Welcome Surprise: Noam Chomsky Understands the IH Metaphor

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Noam Chomsky addresses an Occupy Washington Meeting (3 November) reported HERE

“Without going on with details, what’s being played out for the last 30 years is actually a kind of a nightmare that was anticipated by the classical economists. If you take an Adam Smith, and bother to read Wealth of Nations, you see that he considered the possibility that the merchants and manufacturers in England might decide to do their business abroad, invest abroad and import from abroad. He said they would profit but England would be harmed. He went on to say that the merchants and manufacturers would prefer to operate in their own country, what’s sometimes called a “home bias.” So, as if by an invisible hand, England would be saved the ravage of what’s called “neoliberal globalization.”

That’s a pretty hard passage to miss. In his classic Wealth of Nations, that’s the only occurrence of the phrase “invisible hand.” Maybe England would be saved from neoliberal globalization by an invisible hand. The other great classical economist David Ricardo recognized the same thing and hoped it wouldn’t happen. Kind of a sentimental hope. It didn’t happen for a long time, but it’s happening now. Over the last 30 years that’s exactly what’s underway. For the general population -- the 99 percent in the imagery of the Occupy movement --it’s really harsh and it could get worse. This could be a period of irreversible decline. For the 1 percent, or furthermore 1/10th of 1 percent, it’s just fine. They’re at the top, richer and more powerful than ever in controlling the political system and disregarding the public, and if it can continue, then sure why not? This is just what Smith and Ricardo warned about.”

Comment
I am pleased – and surprised – to say that Noam Chomsky has got Adam Smith’s use of the invisible hand metaphor right (almost). From merely repeating the modern invention of the myth of the “invisible hand”, as attributed to Adam Smith by modern economists, following Paul Samuelson (1948) and an oral tradition among some economists (A.C. Pigou) at Cambridge University, UK, and, a later, George Stigler, et la, Chicago (USA), namely that Adam Smith supposedly said that selfish motives led to the public good and equilibrium (he didn’t), Chomsky has correctly identified that Smith supposed that “the merchants and manufacturers in England might decide to do their business abroad” (many of them did).

This is a mighty step forwards in re-discovering Adam Smith’s legacy and I congratulate Noam Chomsky for so doing. It is based on Chomsky actually reading of what Adam Smith wrote in Book IV, Chapter 2, paragraphs 1-9 of Wealth Of Nations, and not just a couple of sentences in paragraph 9, as Lost Legacy has been banging on about (almost to little avail) each week since 2005.

Yes, I know I have been criticising Chomsky on this issue since 2009 – as recently as a month or so back this year – but scholars must adhere to the code that when someone gets it right, instead of like the majority persistently getting it wrong, their correction must be acknowledged among the Republic of Letters (and conversely, errors that come to light must be owned up to at the earliest opportunity).

Smith’s use of the IH metaphor was not a new theory, a new concept, or a new paradigm, nor a discovery of the ‘hand of God’. It was not a game changer, as they say today. It was the statement of a notable fact of life. In re-stating what he did say, I shall make an important non-pedantic adjustment to Chomsky’s initial statement:

“he considered the possibility that the merchants and manufacturers in England might decide to do their business abroad, invest abroad and import from abroad.”

That merchants and manufacturers “might consider the possibility” of investing abroad, with the consequences that Chomsky noted, was already happening among them since the 14th century, when exports abroad were already significant. Britain is an island and exports and imports were a necessary consequence of its stirring towards commercial society, initially in the form of ‘exports’ and ‘imports’ within the national region (the Age of Commerce cannot develop and remain in an isolated village). Commerce spread out, notably, said Smith, near shippable rivers and the coast, to other regions and, eventually, to foreign coasts (also to move to troops in Europe for incessant wars and pilgrims).

The Fall of Rome (5th century) disrupted the first spread of the Age of Commerce in the Mediterranean and Western Europe, which was disrupted by the barbarian invasions of vast lands left undefended by Rome’s collapse, said Smith. In the revival from the 14th century, commerce re-appeared. Bulk shipping had not been dis-invented; it was revived with bulk cargoes to match (wool from England for ‘luxuries’, gold, etc. from Europe).

Smith’s point was about some, but not all, merchants considering exporting capital of foreign countries and the colonies in America who were put off by the risks implicit and actual in the “foreign trade of consumption” (of course, many weren’t). Among these risks are those associated with commercial trust in dealings with distant traders in foreign countries, also a real problem when trading locally, but a relatively lesser problem in the home-trade with traders he could meet, with known reputations, and proven creditworthiness.

“he can know better the character and situation of the persons whom he trusts, and if he should happen to be deceived, he knows better the laws of the country from which he must seek redress” (WN IV.ii.6: 454).

Smith use of the IH metaphor referred to specific domestic and manufacturers” who were risk averse sufficient to prefer to invest in the “domestick industry” (identified twice) and Smith makes it clear that in so doing he prefers “domestick to that of foreign industry”. This introduced his use of the IH metaphor: “led by an invisible hand to promote and end which was no part of his intention.” (WN IV.ii.9: 456). In short, the ‘invisible hand” was a metaphor for the insecurity of their capital, which by investing locally in “domestick industry” instead, they added to “domestick revenue and employment” (i.e., the whole is the sum of its parts; so every capital invested locally adds to what we now call GDP). [Note: there was no "as if by an invisible hand" mentioned by Smith.]

This was the “public” benefit because domestic revenue adds to growth, while more employment benefits the labouring, jobless, poor. It had nothing to do with the mathematics of welfare, general equilibrium; it was simple arithmetic, Nobel prizes not withstanding.

In sum, with my short qualification, I welcome Noam Chomsky’s step away from merely repeating the modern myths of the IH metaphor. I hope his audience did too.

[Note: I make no comments about the rest of his piece about the ‘Occupation’ of public spaces for peaceful demonstrations of legitimate viewpoints.]

The Unintentional Misleading Consequences of Part Quotations

Robin Amlot, Managing Editor of “CPI” writes on “Unintended consequences” (HERE):

“I did some reading up on unintended consequences as a result of a newspaper story I read the other day. The concept was popularised in the last century by the sociologist Robert Merton in a paper he wrote in 1936 but it actually goes back to our dear old economic chum Adam Smith. Mind you, he mostly focused on the positive aspect with his ‘invisible hand’. Smith maintained that each individual, seeking only his own gain, “is led by an invisible hand to promote an end which was no part of his intention,” that end being the public interest. “It is not from the benevolence of the butcher, or the baker, that we expect our dinner,” Smith wrote, “but from regard to their own self interest.”

“Sadly it is usually more common for the law of unintended consequences to highlight a negative or perverse impact of legislation and/or regulation.”

Comment
“Yes, but”. As we often say to students, who do not quite get a concept correctly. Regretfully on this occasion we must say it to Robin Amlot. He has taken part of a sentence written by Adam Smith in a specific context over nine paragraphs and generalised it almost into a theorem, which was not part of Smith’s intention (thus, at once and, ironically, demonstrating “unintended consequences).

In this specific instance, Adam Smith was discussing the behaviour of some, but certainly not all, merchants, in a particular, but certainly not, all contexts where physically they invested their capital. In this specific case, he referred to those merchants who preferred to invest locally in the British economy rather than send their capital abroad to Europe (or to the British colonies in North America) because of their felt insecurity (risks to) their capital compared to less risky investments in their locality – where they knew the probity of the people with whom they were dealing, and the legal system that they operated within. They preferred, he noted, to keep their capital within their sight, rather than see it it disappear over the horizon.

But by investing locally they added to “domestick industry” and this added to “annual revenue and employment”, which he regarded as a positive benefit. However, and of course, some British merchants were major players in foreign trade – they had less “risk aversion”, as we say today.

The validity of his proposition about these merchants who acted because of their relative insecurity was purely arithmetical – the whole is the sum of its parts. It was not a general theorem. The metaphor of “led by an invisible hand” expressed the behaviour of some merchants and its consequences in “a more striking and interesting manner”, as metaphors are used in English literature and grammar. Indeed, this is precisely what Adam Smith taught his students from 1748 (his Edinburgh public lectures) and from 1751-64 (his Glasgow University Lectures) and we know this because student notes of his “Lectures On Rhetoric and Belles Lettres” in 1763 were found in 1955 and published in 1983 by Oxford University Press (see p29).

