A Glaring Contradiction That Selfishness Leads to Benefits

Christopher Chantrill writes in American Thinker (HERE):

“The Dirty Little Secret of Economics”

Here is a common example of what effectively is a "secret", also argued in serious journals of economics and by serious professional scholars, showing that Christopher Chantrill is not alone in holding two starkly contradictory views about Adam Smith and the so-called “invisible hand’ and selfish benefits without even blushing. Many tutors would comment negatively on their students’ papers if they sent in such an obvious error in a class essay on any subject but on the (mythical) 'invisible hand'.

Here is Christopher Chantrill’s example:

“When Adam Smith came out with The Wealth of Nations, he advanced two startling notions. One notion was the "invisible hand," that businessmen following their selfish interests seemed to be guided into benefiting others in order to benefit themselves. The other notion was a critique of mercantilism, the eternal idea that a state got strong and powerful by exporting goods and piling up gold in its treasury. On the contrary, Smith argued, it was labor that increased wealth, not gold and silver. .”

[The author is a frequent contributor to American Thinker and blogs at americanmanifesto.org. He is also writing “An American Manifesto: Life After Liberalism”.]

Comment
If the ‘notion’ that” that businessmen following their selfish interests seemed to be guided (the "invisible hand") into benefiting others in order to benefit themselves, and the ‘other notion’ of Smith’s was a “critique of mercantilism”, how could he hold both positions simultaneously, when protectionists are about a selfish as one can get?

Don’t get me wrong. Many modern economists pontificate on both ‘notions’ regularly – sometimes with near religious certainty – so Mr Chantrill is not an isolated example.

Consider, how can a businessman’s “selfish’ actions end up as a “benefit to others” and the same businessmen’s lobbying (i.e., clamouring) legislators and those who influence them, to secure tariffs and outright prohibitions on imports, also end up as public benefits too?

Of course, Adam Smith never made such patently nonsensical (and counter factual) arguments.

Smith did not make a general statement in Book IV of Wealth Of Nations about the role of the metaphor of “an invisible hand’. He referred quite clearly to some, but not all, merchants preferring to invest in “domestick industry” rather than invest in the “foreign trade of consumption” because they pereived foreign trade as too risky, which end up, unintentionally, as a public good because it added to “domestick” “revenue and employment” (the former because this increased economic activity above what it otherwise would have been through the “great wheel of circulation”, and the latter, of particular interest to Smith because rising employment, took more poor people out of poverty).

It wasn’t the Sovereigns who initiated mercantile policies of accumulating “gold”, though their war coffers were the beneficiaries, it was the clamour of domestic merchants, backed by suitably pliant intellectuals, who provided the rationale that persuaded Sovereigns to conduct their policies of “national animosity” against neighbours. Yes, these were the same merchants who perceived foreign imports as damaging their own interests and who argued for tariff protection and domestic trade monopoloies against cheaper imports.

In so far, as their selfish motives favouring their monopoly privileges were instrumental in their lobbying, they cannot be said to “benefit others”, particularly domestic consumers facing rising prices, though they certainly benefitted themselves from their higher monopoly prices.

To implicate Adam Smith in these charades is an insult to his legacy and it ought also to be to modern readers of the nonsensical claim that Adam Smith ever argued thus.

A Serious Scholar Disagrees

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

“The neoclassical model”

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Paul Walker:

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

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

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

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

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

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

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

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

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

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

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

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

[GK Comments: agreed.]

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

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

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

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

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

What Is Wrong With Mercantile Political Economy?

Ian Fletcher writes in Huffington Post (25 February) (HERE):

“The great Adam Smith, founder of modern economics, published his epoch-making free-trade tract The Wealth of Nations, the origin of endless subsequent delusions, in 1776. But he was a hypocrite, for Britain in 1776 was not a blank slate upon which free markets and free trade could work their magic. It was instead the beneficiary of several prior centuries of protectionism and industrial policy. In the words of British economist William Cunningham:

‘For a period of two hundred years [c. 1600-1800], the English nation knew very clearly what it wanted. Under all changes of dynasty and circumstances the object of building up national power was kept in view; and economics, though not yet admitted to the circle of the sciences, proved an excellent servant, and gave admirable suggestions as to the manner in which this aim might be accomplished’.

England in this era was, in fact, a classic authoritarian (this is long before English democracy) developmentalist state: a Renaissance South Korea, with kings rather than the military dictators who ruled South Korea for most of the Cold War period. English industrialization must actually be traced 300 years prior to Adam Smith, to events like Henry VII's imposition of a tariff on woolen goods in 1489. King Henry's aim was to wrest the wool weaving trade, then the most technologically advanced major industry in Europe, away from Flanders (the Dutch half of present-day Belgium), where it had been thriving upon exports of English wool. Flemish producers were entrenched behind huge capital investments, which gave them economies of scale sufficient to outcompete fledgling entrants into the industry. So only government action could get England a toehold.
Even in the 15th century, there was an awareness that being an exporter of agricultural raw materials was a dead end--a problem impoverished African and Latin American nations wrestle with to this day. And there was an awareness that free trade will not lift a nation out of this predicament: you need some well-chosen protectionism. Henry VII created, in fact, the first national industrial policy of the modern era, long before the Industrial Revolution introduced artificial energy sources like steam power.

“In Praise of Mercantilism, or Why Economic History Isn't Boring”

Does economic history hold a giant clue for getting America out of its present trade mess? Yes, because it debunks the idea that free trade is how nations become prosperous. Instead, it shows that nations win at international trade by playing a 400-year-old game called mercantilism.

… Mercantilists saw free markets as a useful tool in economics, but not the sum total of economic wisdom. Even their much-mocked obsession with the accumulation of bullion was not as irrational as it is usually depicted as being, given that under a monetary system based on gold, accumulating it is the only way to expand the money supply and drive down interest rates, a boon to investment then as now. Mercantilism, in fact, created the modern European economy and thus made possible the colonial power that economically shaped much of the rest of the world. It is thus the foundation of modern capitalism itself.
Anyhow: Britain functioned on a mercantilist basis for centuries before its much misunderstood experiment with free trade began. Even as late as the beginning of the 19th century, Britain's average tariff on manufactured goods was roughly 50 percent--the highest of any major nation in Europe. And even after Britain embraced free trade in most goods, it continued to tightly regulate trade in strategic capital goods, such as the machinery for the mass production of textiles, in order to forestall its rivals. This was rational, as the win-win logic of free trade starts to break down if productive capital is mobile between nations or if free trade induces productivity growth abroad.

After Britain embraced free trade in the mid-19th century, its long economic decline, of course, began. Today, the United States is making the same mistake, having mistaken the temporary tactical advantages of free trade for a nation at the peak of its economic power for a fundamental strategic truth. Meanwhile, our rivals, especially but not only in the Far East, hold firm to the mercantilist principles that we ourselves employed for 150 years.

