New Interesting Seminar Course from Jeff Weintraub

Jeff Weintraub, a social & political theorist, political sociologist, and democratic socialist who currently teaches at the University of Pennsylvania, has appeared on Lost Legacy while we discussed, amicably and productively (as is proper and appropriate for scholars), matters related to Adam Smith’s thinking. He put on his blog (25 January) most interesting details of a course he ran recently (oh, to be a student once again!).

What is striking about Jeff’s course outline is the centrality of the question he has set for his students to examine. This centres on a theme often discussed on Lost Legacy (though not necessarily subscribed to by Jeff):

to what extent can modern economists attribute to Adam Smith proto-general equilibrium notions (from Arrow an Hahn in General Competitive Analysis (1971) “that a decentralized economy motivated by self-interest and guided by price signals would be compatible with a coherent disposition of economic resources that could be regarded, in a well-defined sense, as superior to a large class of possible alternative dispositions”.

Further, Arrow and Hahn ask: "What will an economy motivated by individual greed and controlled by a very large number of different agents look like?", and students were expected to attempt to address it.

Jeff writes:
“Kenneth Arrow & Frank Hahn put Smith’s theory of the market in perspective”

“This was sent to the students in a seminar on the history of modern economic thought, "Economic Liberalism and Its Critics", that I'm teaching this semester. Right now we're reading & discussing (portions of) Adam Smith's Wealth of Nations. This little item is relevant to that, and it may also be of more general interest. —Jeff Weintraub:

“Nowadays, more than two centuries after Adam Smith published The Wealth of Nations and after so many of his ideas have been absorbed and elaborated by academic disciplines, ideologies, and everyday public discourse, it can sometimes be too easy to take his theory of the market for granted. And doing that can have at least two different kinds of effects, both unfortunate. On the one hand, it may incline people to swallow these ideas too easily and uncritically, as though they were simply common sense, without realizing how controversial and paradoxical many of them are. And on the other hand, it may lead people to underestimate the powerful and startling originality of Smith’s theoretical achievement in WN.”

“The following passage from the Preface to Kenneth Arrow & Frank Hahn’s General Competitive Analysis (1971), which was long one of the most prominent texts in general equilibrium theory, captures something important about the point and significance of Smith’s theory of the market and makes it clear why the central thrust of his theory should remain startling, as well as illuminating, to anyone who takes it seriously.”

“There is by now a long and fairly imposing line of economists from Adam Smith to the present who have sought to show that a decentralized economy motivated by self-interest and guided by price signals would be compatible with a coherent disposition of economic resources that could be regarded, in a well-defined sense, as superior to a large class of possible alternative dispositions. Moreover, the price signals would operate in a way to establish this degree of coherence. It is important to understand how surprising this claim must be to anyone not exposed to the tradition. The immediate "common sense" answer to the question "What will an economy motivated by individual greed and controlled by a very large number of different agents look like?" is probably: There will be chaos. That quite a different answer has long been claimed true and has indeed permeated the economic thinking of a large number of people who are in no way economists is itself sufficient ground for investigating it seriously. The proposition having been put forward and very seriously entertained, it is important to know not only whether it is true, but whether it could be true. A good deal of what follows is concerned with this last question, which seems to us to have considerable claims on the attention of economists” (pp. vi-vii).”

Comment
There are no details to hand available of what was written by the students.

While open to other ideas, I am not happy either with the notion that “general equilibrium” operates at all in real world economies, nor that mathematical models of a general equilibrium have anything to do with the real world. That markets are the least worst of all possible forms for creating, producing and distributing the “necessaries, convenience, and amusements of life”, is not controversial, except with utopian would-be designers of unrealisible perfection. That is why Jeff’s second question (and his student’s answers) is of considerable interest to me.

New Book Exposes Modern Economics to Scrutiny

Yanis Varoufakis writes on a “A Manifesto for Modern Political Economics”
HERE

Yanis Varoufakis, Joseph Halevi, Nicholas J. Theocarakis,
MODERN POLITICAL ECONOMICS: MAKING SENSE OF THE POST-2008 WORLD. Routledge, 2011. £45.

‘Blanchard had this to say about the Nash-Debreu-Arrow formalist project and the theorems it spawned:

“More than 200 years ago, Adam Smith explained that in a market economy individual egoisms combined to bring about the best possible outcome for the community. This proposition was so surprising and so full of consequences that it became necessary to understand its nature and its limits. Thanks to Walras at the beginning of the 20th century, and furthermore thanks to economists like Arrow or Debreu fifty years later, and especially thanks to a huge effort of abstraction and to powerful mathematical tools, the conditions of Adam Smith’s theorem have been clarified.”

Leaving aside serious doubts that Adam Smith would approve of what Walras and the formalists allegedly did in his name, Blanchard goes on to interpret the Nash-Debreu-Arrow theorems as follows:

Having clarified the necessary conditions required to satisfy the Adam Smith theorem, research has been directed almost entirely into investigating what happens when the conditions are not satisfied. Namely, why some markets work badly, and what type of institutions have to be put in place in order to improve their working.”

Note the leap of undiluted faith from the formalist model to the real world. Blanchard’s claim is that the formalism can help us understand why some real markets work badly. It is as if Gerard Debreu had never issued his legendary warning that “…the theory…is logically entirely disconnected from its interpretations”.

