Monday, January 14, 2008

Invisible Hand no 358

Mike Munger, Duke University, ‘Munger on the Nature of the Firm’ does an hour podcast on EconTalk (Russ Roberts) here. It is introduced with this:

Adam Smith quote: Individuals are led, as if by an invisible hand. Paradox: Most economic activity in developed economies isn't led by price at all. It's led by some boss. Command and control. People are led by explicit directions of ...”

Adam Smith did not say: ‘Individuals are led, as if by an invisible hand’. That even distorts the words he did say on the only occasion in Wealth Of Nations where he used the metaphor of ‘an invisible hand’:

By preferring the support of domestick to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as it producer 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 to promote an end which was no part of his intention. (WN IV.ii.9: 456)

Note the key words ‘he intends only his own security’. He refers to risk avoidance. He takes the risk when the state imposes tariffs on and when profits from foreign trade are significantly higher, as they were under mercantile political economy, the subject of Book IV of Wealth Of Nations, but if the tariffs were removed he would invest locally to the benefit of himself (lowering his risk avoidance) and to the benefit of the domestic economy (‘the whole is sum of its parts’). This does not even refer to the operation of markets (a common enough myth among some economists).

Note this was not a statement about a general connection between individual behaviour and the socially beneficent consequence. It occurred, Adam Smith suggested, in ‘many other cases’, but not all and, from the rest of Wealth Of Nations, by no means a majority of cases. For instance Adam Smith mentions on over 50 occasions, when individual self interests led to consequences anything but beneficent for society.

I give the page numbers from Books I and II where the invisible hand is definitely not active:

Some instances of individuals promoting their self interest which do not ‘promote the public interest’ in Wealth Of Nations:

WN: 11; 36; 40; 43; 51-2; 61; 73; 77; 78; 79; 80; 83; 84; 90; 91; 95; 100; 106; 112; 113; 115; 116; 124; 125; 126; 135; 136; 137; 138; 139; 140; 141; 142; 143; 144; 145; 146; 151; 152; 153; 154; 156; 157; 158; 160; 174-5; 285; 339; 340; 342; 344-5; 346; 348; 349.

There are many more in Books III, IV and V.

Here’s the official blurb on EconTalk (always good value, as is Mike Munger), raising issues familiar to those who are acquainted with Ronald Coase’s works:

Mike Munger, of Duke University, talks about why firms exist. If prices and markets work so well (and they do) in steering economic resources, then why does so much economic activity take place within organizations that use command-and-control, top-down, centralized structures called firms? Within a firm, most of the goods and services that the workers use are given away rather than allocated by prices--computer services, legal services and almost everything else is not handed out by competition but by fiat, decided by a boss. A firm, the lynchpin of capitalism, is run like something akin to a centrally planned economy. Munger's answer, drawing on work of Ronald Coase, is a fascinating look at the often unseen costs of making various types of economic decisions. The result is a set of fascinating insights into why firms exist and why they do what they do.”


Blogger Paul Walker said...

raising issues familiar to those who are acquainted with Richard Coase’s works:

*Ronald* Coase.

7:34 pm  
Blogger Gavin Kennedy said...

Thank you for the correction. I shall change it. But I do remember the Coase Theorem from my undergraduate days in the 1960s.

10:09 pm  
Blogger Michael Munger said...

I'm appalled!

Usually I correct others on that point, and here I committed the error myself. The "as if" changes everything, and I have long had the misuse of it among my list of peeves and crochets.

In fact, at first I listened to the tape, assuming you were misquoting me. To my

Thanks for the rebuke, which is well deserved. I shall note it in comments on the podcast site.

Always a pleasure, sir, even if my face is currently rather red.

3:15 pm  
Blogger Gavin Kennedy said...

It's only a minor error and slip of an expression.

I only commented upon it because it is often repeated by persons less knowledgeable than yourself and they might gain comfort from reading it.

Best regards

5:20 pm  

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