Mercantilism has somewhat different application in developed, rather than developing, nations, but its fundamentals still hold good. At the very least, we need to defend ourselves against mercantilist aggression against us, something we are not doing.

Comment
“Mercantile political economy” is how the concept was known from before Smith’s time, but which became ‘Mercantilism’ after Eli F. Heckscher’s magisterial 2-volume Work, published in Swedish (1931) was translated into English from the German edition in 1935, when the German ‘Mercantilismus’ became ‘Mercantilism’ and was adopted by the discipline (personally I prefer and usually use Smith’s name for the phenomenon – and have done since I was an undergraduate).

My problem with Ian Fletcher’s tendentious argument for mercantilism is that is that he takes a very narrow view of what was involved in the history of mercantile political economy in Europe, which survives today in practically every industrialising country (did it ever really go away in the so-called ‘laissez-faire’ decades in 19th-century Britain?).

Mercantile political economy is associated with the centralizing states in European history and the ambitions of kings and princes when faced with dynastic challenges and jealous rivals. Trade was seen as an adjunct of war, and vice versa. Kings saw mercantile development as an instrument of state power and, of course, this growing power had a heavy price in the casualties of wars between and among neighbours, and in more distant regions of the world coming with increasing sailing distances achieved by shipping expeditions that proved anything but benign in the centuries that followed.

Ian Fletcher ignores all of these consequences, as if what happened as northern parts of Europe followed Venice and similar commercial centres in the Eastern Mediterranean in earlier centuries (think of the appalling cost in life – and treasure - in the infamous Crusades) was a mere detail in European history.

In the 17th-18th century, as commercial society gathered some momentum on the way towards, as it turned out, slow growth in the annual output of the “necessaries, conveniences, and amusements of life”, soon to be given a historic boost under industrialization, invention of new techniques and across-industry innovation.

Such was the momentum of mercantile political economy and state glory in the last quarter of the 18th century that when an opportunity presented itself to British legislators and those who influenced them with the forced withdrawal from the former British colonies after the war from 1776, and as advised by Adam Smith in the very last paragraph of Wealth Of Nations (about Britain adapting its mercantile colony ambitions to the ‘mediocrity of its circumstances’), Britain, instead, carried on as normal (learning nothing and forgetting everything) aggressively reinforcing what it held in Eastern Canada, the Caribbean, South Africa, and India , and founding a new ’empire’ in what became Australia, western Canada, Asia and the Pacific. From this consequence came continual wars in Europe, intensified rivalries and more wars among potential trading partners, new shameful aggressions in Asia (for which China still bears old grudges) and gross wastage of human life, ‘treasure, stalled modernization (increasingly captured by new trading powers on the Continent), and dangerous militarisations in Europe that culminated in two ‘world’ wars and several million deaths, and the introduction and spread of a new world force, communism, which killed many millions more.
All this from the consequences of mercantile political economy that Ian Fletcher is unrestrained in his praise of, and, apparently, oblivious of these consequential costs, once again, he probably dismisses them as mere details.

I recommend that he reads Heckscher’s ‘Mercantilism’, Adam Smith’s critique of mercantile political economy (Book IV, Wealth Of Nations) and any number of history books of the post-Medieval World.

Mercantile states left Britain by the 18th century stuck with the false ideas legislated by ambitious Kings, Queens, Courtiers, merchants and legislators, such as the Apprentices Statutes (to promote quality tradesmen and their products, which created legalized monopolies that raised prices and restricted competition); Trade Guilds (aimed at quality assurance and protected incomes that raised prices, restricted competition and innovation); Settlement Acts (to cope with local poor burdens and vagabonds that prevented movement of unemployed labour and localized poverty); and the Navigation Acts that aimed to promote a larger domestic marine trade necessary for defence of an island (raised prices, diverted capital into foreign trade and restricted competition, and promoted wars).

In addition, the laws of primogeniture (necessary for stable inheritance in a monarchy) and entails (to preserve large land ownership among descendants), the effect was to freeze land re-distribution by curtailing breakup sales to new owners, and lowered quality and prevented needed improvements (several British colonies abandoned entail laws and notably prospered).

What Ian Fletcher calls the “developmentalist state” actually acted as a drag-anchor on development and a distorting force in the allocation of capital. Fortunately, as Smith noted in his criticism of some Physiocrats who demanded the institution of Natural Liberty before opulence could be created. Smith remarks that if such a precondition was required then no country would have ever produced any opulence; but many did, if only for a while). Nor did he insist that free trade be instituted – or, indeed would ever be adopted in Britain and called such an idea as ‘utopian’.

Smith was never an ideologue. He had a pragmatic view of what was practical and no illusions about the powerful forces that flourished in the mercantile state, and had done for centuries (and which continued for two more, and counting). He observed and reported; he did not propose grand plans for change. That his observations were not acted upon was not due to his ‘hypocrisy’, as Ian Fletcher suggests; there was no ‘clever plan’ to dupe the world. That is fantasy land, populated by the paranoid and immature conspiracy addicts.

But what is worrying is that Ian Fletcher’s understanding of what is happening in the rise of new developed countries is that they are a ‘threat’ to the USA and 'something must be done about it'. But the mercantile state, bolstered by modern state capitalism, is in no real position to face such challenges using the old mercantile methods and forgetting the lessons of mercantile history.
Mercantile political economy is a dead-end. Adam Smith taught that within the confines of the necessary discretion needed to avoid the full weight of the protectionist establishment, then, as now, rampant within the mercantile state. The best that may be hoped for is that measures are taken over time to mitigate the worst effect of mercantile political economy on a case by case basis.

Adam Smith no ideologue

Gavin Mueller writes the Unfashionably Late Blog (‘so behind we're ahead’) (HERE):

“Adam Smith and Collective Bargaining”

“Adam Smith, for all the considerable flaws in his thinking, wasn’t stupid. He understood the class conflict inherent to the economic system he was describing.

What are the common wages of labour, depends everywhere upon the contract usually made between those two parties, whose interests are by no means the same. The workmen desire to get as much, the masters to give as little as possible. The former are disposed to combine in order to raise, the latter in order to lower the wages of labour.

He also understood that this wasn’t an even match-up. Under 18th Century capitalism, not only were most workers living hand to mouth, organizing was expressly forbidden by law. It’s pretty clear that Smith thought this was an unfair state of affairs.
It is not, however, difficult to foresee which of the two parties must, upon all ordinary occasions, have the advantage in the dispute, and force the other into a compliance with their terms. The masters, being fewer in number, can combine much more easily; and the law, besides, authorizes, or at least does not prohibit their combinations, while it prohibits those of the workmen. We have no acts of parliament against combining to lower the price of work; but many against combining to raise it. In all such disputes the masters can hold out much longer. A landlord, a farmer, a master manufacturer, a merchant, though they did not employ a single workman, could generally live a year or two upon the stocks which they have already acquired. Many workmen could not subsist a week, few could subsist a month, and scarce any a year without employment. In the long run the workman may be as necessary to his master as his master is to him; but the necessity is not so immediate.