The whole Blanchard argument is a complete non sequitur. No investigation of the circumstances under which a Walrasian General Equilibrium will not obtain can illuminate the causes of real market failures. Why? Because the theory hangs together only under assumptions that push it onto a universe in which real capitalist markets could not, physically, exist. Is it not the duty of a leading textbook writer to spell this out? Anything less, we submit, is intellectual poison, especially for the young minds who treat a famous textbook writer as an authority on the subject-matter.

Alan Kirman (1989), one of formalism’s leading lights, sums up our conclusion thus:

“In conclusion, then, it is worth repeating that recent theoretical work has shown how little the Walrasian model has to say about aggregate behaviour. Economists therefore should not continue to make strong assertions about this behaviour based on so-called general equilibrium models which are, in reality, no more than special examples with no basis in economic theory as it stands.”

Does Olivier Blanchard not know this? He ought to, and we think he does. But such is his ideological inner drive to argue that his policy recommendations are founded on a bedrock of good mathematics, that he is being economical with the truth. More disturbing even than this naked act of dishonesty is what Blanchard and his merry colleagues do in order to arrive at their policy recommendations (e.g. the ones he pushes onto the world community as Chief Economist at the IMF): Given the utter inability of Walrasian or Nash-Debreu-Arrow theorems to say anything tangible about the real world, they return to the single sector or Robinson Crusoe types of economies. There is nothing like strong (often austere) economic policies derived from false premises to inspire sheer horror in the hearts and minds of those in the know.

Comment
I am glad that Yanis Varoufoakis made this comment in passing because this otherwise treats the invention of Paul Samuelson in 1948 in his ‘Economics: an analytical introduction’ of Adam Smith’s use of the invisible hand metaphor as something that Smith actually said as regular readers of Lost Legacy will know by now.

However, the new book looks very interesting and gives a fierce critique of general equilibrium economics and much else in modern economics, which causes me to urge that it be consulted. From the article, of which the above is only a snippet, I recommend that your follow the link.

A Phoney Debate

Tyler Cowen writes on Marginal Revolution (HERE): quoting Noah Smith on Interfluidity, headed:

‘Radical claims about recalculation’

‘In a typical microeconomic model, the market clears, because price adjusts to balance supply and demand. In a PSST [Patterns of Sustainable Specialization and Trade] world, this does not happen. The pattern of specialization and trade will not always be disturbed by small changes in prices, because the global pattern itself represents a stable equilibrium (i.e., is “sustainable”). How many computers I buy and sell will depend not only on the price of computers, my desire for computers, and my cost of producing computers; it will depend on the prices, desirabilities, and costs of a bunch of other goods throughout the whole economy. The economy will be riddled with network externalities, and the resultant weakening of the price mechanism means that any market may or may not tend toward efficiency on any given time scale. In other words, in a PSST world, there is no invisible hand.

This opens the door for a hugely expanded role for government (or other large, centralized actors) in the macroeconomy. If global patterns matter as much as local prices, then an actor large enough to perceive and affect the overall pattern might be capable of nudging the economy out of a bad equilibrium and into a better one. Dani Rodrik has been saying this for a long time in connection with newly developing economies, but the same may be true in rich countries when faced with disruptive technological change or globalization.

To which Tyler Cowen comments:
“Believe it or not, that’s not exactly my view. The most serious network externalities problem is most likely underinvestment in new innovation and its supporting infrastructure. Subsidies to basic research can yield very high returns, as they have done for the computer, the internet, and through NIH. Otherwise, when it comes to recalculating the resource allocation on top of the basic scheme of knowledge, I am skeptical that the public sector will do a very good job, for both information and public choice reasons. Private sector rigidities and rules of thumb generally will mean that readjustment is too slow, not that it will fly off the rails into hyperspace, finance being one notable exception. Education and confidence building can speed readjustment, as can nominal gdp stabilization, but if anything the public sector is especially sluggish itself. Traders rang the alarm bell on the subprime crisis, and its later and broader offshoots, well before the regulators did. Has the EU been ahead of the curve on Greece? I don’t think so.”

Comment
‘In other words, in a PSST [[Patterns of Sustainable Specialization and Trade] world, there is no invisible hand.’

The problem is not so much as this qualification is that there is no ‘invisible hand’ in any feasible world known to human societies. There is not really any ‘weakening of the price mechanism’ because the unreal assumption that ‘price mechanisms’ anywhere ‘clear’ in some notion of general equilibrium, which is a fantasy for a real world economy.

Setting out in search of a world where general equilibrium obtains is a chimera not worth the effort of looking for it. Proving it mathematically is nowhere sufficient for it to exist in the real world.

Noah Smith bserves: ‘How many computers I buy and sell will depend not only on the price of computers, my desire for computers, and my cost of producing computers; it will depend on the prices, desirabilities, and costs of a bunch of other goods throughout the whole economy.’ To which I would add a host of other possible factors, none of them under the control of any known human system.

At root it’s a problem arising from belief into the alleged mystical properties of ‘an invisible hand’ for which Adam Smith is not to blame. He used a popular 17th-18th Century metaphor on two occasions only and appropriately by identifying their objects which were neither mystical nor miraculous in the slightest degree, though this has not stopped talented modern economists failing to see what he was actually talking about. Instead they invented a myth I place of his clear usage, and widening out his meaning to refer to market prices, supply and demand and even natural liberty.

In that sense the debate between Noah Smith and highly talented Tyler Cowen is a phoney debate.