The “end” unintended outcome of all the behaviours of merchants is not necessarily always benign, which is precisely what Smith taught and wrote extensively in his polemics against mercantile political economy. Their lobbying by “domestick industry” for tariff protections and outright prohibitions of large numbers of foreign imports were anything but benign, as far as the interests of consumers were concerned (see Book IV of Wealth Of Nations), and constituted what he described as his “very violent attack” on the commercial system of Britain.

Hence, to generalise to all merchants his specific remarks about a small set of specific merchants as unintentionally being in “the public interest” is misleading.

Robin Amlot is not responsible for the near universal ascription of Smith’s supposed assertion that actions by all players in the economy (often presented as applying even when their motives are “selfish”) are unintentionally beneficial is quite wrong. Yes, there are unintentional consequences, many of which can be beneficial and many of which can be non-beneficial (pollution, harmful, and etc.,).

Robin Amlot also slips in another part quotation that may also be misleading: “It is not from the benevolence of the butcher, or the baker, that we expect our dinner,” Smith wrote, “but from regard to their own self interest.” This is from Book I, chapter ii, page 27 of Wealth Of Nations and is part of Smith’s discussion of bargaining, which, of course, mostly is benign but need not always be so (drug dealers). It is part of his recommendation when bargaining with suppliers that the aspirant purchasers “address” the seller’s interests and not just their own (we can serve ourselves by serving the interests of others (as addressed in Smith's other work, The Theory of Moral Sentiments). Barganing has no connection to his use of the metaphor of “an invisible hand” in Book IV and while Robin does not make that connection explicit, he could not if he tried. But his emphasis of selected parts of quotations can be misleading to an author and his readers.

"Absent Clockmaker"?

A. R. Samson writes in Business World On Line HERE:

‘Fruit salad’

‘Economists like to correlate different sets of variables to come to a conclusion like when interest rates rise, inflation is expected to go down as a result. But it is important to group variables that are common and therefore do not taint the conclusion. For instance, a connection can be made between the schedule of a boxing match of the nation’s favorite sports icon leading to light traffic, lower mass attendance, and a drop in crime rate.
…
Another example of this fruity fallacy is the expectation that when there is an increase in money supply, the economically illiterate checks his savings passbook to wonder why his cash balances remain the same. Confusing macroeconomics with personal finance is yet another case of mixing apples and oranges.
Except if you count them both as fruits, apples and oranges are not supposed to be lumped together as if they are identical. Unrelated statistics being wrongly used together constitute the fallacy of mixing apples and oranges.

But like the economic ideas they usually illustrate, our two fruits seem to have dominated the metaphor for irrelevance. Economists do not easily switch imageries. Why is the "invisible hand" (driven by greed and selfishness with no regard for the common good) used as the image for a free market which is unfettered by regulations save supply and demand and perfect information? Why not use the philosopher’s favorite image of the "absent clockmaker" to represent the sometimes chaotic functioning of the universe as if no one is in charge?’

Comment
The short answer is that the misleading belief in ‘an invisible hand’, wrongly attributed to Adam Smith, is an invention, a myth, now endemic among many practicing modern economists, and, sadly, confirmed by some historians of economic thought who should know better (I’ve tried my best to refer them to Adam Smith’s texts, but, I suppose the attractive pull of their own modern agenda for what makes markets work is too much to forego).

What Some Academics Debate About

Luigino Bruni posts on an international web board, Societies for the History of Economics (SHOE), to which many academics interested in the subject (broadly defined) are readers and occasional contributors.

Presently, one subject is a discussion of a member’s question: when it was first asserted that “Adam Smith, was the ‘Founding Father’ of Modern Economics?”

A recent contributor, somewhat annoyed at the tone of the many erudite contributions, mainly quoting from early textbooks that may answer the question (a bit like a trip down memory lane for me), posted his viewpoint, which for obvious reasons to readers of Lost Legacy attracted my attention.

“Smith's idea of invisible hand (mentioned more than once) is actually very central in both his theory of market (wealth of nations) and in his theory of human sentiments and social behaviour: the invisible hand mechanism is one of the most powerful idea in modern social sciences”.

Comment
This contribution among (serious) contributions from historians of economic thought is quite out of step with the historical facts as they apply to Adam Smith, and as regularly documented here on Lost Legacy.

I have kept out of this debate for some weeks since it started because opinions of when, or indeed, whether, Adam Smith was the ‘founder’ of economics is not of great interest to the central theme of Lost Legacy.

It tends to be asserted as part of modern assertions that Adam Smith promoted laissez-faire capitalism and other notions that are more ideological than scholarly.

There are occasional squabbles too over rival claims to this accolade involving Richard Cantilon (1735) or Turgot (1755), or David Ricardo (1817), and even to James Steuart (1767).

Luigino Bruni has widened the argument with entirely dubious propositions about Adam Smith’s use of he metaphor of ‘an invisible hand’ that in their modern form date from the late 1940s (Paul Samuelson and Oscar Lange) and the welfare economists in tandem with the creators of general equilibrium theories in the 1960s (Arrow, Debreu), and in a strange way, with Mises, Hayek and Libertarians too (see contribution from Daniel Klein, most recently in the `March issue of The Journal of Economic Affairs).

If these modern theorists hold views about their meaning of the ‘invisible hand’, in my opinion, it is a perfectly legitimate that they express them, but once they start ascribing their own meanings to Adam Smith, they are up against the historical facts. This may be the case of Luigino Bruni is declamation (unless in the unlikely case that it is a provocation by a troll, of which I am always suspicious of in web disputes).

The Adam Smith, born in Kirkcaldy in 1723, is among the most misquoted and misattributed authors in this modern age.

The Importance of Context in Wealth Of Nations

From Ray Love's earlier comments:

‘So, it seems that Dr. Stiglitz 'does' consider the invisible hand metaphor to imply that by "free markets", and by, the "pursuit of profits, [firms] are led, as if by an invisible hand, to do what is best for the world". In other words, you are using a quote from his writing out of context to align his position with your own. There is a subtle deceit involved here because the title suggests ('Stiglitz is Right') that Stiglitz is endorsing your position on what A. Smith meant by the 'invisible hand'... when, Dr. Stiglitz is suggesting nothing of the sort. Then you repeatedly distance yourself from his other views as if this distancing validates the quote taken out of context. Please explain.’

My Response.

Apologies. I missed this contentious paragraph from Ray Love when replying to the substantive Issues in dispute, which I hope I answered in full.

However, having missed replying to what is described as a ‘subtle deceit’, I would not want to leave it on the record unanswered and want to set the record straight.

My response to Stiglitz, which set this hare running, was not, and never could be presented as my claim that he had ‘endorsed’ my ‘position on what A. Smith meant by the 'invisible hand'.

For a start, I have never claimed anybody has ‘endorsed my position’ of Adam Smith’s meaning of the metaphor of an invisible hand. I am not happy to be in a minority of one (or at most a few) on this issue – but such is one of the burdens of my dissenting scholarship that, in main, I am ignored (and being retired, albeit it emeritus, I am happy to have the friendship and respect of a select number worthy scholars).

I am, however, content to have arrived at my position on what Smith meant on this subject from my a close reading of his published work over many years, including:

a) his three references to the invisible hand, which includes the associated texts (and from which reading, I detect in some, but by no means all, of my critics an apparent deficiency in this respect);

b) further close reading of Smith’s own teachings on the role of metaphors in his Lectures on Rhetoric and Belles Lettres ([1762] 1983), to which none of the my critics over a number of years have, so far, mentioned in their challenges to my interpretation, suggesting their less than authoritative assertion about what Adam Smith meant (The Oxford 1983 ‘Lectures’ are available at low cost from Liberty Fund).

To clear up the suggestion of my alleged ‘deceit’ in asserting that Stiglitz was ‘right’ when he said that the ‘invisible hand is not there’ which, it is claimed, is regarded by me as an ‘endorsement’ of my position.

I should point out that by drawing attention to Professor Stiglitz’s statement it was my endorsement of his latest stated position and not my claim for his endorsement of my position, as I have made clear in the second edition of my ‘Adam Smith: a moral philosopher and his political economy’, 2010, Palgrave, in which I quote from his earlier claims for the existence of ‘an invisible hand’, and further describe (cheeky!) his latest view as ‘his recantation’ of them.

But there is no deceit. Blog posts are necessarily more instant in composition than carefully revised scholarly and refereed papers. If my endorsement of Stiglitz’s statement is considered an endorsement of my position then that is an unwarranted assertion.