Of course, workers organized and fought anyway, were beaten, killed, thrown in prison, and vilified in the capitalist press. But their “masters,” the owners of the factories, organized themselves as well. These organizations operated with the consent of the law to do what it is masters always do, the very aspect that unites them as a class: lower the wages of the workers. But this operated out of sight.”

Comment
Follow the link and read the rest of Gavin Mueller’s case. Gavin’s approach is from a left perspective (makes a change from the usual right wing extremist approach that invents myths about Smith being a believer in laissez-faire, pure free market economics, and mystical ‘invisible hands (of god, etc.,).

However, Adam Smith is much more nuanced a thinker than Gavin Mueller appreciates from the Left and some anarcho-Libertarians believe from the Right.

Adam Smith, as a philosopher wrote that he “observed, but did nothing”, somewhat at odds with Marx and Engels who believed the purpose of philosophy was ‘to change the world’. In Smith’s case he spoke out as Gavin Mueller correctly observes (and quotes from Wealth Of Nations), but he also spoke out in favour of the ‘distinction of ranks’ in society – Smith above all else considered social stability an important element for the growing opulence of the majority of the populations, who ‘feed’ and ‘clothe’ all and he was more than suspicious of the ‘Man of System’ who believes he can, through his schemes, move people like wooden pieces on a chess board, when in fact people have minds of their own and move under their own volition.

I should also point out, respectfully of course, that ‘capitalism’ was a long way from 18th-century ‘commerce’ – the word was not invented in English until Thackeray’s novel, The Newcomes (1854).

The Guilds and Incorporated Towns long preceded Adam Smith’s critique of their monopolizing behaviours, and essentially were legal bodies of artisans and ‘skilled’ tradesmen that restricted new entrants to their trades, fixed (high) prices and exploited consumers (sound familiar to trade unionists and professional bodies?).

The Combination Acts were part of a raft of restrictive laws, aimed at distorting the economy on behalf of mercantile interests. Tariffs and prohibitions were part of them too (supported as much by the workers as by the merchants and manufacturers – and farmer interests). Not surprisingly, modern trade unions also support trade restrictions – even prohibitions too. The ‘brotherhood of man’ extends up to the nations frontier, but no further.

Mercantile political economy lives on. Men and women of ‘system’ still rule the world. Gavin Mueller should contemplate what Adam Smith might have said about that (despite the massive opulence enjoyed by the majority of workers in North America and Western Europe – and soon in China, India, and Brazil, but not, alas, in Venezuela, Cuba, and North Korea.

Claims for the Invisible Hand Fail Simple Tests

Piaroh-Cze writes the Words of Cze Blog (HERE):

“On many occasions, I have asserted that I no longer believed in Adam Smith’s ‘invisible hand’, arguing that even if it still existed (as I think it does), it no longer acts freely and independently and can be and is being channelled by corporate managers and public policymakers (which subverts the concept entirely). In fact, many a time I’ve made policy suggestions which focus on manipulating Adam Smith’s hand. I might not have articulated it as so before, but the point is that this ‘hand’ is now a ‘visible’ one now….

In Adam Smith’s time, markets ran on the craft economy. Businesses were small-scale, goods and services were produced ad hoc and often with the same craftsman working on every stage of its production. Mass orders did not happen because no one could afford them, the notable exception being the military during a war, and that spawned an entire body of military study on how to manage and mantain arms supplies….

… So for Adam Smith, the whole idea of the ‘invisible hand’ worked perfectly. Small producers, small consumers, weak regulation and lack of information infrastructure made moot by the small reach of the market anyway; if the only folks buying their pots at the ones living in the same small town as you are, word of mouth is generally sufficient to facilitate market activity.”

Comment
Does the “invisible hand” exist? Piaroh-Cze writes that “I think it does”.

He adds that “it no longer acts freely and independently” which “subverts the concept entirely”.

So it is a “concept’ (that is, in the mind) either made-up and imagined but not physically present in some sense.

This is a muddle. Best shown by Piaroh-Cze’s construction: the invisible hand’ exists if he thinks it does, but doesn’t if he thinks otherwise.

The muddle begins from his assumption of meaning of the metaphor of “an invisible hand”. Metaphors do not exist in any real sense. They are grammatical constructions of the literary mind.

In so far as Adam Smith used the invisible-hand metaphor (IH metaphor) it most certainly did not exist physically, therefore to say “it no longer acts freely and independently” is physically not possible one way or another. What might change is the imagination of the concept which “no longer acts freely and independently” and that judgement exists only in the mind.

Adam Smith has no confusion about the status of the IH metaphor. He taught his students about the role of metaphors: they are used to “describe in the more striking and interesting manner” their objects (Adam Smith, “Lectures on Rhetoric and Belles Lettres” [1762-3] 1983, p 29).

He only used the IH metaphor in this manner three times in his Works, his Theory of Moral Sentiments (1759), his “Wealth Of Nations” (1776), and in his History Of Astronomy (1795 posthumous, but believed to have been written from 1744-50).

From the context, Piaroh-Cze apparently believes that the IH metaphor has something to do with markets, and is applicable today. This is a fable invented from the 1950s by modern economists and repeated endlessly and widely even today (see Paul Samuelson, Economics: an analytical introduction, McGraw-Hill, 1948, p 36).

BUT SMITH’S THREE USES WERE NOT METAPHORIC IN REFERENCE TO MARKETS.

His use of the IH metaphor in his History of Astronomy was about the belief on Roman citizens that their (invisible, but represented in stone) god, Jupiter, fired thunderbolts with his invisible hand at enemies of Rome – certainly a ‘more striking and interesting manner’ of expressing its object within, what Smith called, their “pusillanimous superstition”. But nothing to do with markets.

In Moral Sentiments his use of the IH metaphor was about how rich and unfeeling landlords in feudal Europe fed their retainers, serfs and slaves, who, with their families, otherwise would die of starvation and who, then, would work their fields and keep out intruders (and who would keep the poor at bay, and also lordly rivals?) – which meant that the landlords had to share their harvests with their much despised underlings, just as much as servants, serfs, and slaves had to work to get fed). The IH metaphor referred to the consequences of this necessary mutual dependence, policed by the Feudal Lord's power and oppression. But, again, it had nothing to do with how markets work.

In Wealth Of Nations, some merchants, but not all, obviously, traded with and invested in the colonial settlements in North America, the Caribbean, Africa, and India, but others preferred to invest all their capital at home, where it was under their immediate control, rather than risk it by sending it abroad and at the mercy of events (shipwreck, piracy and war) beyond their control. The merchants also distrusted people they did not know and who were not subject to UK justice. Therefore, they invested solely in the domestic economy, but in doing so, unintentionally they added to domestic revenues and employment (public benefits in Smith’s view). He used the IH metaphor to describe ‘in a more striking and interesting manner’ the consequence of their risk aversion leading to this public benefit, without making any reference to how markets work, or to greater ‘harmony’ or to the ‘magical’ distribution of the benefits. It was simply the arithmetic rule that the ‘whole is the sum of its parts’.