A Gaia Economist Slips into Error

Molly Scott Cato writes (28 May) on ‘Gaian Economics’ HERE

‘All other green campaigns become futile without tackling the economic system and its ideological defenders. Economics is only dismal because there are not enough of us making it our own. Read on and become empowered!’

‘Less Osborne More Hobsbawm’

Advocates of a market view of the economy and proponents of further and faster globalisation both tend to seek inspiration from the work of Adam Smith, who is taken to be the founding father of market economics. Smith's work The Wealth of Nations, was published in 1776, only on the cusp of the industrial revolution and before its technological advance had had the chance to impact widely on social and economic structures.

The economist who better represents the theory that has come to dominate our modern world is rather David Ricardo, whose most famous work Principles of Political Economy and Taxation was published in 1817, some 40 years after that of Smith, and whose work set the parameters for the world of laissez-faire capitalism and export-led growth that we inhabit today. Ricardo was attempting to theorise the economic reality of a world where labour and land were made subject to market forces, as they had been to only a limited extent in Smith's day.

In an excellent article in the New Statesman back in March, Robert Skidelsky made clear George Osborne's debt to Ricardo, whose economic theories he rather brutally summarised in the following phrase: 'It goes like this: the private sector creates wealth and the government squanders it. The smaller the government – the less it taxes and spends – the more the economy will thrive.' Moreover to a Ricardian there is no fundamental distinction between taxation and government borrowing: borrowing is merely deferred taxation.

This is an article of faith, unsupported by empirical evidence. …

… Economics is a complex system, where numerous variables interact in ways that can never be predictable. This is why jokes about one-armed economists are just foolish: there will always be a multitude of answers to every question and predicting the future is a mug's game. Hence the wise economist leaves his options open, and makes sure that the politicians he is advising do the same.’

Comment
A preliminary observation: Molly (the name by which she writes, so I am not being patronising) adopts the label of economics as the ‘dismal science, and “everyone knows that economics is the dismal science [and] almost everyone knows that it was given this description by Thomas Carlyle, who was inspired to coin the phrase by T. R. Malthus's gloomy prediction that population would always grow faster than food, dooming mankind to unending poverty and hardship.”

However, the facts are different and Molly ought to know the truth about the use of ‘the dismal science’ label, and I assume she does not know, otherwise if she did know she would be ashamed:

“Carlyle's target was not Malthus, but economists such as John Stuart Mill, who argued that it was institutions, not race, that explained why some nations were rich and others poor. Carlyle attacked Mill, not for supporting Malthus's predictions about the dire consequences of population growth, but for supporting the emancipation of slaves. It was this fact—that economics assumed that people were basically all the same, and thus all entitled to liberty—that led Carlyle to label economics "the dismal science."

“Carlyle's target was not Malthus, but economists such as John Stuart Mill, who argued that it was institutions, not race, that explained why some nations were rich and others poor. Carlyle attacked Mill, not for supporting Malthus's predictions about the dire consequences of population growth, but for supporting the emancipation of slaves. It was this fact—that economics assumed that people were basically all the same, and thus all entitled to liberty—that led Carlyle to label economics "the dismal science." Quoted from: David M. Levy and Sandra J. Peart , 22 JANUARY 2001: “The Secret History of the Dismal Science. Part I. Economics, Religion and Race in the 19th Century” HERE:

Carlyle’s bitter attack on Mill came from disgraceful and scurrilous pamphlet entitled: "An Occasional discourse on the Negro Question" 1849 (which is the polite version – it was originally called ‘on the N----- Question’), and was written by the 'great' Thomas Carlyle.

This episode shows that liberal-minded people do not have a monopoly of the social virtues, which is also clear from today’s representatives, such as Molly, or, indeed, the distinguished historian, Professor Eric Hobsbawm in her title.

On the substance of Molly’s article, I am not in total support of her side-blast at David Ricardo, or more pointedly, I have more fundamental disagreements over Ricardo’s influence on economics than an alleged error of George Osborne, the British Chancellor.

Smith’s criticized the consequences of the discovery by government that it could add to its capacity for extracting revenue from taxation from some of its citizens (always unpopular) by borrowing, which was less painful politically, governments soon realized. In fact, because they often needed to borrow to fund their dynastic wars, governments displaced loan repayments and their interest costs to the future, which caused yet more borrowing and interest burdens to future taxpayers.

It is not clear to me the significance of Professor Skidelski’s or Rucardo’s point about Taxation and Borrowing. I do know that the habit of medieval Kings who simply expropriated their lenders when it was expedient to do so is not available to modern governments under the rule of law and that defaulting on debts likewise has downsides, including morally too.

However, Ricardo’s main malign error concerned his analytical devices, which when taken up by the neo-classical economists from the 1870s, especially the mathematically obsessed, has been quite damaging. In order to get determinate ‘solutions’ the assumption of decreasing returns from agricultural examples lead to uni-dimensional economics, which produced fine equations, wonderful graphs, and, eventually, an absence of people from economics, perhaps the most significant loss to unreality, yet attempted by its practitioners. In the extreme, the triumph of ‘general equilibrium’, seen as the pinnacle of economics as a science, is actually a minor triumph of analysis that does not conform (i.e., explain) social reality.