In my paper, ‘Paul Samuelson and the Origins of the Modern Myth of the Invisible Hand’, (in press) I detail his original statements (‘Economics: an introductory analysis, 1948), which started these hares running, and I follow his revisions through the 1960s-00s in 18 subsequent editions (perfect competition, welfare theorems, prisoner’s dilemma, general equilibrium) which derivatives, incidentally, are close to those of Stiglitz’s presentations over the years.

Hence, let me state that I am more than aware of Stiglitz’s earlier work on the invisible hand and that my endorsement of his singular statement (which cannot be an endorsement of my views – he is still stuck in neoclassical-theory land where I am not, and neither was Adam Smith). I am solely concerned with what Adam Smith meant when he used a metaphor (of which his works contain more than a few).

Lastly, Ray writes:

‘I am also curious about how you get around the obvious fact that the very paragraph containing the invisible hand metaphor begins with, and repeats, the term: "every individual". Which, you argue, actually means: "some" ("traders", "merchants") in a variety of ways? There is not a 'way' though, to transform the word 'every'... to mean 'some'.

Let’s read Smith’s text:

The paragraph (9: 455) actually begins with ‘But the annual revenue of every society’, but the contextual theme starts in paragraph 6 (454-5) with:

‘but a capital employed in the home-trade, it has already been shown, necessarily puts into motion a greater quantity of domestic industry, and it gives revenue and employment to a greater number of inhabitants of that country, than an equal capital employed in the foreign trade of consumption… Upon equal, or only nearly equal profits, therefore, every individual naturally inclines to employ, his capital in the manner in which it is likely to afford the greatest support to domestic industry and to give revenue and employment to the greatest number of people in his own country.’

‘7. Secondly, every individual who employs his capital in the support of domestick industry, necessarily endeavours to direct that industry, that its produce may be of the greatest value.’

Therefore, it should be clear that Smith in paragraph 9 refers to ‘every individual’ who engaged in domestick investment, but clearly not to those who engaged in foreign investment because domestick investment did more for domestick revenue and employment than ‘an equal capital employed in the foreign trade of consumption’.

So, contrary to Ray’s claim that ‘There is not a 'way' though, to transform the word 'every'... to mean 'some', we find there is a perfectly legitimate way from reading what Smith wrote. It’s called context, easily missed if read hurriedly and if already convinced that Smith was making a general statement for all the actions of all individual investors, domestic and foreign (and so, convenient for careless neoclassical readers).

Clearly, he wasn’t making such a generalization and this is supported by Smith’s general theme in Book IV of Wealth of Nations, specifically that ‘mercantile political economy’ with its fallacious emphasis on exports and colonies, backed by the Navigation Acts, policed by the Royal Navy and by colonial laws backed by force of arms against other European mercantile rivals, which for many decades had diverted scarce capital from Britain and cost scarce capital in military provisions (two wars), undermined domestic capital formation and lowered domestic annual output and employment.

He regarded the consequent distortion of the natural process of opulence creation as a heavy drag on the spread of opulence, especially to the majority of the population. Hence, what he described as his ‘very violent attack’ on the entire commercial policy of Britain in Book IV. That is context.

All economists owe it to Adam Smith to read what he wrote and to question what their modern colleagues – and, perhaps, they themselves in all humility – have invented about him since the 1950s.

Invisible Hand: the debate continues

Ray (and Paul)

Stilitz’s statement that ‘"Adam Smith, the father of modern economics, is often cited as arguing for the "invisible hand" and free markets: firms, in the pursuit of profits, are led, as if by an invisible hand, to do what is best for the world’ only partly true but in fundamental error; the bit that is true is that Smith … ‘is often cited’ but as he never said anything about an ‘invisible hand’ and ‘free markets’, such citations are false.

Those who cite him in this manner are copying what some modern economist has repeated from the modern economist who originally invented a non-existent association between what Adam Smith actually wrote. How do we know this: because we can compare what Smith wrote on the three times (only) when he used a metaphor of an ‘invisible hand’ and search fruitlessly for any mention of ‘free markets’, or indeed ‘markets’.

In Astronomy ([1744-50s] 1795; posthumous) he mentioned ‘the invisible hand of Jupiter (a Roman god) which was not remotely related to markets.

In Moral Sentiments (1759) he referred to ‘an invisible hand’ leading a ‘rich landlord’ (dating it ‘when Providence first divided the land’), which unambiguously had nothing to do with ‘markets’ free or otherwise.

In Wealth Of Nations (1776) he referred to contemporary ‘merchants’ who preferred to invest locally and not abroad, which had nothing to do with markets’ free or otherwise. It was about a risk-averse investment decision in a highly uncompetitive mercantile system (tariffs, protection, prohibitions, Navigation Acts,, Settlement Acts, Combination Acts, Town Guilds, etc.) where the alternative was equally restricted European countries and British colonies, none of which could be described a ‘free’.

When he discussed markets – in great detail – (Books I and II – and III) he did not mention ‘an invisible hand’. He never linked his use of the metaphor to ‘free markets’ (nor to ‘perfect competition’). Stiglitz – and most neoclassical economists – are wrong and misinformed at best; deliberately misleading at worse – to keep repeating that Smith did what they claim about his use of the metaphor in relation to ‘free markets’.

Stiglitz is right strictly within the confines of his statement that ‘the invisible hand is not there’. That he previously made many statements endorsing the myth of an invisible hand, as understood by modern economists (since Samuelson, et al since the 1950s) is well known to me (I quote his ‘myth’-making regularly in debates) but I jumped on his well publicized one-liner that the ‘invisible hand does not exist’, because it went round the world without qualifications, in the media and this opened the debate.

Indeed, this week’s unprecedented (and welcome) long commentaries on my response to Stigitz’s frankness (for his own purposes, no doubt) is positive because stalwart believers in the myth of an invisible hand in markets have been prompted to object and, in consequence, read an informed Smithian criticism of the myth. In my mind that is a positive outcome.

What Did Adam Smith Mean by the Metaphor of an Invisible Hand ?

Clearly, when Smith says of a trader, that ‘By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention’, he refers only to those who prefer ‘domestic’ to ‘foreign industry’ in this example of his use of the metaphor of ‘an invisible hand’, the object of which (see his ‘Lectures in Rhetoric and Belles Lettres’ ([1762] 1983, p 29, he uses the metaphor for ‘his own security’.

In short, the metaphor, ‘led by an invisible hand’ expresses ‘in a more striking and interesting manner’ the trader’s felt ‘insecurity’ that leads him to invest locally. This is English, not rocket science.

I am sorry to disagree with David because Smith is most certainly ‘limiting his point to the preference, at almost equal profits, for domestic over foreign investments.’ Otherwise, he would not differentiate between those who felt insecure (home traders) from those who didn’t feel so insecure (foreign traders). In an earlier paragraph (no. 6, 454) he discusses the basis of the home trader’s insecurity:

‘In the home trade his capital is never so long out of his sight as it is in the foreign trade of consumption. He can know better the character and situation of the person’s whom he trusts, and if he should happen to be deceived, he knows better the laws of the country from which he must seek redress.’ (WN IV.ii.6:254).

Could Smith have written this clearer for economists? But he wrote mainly for a wider audience - legislators and those who influenced them. To assist his readers he re-expressed their being led by their insecurity by their being ‘led by an invisible hand’ because the metaphor expresses its object in a ‘more striking and interesting manner’, which is exactly what he taught his students and practiced as an accomplished rhetorician.

Interesting that David, who has read Wealth Of Nations, remembers the metaphor of an invisible hand’, but not Smith’s argument that leads up to it. Samuelson observed that economics graduates in the 1930s forgot most of their college economics but remembered the ‘invisible hand’ thirty years after graduating (Economics; an introductory analysis. 1948, p 36), which certainly shows the power of a good metaphor.

I would ask David to comment on Smith’s theory of metaphors and apply that to the first 9 paragraphs of Chapter 2, from which he so confidently asserts Smith’s intended meaning was different to mine.

I agree that Smith wrote ‘in this and many other cases’ where people were led (incidentally, never ‘as if by’) an invisible hand. But he never gave other examples in Wealth Of Nations, though he gave other examples of metaphors serving the exact same rhetorical purpose as is under discussion, wherever he felt he needed to reinforce a less clear object.