In no way can it be construed from these reference that the IH existed or that “for Adam Smith, the whole idea of the ‘invisible hand’ worked perfectly”. The metaphor applied to its object of the insecurity felt by some merchants that "led" them to act as they did. But nothing to do with how markets work.

Hence, the assertion that whether the IH metaphor physically exists or not, in Adam Smith’s thinking, was not and is not dependent on the existence or nature of markets. Piaroh-Cze presents an idealistic picture of markets in Smith’s time that “ran on the craft economy. Businesses were small-scale, goods and services were produced ad hoc and often with the same craftsman working on every stage of its production.” [Incidentally, early craftsmen did work on 'every stage of production.)

The reality was quite different. Smith dissected the commercial system in Britain, dominated and distorted, as it was, by mercantile policies against which he launched his “violent attack” in Wealth Of Nations. The Elizabethan Trades Guilds that ran legal monopolies of almost everything sold in towns; the Apprentice Statutes, the Settlement Acts, the Royal Charters granting monopolies across all businesses, plus the tariffs and prohibitions, and Cromwell’s Navigation Acts, inheritance, specially landed estates, of primogeniture and entails, the Combination Acts against labour but not against employers, and the patronage and corruptions of governments at all levels, these , all conspired to paint a different picture that markets “worked perfectly”. They didn’t and still don’t.

Piaroh-Cze’s case fails the historical test of the facts, and also fails any test of reading Adam Smith’s actual Works.

An 'Historically-Informed Progressive' Distorts Adam Smith

Sasan Fayazmanesh (Professor Emeritus of Economics at California State University, Fresno) posts in Real Economics (promoting itself as ‘Technologically Literate, Historically Informed, Politically Progressive’ (not modest then) HERE:

“Waiting for a New Economic Theory”

“Economic theories, for the most part, have emerged in response to particular social situations or governmental policies. For example, Francoise Quesnay’s 18th century Tableau Economique came into being in reaction to the plight of the French peasantry, excessive taxation, and government regulation that followed mercantilist teachings. Adam Smith’s “invisible hand” theory similarly appeared as a response to mercantilist restrictions. It also corresponded to the early stages of the Industrial Revolution, when inventions and innovations made England relatively prosperous. Thomas Robert Malthus’s population and glut theories emerged in the midst of the Industrial Revolution, when migration of peasants to the cities, unemployment, and poverty became rampant. Karl Marx’s version of the labor theory of value was a response to the revolutionary movements in 19th century Europe, as exemplified by the 1848 uprising and the 1871 Paris Commune. John Maynard Keynes’s “general theory” was developed in the midst of the Great Depression and was a response to the laissez faire economics and policies that prevailed at the time.”

Comment
The problem I have with this 'informed history' is its generalizing to the point that it just fits plausible claims to suit a theme, echoing the off-hand quips of the leftist certainties of 1960s academic coffee-rooms across the land, which when repeated by impressionable students sounded hollow.

Taking Adam Smith’s case, for instance, the ‘mercantilist restrictions’, these restrictions, in the main were present for a long time before Smith developed his ideas. The Navigation Acts went back to the 1660s – over two-hundred years before he gave his Lectures on Jurisprudence (1762-3) and began writing Wealth of Nations in 1764.

Moreover, it was Queen Elizabeth’s ministers a hundred years earlier in the 1500s who introduced the mercantile laws on Apprentices, Settlement, Guilds, and monopolies through patents, licences, and Royal charters.

One might ask if it’s a stretch to assert factor A caused Book B, when the cause is so loosely dated to the critique. Worse, in the 1760s, the so-called ‘Industrial Revolution’ that really become prominently from the 1800s, was hardly noticed by Adam Smith (if at all), or indeed anybody else at the time. By the time that it arrived so prominently, Smith's legacy had been distorted as to be unrecognisable and he was dead. Methinks Professor Sasan Fayazmanesh is stretching causation to suit his convenience.

He really grasps at straws with: "Adam Smith’s “invisible hand” theory similarly appeared as a response to mercantilist restrictions."

What ‘theory’ is this? Smith did not have a theory; he used a popular and rather common metaphor, which is a word or words that refers to an “object”, but in a “more striking and interesting manner”, which I am sure Professor Sasan Fayazmanesh is well aware of, having read Adam Smith’s Lectures on Rhetoric and Belle’s Lettres” ([1763] 1983, p 29, Oxford University Press).

And the metaphor’s “object” on this occasion? It was the insecurity of some, but not all merchant traders in mercantile Britain who were risk averse to sending their capital abroad and, therefore, were led by that very insecurity to invest locally, which had the unintentional consequence of adding to national investment and employment – because the whole is the sum of its parts.

Further, this consequence occurred, not “as a response to mercantilist restrictions”, but under their protection! These particular British merchants, discussed by Smith in Wealth Of Nations, were protected by the British Royal Navy, and by scores of mercantile laws and regulations – and still they felt insecure abroad – but less so when they invested within Britain and felt ‘protected’ by mercantile tariffs and prohibitions, the Navigation Acts and the mercantile regulations.

Professor Sasan Fayazmanesh slips up in being “Historically Informed’ in the Real Economics Blog on this occasion.

He is, however, right in his assessment of modern economics:

“The free market advocates still fall back on the marginalist or “neoclassical” theories that have dominated economic teaching since the end of the 19th century (the term “neoclassical” is a misnomer, but it is widely used). This unreal, a-historical theory started not with analyzing any real economy or human behavior, but with certain concepts in mathematical physics.”

With one quibble. Not all ‘neoclassical’ economists are ‘free market advocates’ and not all ‘free market’ advocates are ‘neoclassical’ economists. It’s a lot more complex than that.

Most of us 'free-market economist only claim to be ‘classical economists’, closer to Adam Smith than Ricardo or Marx.

A Thoughtful View From CATO

Gerald O’Driscoll writes in the Wall Street Journal (22 April) “CATO Blasts Mercantilism” and reproduced in part in Right Side News Blog:
HERE

‘Free markets depend on truth telling. Prices must reflect the valuations of consumers; interest rates must be reliable guides to entrepreneurs allocating capital across time; and a firm's accounts must reflect the true value of the business. Rather than truth telling, we are becoming an economy of liars. The cause is straightforward: crony capitalism. ... If we want to restore our economic freedom and recover the wonderfully productive free market, we must restore truth-telling on markets. That means the end to price-distorting subsidies, which include artificially low interest rates. No one admits to preferring crony capitalism, but an expansive regulatory state undergirds it in practice. Piling on more rules and statutes will not produce something different than it has in the past. Reliance on affirmative principles of truth-telling in accounting statements and a duty of care would be preferable. Deregulation is not some kind of libertarian mantra but an absolute necessity if we are to exit crony capitalism.

