am correct) that you are not criticizing Polanyi's reading of the hidden/invisible hand. You and Polanyi agree that this metaphor was "exaggerated out of all proportion". You and Polanyi and Emma Rothchild also all agree that "Adam Smith wished to discourage the idea that the self-interest of the merchant naturally benefited the community." Am I correct in both those assertions?

Second, I am in no position to evaluate Polanyi's claims about primitive and archaic societies. I will note that Polanyi was writing primarily in the 1940s and 1950s, and the text you cited was from the 1990s. So, are you criticizing Polanyi for being wrong now or saying that he should have known even 50 years ago that he was wrong? Perhaps this difference does not matter, but I would like to clarify.

Third, while I am not in a position to evaluate the secondary literature on Polanyi's claims about primitive and archaic economies, I will point to one source that attempts to do just that and comes out much more sympathetic to Polanyi than your quick dismissal here. Gareth Dale has just published a highly-regarded book on Polanyi and his legacy, Karl Polanyi: The Limits of the Market. In Chapter 4, on "Trade, markets and money in archaic societies" (esp. 185-187), Dale tackels this question directly. I have not read the section thoroughly, but the conclusion presents a much more balanced take on Polanyi's insights into archaic societies noting that many of his critics misread his position. For example, you cite the existence of money in ancient Rome as evidence of the existence of markets. Polanyi asserted that markets existed and played a substantial role in archaic (though not tribal, I believe) economies, but they were not the primary form of integration. The mere existence of markets is part of Polanyi's understanding, not a datapoint in counter to it. The question is, what sort of markets were they? Fixed price, or supply-demand-price markets? Markets for land and labor and food or luxuries? Etc. Again, I cannot speak to the recent historical work on ancient civilizations, but I want to note that it is easy to read Polanyi's claims as being more absolute than they are.

Fourth, following from point three, Polanyi asserts that Smith is wrong about "TBE", that most people in most times and places have not engaged in much trucking, bartering and exchanging, and especially not over the most important goods (labor and land). Again, I am no expert in the history of markets and exchange! But, for Polanyi's theoretical claim about human nature (or the lack thereof) to hold, whether or not "TBE" exists in Rome is not entirely crucial. The important thing is that there exist some substantial number of societies in which these activities are not found. I think the case for the absence of truck, barter and exchange is more compelling for "tribal" rather than "archaic" societies (to use Polanyi's terms). For an interesting take on the history of the encounter between economic and anthropological thought, I recommend Heath Pearson's (2000) "Homo Economicus Goes Native" in History of Political Economy. I would be very curious as to your take on whether or not Smith believed that "truck, barter, and exchange" was part of human nature, and if so what that meant for Smith (since you assert, and I am readily willing to accept, that Smith's understanding of exchange was complex).

Fifth, I believe I agree with you that Smith was much more interested in saving the Indians from the horrors of the EIC than Polanyi notes in that brief (and, to reiterate, not intended for publication) passage. Beyond that, I do not have a strong sense of the whole of Smith's take on the EIC, and I very much defer to your reading!

Sixth, and last, I am curious as to your thoughts on Rothschild's work on the invisible hand. Here you suggest that she "still misreads" the role of the metaphor. Which "more striking and interesting" metaphor are you referring to? Overall, what is your take on Rothschild's Economic Sentiments, and her assertions re: how Smith's legacy was perverted into the employer's creed?

Comment
Many thanks Dan for your comments and questions. You address the issues clearly and I shall attempt later today to explain my criticism of Polanyi and where I agree/disagree with Emma Rothschild (her Economic Sentiments is a brilliant book). Meanwhile, I am grading MSc exams at present (a relic of my old day job) and must finish before Christmas. Some hope ...
Best regards, Gavin