Disequilibrium rules. Equilibrium is at best partial – never general as the persistence of temporary relapses into recessions and depressions, followed by temporary booms, shows. Whether this is ‘good’ or ‘bad’ thing is less important than the recognition that it happens. The question is whether societies can live with these events, with the subsequent question of whether- and more particularly ‘which’ - political interventions to ‘correct’ these events makes things ‘better’ or ‘worse’.

Adam Smith made (very) few predictions. His almost entire approach was historical – how did we get to where we are – and not predictive. If anything he remained sceptical of predictions and of the likelihood that political elites would choose the appropriate policies to remove existing anomalies –they were, more often, the cause, not the cure, of errors in economic management (mercantile political economy). I confess, not to having much faith in ‘gaia economics’, or other would be salvation (New Economics Foundation, etc.,).

But I mean no malice. I will read what Molly writes, and wait and see.

Progress Yes, Equilibrium No!

Tim Harford (the undercover economist), writes, 21 May, (HERE):

‘A font of wisom on economies of scale’

‘Annoyingly, economies of scale are analytically inconvenient – if you want to build a textbook model of an industry with scale economies, the mathematics are messy – and yet Adam Smith’s famous example of the pin factory simply illustrated how fundamental economies of scale are to economic progress.’

Comment (not a criticism)
In practice, what actually happened in pin-making illustrates what happened across manufacturing in the nineteenth to twentieth centuries through the introduction of power-driven machinery which enabled fewer, not more, individual workers to complete the work of many men, and increase output substantially. In 1820, there were 11 pin factories in Gloucester employing 1,500 people, but by 1870, the pin industry in Gloucester was gone. By 1939, the number of pin manufacturers in the United Kingdom had shrunk to about 12, and by 1978 there were only 2, as a result of mergers, take-overs and firms leaving the trade (HERE).

Smith’s example of the constituent elements in the manufacture of the common labourer’s coat (WN I.i.11, 22–23) is probably significant than his more famous pin factory, but most readers do not turn the few extra pages to get to the more significant (for the 21st century) labourer’s coat example. The multiple instances of manufacturers simultaneously and serially improving the productivity of their production processes in response to the possibilities of the growing extent of their own markets constantly changes their supply chains forwards and backwards and increases the productivity of the entire set of producers along their supply chains. This happens among their customers and among their customers’ customers, most of whom have limited or no connections with each other.

Improvements in hand tools from an improved division of labour not only reduces the unit costs of making shears, say, for sheep shearing, but might also improve hammers for carpenters, and all manner of other metal tools for others to meet rising demand in their and ever more complex extended markets. As output rises in response to a growth in the extent of all the sub-markets, it separates the operations into more roundabout processes, adding to productivity across more than one industry (inputs into one industry may also be inputs into others).

The division of labour is not limited to one pin factory; it affects cumulatively all processes that use pins and nails, and, later, affects the productivity of nails and other attachments, plus changes in technology, materials, and processes. Thus, the ‘enlarging of the market for any one commodity, produced under conditions of increasing returns, generally has the net effect . . . of enlarging the market for other commodities’ (Young, Allyn (1928) (HERE).

Young gave interesting examples of the cumulative effect of these processes in the early printing industry that promoted producers of wood pulp, inks and their ingredients, metal type, technologies for producing illustrations, and the manufacturer of specialised tools and printing machines, plus suppliers to the printing trades and other industries (Young, 1928, 537).

He also advised that increasing returns are not ‘discerned adequately by observing the effects of variations in the size of an individual firm or of a particular industry’ because ‘the progressive division and specialisation of industries is an essential part of the process by which increasing returns are realised’ across ‘all industrial operations’ when ‘seen as an interrelated whole’. He identified increasing returns as dependent ‘upon the progressive division of labour, and the principal economies of the division of labour’, which cumulatively arise from ‘using labour in round-about or indirect ways’. Lastly, while Smith said ‘the division of labour depends upon the extent of the market’, the extent of the market ‘also depends upon the division of labour’, and in this ‘circumstance lay the possibility of economic progress, apart from the progress which comes as a result of the new knowledge’ (Young, 1928, 538; see also: Roger Sandilands HERE).

Smithian growth is an open, not closed, process driven by increasing, not diminishing, returns (Ricardo's error). The economy is not in a state of equilibrium (as 'proven' mathematically but nowhere has it applied; the mathematics are not just 'messy' - they are futile) because (in relatively free capitalist economies) many millions of individuals participate in it, normally without central control, quite independently of each other, with (for ‘better’ outcomes) few imposed constraints on imitation, innovation or invention, and without regulated setting of prices or costs and supervision of the process of their bargaining exchanges (attempts to impose such constraints normally have not been successful). Disequilibrium in an economy is endemic because there is plenty of scope for human error, for mistaken readings of market conditions, and for failures to innovate or adapt when maybe they should have, or possibly when they shouldn’t (as Adam Smith showed in relation to mercantile Britain). Interventions are also fraught with error for the same human proclivities to meddle to ‘improve’ outcomes.

It may be better to abandon theories of equilibrium in economics and the search for it, with the expectation of Nobel prizes for ‘proving’ it in theory (General Equilibrium), though clearly never finding it anywhere in practice.

Once More With Feeling...