If we had any quibble with this article it would be, first of all, along the lines of the utilization of the term "crony capitalism." It seems to us that another term, historically more precise, would be mercantilism. In America, those who regularly deal in sociopolitical terminology seem determined to substitute their own words for words that already available. We don't understand why this is necessary. Somehow, for instance, America lost sight of what "liberal" meant in Europe; thus to use the term "classical liberal" in America often needs an explanation now…

… Likewise, "crony capitalism" may have more of a meaning in America than Europe, though mercantilism has considerable potency in our opinion. We read this in the Library of Economics and Liberty: "In contrast to the agricultural system of the physiocrats or the laissez-faire of the nineteenth and early twentieth centuries, the mercantile system served the interests of merchants and producers such as the British East India Company, whose activities were protected or encouraged by the state." …
… Indeed, the process of mercantilism advantages some private interests over others. The United States, like Europe, has been moving toward a full-blown mercantilist-style system for some time now. Perhaps the system could be termed neo-mercantilism. It doesn't have all the formal elements of mercantilism (as regards government accrual of gold bullion, etc.) but it certainly has supported a strong relationship between a favored business class and the government itself. …

… The problem with such approaches, of course, (from a purely anarcho-capitalist point of view) is that one needs an "enforcer" to ensure that such concepts are properly adhered to, and almost inevitably one may end up with a regulatory authority once again. It would seem, therefore, based on this article and similar rhetoric - especially from CATO which seems to espouse "reasonable" libertarianism - that there is still, even within American libertarian circles, an impulse to distrust markets themselves, and their inherent disciplinary abilities. We would like to offer up the idea that the Invisible Hand itself is a formidable disciplinary device. Wouldn't a company that consistently misleads customers or investors run itself out of business - regardless of whether it was under an affirmative obligation to exercise a duty of care?’

Comment
G. P. O’Driscoll, jr, is the author/editor, 1979, of Adam Smith and Modern Political Economy, Ames. IA: Iowa State University Press.

This long article (follow the link) is quite refreshing and suggests that some new thinking is underway at the Cato Institute (a libertarian think tank) about the status of modern US capitalism.

I have long argued that mercantile political economy did not disappear after Adam Smith; it continued, after the loss of the British colonies in North America, in the Caribbean, Canada, India, South Africa (later most of Africa), in the North Pacific, and Australia and New Zealand. As Britain’s first empire fell away (George III would not compromise on anything, so he lost everything), its second empire grew in strength until full-blown colonialism was back in force. Coinciding with the growth of the modern state – still small by today’s standards – mercantile interests were back in business, so to speak, of which ‘crony capitalism’ is a very American alliteration.

I am not taken with the idea of the ‘invisible-hand’ as a ‘formidable disciplinary device’. How and with what means would a metaphor (for what?) exercise self-discipline? Asking if a company whether a ‘company that consistently misleads customers or investors run itself out of business - regardless of whether it was under an affirmative obligation to exercise a duty of care, invites my not entirely cynical response of: ‘I doubt very much if it would!

Similarly I have little faith in regulation, which I agree, tends to self-proliferate once embarked upon both from ever inventive amendments to existing processes and unintended extensions of the regulations to fringe and peripheral areas to ‘plug gaps’ and ‘evasions’ in the interests of multiplying head counts among the regulators.

Some Good Sense on Trade Policy

John Papola writes in What the Hell do I know? (HERE):

“about 600-year-old defunct economics in the state of the union address?”

“As part of a speech that was marvelously delivered and, as is typical of such things, coated with pandering and economic nationalism, the President made the proclamation that his trade policy would attempt to double American exports. I doubt this was a Steve Jobs-style teaser for a hot new product coming from the Whitehouse that will fly off the shelves worldwide like the Apple iPad. No, this export goal is going to be sought through restrictive government trade and tariff policy. There is a name for this kind of economic policy and it’s nothing new (and certainly not “change”): mercantilism.

Mercantilism is economic nationalism for the purpose of building a wealthy and powerful state. Adam Smith coined the term “mercantile system” to describe the system of political economy that sought to enrich the country by restraining imports and encouraging exports. This system dominated Western European economic thought and policies from the sixteenth to the late eighteenth centuries. The goal of these policies was, supposedly, to achieve a “favorable” balance of trade that would bring gold and silver into the country and also to maintain domestic employment. In contrast to the agricultural system of the physiocrats or the laissez-faire of the nineteenth and early twentieth centuries, the mercantile system served the interests of merchants and producers such as the British East India Company, whose activities were protected or encouraged by the state.

Mercantilism, at its heart, is a deeply pro-merchant/pro-“business” approach to trade, hence the name. Mercantile policy uses protectionist tools like tariffs and import quotas to help the narrow group of exporters at the expense of consumers and society on the whole. Why is Coca-Cola made of corn-syrup instead of sugarcane? Mercantile import quotas on sugar that help out the Domino Sugar corporation at the expense of the rest of us is the reason. Mercantilism is a 600-year-old doctrine, which is funny because many mercantile market skeptics critique the free-market liberalism of Adam Smith as being “our of date” and “a 200 year old doctrine”. Based on age, the trade policy of the Obama administration makes Adam Smith look downright hip."

Comment
You must read this critique of today’s version of the 600 year-old mercantile policy of modern economies. Follow the link. It’s an highly original – and mostly correct – appreciation of what has been going on since Adam Smith’s time.

The facts are that not much notice was taken in practice in regard to Adam Smith’s detailed critique of the mercantile political economy, laid out on Wealth Of Nations (mainly Book IV). Yes, the Corn Laws were repealed, but the British navy and numerous British regiments enforced commercial relations between Britain and subject states throughout the 19th century.

Tariff reform was always on the agenda at some time or another; but kept coming back, and never really went away. It’s not as if Smith advised that all protective tariffs should be scrapped immediately, or overly hasty, or in ignorance of their effects on those dependent on protection to keep their jobs and incomes.

“Slowly and gradually” were Smith’s watch-words.

A Reader is Perplexed by Lost Legacy on the Invisible Hand

[A Reader, Ian B, comments on yesterday's post and his question deserves a fuller treatment than afforded by space on the comments page. It raises issues which may of wider interest. My reply follows.]

Thank you, Ian B, for asking your question and for the polite manner by which you express your perplexity and disagreement.

You will note that the blog is about Adam Smith’s Lost Legacy and has been published since February 2005, during which time I have addressed the “invisible hand” on many – probably on most – occasions.

Economics as a discipline has many problems when dealing with the history of its ideas. Among these we can list several ideas wrongly attributed to Adam Smith, the invisible hand being a prime example.

Few people who quote from Wealth Of Nations, 1776, or his earlier, Moral Sentiments, 1759, have read either of his works and many know very little about him. The minority who have read his works, often attribute to him ideas he never had nor expressed. They go with the flow, like a crowd of latter-day flatterers cheering the proverbial ‘naked emperor’.

