What Has Joe StIglitz Learned?

Elena Callahan reports (2 April) on New Deal 2 (“a project of the Franklin and Eleanor Roosevelt Institute”) HERE

“Stiglitz: The Invisible Hand is Invisible Because It Isn’t There”

In a keynote address, Roosevelt Institute Senior Fellow Joseph Stiglitz also argued that healthy societies have strong governments and that his research has shown that “the reason the invisible hand often was invisible was that it wasn’t there.”

“… Stiglitz says that “most Americans don’t realize that we are no longer the country of opportunity that we think of ourselves, that America today has less equality of opportunity than any of the other advanced industrial countries.” He points out how many like to say that our economy is doing well because GDP is growing, but that “if you’re going to be judging how well an economy is doing, clearly I think the key metric that one wants to focus on is what is happening to the living standards of most citizens.” He says that most Americans don’t realize how bad we’re doing, including the fact that “the median income of a full-time male worker today is the same as it was in 1968,” and “if you look at median household income it is the same today as it was a decade and a half ago.”

How did our society get to a place where government has taken a back seat and where people are wary of government control? Stiglitz thanks the conservatives who have successfully touted false ideology about markets over the past 40 years. While they like to blame the government for inequality, Stiglitz notes that not even Adam Smith thought markets were anything beyond efficient. “Nobody ever said that they were fair, that they would lead to a distribution of income that was socially acceptable.” Furthermore, he says, “many of the aspects of our inequality are a result of market failure. People who don’t have health insurance when they get sick wind up in extreme poverty and they can’t get health insurance because of a whole set of market failures.” He says it’s “striking that in spite of the fact that there is no intellectual basis for what you might call a ‘Smithian’ view that unfettered markets lead to efficiency,” conservatives have marched ahead with this idea.
So why was there so much economic growth after World War II? Stiglitz says one reason is “the legacy of the Roosevelts, the legacy that government made a difference.” In making the case for government he also points out that “government has played an important catalytic role in a whole variety of other areas. If you think about our modern economy, you think about Internet, you think about biotech, you think about telecommunications and all of these things rest on government-funded basic research.” He recalls a conversation with a Scandinavian finance minister who, when asked how his economy was so successful, answered “high taxes.” Stiglitz took away that “if you’re going to have a well-functioning economy… you have to pay for what you get. You need to have a well-functioning government that provides education, infrastructure, research, technology, all these things, and we have to pay for it.” Given that markets are not predictable nor interested in social problems, our government should stop bailing the financial institutions out and start investing in its people and the institutions that benefit them.”

Comment
Those of us who are suspicious of politicians in government and the Sir Humphrey's among civil servants, who administer legislation initiated by politicians and those who influence them, are frustrated by the analysis of the likes of left-of-centre, Joseph Stiglitz, that what governments ought to do, they should do more of, and critics of government policies from a right-of-centre perspective who say that whatever governments do now, they should do less of it. These views are matched by contrary views among left-socialist statists who say that governments should do everything and by anarcho-libertarians that governments should do practically nothing at all.

Both perspectives share the same fallacy about Adam Smith’s contributions to these debates. Stiglitz correctly states: there is no such thing an “an invisible hand”, but continues to believe in the ideas of neoclassical economics. Leftwing critics of the fallacy of the “invisible hand” also believe that it is an essential idea of neoclassical economics and attribute it to Adam Smith. For both sets of believers, the modern interpretation of the metaphor is attributed to Adam Smith, as it has been since the late 1940s, summarised (by Paul Samuelson) in the crude fantasy that Smith said that even “selfish” motivations lead unintentionally to social betterment, a wholly pernicious doctrine, about as alien to Adam Smith’s philosophy as one can get.

Interestingly, the Marxist economist, Oscar Lange, while at Chicago, from where Samuelson graduated, adopted from its oral tradition the importance of the role of the “invisible hand” to market economies, and in his plans for socialist economies envisaged the state taking over its role from the superior ability of the State planners to allocate resources “better” in place of the market’s “invisible hand”, amidst what Marx called the “anarchy of capitalist production”.

And the roots of the prevalent, but wholly misleading, belief in the “invisible hand” was a child of what became the Cold War, first in the perceived threat to market-based capitalism from the socialist economics of the Soviet planned economy, and later, from the mid-1940s, from the perceived military threat of an enlarged Soviet Union following its take-over of Eastern Europe and the post-war surge of mass communist parties in Western Europe, plus, of course, after 1949, the seizure of power by Mao’s Communist Party in China. There was also a perceived threat to capitalist hegemony in Western Democracies from social-democratic governments, and anti-colonial movements in what was known as the Third World. The myth of the “invisible hand” became a powerful ally of defenders of capitalism.