Writing in the “Ultra-Bourgeoisiology” Blog (HERE):

“Smith appears to make some questionable assumptions in offering the theory of the invisible hand. The following passage encapsulates the problem:

'Every individual is continually exerting himself to find out the most advantageous employment for whatever capital he can command. It is his own advantage, indeed, and not that of the society, which he has in view. But the study of his own advantage naturally, or rather necessarily, leads him to prefer that employment which is most advantageous to the society.' (IV.2.4)

Assuming, however, that individuals are nonetheless predominately motivated by the particular configuration of self-interest that Smith has in mind, it is unclear whether the “society” to which advantage accrues is necessarily the immediate and “entire” society to which the individual belongs. It seems quite plausible that the benefits thus obtained might be concentrated in very few hands within a society. Do these beneficiaries represent the interests of society in general? Smith clearly privileges the total sum of “benefits,” but in this case there seems to be some ambiguity in the meaning of “benefit,” especially when some elements within society may actually experience substantial “losses” in the process.

… If Smith is right that society receives the greatest benefit even when every individual works to advance his own advantage, and if such a theory informs this egocentric modality, it seems that maximizing the public good is precisely the goal—why must it be hidden?”

Comment
I made the following comments on the Ultra-Bourgeoisiology” Blog:

“Adam Smith did not have a "theory" of "an invisible hand". That was an idea invented by modern economists from the 1950s. Smith used '"an invisible hand" as a metaphor in Wealth Of Nations (Book IV, chapter 2, p 456) for some, but not all, merchants, who were concerned with the security of trading with foreign countries or the colonies, and, therefore, preferred to trade "domestically".

It was their concern for their own security that 'led them' to invest in "domestick" industry, which Smith correctly noted added to "domestick annual revenue and employment" - a purely limited arithmetic outcome (the whole is the sum of its parts) - which Smith believed was a public benefit. The idea that this was a general benefit across all participants to the same degree was invented by, among others, Paul Samuelson in his Economics text, 1948, p 36, and in theories of General Equilibrium.
The author quoted a few lines from paragraph 9 and missed the particular and limited meaning Smith gave to it, as well as ignored the previous 8 paragraphs in which Smith makes clear his meaning. Metaphors express "in a more striking and interesting manner" their "objects" (see Adam Smith's own "Lectures in Rhetoric and Belles Lettres" [1763] 1983, p 29.”

I should have added that market prices are not invisible – it evident that they are very visible – and the metaphor cannot therefore refer to a “theory of markets”. The relative insecurity of market participants is invisible, which, on this occasion, is the object of the metaphor.

General Equilibrium and the Myth of Invisible Hand

‘endeavour15’ writes on Article Field.com:
Properties of a Competitive General Equilibrium HERE

‘These conditions are obviously an idealized situation. But were such an economy to exist, it would be one in which Adam Smith’s invisible hand could rule without any impediment from externalities or imperfect competition.
 For this economy, we can describe consumer behavior and producer behavior and then show how they dovetail to produce an overall equilibrium. First, consumers will allocate their incomes across different goods in order to maximize their satisfactions. They choose goods such that the marginal utilities per dollar of expenditure are equal for the last unit of each commodity.’

Comment
The original source of this connection between Adam Smith’s use of the invisible hand metaphor and general equilibrium was Paul Samuelson in his popular text, ‘Economics: and Introductory Analysis’, McGraw-Hill, 1948 (19th edition, 2010).

The connection had absolutely no basis in anything written by Adam Smith (see Kennedy, G. 2010. ‘Paul Samuelson and the Invention of the Modern Economics of the Invisible hand’, Journal of the History of Ideas, forthcoming, December, 2010).

The metaphor had nothing to do with perfect competition, or anything like it. Smith used the metaphor once only in Wealth Of Nations and once only in Moral Sentiments, and in neither case, it had nothing to do with markets.

‘Rich landlords’ in pre-commercial society fed their serfs and retainers from the produce of their fields because they had no choice – starving peasants could not work the landlords’ land; some, but not all traders preferred to use their capital domestically in 18th-century Great Britain which was riddled with the mercantile competitive restrictions of and direct prohibitions on we now call ‘mercantilism’ (chartered monopolies in every town, tariffs and direct prohibitions on imports, restrictions on the mobility of labour, prohibitions on settlement outside the parish in which labour was born, prohibitions on engaging in trades without serving 7-year apprenticeships, and the Navigation Acts monopolising British foreign trade), none of which are remotely competitive, let alone ‘perfectly so).

For General Equilibrium to operate in maths, it cannot operate in real world. There is no ‘invisible hand’; Adam Smith used is as a metaphor for ‘necessity’ and ‘risk aversion’.

The Dead-End of General Equilibrium in Practice

Dr Madsen Pirie of the Adam Smith Institute writes Here
which is part of his series on “Philosophical Observations on Economics.”:

“There is no equilibrium position in economic activity”

“Economists used to talk, and some still do, of the equilibrium position at which supply meets demand. Demand generally decreases as price rises, while more suppliers will tend to enter the market as prices rise. The equilibrium price is supposed to the price at which the supply exactly matches the demand. People use this (and other) 'equilibrium' notions to derive equations which aim to describe how an economy behaves.

The problem is that equilibria are entirely theoretical abstractions and do not occur in real economies. The real economy is characterized by motion. There never is a point at which supply meets demand. Demand changes from moment to moment, and so does supply. There are countless economic actions taking place every moment as potential consumers change their positions on whether they are in the market for particular items, and potential producers decide whether or not to put more produce on sale. Even further back, producers are deciding whether to commit resources now to augment production in a few months time, in anticipation of what demand might be.”