The metaphor of the “invisible hand”, used only three times by Adam Smith, once only in each in his two books, and once in his ‘juvenile essay’ on Astronomy, commenced when he was a 21-years old student at Oxford. It was published posthumously in 1795.

The metaphor itself, however, was a popular literary metaphor in both classical times, before the fall of Rome, and from the 17th century through to the 21st century (it appears in one of the “Tarzan" novels). I know of over 40 independent instances of its use, many in books in Adam Smith’s library.

Hence, on the starting-line for a debate on the significance of the “invisible hand” for Adam Smith, we have a popular literary metaphor, his use not commented upon in his lifetime by his readers, and hardly commented upon until the late 19th century by anybody. From mid-20th century until today, floods of references to “Smith’s invisible hand” appear – nowadays daily - and so frequently, that the metaphor and Adam Smith are almost synonymous.

Most comments upon his isolated use of the metaphor impute various meanings to it, for which there is scant evidence that Smith regarded it as imputed(your example is fairly common; but there are many others that are complex, general, and even theological).

In brief then, what do we make of the metaphor of “an invisible hand”? You state that the metaphor is: “simply the (surely reasonable) observation that the economy is self ordering due to the selfish actions of its agents.”

With that view you jump two centuries from Adam Smith’s in Wealth Of Nations. My observation is that whatever the truth of your view, perfectly fine if it is your name only, but it was not Adam Smith’s, and the claim that it was is a “myth”.

You may protest that whatever Smith said or meant is less relevant than the “surely reasonable” observation of many economists that the economy is “self-ordering due to the selfish action of its agents”.

Well, of course, Adam Smith did not consider self-interest to be “selfish”; in fact he went some ways to reject selfishness as an operational motive in economic (and social) transactions. In his earlier work, Moral Sentiments, he explicitly rejected such ideas, as expressed by his earlier “licentious” contemporary, Bernard Mandeville in his “Fable of the Bees” (“Public vice, public virtues”), 1734. (There are several earlier posts on Lost Legacy discussing these particular points.)

I shall move on. You confirm that the metaphor of an “invisible hand”, as understood today, is derived from Adam Smith’s use of it in Wealth Of Nations and you assert that there is “plenty of evidence that confirms Smith's invisible hand - the less regulated the market, the more ordered it is”.

Two problems with your assertion: first Smith never said anything like this in Wealth Of Nations, and second, he found in the case of banking in mid-18th-century Scotland that the absence of certain necessary regulations caused turmoil in the banking sector and required the intervention of law, noting, en passant, that even though this was “a manifest violation of natural liberty” it was necessary because their actions otherwise “endanger[ed] the security of the whole society” (WN II.ii.94: 324).

Let us now look at Smith’s actual use of the “invisible hand” metaphor. First, he used the metaphor only once in Wealth Of Nations; second his use had nothing to do with markets, supply and demand, the absence of regulations, or prices. Those associations for it were invented in the second half of the 20th century by modern economists.

Smith discusses the distortion of the British economy by the diversion of merchants’ capital from the home trade to foreign trade in Europe and with the British colonies in North America. From the British monopoly of all trade with its colonies, and the monopoly influence of the Acts of Navigation (imposed since Cromwell’s time), merchants’ foreign trade could be highly profitable compared to local trade. Likewise, in respect of trade with Europe. However, there were higher risks in such profitable trade: shipping losses, poor investments, local fraud in foreign countries and the colonies, and long delays in turning-over capital for re-use.

Some merchants, but manifestly not all, preferred to invest locally in Britain because, though less profitable, it was more secure for them. It was these merchants that Smith focused on:

“…the annual revenue of every society is always precisely equal to the exchangeable value of the whole annual produce of its industry, or rather is precisely the same thing with that exchangeable value. As every individual, therefore, endeavours as much as he can both to employ his capital in the support of domestic industry, and so to direct that industry that its produce may be of the greatest value; every individual necessarily labours to render the annual revenue of the society as great as he can. He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. 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” (WN IV.II.ii.9: 456).

All merchants are motivated to use their capital most profitably and the only difference between those merchants who engage in foreign trade and those who engage in domestic trade is that the latter do so because of their concerns for their “own security”. We now call this risk aversion. Smith explains that it is their insecurity that leads them to do what they do. In fact, no other explanation is given nor needed.

However, he goes on to point out that their actions have unintentional and unintended consequences, specifically that “By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it”, and it this outcome (society is wealthier, measured by the “annual output of the necessaries, conveniences, and amusements of life”, or what we now call GNP) that people are “led by [NOT “as if by”] an invisible hand”.

But he has already identified the subject of the metaphor: their “own security”. And here we can agree: “no such hand actually exists”, but much of the profession, since the 1950s, has come to believe that there is “an invisible hand”, guiding the market, prices, supply and demand, general equilibrium, social harmony and so on, and on most campuses teach their students to believe that the metaphor is a real object, that it exists, when manifestly it doesn’t, at least to Adam Smith.

It is that “part of Smith's invisible hand [which] is mythical” in my view.

I hope I have elucidated the issues which you raise and reduced, if only a little, your “perplexity” upon reading Lost Legacy for the first time.

Extremism is Seldom Convincing

Ben Linskey writes for the Observer online (London) HERE:

“Health care debate masks real issues"

“There are two basic means by which to do this. One option is to establish a free market, in which the "invisible hand" famously identified by Adam Smith works to distribute goods in the most efficient means possible. The other is to place all economic goods in the hands of a single governing agency and entrust it to use its presumably superior wisdom to determine who should have what. This latter method, of course, is fraught with problems. America has long favored free markets over central planning, but in recent years, the United States have abruptly and dramatically shifted course, bringing many formerly private sectors of the economy under government control and spending at an astonishing rate.”

Comment
Ben Linskey, reportedly a Libertarian, paints the picture in contrasting colours, when in fact it should be monochrome.

For a start Adam Smith did not use the metaphor of the invisible hand to illustrate how it “works distribute goods in the most efficient means possible”. That is a modern interpretation somewhat different from Adam Smith’s idea.

It gives the metaphor an aura it does not deserve nor does it carry it well. It’s what some Libertarians and assorted ideologues wish rather what happens.

I would think this should be abundantly plain to any reader of Wealth Of Nations who reads of Smith’s unfriendly suspicions of how 18th- century ‘merchants and manufacturers’ actually behaved in their steadfast pursuit of monopoly profits, schemes to eliminate competition, lobbying for special favours from legislators, gifts to those who influenced them, and hostility to free-trade for themselves.

Has that much changed in their behaviour today? How many lobbyists does it take to pass legislation in Congress or Parliament?

Smith’s use of the metaphor of the invisible hand in Book IV of Wealth Of Nations related to some – not all – merchants who were risk averse in respect of foreign trade (including with the North American British colonies) and who naturally preferred to trade locally in Britain. By doing so, they added to domestic capital formation, which raised domestic GDP (using modern terminology), considered by Smith, rightly, to be in Britain’s interests).