And its praises were sung in a increasingly loud voice as the 60s gave way to the decades after, which we can trace in the surge in mentions of its virtues from hardly next to no mentions of the role of Adam Smith’s so-called “invisible hand” from when he died in 1790 right through to 1875, and then only a trickle to the 1930s. Only after Paul Samuelson published his invention of the “selfish” invisible hand leading to public benefits from 1948 (‘Economics: an analytical introduction’, McGraw-Hill) did the modern myth acquire traction. Warren Samuels provided the astonishing data of public mentions of the invisible hand from the 1940s to the 1990s in stark contrast to the barren decades of no mentions at all to the 1870s (‘Erasing the Invisible Hand: essays on an elusive and misleading concept in economics’, 2011, Cambridge).

The old Cold War is over, and capitalist economies have lost their shine. Faith in the system-saving “invisible hand” is draining away. Stiglitz is an early manifestation of the beginning of the drain. But whether his proclaimed alternative to markets is sound, I have my doubts.

He writes:

“our government should stop bailing the financial institutions out and start investing in its people and the institutions that benefit them.”

It sounds attractive as a one-liner, but has he really learned from the over-due demise of “invisible hand”? The current problem is government borrowing to fund bloated expenditures. The overhanging deficits have to be funded and repaid. They are so large that borrowing to spend more are acts of prodigality. Willing lenders do not match the appetites of clamouring borrowers, nor does the political will of legislators match the aspirations of restless (e.g., Bradford) electorates.

Not bailing out banks is an easy target. Cutting welfare spending is highly unpopular; it is even unpopular to cut welfare spending among the rich because of the clamour it causes at the margin. We are a long way from ‘death to the Kukaks’, but starting down that road is the sort of pass-the-buck politics where it paralyses action to change the arithmetic of the perceived spending disaster.

Joseph Stiglitz Repudiates the Invisible Hand, but Accepts the Myth of Adam Smith's Culpability in Promoting It

A short video of Joseph Stiglitz declaiming the modern version of Adam Smith’s alleged ‘doctrine’ of the ‘invisible hand’ is available HERE

‘Joseph Stiglitz Against Adam Smith's Invisible Hand’

“Nobel Prize winner Joseph Stiglitz challenges the influential teachings of 18th-century economist Adam Smith, citing flaws with Smith's metaphor of an "invisible hand" guiding the free market. "The reason the invisible hand often seemed invisible was that it wasn't there," he says. Stiglitz claims an uncritical adherence to Smith's ideas is partially to blame for the current financial crisis.”

Comment
Stiglitz’s declamation takes the view that the modern teaching of “almost every graduate school in the country’ is wrong, because the ‘invisible hand’ is ‘not there’, which leaves Adam Smith lumbered with what was a modern invention (see Paul Samuelson, Economics: an introductory analysis, p 36, McGraw-Hill, 1948) that is not supported by the Smith’s texts, not just by a nuance, but by being quire contrary to anything Smith wrote.

Stiglitz argues that the claim that modern markets do not support the modern assertions and the evidence exposes the fallacy that they do, and yet he still lumbers Adam Smith with the authority for the claims made in his name.

The fact is, Adam Smith is wholly innocent. That he was ‘wrong’ in some way is a ludicrous claim; the guilty parties are all those lemming-like economists who repeat the charge of Smith’s “error”, but who have never bothered to read Adam Smith’s use of the metaphor of an invisible hand on the three occasions only that he used it. In none of these uses was he referring to anything remotely related to ‘perfect competition’. The edifice collapses on the evidence, yet very bright minds believe the contrary.

He referred in Astronomy to credulous Romans who believed that the God Jupiter fired thunder bolts in his anger (Smith called it ‘pusillanimous superstition’; In Moral Sentiments he referred to rich warlord/feudal landowners, not markets, and in Wealth Of Nations he referred to some, but not all, merchants in mercantile Britain, who preferred the relative ‘safety’ of a tariff-ridden, outright prohibitionist, mercantile monopoly of Guilds, the Apprentice Statutes, the Settlement Acts, and Chartered-venturer Britain to risking their capital abroad (protected by the Navigation Acts, policed by the Royal Navy) .