[Follow the link for the rest of the article]

To which I offered a comment:

“Congratulations, Dr Pirie. You have observed reality and not accepted that we can model it accurately with equations seeking to 'prove' equilibrium in markets. Beyond first year economics, equilibrium notions are misleading. The pursuit of scientific credentials from the 1870s - while rooting them by assertion in ancestral Smithian economics - has led to illusions of predictability and imaginary theorems, more poetic than real.

Smith never made predictions (except that the former colonies in North America would become the most powerful economy in the world by the 1870s) because given the multiple distortions and wrong-headed mercantile political economy myths in his day he knew enough about human interactions to know how easy it was to be wrong about the present.”

[Disclosure: I am a Fellow of the Adam Smith Society.]

Markets and Panglossian Invisible Hands

Scott Cooney, author of Build a Green Small Business: Profitable Ways to Become an Ecopreneur (McGraw-Hill) writes a slanted piece in Triple Pundit (‘people, planet, profit’) HERE: “Paul Hawken on the State of the Markets”:

“To those that argue the efficient market hypothesis, based on Adam Smith’s theory that the ‘invisible hand’ of the markets will right our course and get us on a path to clean energy, Hawken responded that not only has this not occurred, but that the theories of the free market are even arguable at best. “Markets prove most of the people wrong, most of the time,” he said. Otherwise, they wouldn’t function. It’s a bit like Vegas.”

Comment
Scott’s article primarily is about environmental change, of which I have no comment, and while I have no particular sympathy with the “efficient market hypothesis”, or the rest of the apparatus of the omaginary mathematical markets without humans – a successor to the imaginary market beliefs of something vague called “Providence” inhabited by invisible gods and other superstitions – I am fairly certain, as I can be, that Adam Smith had little to do with any of them.

He certainly did not associate the invisible-hand metaphor with “markets”.

By observation, people make mistakes. Some people are sometimes “wrong” – have to be, otherwise how would a market work if everybody made the “right” decision, perfectly adjusting their efforts with infinite velocity to ever changing signal?

Adam Smith recognized these actualities in noting that ‘projectors’ who make mistakes and lose their capital (or anybody else’s) are in the same unproductive role of the prodigals. Losers of their capital do not reproduce their costs plus a profit, that is, they are unproductive.

Paul Hawken makes his case against markets by misquoting Adam Smith and attributing to him views out of context, which he did not hold. Paul believes certain of Smith's epigones, who justify their fantasy world of mythical general equilibrium outside of any known society of human beings, by trying to give their fantasies authority by linking them to the wholly innocent Adam Smith. They might as well call in Dr Pangloss for support.

[Apologies for not supplying references here, but my Adam Smith library (Glasgow edition of the Works and Correspondence of Adam Smith, Oxford University Press) is in another place - temporarily].

Excellent Writing But Still Mythical

Atanu Dey writes a highly readable and lively piece on “Why education matters” HERE

“I am sure that there is no secret cabal of powerful people with evil glints in their eyes plotting to keep Indians illiterate. But individual behavior motivated by private incentives - micro behavior - have consequences at the social level - macro outcomes - that are not intended by individuals. The most famous example of this is Adam Smith's "invisible hand" - the market mechanism that grinds out the socially beneficial outcome even though an individual is only interested in his or her own welfare. So also, there could be what we can call the "invisible fist" of the government which can pummel the life out of a society even though no single government official is doing anything more than making his or her life comfortable.”

Comment
Atanu Dey writes well and complains that 33 per cent of Indian adults are illiterate. An alarming statistic for any country and doubly so for the world’s largest democracy.

His clever construction of the possible reason why government action fails to address the illiteracy problem by drawing a parallel with the invented notion of an “invisible hand” in the economy, wrongly attributed to Adam Smith by modern economists is well stated. But good writing is still vulnerable to the evidence.

Because Adam Smith didn’t write anything about the “invisible hand” being a “market mechanism” that “grinds out the socially beneficial outcome even though an individual is only interested in his or her own welfare” - see numerous posts in Lost Legacy that expose this myth – it was at root a myth created by well-meaning modern economists as part of anti-Soviet planning propaganda during the Cold War (and over enthusiastic mathematicians carried away with their 'proof' of general equilibrium applying to the real world).

Their motives were laudable – Stalin’s Soviet planning was backed by repressive civil violence and threatened to cause World War III (and IV and V, etc.,). But by their apparent endorsement of unrestrained behaviours their own unintended consequences created a mythical monster that self-interest, elided by epigones in selfishness, worked out, Panglossian-like, for the “best of all possible worlds”, covering over a plethora of externalities that damaged the interests of the rest of society (pollution, environmental destruction, monopoly pricing, protectionism, and local wars arising from them.

By associating Adam Smith with the invented myths, they traduced his reputation too. Most economists actually believe that Smith was the author of the myth. He wasn’t.

Yet many climb on the bandwagon that the current recession ‘exposes’ the ‘failures’ of following Adam Smith’s policies, in particular ‘laissez-faire’ (which he never supported – nor mentioned even once), ‘lack of regulation’ (when in fact he specifically advocated the exact opposite where it came to bank policies “which might endanger the whole security of the society”; see WN II.ii.94: 324) and the mythical “invisible hand”, mere metaphor for an entirely different set of circumstances).

