Friday, February 03, 2006

Invisible hand, no 29:

Adam Smith is often credited with supporting events in the daily news by people who manage to get him wrong or to accuse him of nonsense he did not write, but which they believe he wrote because they picked up something somebody else told them long ago in a poorly taught Economics 101.

A classic example a few days ago (27 January – apologies for commenting on it late but I have been in rural France and my Internet connection was via a single telephone wire, not broadband) appeared in, Asheville, (‘voice of the mountains), North Carolina, USA, under the Editorial heading, quoting the Wall Street Journal:

“Automakers forced to innovate and improve, as must rest of US industry”.

The piece below includes the following assertions, partly disguised by the word ‘probably’:

Adam Smith would probably applaud Ford Motor Co.’s decision to cut 34,000 jobs from its North American work force and idle 14 North American factories.
For years, the Wall Street Journal says, Ford and GM relied on making a lot of money on a few products, mostly SUVs and trucks, to cover losses or bolster slim profits on small and midsize cars. They built vehicles, even when sales of those vehicles were slow, to keep factories running and avoid paying wages required by union contracts to idled workers

What possible evidence do the editors of the Citizen Times adduce for this story?:

To Smith, whose “Wealth of Nations” published in 1776 is viewed by many as the seminal work in economics, paying workers to make something no one wants would constitute major market inefficiency.

“Wealth of Nations” was written as feudalism was giving way to the Industrial Revolution. It challenged and was largely responsible for discrediting mercantilism, a system of controls on industry that bore heavily on the rising merchant classes and that saw foreign trade as primarily a means of strengthening the state. The idea behind mercantilism was to bolster the state’s coffers.

‘Feudalism’ (a form of land ownership complete with tied labour) gave way to landlords and yeoman/tenant farming long before the ‘industrial revolution’ in the 19th century, itself a century subsequent to Adam Smith’s time on Earth (1723-90). I am not sure that ‘Mercantile’ political economy (‘mercantalism’ was not a word known to Smith nor anybody else in the 18th century) ‘that bore heavily on the rising merchant class’.

Mercantile policies certainly ‘bore heavily’ on the labouring poor and the unemployed tradesmen, who were denied the right to work in a trade unless they had served seven-year apprenticeships and which denied them the right to leave their parish and seek work in another one without meeting near impossible conditions (written permission from the local church minister read out at the end of Sunday church services plus a residence duration of 30 days without work).

Smith saw labor, rather than commodities or land, as being the real source of a nation’s wealth.”

Not quite. Smith saw the nations’ wealth as the annual output of products (we call it Gross Domestic Product nowadays) and not the amount of gold or silver bullion held in the nations’ strong boxes. I think the editors are confusing ‘wealth’ with some speculations Smith suggested about the source of ‘value’. This is not the place to elaborate on this latter misconception about Smith.

The annual labour of every nation is the fund which originally supplies it with all the necessaries and conveniences of life which it annually consumes, and which consist always either in the immediate produce of that labour, or in what is purchased with that produce from other nations,” he wrote.


“… This proportion must in every nation be regulated by two different circumstances; first by the skill, dexterity and judgment with which its labour is generally applied; and, secondly, by the proportion between the number of those who are employed in useful labour. ... Whatever be the soil, climate or extent of territory of any particular nation, the abundance or scantiness of its annual supply must, in that particular situation, depend upon those two circumstances.”

Yes, but it is not clear if the editors understand what Smith was on about.

In other words, wealth rests in the knowledge and productivity of the people of a nation, not in the commodities or the natural resources it possesses.”

To be productive Smith argued that labourers had to be employed in occupations that produced goods that were sold in markets. Being employed “to keep factories running and avoid paying wages required by union contracts to idled workers” does not make labourers productive. It is a situation that cannot last indefinitely – the employer eventually runs out of money to pay wages. If this was not true, then we could print/borrow money to ‘employ’ people to do nothing and everybody would be ‘wealthy’. But Smith did not say anything about whether this or that policy was ‘good’ or ‘bad’, nor that he would ‘applaud’ a policy of sacking 34,000 employees (or employing them). In his days work forces of over 20 were extremely rare in Britain (excluding the church, the government and the armed forces – the Royal Nay employed over 200,000 at the height of wartime).

The editors’ killer assertion follows:

He proposed that allowing people to pursue their own self-interest, pretty much unfettered, would benefit society as a whole and that the “invisible hand” of the market would self-correct over-pricing, oversupply, and other market inefficiencies.”

To which the editors add the nonsense:

Thus, it would seem, Ford, GM and DaimlerCrysler have been touched by the market’s invisible hand.”

Smith said nothing of the sort. He used Shakespeare’s metaphor (Macbeth 3:2) of the invisible hand only once in “Wealth of Nations” and it had nothing to do with market ‘efficiencies’, not even with markets, and there were no Smithian markets with an invisible hand in his writings on markets that “would self-correct over-pricing, oversupply and other market inefficiencies.”

His use of the invisible hand metaphor was about motivations that had unintended outcomes (the so-called ‘law of unintended consequences’) that on some occasions benefited society and on others worked against society’s interests. Monopolists were motivated to raise prices against consumers, restrict competition and over-charge consumers. If they were left alone to ‘pursue their own self-interest, pretty much unfettered’, they made society worse, not better, off.

“Ford, GM and DaimlerCrysler’ have not ‘been touched by the market’s invisible hand”. They have been driven by the effects of the brute course of events that are well understood by economists (who get past Economics 101). There is nothing invisible in markets, nothing mysterious and nothing miraculous.

Ford, GM and DaimlerChrysler can see and read the figures in their accounts, look outside their office windows at the visible lines of unsold vehicles, read the reports coming back from dealers, visit dealers’ showrooms and see the unsold vehicles for themselves, film the unsold stock to show to their colleagues on the Board and read the proposals for action from the CEO and the Financial Director (and read messages from their Banks, other creditors and letters from shareholders) and act accordingly.

In fact, you do not have to bring Adam Smith into the discussion at all, but if you must, please stop dragging in the usual nonsense about invisible hands, alleged images of Smith ‘applauding’ an event over 200 years after he died, and assertions about the history of political economy that you do not understand and consequently get wrong.


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