For example, when discussing the 'judicious operations of banking’, he referred in a ‘more striking and interesting manner’ by expressing how banks could ‘convert’ a ‘great part of its highways into good pastures and there by to increase very considerably the annual produce of its land and labour’, using, as he put it: ‘if I may be allowed so violent a metaphor, as a sort of wagon-way through the air’ (WN II.ii.86: p 321).

He also referred to the less secure basis of paper money, because paper, ‘as it were’ was ‘suspended on the Daedalian wings of paper money’ rather than ‘the solid ground of gold and silver’ (Ibid).

Smith’s reference to "It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest", which is often associated with the metaphor of an ‘invisible hand’ by some modern economists (not always making clear it is from Book I not Book IV and on a different subject) does not require a metaphor to enhance its meaning (though theological critics of markets are given to making assertions about it showing Smith’s ‘greed’ and ‘selfishness’, but they misread it too). Both parties to the transaction act from their self-interests, and Smith specifically advises that each should address the self-interests of the other and not their own, to lay the basis for a bargain: ‘Give me that which I want, and you shall have this which you want.’ It does not require an invisible hand to lead them; only their self-interest in acquiring what they need (dinner for the customer, wherewithal for the sellers).

I shall ignore the invented assertions about ‘“Smith was in favor of home and motherhood and against the man-eating sharks”. I am a Fellow of the Adam Smith Institute (UK) and Trustee of the David Hume Institute Scotland) and I am not short of good reasons for preferring markets to state management and liberty to tyranny. Lost Legacy is an academic site dedicated to the defence of Adam Smith’s legacy. It avoids politics, particularly in countries where I do not vote, hence my avoidance of commenting generally on Stiglitz’s policies.

Lastly, I have long been skeptical of ‘laissez-faire’ from its origins in France, which was not about free markets for consumers. M. le Gendre was a ‘plain spoken’ merchant wanting freedom for merchants from Colbert’s Interference in 1690, but said nothing about consumers. Merchants can only be contained by vigorous competition. Laissez-faire does not provide that; the law can. I think this was why Smith did not endorse it; he preferred natural law and liberty. But that leads us to another discussion, namely moral sentiments.

[I am grateful for David for taking time to debate these issues and hope they help elucidate these important issues.]

Don't Rely on Wikipedia for Knowledge of Adam Smith

Anonymous writes in Rewards HERE:

"Bullies are the invisible hand "of the intellectual rewards."

“In economics, the “invisible hand”, additionally accepted as the “invisible duke of the market”, is the appellation economists use to call the automated attributes of the marketplace. It is a allegory aboriginal coined by the economist Adam Smith in The Theory of Moral Sentiments. For Smith, the airy duke was created by the affiliation of the armament of self-interest, competition, and accumulation and demand, which he acclaimed as actuality Able of allocating assets in society. This is the founding absolution for the laissez-faire bread-and-butter philosophy. (Information quoted and taken from Wikipedia)”

Comment
‘a(sic) allegory aboriginal coined by the economist Adam Smith in The Theory of Moral Sentiments.’ Rubbish! (There is no politer way of expressing it.)

The metaphor was already well known in literature long before Adam Smith published Moral Sentiments (1759). It appeared in classical literature, and, for example, in Shakespeare (Macbeth, 1605) and Defoe (1722). Smith was born in 1723 and the metaphor was very popular in theological works and church sermons.

Smith’s first published use of the metaphor of an invisible hand had nothing to do with markets (or ‘competition, and accumulation and demand’) at all; it referred to the behaviour of ‘rich landlords’ using some of their annual output from agriculture to feed the serfs and peasants, which by any count was an unavoidable obligation, because, otherwise, there would be nobody alive to clear, plant and harvest the rich landlords’ crops each year.

His second use was in Wealth of Nations and it had nothing to with ‘markets’ or ‘competition, and accumulation and demand’. It was a metaphor, expressing in a ‘more striking and interesting manner’ the choice made by some, but not it all merchants, to prefer local investment because of their perceived greater risks of investing abroad. The context had nothing to do with ‘competition’ at the time, given that 18th-century Britain was dominated by mercantile political economy with its monopolies, tariffs and prohibitions in respect of trade.

These institutional interventions did not ‘actuality’ ‘allocate assets in society’.

It was the act of investing locally that added to national output and employment – the ‘whole is the sum of its parts – a mere arithmetic consequence of the risk aversion of the local traders.

The assertion that the whole is the sum of its parts’ is hardly ‘the founding absolution for the laissez-faire bread-and-butter philosophy’. Moreover, Adam Smith never referred to ‘laissez-faire’ on anything he wrote. The belief that he did is a modern invention by economists who have never read Adam Smith’s works.
The author confirms my assertion of his/her never having read Adam Smith with the revelation that: ‘Information quoted and taken from Wikipedia’, a wholly unreliable resource, quite often on a level with the corny ‘jokes’ found in Christmas crackers.

An Excellent Review of The Failings of Neo-classical Economics

In Reality Base Blog (HERE)a book review by John Gray in the London Review of Books, is reported (25 November):

“Animal spirits and what else is wrong with neoclassical economics”

“A much discussed book this year has been Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism by George Akerlof and Robert Shiller.

He credits Akerlof and Shiller for their evisceration of neoclassical economics for assuming at its core rational behavior of human beings—conceiving them to be a species, homo economicus, that is not us. Gray goes beyond this and points out that even if we all were homo economicus, important parts of the future are always unknowable and cannot be quantified and factored into market decisions as probabilities. A third theme of the review is the hubris of the neoclassical school in assuming that the magic beans they had discovered would work in any environment and that, indeed, no other doctrine would lead to economic abundance. Unaccountably and regrettably, these ideologues appear not to have noticed in the real world the massive contradictions to that view. A few excerpts:

. . . . The trouble with prevailing theories, in Akerlof and Shiller's view, is that they assume human beings are more rational than they actually are. 'This book, which draws on an emerging field called behavioural economics, describes how the economy really works,' they claim. 'It accounts for how it works when people really are human, that is, possessed of all-too-human animal spirits.' . . . .

. . . . If economists have failed to explain repeated crises, it is because they have interpreted economic activity through an unreal model of rational decision-making. Thinking of human behaviour in this way allows them to claim a high degree of precision for their discipline, which is presented as a kind of applied mathematics. But they have left psychology out of their equations.

. . . . The fact that markets are flawed seems novel only in the context of the economic orthodoxy that prevailed between the wars, and in the run-up to the recent crisis. It is wrong to imply, as Akerlof and Shiller do, that the classical economists believed otherwise. 'Just as Adam Smith's invisible hand is the keynote of classical economics,' they write, 'Keynes's animal spirits are the keynote to a different view of the economy – a view that explains the underlying instabilities of capitalism.' Here they are endorsing the caricature of Smith propagated by neoliberal ideologues anxious to confer a distinguished patrimony on an illegitimate intellectual offspring. . . .

If Akerlof and Shiller's grip on the history of economic thought is shaky, they also fail to grasp why Keynes rejected the idea that markets are self-stabilising. . . .

[I]n his canonical General Theory of Employment, Interest and Money (1936) he concluded that there was no way anyone could make forecasts. Future interest rates and prices, new inventions and the likelihood of a European war cannot be predicted: there is no 'basis on which to form any calculable probability whatever. We simply do not know!' For Keynes, markets are unstable less because they are driven by emotion than because the future is unknowable. To suggest that the source of market volatility is unreason is to imply that if people were fully rational markets could be stable. But even if people were affectless calculating machines they would still be ignorant of the future, and markets would still be volatile. The root cause of market instability is the insuperable limitation of human knowledge. . . . .

The central flaw of the economic orthodoxy against which Keynes fought in the 1930s was to imagine that an insoluble problem – human ignorance of the future – had been solved. The error was repeated in the 1990s, when economists came to believe that complex mathematical formulae could tame uncertainty in the murky world of derivatives. . . .

. . . . Hayek said that governments could never know enough to plan the economy successfully – a claim vindicated by the miserable record of central planning in Communist countries. At the same time, he attributed near omniscience to markets, and never doubted that if left to its own devices the economy would liquidate mistaken investments and return to equilibrium. Against this, Keynes had shown that there is no market mechanism that ensures revival; economic contraction can be self-reinforcing, and only government action can then create a way out."

Comment
This is more like it. Not having read Akerlof and Shiller’s book, I cannot blindly endorse everything they may have said, but their charge against “Homo economicus”, also made regularly on Lost Legacy, and their objections to mathematical modeling of economics, which precludes humans behaving as they really are, is very welcome.