Spare Us From the Invisible Hand

Patrick Kilbride writes in Chamber Post HERE:

“Free People, Free Minds, Free Markets”

‘In the 18th-century, Adam Smith left us with the indelible image of markets producing desirable social outcomes through the work of an "invisible hand." ’

Comment
In an otherwise neat argument for both liberty and free markets, Patrick Kilbride spoils his case with modern nonsense about Adam Smith and his use of the metaphor of “an invisible hand”.

Smith did not use the metaphor when explaining either how markets work generally (Books I and II, Wealth Of Nations) or how some, but not all, merchant traders preferred to invest locally following their concerns about the higher risks of investing abroad or in shipping (Book IV.ii, Wealth Of Nations).

In fact, a close reading of the only place in Wealth Of Nations where he used the metaphor of an invisible hand, shows that he first explains in detail the circumstances leading some, but not all, merchant traders to behave as they did (paragraphs 1 to 8, chapter 2, Book IV), and only then deploys the metaphor for the consequences of their specific behaviour (“intending their own security”), conforming to the arithmetic rule that the whole (the national annual output of wealth, including local employment) is the sum of its parts – the more merchant traders who are risk averse, despite the high profits from foreign and colonial trade, the greater the total annual wealth, including domestic employment.

Modern economists have invented a whole new meaning to Smith’s singular use of the metaphor, giving it the characteristics of a “law” of markets, though it was never stated as such by Adam Smith.

The modern invented meaning is commonly taught in first year economics courses and textbooks, and such is the effect of it on modern economists, it is extremely difficult to dislodge it – they seldom actually read Wealth Of Nations or even the relevant paragraphs (1 thru 8) and, by relying on a truncated extract from paragraph 9 only, they remain solidly convinced that Adam Smith explicitly stated what their tutors told them he wrote.

This gives succour to hostile critics of markets who throw the “invisible hand” back at them (“invisible fist” or, as seen recently, “invisible middle finger”, and such like). But there is no actual “invisible hand”, it does not exist and never did. The metaphor is just that, a metaphor, and one that was popular in literature, sermons, and poems in the 17th and 18th centuries – I have a list of 59 examples of its uses, besides Smith’s.

Mathematicians called it into being when “proving” that general equilibrium in an imaginary market, loaded with assumptions that removed all semblances of real world economies, was a theoretical possibility (Debreu, Arrow). Others (Samuelson, Freidman) and among them propagandists against Soviet communist planning, used the metaphor to good effect – Stalin needed the gulags to enforce planning, but free markets had an “invisible hand” that did its work without menace.

Editors of Time, Newsweek, Wall Street Journal, Financial Times and assorted media journalists loved the “invisible hand”, Nobel Prize winners sang it praises, and the epigones believed in its miraculous powers with the passionate certainties of Jihadists.

Worse, the invisible hand became an alibi of last resort, flaunted all round as if it existed. When it “failed”, the invisible hand was dumped among wails and the gnashing of teeth in wholesale “confessionals” (Alan Greenspan).

Markets suddenly became naked – they always were naked, but the veil of the invisible hand obscured their nakedness. It never was the answer to everything that could go awry in the normal condition of disequilibrium in all economies, much of it excited to crises by public policy interventions by legislators and those who influenced them.

Smith was right about them and the damage they could inflict – fortunately “there is a lot of ruin” in an economy, as he might have put it in another context...

A Good Book Ruined by Misunderstanding Adam Smith

Richard Bronk, 1998, Progress and the Invisible Hand, London, Little, Brown and Company:

“For the ‘invisible hand’ of the market is seen to lead to the most efficient satisfaction of the wants of different market participants, and in this sense to maximise the social good, merely by harnessing the selfish desires of individuals to further their own ends.” (p 7)

“The invisible hand is a metaphor for the free market’s ability to spontaneously to reconcile and balance the requirements of competing individuals pursuing their own self-interest is such a way that self-interested behaviour can unintentionally promote the interests of society as a whole.” ( p 92)

“In the years that followed publication of The Wealth Of Nations, the conditions which Smith had stipulated (in particular, the need for perfect competition) – and the implicit moral context which he, as an Enlightenment moral philosopher, which he had assumed – were not as well remembered as his central message of the power of the invisible hand. It was this image which entered Western consciousness and helped to underpin faith in human progress.” (p 95)

“In this limited-efficiency sense, modern economists have succeeded in proving Adam Smith’s first intuition with regard to the invisible hand, that a perfectly free market can ensure that the pursuit of individual self-interest or preference satisfaction, as expressed through the market-exchange mechanism, will increase the benefits of society taken as a whole.” (p 107)

Comment
The above quotations are representative of how Smith’s use of the metaphor on “an invisible hand” has elided from its original use by Smith from a summation in a “striking manner” – which is the role of metaphors – in a case where merchant traders choose between exporting their capital abroad and investing in their locality from considering the risks of each choice and their relative profitability (wholly explained in Book IV of Wealth Of Nations, chapter2, paragraphs 1-9: 456), into a general principle of how markets operate, how supply and demand sets prices, and how society benefits from competition (incidentally covered in Books I and II without any mention of "invisible hands"!)

Richard Bronk pays no attention whatsoever to the stark difference between Adam Smith’s use of the popular, 18th-century metaphor and how modern economists, roughly from the 1940s, transformed its role (from metaphor into a 'concept', a 'principle', and a 'theory') and generalised its effects into general equilibrium theory, both verbal as a 'miracle of markets' and as a mathematical "proof" of the miracle. One consequence of Bronk’s ahistorical treatment of Smith’s role in the transformation, is that he attributes to Smith modern ideas of which he was wholly innocent.