If you could ever get further from competitive markets, I cannot think of what it would look like, short of total State communism. And despite all this, modern economists read into Smith the 'First Welfare Theorem' and 'General Equilibrium'!

Not since astrology and alchemy ran through and alongside natural science has a discipline claiming to be science (in this case modern economics) promoted such a crass error and called it scientific.

From Perfect Rationality to Utopia

Dr Eamonn Butler writes on the admirable Blog of the Adam Smith Institute (London) another piece of excellent analysis from the pro-market ASI (HERE) :

“Stiglitz: A new economic model”

“I believe Professor Stiglitz is tilting at a straw man. Advocates of free markets have never believed them perfect. Markets are not static, like the textbook picture of supply and demand curves magically balancing at a particular price. As Mises and Hayek observed, markets are in constant motion: perhaps they are always tending towards balance, but with millions of buyers and sellers in millions of markets all competing for the same resources and getting in each other's way, they never quite achieve the textbook bliss. Nor are economic agents rational in the way the textbooks would have it, always demanding more of whatever is cheap. They are not computers, but human beings. There is a limit to the amount of anything they want. They value non-economic goods (such as honour) as much as economic ones, and will often give up the latter for the former. Economics is driven by those highly personal, emotional, wants and values: it is never going to be a matter of rational calculation....

It is perfectly possible to believe that markets do not clear perfectly and automatically, and that economic agents do not behave rationally, and yet conclude that markets work better if the government stays out of them. Sure there is market failure, but there is also government failure too. At least markets work through the wisdom and information of the whole population; government reflects the decisions of a small, distant, and inevitably self-interested class of politicians and civil servants. Sure we act as irrational human beings, and make mistakes in our planning that lead to losses and imbalances. But would we really trust that same small, distant (and, to be honest, rather slow) coterie to be able to plan our future better than we, ducking and weaving through a world that constantly changes, could do for ourselves?”

Comment
I think part of the problem was (and remains) the passionate search for making ‘political economy’ (as Adam Smith envisaged it) a ‘hard science’ from the 1870s and the subsequent formal achievement if that objective by the 1960s (though physicists in the Sante Fe Institute found that what passed for advanced maths among economists were somewhat primitive by the standards of 'hard science').

Starting with calculus, the rate of change of two variables and compressing the complexities of human behaviour into the single dimension of rationality and tracing the influence of variations in price, predictable outcomes were found, assuming that the world conformed to the stripped-down models that became prevalent in Economics textbooks from the 1950s.

With invented associations between rational self-interest and assumed ‘good outcomes’ for society, a narrative was created that bore little relevance to the real world. Predictions from such models were not realized – and occasionally proved to be disastrously out of kilter with real events – which caused and causes resurgences in ‘anti-market’ rhetoric from the Marxists, who never really went very far away, social-democrats and people like Stiglitz, who looks for a ‘top down’ new economics, as if anything as complex as an economy can be ‘designed’ (by who) for what agreed purpose?

History shows no such design capability exists.

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.

Ray Love Explains His Case

A Correspondent writes: By Ray L Love: (paragraphs inserted for readability)

As it turns out, Wiki has a quote from Stiglitz that further explains his position on this very issue:

"The Nobel Prize-winning economist Joseph E. Stiglitz, says: "the reason that the invisible hand often seems invisible is that it is often not there."[10][11] "Stiglitz explains his position:" "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. But unlike his followers, Adam Smith was aware of some of the limitations of free markets, and research since then has further clarified why free markets, by themselves, often do not lead to what is best. As I put it in my new book, Making Globalization Work, the reason that the invisible hand often seems invisible is that it is often not there."

"Whenever there are "externalities"—where the actions of an individual have impacts on others for which they do not pay, or for which they are not compensated—markets will not work well. Some of the important instances have long understood environmental externalities. Markets, by themselves, produce too much pollution. Markets, by themselves, also produce too little basic research. (The government was responsible for financing most of the important scientific breakthroughs, including the internet and the first telegraph line, and many bio-tech advances.)"

"But recent research has shown that these externalities are pervasive, whenever there is imperfect information or imperfect risk markets—that is always."

"Government plays an important role in banking and securities regulation, and a host of other areas: some regulation is required to make markets work. Government is needed, almost all would agree, at a minimum to enforce contracts and property rights."