Nobody actually reading Adam Smith would conclude that humans are, or will become, rational calculating machines, or that economies are closed systems in general equilibrium, and thus predictable, let alone always prone to the working for the public good in a Dr Panglossian “best of all possible worlds”.

That markets are better, in an acceptable sense, than their alternatives is a modest requirement, as the experience of Soviet central planning and the accompanying tyranny, is adequate testimony. But that is where we start from, not where we end.

The hubris of a belief in a predictable world, and events in it, is a serious flaw in the modern “science” of economics. Smith, like the later Keynes, did not endorse the myths of predictability – hence there are few, perhaps only one or two, specific predictions in Wealth Of Nations - one being that the former British colonies in North America would be wealthier (measured by the “annual output of the necessaries, conveniences, and amusements of life” within a century of 1776).

Nor was the 20th-century re-invention of the metaphor of "an invisible hand" as a comforting assurance that whatever the moral failings, or externality-induced misery, that was inflicted by individual "merchants and manufacturers" (to which we can add some governments some of the time, and a few governments all of the time), on the rest of society, was somehow a social benefit.

It wasn't, and economics as a "science" can only delude its practitioners into believing such nonsense by denuding its "models" of human beings. This charge cannot be made against Adam Smith.

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.

The Hesitant Hand by Steve Medema: Review Part 2

In the ‘Hands of Adam’ Steve Medema shows his class as an historian of economic ideas. I found his account of the role of self-interest in commercial society very fair, without the usual cliché errors found in many accounts.

Starting from the proposition in Moral Sentiments that our benevolence towards others diminishes as social distance increases without damaging the social fabric because all others have degrees of overlapping benevolence right across society, and benevolence is not, and cannot be, the sole, or even major force, for exchange behaviour, and, fortunately for human habitation and procreation, it is not necessary that it be so.

A society, we are reminded in TMS can exist with loving relationships, and it is well when it does, but it can also exist without such feelings provided there is a ‘mercenary exchange of good offices’.

Enter here the famous assertion by Smith of the ‘butcher, the brewer, and the baker’ and our need when engaged in an exchange transaction to appeal to their interests not ours (be ‘other centred’; never selfish). Steve shows that for Smith, self-interest is not a ‘one way street’ – what a lot of senseless twaddle would be saved if miss-readers of Smith would get that right!

Steve correctly sets out self-interest in Smith’s lexicon:

‘that the pursuit of self-interest serves the best interests of society as a whole, that self-interest and the social interests are partners rather than enemies’ (19). Self-interest should be facilitated rather than restrained.

The explanation of why this was true for Smith is wonderfully clear, though, Steve notes, ‘Smith is at once vividly descriptive and maddeningly vague’. Echoing Mirabeau (thinking you serve yourself, you serve others), the individual attempts to employ his capital where he expects to earn the highest return, and in doing so, he generally neither intends to promote the public interest, nor knows how much he is promoting it’, followed by the famous metaphor of ‘an invisible hand’.

Steve comments:

‘An invisible hand – this is a specific as Smith gets. What Smith meant by this is anyone’s guess, and plenty of guesses have been offered, ranging from God to government’. But whatever it is, Smith was convinced of its propensity to channel self-interest in socially useful directs’(20).

I can agree with that formulation as it encompasses Smith’s proper use of a metaphor, which is to explain something by adding ‘beauty’ when ‘so adapted that it gives due strength of expression to the object to be described and at the same time does so in a more striking and interesting manner’ (Smith: Lectures in Rhetoric and Belles Lettres, 1763).

A great deal of wasted ink and paper would be spared if only economists would read the nine paragraphs of Wealth Of Nations leading to the metaphor of the invisible hand and see how simply caps his technical description of economic and social process leading to people thinking they are serving themselves when in fact they serve general society, by his employing the common 18th-century metaphor of ‘an invisible hand’. Steve’s compromise treatment is masterly.

Smith develops the sense of ‘congruence’ (Steve’s word), even ‘harmony’ as ‘some would say’ (I prefer potential ‘congruence’) between private and social interests, to his critique of mercantile political economy and Physiocracy, both of which, Steve shows, inevitably distort by monopolies and misguided government interventions (those promoted by lobbying for special, especially corrupt, interests) and thereby interfering with the otherwise free actions of individuals judging their best interests in moral and legally constrained codes of behaviour and acting accordingly.

Here Steve highlights something that is worth developing (21). The absence in Smith’s work of a critique of the ‘internal logic’ of mercantile or Physiocratic thinking: on their own terms they promote the ends they seek (the accumulation of gold or the growth of agriculture output) – as China seems to be sliding towards in buying up the planet with its mountains of US treasury bills and hoping to hold down peasant incomes.

Smith disagreed with their consequences – state action by the former theories (necessarily at the sacrifice of liberty) versus growth of real wealth (the annual output of the ‘necessities, conveniences, and amusements of life’) through individual self-interest in conditions of liberty.

Steve confronts the conundrum of self-interested actions can be malign. Some voices, bought and paid for, advocate absolute freedom for corporations and individuals, the consequences of which are discussed widely. Unfortunately, the remedies (especially from the environmental lobby) of which involve draconian interventions by uncontrollable governments, agencies and neighbourly busy-bodies, plus ‘that insidious and crafty animal, vulgarly called a statesmen or politician’ (WN IV.ii.39).

Steve recognises that Smith was never a one-track voice for everything changing at once. He was far more pragmatic; never an ideologue. He did not make many predictions, nor did he expect much to change, except ‘slowly and gradually’, perhaps in many cases never quite reaching its end goal. He said as much in respect of free trade ever becoming accepted in Great Britain this side of ‘utopia’.

His message was that competitive markets were generally better than state grand plans. He didn’t even consider that ‘natural liberty’, as was envisaged by the Physiocrats, was a necessary condition for the spread of opulence – if it was, he opined, it is unlikely that any country would ever have progressed towards it (WN ix.28: 674).

Nor, Steve observes, were the necessary roles of government minimal (23) – Smith was not a laissez-faire purist or even near being so. The list of proposed roles for the state, collected in Book V and elsewhere scattered throughout Wealth Of Nations, is quite long, and probably much longer than the purveyors of Smith, the laissez-faire advocate, realise. Steve covers this material with both conviction and economically.

Smith, says Steve:

‘was not, as some have imagined, a proto-modern. Smith’s view of man is not economic man with his rational, single-minded pursuit of his self-interest’. Furthermore, Smith did not argue that private action was optimal, in the modern efficiency sense, nor even that it was superior to governmental alternatives. Smith considered the link between private and social interests partial and imperfect, but he was also of the mind that self-interest, properly channelle, tended to engender positive results, rather than negative ones, and that government interference with its operation in the economic sphere would generally lead to inferior results’ (25).

I think we can sum up Smith’s approach as being: ‘markets where possible; the state where necessary’.

Steve’s last line in this chapter is evocative:

‘Self-interest, then, had finally found legitimacy’.

[In Part 3 we move on to the ‘Harnessing of Self-Interest’ with ‘Mill and Sidgwick and the evolution of market failure’.]

Mythical Basis for a Theory

Linda Naiman writes at the Creativity at Work Blog HERE:

“Taking Responsibility for the Whole”

“Built into the concept of capitalism and free enterprise from the beginning was the assumption that the actions of many units of individual enterprise, responding to market forces and guided by the ‘invisible hand’ of Adam Smith, would somehow add up to desirable outcomes.

“But in the last decade of the twentieth century, It has become clear that the ‘invisible hand’ is faltering. It depended upon a consensus of overarching meanings and values that is no longer present. So business has to adopt a tradition it has never had throughout the entire history of capitalism: to share responsibility for the whole. Every decision that is made, every action that is taken, must be viewed in the light of that kind of responsibility.”

Comment
The “assumption” that market forces were “guided by the ‘invisible hand’ of Adam Smith” add up “to desirable outcomes” was not “built into the concept of capitalism and free enterprise from the beginning”.

That is a modern myth spread widely and repeatedly from the 1950s by modern economists (though it was earlier taught in the Chicago oral tradition from the 1930s). It was backdated to Adam Smith to give the myth high-level approval, as if he had made the metaphor of ‘an invisible hand’ a central theorem of his analysis of 18th century commercial markets (he never knew of ‘capitalism’, a word invented in English for the first time in 1854 – see Oxford English Dictionary).