Smith favoured competitive markets over monopolies (he was not opposed to state intervention on principle, where the role was to protect the consumer, e.g., banking regulation; quality of bullion; quality of cloths, and such like). He knew nothing about "perfect competition" - an idea from the inter-war years - and regarded "harmony" as a goal, not a destimation.

Bronk writes “In the years that followed publication of The Wealth Of Nations” - first edition 1776, Smith’s last edition 1790. Even taking the last edition date, practically no interest was taken in Smith’s use of the metaphor at all. Dugald Stewart mentioned the paragraph from Book IV, in a footnote to his Lectures in Political Economy, in 1808 (later re-published in his Collected Works, 9 volumes, 1856), but hardly anybody mentioned the metaphor again until a few mentions in the late 19th century - Malthus, Ricardo, Marx for example, did not focus on it.

For Bronk to assert that Smith’s other ideas “were not as well remembered as his central message of the power of the invisible hand” is breathtaking in its “ahistorical” hyperbole. Practically nothing was said about the “invisible hand”, even in the 1880s, compared to Smith’s alleged views on laissez-faire, his “ alleged labour theory of value”, and his polemics against “tarrifs”, “mercantile political economy”, and his alleged “small government” policies.

Much of this attention dominated accounts of Smith’s economics through to the early 1930s, when the Chicago, oral tradition began to take an interest in the “invisible hand” by applying its mystical powers from risk-averse merchants to markets as a whole (remember that the challenge, such as it was, in the Great Depression began to circulate from a critique of markets compared to the “new”, albeit doomed, central planning in Communist Russia), and, from the late 1940s, the invisible hand, partly transformed into a theory, emerged in print, most famously in Paul Samuelson’s textbook, Economics, (1st edition 1948; still going strong in its 18th edition). The depression was over, but the Cold War was on.

The new, invented invisible hand, began to appear in all textbooks, and slowly at first, then in torrents in journal articles, across the media, into the rhetoric of politicians and "experts", and lastly among the general public.

Bronk wrote post the mathematical “proof” of general equilibrium (Debreu and Arrow) and, from then on, the modern invented role of “invisible hands” has never looked back. Bronk blames the modern “invisible hand”, repeatedly misattributed to Adam Smith, for its “sins, as modern economics popularises it among governments in their trenchant beliefs in unlimited progress.

His book was written as the 1999s were recovering from the 1997-98 recessions (it reads quite up-to-date in the current recession of 2007-09!). I am surprised a new, revised, edition has not been published. If it were, I bet it would not add anything about the causes of the current crisis, nor change anything about the statements attributed to Adam Smith’s culpability in failures of modern macro-management. Indeed, Bronk could quote from similar tales in support of his own that have appeared almost daily in the media, and on many Blogs, blaming the “invisible hand” for its inadequacies as a positive force.

I have no complaints about Bronk’s criticism of modern economic management (or lack of it) – in fact, I enjoyed quite a lot of his analyses (he is good, clear writer). If he disassociated Adam Smith from the modern myth of the “invisible hand”, I would have much to say in Bronk’s favour.

Research Project to Challenge Modern Economists on Their Invisible Hand Explanations

I returned to more serious research today for my larger project on the invisible hand. This work has gone slowly up to now because, as I have mentioned, I am waiting for Warren Samuel’s paper to be published (now set for later this year in a collection edited by Jeffrey Young and is to be published by Cambridge University Press). I considered it prudent not to go too far ahead in case Warren’s promising treatment made my own redundant, or, in the unlikely event that Warren was off target in some fundamental way, my own paper may have required considerable re-work.

Research develops its own pace, sometimes like walking through treacle into dead-ends, tinged with boredom, and at other times flies along under an exciting momentum from the pieces falling into place, opening new insights, re-constructed ideas, and closing the gaps in understanding.

Having dealt with Adam Smith’s meaning of “an invisible hand” in two papers for the Econ Journal Watch (May and September), I am now working more intensely on phase 2, so to speak, (and have been since 2008) which analyses how and why the invisible hand metaphor was taken up, mainly in the middle decades of the 20th century, by modern economists, in part to make an ideological case for markets (sometimes tinged with theological claims and assertions) over the challenges from both creeping state capitalism and Soviet-style central planning. The other part, included genuine enthusiasm among economists from the 30s to the 70s from their pursuing lines of research into general equilibrium theory.

The problem, which I have been focussed on since my preliminary work from 2003, for my book, Adam Smith’s Lost Legacy (2005), is why modern main-stream economists embedded their theories of “invisible hand” in capitalist markets and, simultaneously, attributed to Adam Smith the role of progenitor of their work.

I have been unable to read into Smith’s works anything remotely like these modern attributions – the fact that they do not qualify for such roles on the basis of what he wrote remains, for me, in stark contrast to what senior colleagues in the discipline claim to have found.

This next project is my attempt to answer this dichotomy from what distinguished economists assert they have read in Moral Sentiments and Wealth Of Nations (and his essay on the History of Astronomy) by coming at the problem from the other direction:

What exactly do modern economists claim for their “invisible hand”, where did these views originate (Chicago, MIT, LSE, and so on, and what evidence is there for such a role in their models of modern economies (general equilibrium, growth theories, welfare economics, business cycles, and recent history)?

I shall report from the research front occasionally on Lost Legacy and share my progress with readers.