Markets were analysed in Books I and II of Wealth Of Nations and Smith did not mention the invisible hand as having any role in them. Whether the goods were distributed “efficiently” depended on a host of other factors, including profitability, successful investments, productively, lack of monopolies, the absence of restrictive practices and tariff protections.

Ben’s alternative to his vision of markets led by an invisible hand is “to place all economic goods in the hands of a single governing agency and entrust it to use its presumably superior wisdom to determine who should have what.” This reads more like something Marx and Engel’s might have written. It was not the alternative postulated by Adam Smith to his ideas in Wealth Of Nations.

The alternative to freer markets where possible (not laissez-faire, which was never advocated by Adam Smith), with state-funded and legal interventions where necessary. This was precisely what obtained in 18th-century Britain, the system of “mercantile political economy”, with state interventions at all levels (the Statute of Apprentices; the Settlement Acts; hostile tariff and prohibitions based on “jealousies of trade”, wars of dynastic succession in Europe, the Navigation Acts, and colonies).

Modern states have gone far beyond the interventions of the 18th century, as well as continuing some of the habits inherent in jealousies of trade. That modern societies required new forms of intervention does not decry their need. Smith advocated state interventions in banking, for example, to protect the citizenry even though individually they were “manifest violations” on perfect liberty (WN II.ii.94: 324).

He was never an ideologue, a tag that unfortunately cannot be disclaimed by some Libertarians.

Beyond The Facts

Anthony North posts in Beyond the Blog HERE:

“Let me make something very clear. Greed is not bad. In order to succeed both individually and as a society, we need to be stimulated. Due to this, we have urges. Without them I doubt if humanity would have advanced at all – and greed is one of those urges.

The problem comes in the level of greed we display. Be too greedy and we hurt both ourselves and society, so it’s a matter of balance. Sadly, though, in today’s capitalism we have a glorification of greed, with it getting out of control. This was not how capitalism was meant to be, originally devised by Adam Smith as a
philosophy to go alongside thrift. We seem to have turned something noble into a feeding trough.”

Comment
“Greed is one of those urges” but is it predominant? Is everybody greedy for everything all of the time? I don’t think so. Life would be pretty grim if it was.

Bernard Mandeville, author of “The Fable of the Bees” (1724), developed a whole philosophy on the basis that greed predominated and he gave it his blessing (“Private Vice, Public Virtue”).

Ayn Rand modernised the idea that selfishness was a virtue and created a school for her philosophy (“Objectivism”) which found popularity undergraduates philosophy classes. (You can find some of her lectures on U-Tube, with wide-eyed students listening in awe).

However, greed and selfishness were never popular with Adam Smith. He called Mandeville’s philosophy “licentious” but plausible in parts as an observation of an aspect of human nature in his book The Theory of Moral Sentiments (1759).

Anthony asserts that “in today’s capitalism we have a glorification of greed, with it getting out of control.” Well, is a point of view, though you can read 18th-cxentury sermons in the same tone, and I doubt whether you will find examples throughout history where similar sentiments have not been expressed by someone about their contemporaries.

But Anthony also asserts “This was not how capitalism was meant to be, originally devised by Adam Smith as a philosophy to go alongside thrift.” Where does Anthony get the mishmash of erroneous ideas to compose such a sentence?

There is no such way in which ‘capitalism was meant to be’. Social systems are not ‘designed’ by anyone. The appear in various forms and experience different histories according to how individuals react to circumstances.

Hayek, and others, refer to this as a ‘spontaneous’, or ‘emergent’ order, unintentionally arising by the independent actions of people. That, if I may say so, is their strength. No single person could undertake the myriad of actions that would enable an economy to establish itself, for good or ill.

Which makes the second part of his paragraph, “originally devised by Adam Smith as a philosophy to go alongside thrift”, a misreading of both the emergence of what we call now call capitalism and a misattribution to Adam Smith of that which he had no conscious part.

For a start, Smith neither knew the word, nor the phenomenon of ‘capitalism’. The word itself was first used in English (Oxford English Dictionary) in 1854 by Makepeace Thackeray in his novel, The Newcomes. Smith died in 1790. He couldn’t devise that which did not yet exist, and couldn’t devise a complex economic system even if he had wanted to. In fact, he warned against ‘men of system’ who, ‘wise in their conceit’, force their designs upon others.

Adam Smith was a moral philosopher and saw his scholarly duty as ‘doing nothing, but observing everything’. He analysed how commercial societies functioned in 18th-century Britain – already a major trading economy and major political player in Europe – and wrote in his Wealth Of Nations a devastating critique of mercantile political economy, as practised in Europe.

The players in commercial society dispersed in their private lives did not conform to a master plan for commerce or government. Depending on their history and circumstances their commercial societies grew ‘slowly and gradually’ (some of which struggled because state interventions held back their natural courses and all were affected by the usual ‘jealousies of trade’, petty wars of dynastic succession, legislated anti-competitive tariffs, protections and prohibitions, and the vagaries of different personalities.

To see history as a journey from a sort of ‘ideal’ design towards “a feeding trough” is quite inadequate. Anthony North should re-think his assessments, perhaps read a bit more Adam Smith, and reflect on his current opinions.

Update on 19th Century Mercantile Britain

Up date on yesterday’s notice of Nye’s article on continuing mercantile policies of Britain in 19th century:

Douglas A. Irwin writes to mention his response to Nye’s paper: “Free Trade and Protection in Nineteenth-century Britain and France revisited: a comment on Nye” HERE:

I have yet to read both papers carefully and I shall report later.

Did Britain Ever Adopt Free Trade?

John V.C. Nye’s paper, “Political Economy of Anglo-French Trade, 1689-1899: Agricultural Trade Policies, Alcohol Taxes, and War” is published by the American Association of Wine Economists, as AAWE Working Papers, no 38 Economics, HERE:

From the Abstract:

“Britain – contrary to received wisdom – was not a free trader for most of the 1800s and, despite repeal of the Corn Laws, continued to have higher tariffs than the French until the last quarter of the century.

War with Louis XIV from 1689 led to the end of all trade between Britain and France for a quarter of a century. The creation of powerful protected interests both at home and abroad (notably in the form of British merchants, and investors in Portuguese wine) led to the imposition of prohibitively high tariffs on French imports -- notably on wine and spirits -- when trade with France resumed in 1714. Protection of domestic interests from import competition allowed the state to raise domestic excises which provided increased government revenues despite almost no increases in the taxes on land and income in Britain. The state ensured compliance not simply through the threat of lower tariffs on foreign substitutes but also through the encouragement of a trend towards monopoly production in brewing and restricted retail sales of beer (which began around 1700 and continued throughout the eighteenth century).