Smith used the metaphor of ‘an invisible hand’ only three times in nearly a million words: once only in his Essay on Astronomy, written from 1744 to 1758, unpublished in his lifetime and published posthumously in 1795; once in Moral Sentiments, 1759; and once in Wealth Of Nations, 1776.

In no sense was the metaphor about “responding to market forces and guided by the ‘invisible hand”. In fact Smith discussed how markets worked in Books I and II in Wealth Of Nations without any mention of ‘an invisible hand’. That he is alleged to have done so is a myth – a sort of ‘academic campus myth’ like those ‘urban myths’ we hear so much about.

Modern economists blessed their mathematical models of general equilibrium with quasi-miraculous foundations and it was used also to proclaim the self-evident superiority of capitalist institutions and markets over the then prevailing counter-claims of the centralized planned economies of communist rivals.

Modern economists ‘over egged the pudding’, as we say in English. Markets are superior in most cases to non-market institutions and do not need the imaginary aid of so-called invisible hands, and certainly not associated with Adam Smith's isolated use of the metaphor, a wholly innocent victim of the purloining of his legacy.

That there may be a role for regulation, made on a case-by-case basis and not as a catch-all cop out, is quite consistent with Adam Smith’s moral philosophy and political economy.

Smith was NOT opposed on principle to intervention in some markets; his outright opposition to the forms of government inspired interventions from the 16th century in Britain through policies which he described as ‘mercantile political economy’ (many features of which remain active today) should not be taken as evidence for his general views on the levels of government promoted interventions.

Smith in Wealth Of Nations identified several important areas for government intervention – such as in banking regulations (even if it was contrary to his principles of ‘natural liberty’ when the security of people was at stake) - and in weights, measures, quality of cloths, gold and silver, the Mint, and post offices. He advocated public funding of in ‘public works’ (roads, bridges, canals, harbours, town cleanliness, and pavements) and in public institutions (education and aspects of health). He also advocated the separation of church and state.

His general policy is best summed as ‘markets where possible’ (operating under the justice system - an independent judiciary, Habeas Corpus, and trial by juries) and ‘public works where necessary’. Which is a far cry from the so-called ‘night watchman state’ (actually an idea of Ferdinand Lassell’s, the firebrand 19th century socialist, not Adam Smith’s).

Invisible Hands that 'Step In'

Hans Wagner at Daily Markets writes on ‘Bond Yield Curve And The Stock Market’ HERE:

“In theory, rising interest rates should be good for stocks. Rates tend to rise when the economy is recovering from a down turn. However, higher rates can also be a determent to an economy that is recovering. That is why the Federal Reserve is keeping short-term rates near zero. However, controlling long-term rates is much more difficult. The hidden hand of Adam Smith steps in and forces all entities to deal with the realities of economics.

When rates go up, many investors seeking safety, who had been buying stocks, opt for bonds to receive their yields tempting. When investors perceive they can get better returns from long-term bonds than from stocks it takes money out of the stock market. This tends to put downward pressure on stocks prices. In addition, companies that sell long-term debt will pay more now that rates are higher. This reduces their earnings power.”

Comment
Hans Wagner writes a clear, concise, and accurate account of the Bond Yield Curve, accepting that the BYC is a possible prediction; more of a guide from the past for possible, but uncertain, future behaviour.

The authorities can attempt to influence future behavour by manipulating current and future yields, which may have a desired affect or may meet with stubborn resistance as opinions diverge and losses mount for some.

What investors in stocks and bonds do in their anticipations of the future is down to their usual perceptions of risks. Here, Hans employs a metaphor to skate over the effects of investors’ judgements: ‘The hidden hand of Adam Smith steps in and forces all entities to deal with the realities of economics.’

He does not explain how an ‘invisible hand’ is able to ‘step in’ (more a role for a foot). In practice investors do what their degree of risk avoidance influences them to do. The ‘realities of economics’ are not read from a textbook - more likely from professional advisors angling for commissions to advise them or subscriptions to their newletters – and opinions may differ about the ‘realities’ of ‘economics’.

In short, if investors follow the advice or their best guess and behave according to the Bond Yield Curve’s predictions of future yields, assuming they find and trade with others offering contracts carrying interest rates according to their fancies, and assuming these prove profitable in practice, then Hans would ascribe their behaviour to ‘the invisible hand’ with a ‘foot’ attached. Of the others – there are always others – who behave differently, they have shrugged off the ‘invisible hand’ and have side-stepped its ‘foot’.

Why not say so, by explaining the role of the yield on the risk perception of investors, as identified by changing interest rates on short and longer term bonds compared to alternative perceptions of earnings from future share prices?

If stuck, try admitting that its all down to differences of opinions, backed by trades in shares and bonds? Of course, for a professional advisor to admit that what people do is respond to changing prices and yields would hardly be worth a fee or commission, or the price of a publication.

That’s where a widely shared quasi-religious belief in invisible hands ‘step in’ to obfuscate behind a veil of ignorance and a multitude of opinions. It's the difference of opinions that makes the market in shares and bonds (acknowlegements to the American author who said something similar about horse racing, but whose name I have forgetten this morning).

On Reducing Adam Smith to a Metaphor

Emanuel Derman writes in Emanuel Derman’s Blog: ‘ Economics as Economics’(7 May) HERE:

“Last week I spent a day at the Perimeter Institute in Waterloo, Ontario. It's a sort of institute for advanced study devoted to theoretical physics, and they had a meeting on The Economic Crisis and its Implications for The Science of Economics (sic).

One thing occurred to me in connection with trying to create a workable economic theory. Everyone is motivated by analogies: economics as physics, economics as collective phenomena with phase transitions (cellular automota, agent-based theories, which sounds sensible) economics as a gauge theory with a local invariance group (which sounds beautiful but maybe overambitious), economics as evolution, economics as biology, economics as computational neurology.

But if you look at new theories that burst on the world successfully -- Darwin on the origin of species, Adam Smith on the invisible hand, Freud on the subconscious, Marx on capital -- they weren't driven by analogies. They looked at the world with fresh eyes and made up an explanation for what they saw. Not everything is a metaphor.”

Comment
Extraordinary thinking represented here, with deep irony too. Everything goes well for Emanuel Derman until his last paragraph.

Among ‘new theories that burst on the world successfully’, he includes Adam Smith. Allowing for a bit of hyperbole, we still have trouble recognizing that ‘Adam Smith on the invisible hand’ burst on the scene, which is more than a stretch of the imagination.

Adam Smith might be said to have ‘burst on the world successfully’, if by that is meant his Moral Sentiments and Wealth Of Nations, but ‘Adam Smith on the invisible hand’?

The invisible hand’ was hardly noticed for 100 years; some ‘burst’!

Worse, Smith who used the words once only in each book, certainly ‘looked at the world with fresh eyes and made up an explanation for what [he] saw’ but he did not use the ‘invisible hand’ as ‘an explanation for what [he] saw’.

Smith explained what he say, taking near on a million words in doing so.

Emanuel Derman, ironically is right: ‘Not everything is a metaphor’, but the invisible hand was a metaphor. It didn’t explain anything; it substituted for one!

Smith had already explained what he saw when he observed, analysed, and wrote about how markets worked in Wealth Of Nations (Books I and II). His use of the well-known, 18th-century literary metaphor, of ‘an invisible hand’ in Book IV, was not a ‘new theory’; it wasn’t even a theory, it was a simple metaphor, and was most certainly not comparable to, say, ‘Darwin’s Origin of Species, … Freud on the subconscious, Marx on capital’, or even Adam Smith himself on the nature and causes of the wealth of nations.

That 'Not everything is a metaphor' is absolutely right; so why does Emanuel Dearman reduce Adam Smith so precisely to the metaphor of 'an invisible hand'?

Adam Smith on Liberty

Today’s Tomas Estrada-Palma Message (‘I am the great grandson of Don Tomás Estrada-Palma, the first elected president of Cuba, 1902-06). HERE:

Preface to the Post:

‘Tomás Estrada-Palma: LocaAnnapolis, MD, United States’

‘Let entrepreneurs into Cuba, keep the tax low and watch the economic explosion happen. Whenever there are more jobs than workers the wages and benefits are driven upward. That's because entrepreneurs compete for a limited supply of workers. Those who lose the competition will not be as successful because they can't grow without more laborers. Finally, the first modern society on the planet will be populated by people who are neither slaves to the pharaohs of industry nor government. Cuban workers will have the best job security in the world!'

