Wednesday, December 31, 2008

Two Paragraphs, One Completely in Error, the Other Absolutely Right

Jeff Schweitzer, who served at the White House during the Clinton Administration as Assistant Director for International Affairs in the Office of Science and Technology Policy, writes “The Big Lie Exposed: Wall Street as Institutionalised Fraud” in the Huffington Post, HERE:

Wall Street is everything that Adam Smith feared. Smith, the father of modern economics, said that the invisible hand only works in a society adhering to moral norms that prohibit theft and misrepresentation. Yet theft and misrepresentation are the twin gods of Wall Street.”


The market looks nothing like that envisioned by Adam Smith. In stark contrast to Smith's theories, the Street's history is nothing but one of fraud for the simple reason that the entire enterprise is built on a deeply fraudulent idea: that the future can be predicted.”

Two paragraphs; one absolutely fictitious (the ‘invisible hand’ had to do with “society adhering to moral norms that prohibit theft and misrepresentation”) and one absolutely right (“a deeply fraudulent idea: that the future can be predicted).”

For the first paragraph, what more can Lost Legacy comment on the myth of the invisible hand? Read my posts in any week from this past year (or past years) and there is likely to be an explanation of the origins of this myth.

Briefly, one more summary: Smith discusses how markets work in society in Books I and II of Wealth Of Nations without mentioning the metaphor of ‘an invisible hand’. Not a lot of people, especially among economists and those they advise, seem to know this.

In fact, the sole reference to ‘an invisible hand’ is in Book IV of Wealth Of Nations (IV.ii.9: p 456, OUP/Liberty Fund edition 1976; Edwin Canaan, 1937 ed. p 423, Random House).

Smith used this popular 18th-century literary metaphor only once after explaining why some (not all!”) risk-averse owners of capital-stock preferred to keep their capital investments close to them rather than undertake the greater risks (and greater profits) of sending it abroad to the British colonies in North America, and how this resulted in local domestic investment in projects and consequent local employment being larger than it would otherwise be (the whole being the sum of its parts arithmetically).

Nothing was said about how markets work, and nothing about “society adhering to moral norms that prohibit theft and misrepresentation” associated with ‘an invisible hand’. Moral norms were central to Adam Smith’s thinking, but had nothing to do the metaphor of ‘an invisible hand’.

From anecdotal tales and oft-repeated media assertions, most people – among whom I think Jeff Schweitzer is probably included – appear to believe that Adam Smith’s Wealth Of Nations is replete with ‘his’ so-called ‘theory’ of ‘the invisible hand’ of the ‘market’ and the ‘happiest of all possible happy societies’ (after Voltaire). It was a two word metaphor used only once in Wealth Of Nations; it was not a theory.

For further elucidation, may I suggest you download my paper, “Adam Smith and the invisible hand: from metaphor to myth" from the Home page of Lost Legacy (click the red words near the top of the page).

The second paragraph is true: the future cannot be predicted. Adam Smith did not make predictions about the future. And because the future cannot be predicted a great deal of modern economics is pure, though lucrative, mumbo-jumbo.

Banks, corporations, investment analysts, governments and their agencies, all hire high-salaried economists to predict the future; tv programmes and the media run regular features on the future of stocks, currencies and funds.

Like sporting outcomes, the unknown future creates the professional ‘science’ of probability, dressed up as prediction, otherwise known as gambling.

But this too had nothing to do with Adam Smith. When he mentioned ‘fortune’ it was clear that he considered it unpredictable.

Only in the models of neoclassical economics – absent as they are of people – do the players have perfect knowledge of each other’s preferences. On this paragraph, I agree with Jeff Schweitzer; as for the other paragraph we could not disagree more.



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