Friday, September 16, 2005

Markets Are Not Mysterious - We Know How they Work

"Financial Literacy Matters at All Ages"
(Korea Times, 13 September) by Dr. Horst J. Kayser, President & CEO of Siemens, Korea

“Why is it that in a market economy everybody maximizes his personal benefit and still is able to contribute greatly to the social good when the mechanism of the “invisible hand,” as Adam Smith called it, works freely and if individuals act according to the rule of law?”

Dr Kayser confuses a view attributed to Adam Smith with what he actually wrote in “Wealth of Nations” (Book 4, page 456). His so-called ‘invisible hand’ (actually Shakespeare’s in Macbeth: 3.2) applied to a single situation he described when traders preferred to place their scarce capital stock locally (where they could monitor it) rather than abroad (where they couldn’t). They did this to protect their investment more easily, but in doing so they benefited the national economy. His comment was about personal motivation and not about how markets operated. It was possible for personal motivations – self-interest - to work both benignly and malignly. Not all self-interest works for the common good (monopolists, polluters, anti-competitive businesses, employers who treat their workforces badly, etc.).

Others attributed near mystical powers to markets and extended Skakespeare's metaphor under Adam Smith's name, into a ‘mysterious’ mechanism. But Smith knew (and the rest of us know) how markets operate; there is not need to mystify them, nor consider them miraculous. Significantly, Smith did not refer to the invisible hand when he analysed markets in Book 1 of “Wealth of Nations”.


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