The Post:

Stock Manipulation (23 April)

‘What's going to happen? Adam Smith wrote that the invisible hand of the marketplace always corrects the price of everything eventually. What the Treasury Department is futilely attempting to do is to re-inflate the stock market bubble. They will fail dramatically and very soon. The bubble is going to pop and the drop will be much more significant than if the government would have just left things alone.’

Comment
I posted the Preface because for its contents, because Tomas Estrada-Palma, deserves to be saluted and respected by all who believe in Liberty.

His later post is less clear. Adam Smith did NOT write that ‘the invisible hand of the marketplace always corrects the price of everything eventually’. Smith wrote that markets determine the ‘the price of everything eventually’.

There were no invisible hands involved in Adam Smith’s writings about markets, as can be seen in Books I and II of Wealth Of Nations.

That is a myth invented in the middle of the 20th century by modern economists (download my paper, ‘Adam Smith and the invisible hand: from metaphor to myth’, from ASLL Home Page: click where invited to do so).

Tomas is correct: ‘the Treasury Department is futilely attempting … to re-inflate the stock market bubble.’ And burdening current and future generations with immense debts that will have to be repaid from taxation.

On Cuba’s future, I am sure it would be in safe hands if its people elect a (small) government to be ‘at peace, introduce easy taxes, and a tolerable administration of justice’ (Adam Smith, 1755).

The best response to Castroism is not bloody revenge nor mass persecution of his acolytes: let the people create prosperity based on justice and competitive markets. Keep an eye out for monopolistic tendencies and special pleading for privilege; stamp out corruption, fraud and favours.

And above all secure the people with Liberty.

A Humourist and the Invisible Hand

Geoff Elliott, Washington correspondent of The Australian (‘on-line newspaper of the year’) HERE:

‘A mishap on freedom highway’

‘In that 2007 interview O'Rourke had just finished a book on Adam Smith. Smith's famous The Wealth of Nations, with its theory about the invisible hand of markets, is the bedrock for libertarian economic thought and on what O'Rourke has pinned decades of witty observations, starting in Rolling Stone and proceeding to 12 books such as Holidays in Hell, Eat the Rich and Give War a Chance.

One has to feel sorry for PJ, though. This is the man who calls all politicians dingbats and wished the hell government just got out of the way. Now he's like someone walking through the ruins of their house asking, "What the hell just happened?"

Smith, though, remains as relevant as ever, he says. The market is now doing its job, despite the best efforts of government to stop it. In O'Rourke's view, channelling Smith, throwing trillions in taxpayers' money at the problem is folly.
"How, then, would Adam Smith fix the present mess?" O'Rourke wrote in the Financial Times recently. "Sorry, but it is fixed already. The answer to a decline in the value of speculative assets is to pay less for them. Job done."

"You know Adam Smith was much better on the whole speculative bubble thing," O'Rourke tells me. "He had that nailed. Smith has a recognition, unlike others with greater technical expertise, that you are mainly talking about psychology here. Simply, Smith saw bubbles as more to do with the human desire to fool itself."

Bubbles and mania are nothing knew. But clearly there was nothing in Smith's writings that allowed the likes of O'Rourke to predict the mother of all economic meltdowns, and O'Rourke sounds slightly chastened when he speaks of the events of the last 12 months.

"What we just saw was a terrific overvaluation in every asset class. It is pretty remarkable, really. We just had huge runaway inflation - Weimar Germany standards - but it was in credit and money supply."

P.J. O'Rourke will lecture in Sydney on April 21 and in Perth on April 28 on "Invisible hand v visible fist: securing the future wealth of nations" for the Centre for Independent Studies. The Australian is co-sponsoring the visit. For details and bookings, call (02) 9438 4377, email events@cis.org.au, or visit: www.cis.org.au

Comment
P. J. O’Rourke is famous for his writing style and his book on Adam Smith’s Wealth Of Nations, deservedly is a best seller, though I have reservations about some of his interpretations, notably on his swallowing and then regurgitating the unreliable, and incorrect, Chicago/Samuelson/ Friedman invention about Smith’s so-called theory of an ‘invisible hand of markets’.

My essay, ‘Adam Smith and the Invisible Hand: from metaphor to myth’ discusses what Adam Smith actually wrote when using (once only) The Metaphor in Wealth Of Nations and rebuts claims, popularised in the 1950s in academe, about The Metaphor being a theory of markets. Readers can download an early draft (2008) HERE

That some economists, and their readers, have gone from worshipping mythical invisible beings and hands (‘pusillanimous superstition’ according to Smith) when discussing how markets work to confusion and dismay when the myth turns to shadows, is instructive.

The real damage to Adam Smith’s legacy occasioned by the invention of the myth of the invisible hand, in lieu of understanding how markets actually worked (fully explained by Adam Smith without mentioning disembodied body parts at all in Books I and II of Wealth Of Nations), has been enormous. Some economists turned Smith’s single use of the popular 18th-century metaphor into a religious experience – it became in effect the ‘Hand of God’ – and added a perfectly redundant and misleading mysticism to the very real, earthly experience of humans in societies.

That markets, and the exchange behaviours associated with them, have a long history in the long march of our species from brutish ignorance to modern science is not a ‘miracle’, nor evidence of ‘providence’, nor the consequence of a gentle guiding force of invisible beings, with or without hands. Humankind achieved it all by itself, for good or ill.

We do know that when human societies, for whatever reasons, curtailed, suppressed, or abandoned institutions dominated by voluntary exchange, they languished in the poverty of the alternatives to markets.

P. J. O’Rourke favours markets, but does not (yet) understand them. His popularisation of Wealth Of Nations, while a noble quest, perpetuates the modern myths of those ideologues who faced up to the collectivist challenges of the Cold War decades.

He now turns his wit to the bust part of the cycle after its boom, making his highly-readable presentations in Australia likely sell-outs without too much marketing effort. He does not show signs that he understands his own contribution to the boom in his romance with the myths of modern economists.

Some thoughts on ‘Spontaneous Order’ Type Explanations

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The market, explains Hayek is “the result of human action but not of human design.” I agree wholeheartedly with that statement. The problem comes next when we try to explain how the processes of human action become the outcome known as market solutions.

I am not convinced that the concepts of 'spontaneity', or 'invisible hands', in their modern guises (since the 1950s) advance science as an explanatory mode for understanding complex fields like markets, social change, and social evolution.

The problem I have with ‘spontaneity’ is in its inadequacy for explaining how markets work; it substitutes a conclusion (spontaneity) for a process. In its ‘invisible hand’ guise, I have criticised it on Lost Legacy for its mystical tones. It is a particular target for my criticism of modern attributions to market forces, though in fact, markets have been well understood since Adam Smith’s days. He did not need, nor did he use, an ‘invisible hand’ non-explanation to analyse market exchanges through price signals in Books I and II of Wealth Of Nations, though modern economists slip the metaphor in at every opportunity and, today, many believe that the metaphor of 'an invisible hand' is the explanation.

Human action in markets has history behind it. The propensity to ‘truck, barter, and exchange’ did not appear spontaneously; it was not an innate faculty that humankind were born with. It emerged over untold millennia and, in a sense, it still is emerging in its contests with that prime alternative to voluntary exchange, that of violent plunder, theft, and coercion, which I have attempted to explain in my papers, The Pre-History of Bargaining, Parts I and II; and about which I may soon be re-writing into an accessible book.

People learn, as they do in most cases of human-to-human exchanges, to barter and exchange through processes like mutually beneficial reciprocation (‘quasi-bargaining’), Gift exchanges common to all human cultures, and the simultaneous exchanges of modern bargaining, all of which have a long history and pre-history. I agree with Jim Otteson that people are engaged in exchange across a wide variety of social fields (Otteson, J. 2002: Adam Smith’s Market Place of Life’, Cambridge University Press).

Human knowledge is passed on and absorbed by generations in all aspects of life, which need not mean that lessons once learned are adopted, but neither do they need to re-invent everything in the knowledge base. But humans are thinking actors as well, and the proclivity of trying to ‘improve’ how they and others act is ever present, not least because any form of human action has positive and negative outcomes (if only in the opinions of some observers).