"The real debate today is about finding the right balance between the market and government (and the third "sector"—non-governmental non-profit organizations.) Both are needed. They can each complement each other. This balance differs from time to time and place to place.[11]" ---

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.

I am also curious about how you get around the obvious fact that the very paragraph containing the invisible hand metaphor ( see David's comment) 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'.

Stiglitz is Right

‘fundamentalist’ writes in The Economist comments column on an article Rawls and the open economy (Matt Yglesias) HERE:

‘Stiglitz: "Celebrated results, such as Adam Smith’s invisible hand, did not hold; the invisible hand was invisible because it was not there."

He is exactly right! The invisible hand was not there because the state had hog-tied it and stuff it in a well with its 50,000 pages of new regulations every year. No free marketeer has ever suggested that the market will work perfectly in every and all circumstances. They have always warned that state intervention will crush the invisible hand.’

Comment
The invisible hand ain’t there because it ain’t. Adam Smith never said it was, ’50,000 pages of new regulations every year’ notwithstanding.

Smith’s use of the metaphor was not about markets, regulated of otherwise and in none of the three cases that he uses it was it about markets.
The belief that he did refer to markets is a wholly invented myth by modern economists from the 1950s.

Joe Stiglitz on Message, Again

Michael Stutchbury, Economics editor, The Australian reports:
HERE:

‘Labor's money injections win dubious approval’

‘Stiglitz claims such market failure is pervasive and endemic. The famous invisible hand of 18th-century Scottish economist Adam Smith is often invisible because it's not actually there. "Markets do not in general lead to efficient outcomes," Stiglitz claimed in giving the Douglas Copland lecture in honour of the first president of Australia's Economics Society.’

Comment
Stiglitz has said this before (as reported on Lost Legacy) and it is to be hoped will set a trend among modern economists.

He combines a denial of the assertions (emanating from Paul Samuelson, among others, from the 1940s) that Adam Smith’s use of the invisible hand as a metaphor was about ‘market efficiency’ and that all the self-interested actions of people in markets unintentionally produced beneficial outcomes for the public good, with an acknowledgment that this was not true either in fact or in theory.

It remains to be seen just how widespread these iconoclastic counter-assertions permeate into the main body of modern economists, but it is a start.

Lost Legacy welcomes what Stiglitz is saying in 2010.

Definitely Worth Another Look

Geoff Hautefort ("le monde perpendiculaire de Geoff Hautefort”) quotes Joe Stiglitz’s article in The Guardian (20 December) is HERE

“This year's Nobel Prize celebrates a critique of simplistic market economics, just as last year's award (of which I was one of the three winners) did. Last year's laureates emphasised that different market participants have different (and imperfect) information, and these asymmetries in information have a profound impact on how an economy functions. In particular, last year's laureates implied that markets were not, in general, efficient; that there was an important role for government to play. Adam Smith's invisible hand - the idea that free markets lead to efficiency as if guided by unseen forces - is invisible, at least in part, because it is not there.

This, too, is not news to those who work day after day in the market (and make their fortunes by taking advantage of and overcoming asymmetries in information). For more than 20 years, economists were enthralled by so-called "rational expectations" models which assumed that all participants have the same (if not perfect) information and act perfectly rationally, that markets are perfectly efficient, that unemployment never exists (except when caused by greedy unions or government minimum wages), and where there is never any credit rationing.

That such models prevailed, especially in America's graduate schools, despite evidence to the contrary, bears testimony to a triumph of ideology over science. Unfortunately, students of these graduate programmes now act as policymakers in many countries, and are trying to implement programmes based on the ideas that have come to be called market fundamentalism.
Let me be clear: the rational expectations models made an important contribution to economics; the rigour which its supporters imposed on economic thinking helped expose the weaknesses underlying many hypotheses. Good science recognises its limitations, but the prophets of rational expectations have usually shown no such modesty.

Vernon Smith is a leader in the development of experimental economics, the idea that one could test many economic propositions in laboratory settings. One reason that economics is such a difficult subject, and why there are so many disagreements among economists, is that economists cannot conduct controlled experiments. Nature throws up natural experiments, but in most circumstances, so many things change so rapidly that it is often difficult to untangle what caused what.

In principle, in a laboratory, we can conduct controlled experiments, and therefore make more reliable inferences. Critics of experimental economics worry that subjects bring to experimental situations modes of thought determined outside of the experiment, and thus that the experiments are not as clean and the inferences not as clear cut as in the physical sciences. Nonetheless, economic experiments provide insights into a number of important issues, such as the improved design of auctions. Most importantly, the irrationality of market participants, which was the focus of Kahneman's work, has been verified repeatedly in laboratory contexts.