This history is analyzed in terms of its effects on British fiscal and commercial policy from the early 1700s to the end of the nineteenth century. The result is a fuller, albeit revisionist account of the rise of the modern state that calls into question a variety of theses in economics and political science that draw on the naive view of a liberal Britain unilaterally moving to free trade in the nineteenth century.” (JEL Classification: F13, H20, N40, N43, N53, O13, Q17)

Comment
I received this paper this morning and was immediately attracted to it by the abstract.

Regular readers may have noted my occasional comment that Adam Smith’s free-trade reputation is often exaggerated and as often it is associated with claims that Wealth Of Nations ushered in an age of free trade policies in Britain. The mercantile political economy, of which Wealth Of Nations was heavily critical, is supposed to have been replaced by grateful legislators persuaded by Smith’s arguments.

I have long suspected that this picture is not just over done; it is absolutely wrong.

The end of the first British empire following the loss of the British colonies in most of North America (Canada, a prize won from the French, remained under the jurisdiction of Britain – from 1789 France turned in on itself; and the Caribbean island prizes remained slave colonies) did not usher in an era of free trade.

The old mercantile habits continued, and with them the lust for empire was nurtured.
In 1788 the penal colony of New South Wales was founded, to which New Zealand was added and the rest of Australia followed, by which time the disgrace that was India under the East India Company was taken over directly by London and the elements of the second British Empire took shape.

Into this mix, the idea grew that British foreign and domestic policy was one of free trade and the end of mercantile political economy with its regulations, restrictions, special interests, and jealousies of trade. I suspect this picture is untrue and I look forward to reading John Nye’s paper as a contribution to correcting part of the image.

I doubt if mercantile political economy has ever really gone away from Britain despite Adam Smith and the Wealth Of Nations and all the talk of major changes in the 19th century. The so-called industrial revolution – more like slow and gradual partial industrialisation – which produced the illusion of success affording the governments of the day the means to practise ‘business as usual’.

I shall keep you posted.

Interesting Reading List and a Surprising Exclusion

Mark Blyth, Professor of International Political Economy
at Brown University writes in Chicobilly and Other Stories HERE:

“WHAT TO READ ON STATES AND MARKETS”

Summary -- An annotated Foreign Affairs syllabus on states and markets.

“As governments around the world have responded to the global economic crisis, questions about the appropriate relationships between states and markets are once again a matter of intense public and policy debate. As the discussion proceeds, the subject's long history is worth bearing in mind. The canonical authors one might think to start with --Adam Smith and Karl Marx -- are not actually all that helpful. Smith's writings on the state should be read against his indictment of the mercantilist system, not in relation to the modern world, and Marx's writings on the state, despite some notable epigrams, are also not particularly relevant to the contemporary era.”

Comment
“Smith's writings on the state should be read against his indictment of the mercantilist system, not in relation to the modern world” is almost correct in so far as it rises beyond the modern (pathetic) assertion that because Adam Smith was severely critical of how 16-18th century government interventions that imposed mercantile policies on behalf of small private monopolies (originally with the best of intentions but soon corrupted by their anti-competitive behaviours), it followed, argued the epigones, that all state interventions were bad, for which they claimed Adam Smith said so. He didn't.

Hence, the myth of the ‘night-watchman state’ became a shibboleth of modern proponents of modern laissez-faire economics.

Ironically, the actual phrase, ‘night watchman state’, indulged in by some over-enthusiastic propagandists of what they call laissez-faire, was a popular utterance of the 19th-century firebrand socialist, Ferdinand Lasselle, when mocking market-minded politicians for not establishing the strongest possible (socialist) state imaginable.

A reading of Wealth Of Nations (Books II, IV and V) shows that Smith's, often biting, criticisms of mercantile state policies did not preclude appropriate roles for a state (predicated on Liberty and Justice), or, as we might put it, ‘markets where possible, state interventions where necessary’).

Follow the link to read Mark Blyth’s recommended reading list – not quite what I would have selected. Also, given that the mercantile state is still with us in many respects, I would think Wealth Of Nations would be an admirable choice too.

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).

Adam Smith Did Not 'Invent' Capitalism

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Natasha Chart writes in Sustainable Food (HERE)
Natasha Chart writes in Sustainable Food (HERE)

‘Market Consolidation and Anti-Trust’

“It would have disgusted Adam Smith, the moral philosopher who invented capitalism, to see such powerful monopolies still running the show and claiming to be following the system he proposed to rid the world of mercantilism and all-powerful guilds.

Comment
We know what Natasha means but, for the record, Adam Smith did not ‘invent capitalism’.

The word itself was unknown in English until 1854 (Oxford English Dictionary) and Smith died in 1790. Smith wrote about ‘commercial society’, as practised in mid-18th century.

Moreover, societies are not ‘invented’ by anyone. They evolve of their own volition from the unintended consequences of the actions of individuals over long time periods. Attempts to ‘invent’ societies always fail (e.g., Marxist , socialist and other ‘utopias’, as, nowadays calls for a complete legislative change from modern capitalism to independent, local, entities), and end up with tyrannies unanticipated by their idealistic initiators.

Adam Smith was a philosopher who ‘did nothing, but observed everything’.

He was a fairly severe critic of the existing commercial arrangements of Britain, but also a very moderate realist about the prospects for major legislative changes in the near future. He believed tariff changes would only work if introduced slowly and gradually because of their disruptive consequences for the labourers affected by unemployment, and for the lack of will among legislators and those who influenced them, for example.

He did, however, propose the repeal of the mercantile Acts of the British Parliament, especially those pertaining to the ‘all-powerful guilds’, the Settlement Acts (preventing labourers leaving their parish to look for work in other parishes), the Apprenticeship Acts (preventing skilled and semi-skilled labourers from exercising their skills in places other than where the served their 7-years as apprentices, and preventing the easier spread of new technologies in 'apprentised trades'), and the legislative abuses of the Acts of Navigation (he agreed with the Act in principle when limited to ensuring that Britain had enough seamen and ships to defend it island from naval attack, but thought the all-embracing monopoly of the colonial trade (with North America and the Caribbean) was detrimental to Britain’s (and the colonists’) interests (see Book IV, Wealth Of Nations)

In the event, some of these changes were not affected until the mid (the Navigation Acts) and late 19th century (universal education provisions).

But, of Adam Smith ‘inventing’ capitalism, there is no evidence whatsoever. That he would see modern society as essentially unchanged from 18th century mercantile political economy that he knew so well (timid steps to free-trade in the major economies, like the US and Europe; predominant popular views associated with ‘jealousies of trade’ and beggar-thy-neighbour' popular policies; wars not for defence and often for indeterminate ends; and the dominant practises of local monopolies, etc.,) I do not agree with Natasha that he would be 'disgusted', or even surprised.

Smith well understood the foibles of people, especially in government and the legislatures. In probably the only prediction he ever made - the future supremacy of the USA's economy over all others by the late 19th century - he would feel vindicated
But 'disgusted' - I don't think so.