My main consideration in this post is not to present a new theory. That themes of modern ‘explanations’, such as ‘spontaneous order’, and, to an extent, that of the attribution to Adam Smith of what modern economists call the ‘invisible hand’ phenomenon, do not explain, indeed obfuscate, what Adam Smith stated was the purpose of philosophical science, namely, to reveal the ‘connecting principles of nature’, which ‘abounds’ with:

‘events that appear solitary and incoherent with all that go before them’… ‘by representing the invisible chains which bind together all these disjointed objects, and endeavours to introduce order into this chaos of jarring and discordant appearances, to allay this tumult of the imagination, and to restore it, when it surveys the great revolution of the universe, to that tone of tranquillity and composure which is both most agreeable in itself, and most suitable to its nature’ (Adam Smith: 'History of Astronomy', II.12: pp 46-47).

General themes, such as ‘spontaneous order’ and ‘invisible hand’ explanations move away from science in my, necessarily, humble view, in contrast to Smith's use of the example of uncovering the ‘connecting links’ with his parable of the loadstone under the table actually moving the pieces of iron on the table, which an uninitiated observer thinks are moving miraculously on their own! But once explained by the physics of magnetic fields, the ‘miracle’ (such as an invisible hand explanation) disappears (Smith, 'History of Astronomy', II.5 p 40, 42), but when it is left unexplained, notions of ‘mystical’ orders and ‘invisible’ body parts, take on a credibility of their own

In Moral Sentiments and Wealth Of Nations, on the two occasions only where he uses The Metaphor of an invisible hand, he explains the cause of the supposed 'miracle' first and introduces The Metaphor last. I think the science of the explanation is more important than The Metaphor, and I offer the thought that we should concentrate on the science, not The Metaphor.

Taking my analysis of Adam Smith's two cases (the Astronomy incident of the Roman god Jupiter, is sui generis), I have shown exactly what Smith indicated were the causes of the so-called invisible hand 'events'. In Moral Sentiments, the landlords did what they could not avoid doing in three ways: first, they used some proportion the food output from their land for their own consumption (not all of which went into their limited stomachs - they could also 'sell' some amount of the food output for purchasing other goods that were not restricted by the size of their stomachs - jewellery, fancy clothes, artefacts, and luxuries, or their consumption of their profits); secondly, they used another proportion of the output for next year's sowing (no seeds, no food); and thirdly, they paid some of their output as the subsistence for their peasants and their families to survive the winter to do next season's farming, herding, and so on. All fully explained; no 'invisible hand' at work; we can see the loadstone!

In Wealth Of Nations, he described how the psychological state of degrees of risk-avoidance led some wholesale merchants to trade with the colonies for compensating higher profits, under a regime of the monopoly Navigation Acts and the power of the Royal Navy; and he described the circumstances that led some other merchants to invest locally, even for lower, or not much less of the same profits, which added to national output (because the whole is the sum of its parts – the more parts the larger the whole). Again no need for an invisible hand, except as a metaphor, which is the proper use of metaphors (Adam Smith: Lectures in Rhetoric and Belles Lettres, {1762-3]).

Briefly, I think the science of the explanation for events is far more important than the themes of 'spontaneous order' and the metaphor if an 'invisible hand'. I offer the thought that we should concentrate on the science and not the themes.

Gary Makes a Good Point

A comment from ‘Gary’, with whom I have been debating The Metaphor of the ‘invisible hand’, as Adam Smith used it and as it is used today by modern economists, set me thinking after I had responded (see below to my post "A Reply to a Commentator" and the two comments appended therein.

This is a quote from Gary’s comment:

‘One of my disagreements is in the use of the term "invisible hand". In reading your paper (and the examples in this post) it's hard to ignore the fact that none of the references you cite used the term "invisible hand" (The Metaphor if you prefer) the way Adam Smith used it - in reference to economics.

Most use the term in reference to God, Providence, or other supernatural force. A few use it in reference to natural forces such as wind; there are a few military references; but none use it in reference to economic principles.

It may be a mistake to say the Adam Smith "coined" the term "invisible hand", but after reading your paper and other sources over the past few days, I believe it's still accurate to say he was the first to use The Metaphor in the context of economic principles.

The closest thing of which I'm aware previous to Adam Smith is "The Grumbling Hive: Or Knaves Turned Honest" by Bernard Mandeville http://www.effor.com/blog/index.php/the-grumbling-hive"

That poem effectively describes what the "invisible hand" means today, even though Mandeville never used the term.’

My initial response was as follows:

“On Smith's use of The Metaphor, I am not sure I agree completely with you.

Smith did not write about 'economic principles' in his use of the invisible hand. His first use was about pagan religion (History of Astronomy); his second was about feudal landlords avoiding his peasants and retainers starving to death, dsespite their psychological delusions of 'beauty' (Moral Sentiments); and the third was about risk-aversion - another pyschological impulse (Wealth Of Nations. All covered by prior use by other authors.

When he did write about how markets work, Book I and II, and how commercial society evolved (Book III) he did not use The Metaphor at all.

The users of The Metaphor in economics were the post-1950s modern economists, not Smith.

Smith is often confused with Mandeville - selfishness and greed etc.”

I thought about this exchange over-night (I am like that) and think I should record that in all the years in which I have been debating The Metaphor on Lost Legacy (since 2005) and in seminars, correspondence, and from reading articles and books from professional economists and academics from other disciplines, I cannot recall an occasion in which anybody before Gary who has raised such a sensible objection to the case that I expound about Smith’s use of The Metaphor.

This is quite striking. It’s not striking because Gary made a knock-out blow to my case – my response suggests why I do not accept his point - but he did make a significant point that I had not thought of before.

The Metaphor, as Adam Smith used it in the three occasions he did so - credulous beliefs of ‘savages’ and pagans (History of Astronomy), consequences of the psychological ‘deception’ of the ‘man of enterprise’ (Moral Sentiments) and the psychology of the risk-avoidance of the wholesale merchant (Wealth Of Nations) – was transposed by post-1950s modern economists, such as Samuelson, Friedman, and their graduate classes of US and UK economists, into a supposed invisible and mystical force within markets and without content or any identifiable mathematical term in their modern equations, which supposedly are representative of how markets work.

I have stressed how the popular literary Metaphor was used by Adam Smith as a ‘figure of which can have ‘beauty’ if it ‘is so adapted that it gives due strength of expression to the object to be described and at the same time does this in a more striking and interesting manner’. As such, The Metaphor is representative; it does not have substance; it is not identical to its object, and neither is it a ‘concept’, a ‘theory’ or a ‘paradigm’ (see my 2008 paper, “Adam Smith and the Invisible hand: from metaphor to myth”, downloadable HERE:

Adam Smith used The Metaphor to give ‘due strength of expression’ in ‘a more striking and interesting manner’ of the ‘beauty’ of the consequences of rich feudal landlords who were deceived by the flattery of their possessions into providing subsistence to the poor peasants who worked for them, and likewise to the consequences of the risk-avoidance of some merchants who invested their capital locally. That was Smith’s contribution, typically keeping his feet on the ground, so to speak, because he explains what goes on before adding a metaphor.

However, and this is the ultimate significance of Gary’s intervention in our debate, the post-1950s generations of economists who transposed The Metaphor from Smith’s psychological drivers of landlords and merchants, into an unexplained ‘theory’, ‘concept’, even ‘paradigm’, of how markets work by ascription, devoid of content or explanation, and in doing so they added a mystical layer of assertion over what the science of economics is supposed to explain.

Where Adam Smith, and others who came afterwards, diligently explained, without notions of invisible 'hands’ or ‘beings’, more associated with ‘pusillanimous superstition’ than with scientific analysis, the post-1950s generations of supposedly modern, scientific economists, with batteries of mathematical techniques at their disposal, did, was and is to take their science back to rest on a primitive mumbo jumbo, which would not be out of place among the credulous generations of the Middle Ages and those who lived even earlier.

And they have done this all in the name of Adam Smith in a sorry attempt to give their ideology an authority it does not deserve, under the driving force of that dangerous notion that there is an invisible force (some credit it to God) at work guiding the self-interests, even selfishness, of entrepreneurs, unbeknown to them, that magically, somehow, turns even the most sordid of actions into social benefits, of which those who suffer, or lose out, or are inconvenienced, some without their limbs, others without the lives of their loved ones, have at least the comfort of being told that public good can come from public bad!

Worse, legislators and those who influence them, buy this crap and are encouraged to give the perpetrators of and the beneficiaries from, this lie in the illusion that it is true because The Metaphor says so.

That is what, no less, is at stake in the, rather lonely, battle to retrieve Adam Smith’s legacy from the epigones.

My thanks to Gary for raising these issues in a coureous ‘more striking and interesting manner’. His passionate advocay of free markets is in good, visible, hands!