The Nobel Prize signifies how important it is to study people and economies as they are, not as we want them to be. Only by understanding better actual human behaviour can we hope to design policies that will make our economies work better as well.”

Comment
Yes, the article is worth reading through (most of it is above) I have already quoted Stiglitz’s recant from his previous orthodox views on the invisible hand. The article in full is reproduced from a French Blog.

Support that explores the crumbing grounds on which the Chicago type economics of their version of Adam Smith stands – ‘the granite of self-interest’ according to George Stigler (1976) – cannot be repeated enough across the discipline.

Read and pass it on, please.

Stiglitz Takes on Rationality in Economics

Peter Boettke reports on Coordination Problem (HERE) comments on another speech by Professor Stiglitz, this time on rationality assumptions, the central core of neo-classical economics (Homo economicus for example), which is reported by Economist Online (HERE):

The speech originally was reported in Wall Street Journal.

The comments appended to the report show a clear tendency to attack Stiglitz for his complicity in teaching neo-classical mainstream economics (rather than take a ‘better a sinner who repents, etc., …’ approach and to question his status as one of the anointed priesthood.

A few Austrian commentators also make the point that if we adopted their approach there wouldn’t be much of a problem, which itself is a problem.

“Joseph Stiglitz didn't mince words when he kicked off the American Economic Association's annual meeting in Atlanta on Saturday. The Nobel laureate, who teaches at Columbia University, launched into a blistering attack on fellow economists for building models that rely on rational behavior when the financial crisis offers so much evidence of irrationality.

Wall Street also got a broadside. To Mr. Stiglitz, the purpose of a financial system is "to manage risk and allocate capital at low transaction costs." What actually happened? "They misallocated capital. They created risk. And they did it at enormous transaction costs.”

No doubt we'll read more about his speech.

Hurray! Joe Stiglitz Stamps on the Invisible Hand

Joseph Stiglitz (an Economics Nobel laureate and university professor at Columbia University. Author of:”Globalization and Its Discontents” and “The Roaring Nineties. His latest book, Freefall, will be published in January ) writes (31 December) in China Daily
HERE: and HERE

“Harsh lessons we may need to learn again”

“The best that can be said for 2009 is that it could have been worse, that we pulled back from the precipice on which we seemed to be perched in late 2008, and that 2010 will almost surely be better for most countries around the world. The world has also learned some valuable lessons, though at great cost both to current and future prosperity - costs that were unnecessarily high given that we should already have learned them.

The first lesson is that markets are not self-correcting. Indeed, without adequate regulation, they are prone to excess. In 2009, we again saw why Adam Smith's invisible hand often appeared invisible: it is not there. The bankers' pursuit of self-interest (greed) did not lead to the well-being of society; it did not even serve their shareholders and bondholders well. It certainly did not serve homeowners who are losing their homes, workers who have lost their jobs, retirees who have seen their retirement funds vanish, or taxpayers who paid hundreds of billions of dollars to bail out the banks”.

Comment
At last! A major modern economist sees the light about the fiction of the “invisible hand”, usually, with knee jerk regularity, attributed to Adam Smith, as if he made the metaphor mean what most modern economists insist it to mean: the invisible guiding influence in the commercial/capitalist economy that creates that wonderful ‘miracle’ that no matter what your motivation it ensures that it benefits ‘society’.


The sheer implausibility of this modern assertion (invented in Chicago in the 1930s, and then carried forth across US campuses everywhere – in Britain there was a slower uptake) from the 1950s to today.

That Joe Stiglitz has stepped out of line, no doubt to be rubbished by many colleagues (‘how dare you say there is no Santa Claus – take that you spoiler of children’s happy illusions … [biff, bang and butt]. Of course there is an invisible hand (and an invisible foot too) and everybody who knows anything about Adam Smith and markets – except for some cranks - says there is’.

It’s about the current crisis and the moral dimension of who gained most, as if nothing has happened or changed, and who lost out.

UPDATE: The 2009 Prize for the best contribution to restoring Adam Smith's Lost Legacy is awarded to Professor Joseph Stiglitz.

UPDATE 2: The Stiglitz annnouncment that the invisible hand does not exist is reproduced at Business Insider (Silicon Valley) HERE

UPDATE 3: It's at The Huffington Post too HERE: