Tuesday, April 10, 2012

A Political Scientist Mostly Right on the Invisible Hand and General Equilibrium Theory

Jonathan Schlefer writes (10 April) in Harvard Business Review “There is no invisible hand” http://blogs.hbr.org/cs/2012/04/there_is_no_invisible_hand.html?utm_source=twitterfeed&utm_medium=twitter

A short extract below but follow the link and read the whole post. He says useful things about general equilibrium theory.

One of the best-kept secrets in economics is that there is no case for the invisible hand. After more than a century trying to prove the opposite, economic theorists investigating the matter finally concluded in the 1970s that there is no reason to believe markets are led, as if by an invisible hand, to an optimal equilibrium — or any equilibrium at all. But the message never got through to their supposedly practical colleagues who so eagerly push advice about almost anything. Most never even heard what the theorists said, or else resolutely ignored it.

Of course, the dynamic but turbulent history of capitalism belies any invisible hand. The financial crisis that erupted in 2008 and the debt crises threatening Europe are just the latest evidence. Having lived in Mexico in the wake of its 1994 crisis and studied its politics, I just saw the absence of any invisible hand as a practical fact. What shocked me, when I later delved into economic theory, was to discover that, at least on this matter, theory supports practical evidence.

Adam Smith suggested the invisible hand in an otherwise obscure passage in his Inquiry Into the Nature and Causes of the Wealth of Nations in 1776. He mentioned it only once in the book, while he repeatedly noted situations where "natural liberty" does not work. Let banks charge much more than 5% interest, and they will lend to "prodigals and projectors," precipitating bubbles and crashes. Let "people of the same trade" meet, and their conversation turns to "some contrivance to raise prices." Let market competition continue to drive the division of labor, and it produces workers as "stupid and ignorant as it is possible for a human creature to become

The sorry invisible hand myth owes more to imagination and hope than it does to economics from Adam Smith. Its modern form really began its take off with Paul Samuelson’s successful textbook, “Economics: an analytical introduction”, McGraw-Hill 1948, and continued through to edition 20 in 2010. It had an earlier oral presence at Chicago (where Samuelson was an undergraduate) and Cambridge, England (A. C. Pigou). Even Oscar Lange postulated (1938 and 1947) a rival and “better” invisible-hand role by socialist planners. The Soviet planned economy challenged capitalism from the 1930s and in Cold War rivalry, with large communist parties and social-democratic in Western Europe, the myth asserted the innate superiority of capitalism with its “invisible hand”. Since the current recession, increasing questions appeared about its existence. Warren Samuel’s last book, “Erasing the Invisible Hand, essays on a elusive and misused concept in economics”, 2011 (Cambridge) exposes the modern history of the mythical “invisible hand” since its heyday from the 1960s through to the late 1990s.

Jonathan Schlefer's last sentence on the division of labour is woefully wrong as representative of Adam Smith's meaning. See my criticism of Chomsky's allusions to the same misreading,



Blogger Paul Walker said...

The point about the "invisible hand" or more correctly the price/market system is not that it is perfect - it would only be so if people were prefect - it is that it is better than the alternative.

"The financial crisis that erupted in 2008 and the debt crises threatening Europe are just the latest evidence."

I can't help that think that the crisis is evidence against the "visible hand" of government.

9:44 am  
Blogger Gavin Kennedy said...


If the "invisible hand' is the "price/market system" then the metaphor is redundant. It was not redundant when Adam Smith used it to "describe its object in a more striking and interesting manner" (Smith, Lectures on Rhetoric and Belles Letrres" (1762), p 29. And its object in TMS, the absolute necessity for landlords to feed the "thousands whom they employ", and in WN, the security concerns of the merchant who traded domestically, rather than abroad. Incidentally, both motives were "hidden".

Markets work by the very visibility of their prices.

The habit of contrasting government actions as "visible" is part of the modern argument for government actions. It seems to me, that you are right to question just how "visible" government actions are in practice. Why governments act this way rather than that way, is deeply controversial, as are politics in general.


2:07 pm  

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