Monday, July 30, 2012

Adam Smith and GDP/GNP Analysis

Evan Soltas, a student at Princeton University, posts on his Blog HERE 
“A New Generation of Econ Data?”
“In the beginning, there was no economics data. Greats like Adam Smith wrote treatises on political economy in the equivalent of near-total darkness. Later economists such as Vilfredo Pareto and Alfred Marshall introduced mathematical foundations, changing the direction of what had been a very qualitative philosophical endeavor. After the Great Depression, Paul Samuelson and John Hicks consolidated Keynes' work into the modern field of macroeconomics -- and they received critical (and I might argue significantly under-appreciated) support from econometricians and statisticians like Simon Kuznets.
I found this article by Evan Soltas interesting, though my comments are directed at this first paragraph.
I am not so sure that Adam Smith and contemporaries wrote “in the equivalent of near-total darkness”, though I get what he means. 
There were no systematic treatises on political economy on hand; there was quite a large pamphlet-size literature on economic subjects written in the 17th-18th centuries, of which Yale (I think) has assembled over 4,000 pieces available (now) for consultation, most of which were not known to Smith (and probably not known en masse to others.  In 1767, Sir John Stuart, a recently returned Jacobite exile, published his 2-volume, Principles of Political Economy, which we know Smith had read, but he did not mention it in Wealth Of Nations.*  Two further sources can be traced from Smith.  First was Cantillon’s privately circulated thesis (1735), mentioned by Smith; the other was Turgot’s more substantial anonymous publication, considered by some scholars to be previous to WN.**
The mathematisation of political economy was of mixed blessing.  It cleared up the fuzziness of language at an eventual cost of removing political economy from contact with reality.  Statistics was also a new subject in the late 18th century (see my history of statistics: “An Invitation to Statistics”, Wiley, 1984 – Amazon now sells it for 1c [!]).
The History of economics may be bit like the history of astronomy; both subjects started with observations melded with a few old concepts; then the concepts took over, and the real world made to fit the new concepts. 
In the case of astronomy this hindered knowledge as the religious concepts of the earth and the heavens circulating the sun ruled supreme as the word of God, until ever improving ongoing observations challenged the concepts, which, once they proved overwhelming,  rescued astronomy from rigid religious concepts.
Economics is going through a stage of the dominance of new concepts, such as theories of homo Economicus with rational humans making rational choices beautifully accounted for by pure maths, which had overwhelmed the political economy of Smith's times.  Maths has taken over; quantitative work – including statistics of behaviour and tests of rational concepts in behavioural games - have kept the debate about the real world alive.
In this process, Smith’s ideas are still worth studying, provided we stick to what he was writing and not to how modern ideas have allegedly made them redundant historically.  Take, for example, Smith’s limited and primitive  ideas on productive/unproductive labour.  In modern GNP work his distinction is disregarded as not precise enough.  Yet it keeps rising in modern dialogues.  Pure government expenditure does not have the same productive effect of market expenditure; the former has to be replaced pound for pound from taxation and borrowing.  Market activity reproduces itself pound for pound, plus additional pounds in the form of profits.  Smith was drawing this distinction which exists though it was not clear enough theoretically for quantification. 
Smith also was inconsistent and the margins were vague.  Government expenditure was not unproductive when it purchases goods and services from private enterprises.   Take defence expenditures (the first duty of government).  Defence suppliers receive revenues from the government, and reproduce the costs of their defence services – they also make a profit and pay their suppliers and the wages of their employees to stay in business.  The defence departments pay their soldiers and seamen, which is unproductive in Smith's sense as these forces do not generate a revenue to cover their costs and the costs of their materials used in defence, but they consume through markets, adding to local revenues.  Much has been written and studied on local defence-sourced multipliers.
Likewise with his example of consumers spending money on wines and their dinners in restaurants, hotels and theatre goers, seeking legal advice, and such like.  Consumers of these services do not reproduce their expenditures – they consume them.  However the restaurants, hotels, theatres, puppeteers, lawyers – even Brothel keepers and the courtesans – are productive in Smith's sense.  They receive incomes that reproduce their costs plus profits.
It is a muddle, true, as expressed in WN, but the point remains; those activities that recover their costs plus a profit add to economic activity and those than do not, do not.  These last are the necessary costs of an economy functioning; those that do recover their costs plus a profit are the necessary revenues that enable an economy to continue and to grow. It is not a GNP analysis as shown in the statistics.  Smith's distinction is still worth understanding, as are GNP/GDP statistics, and their derivation. 

*Smith in correspondence to Adam Ferguson.  Stuart made a case for mercantile tariffs and such like, and while Smith knew him socially, they did not agree (politely).  He told Ferguson that he had “confuted” all Stuart’s arguments in WN without mentioning “his” (Stuart’s) name.
(It was considered impolite in 18th-19th century literature to criticise living persons by name – first and last letters with dashes in between were sometimes used instead  Smith just left Stuart's name out, perhaps to save embarrassing friend).
* Turgot was a senior state official in the French King’s service and was near paranoid about anyone mentioning his name in view of the consequences.  All printing in France was subject to bureaucratic censorship.  Turgot often used aliases and also urged writers not to mention his authorship ever.  From textual evidence, we know Smith used similar expressions from Turgot’s main published work in later editions, after the first edition of WN in 1776, and long after passages reproduced in WN from his Lectures in Jurisprudence, 1762-63.  Turgot had many ideas in advance of anybody else though he sometimes appeared to be quasi-Physiocratic.

Sunday, July 29, 2012

Against the Invisible-Hand Only If It Gets Us Contracts

Zheng Yangpeng and Lu Yanyu  write in China Daily HERE 
On right track for growth model change”
“In an interview with China Daily, Aeroe - whose organization is tasked with helping small business in developing and transition-economy countries - said the Chinese government's very visible hand on the economy, is working better than the international market's often invisible, more natural influences in helping companies here build their competitiveness around the world, and change their image.

"In my opinion, there is no invisible hand (in an economy).

"It doesn't exist. For a well-functioning market, it is amazing how many intelligent policies are needed," Aeroe said.

He said that the government's tackling of issues "simultaneously from industrial development to education to infrastructure to urbanization" has been well planned and delivered, and in contrast to many Western economies, China's evolution is being handled with "long-term vision" in mind, not short-term gain.”
When I read this post earlier today, I thought that the challenge to the myth of the “invisible hand” had reached mainland China.  This would be good news, but my rising euphoria was quickly tempered by reading and noting who said this and what his reasoning may be.
But after several visits to China, Anders Aeroe - a senior director of the World Trade Organization-linked International Trade Centre - says that he thinks the country remains firmly on track to successfully transform its manufacturing-led growth model of the past 20 to 30 years, into a more sophisticated economy, led by innovation and services.

In an interview with China Daily, Aeroe - whose organization is tasked with helping small business in developing and transition-economy countries - said the Chinese government's very visible hand on the economy, is working better than the international market's often invisible, more natural influences in helping companies here build their competitiveness around the world, and change their image.”
Call me cynical but can you spot what caused my excitement to cool?   Look at the clues:
Touting for business in China is not easy.  Especially when you represent a “organization … tasked with helping small business in developing and transition-economy countries”.
Yes, he’s selling consultancy services to small businesses to help them in “developing and transition economies”, which is almost a perfect fit China –  a “transition-economy” country if ever there was one.  And one that has a state bureaucracy, via its national and regional power centres, “tasked” by the political regime to carry out that transition.
The interview in China Daily is a PR job.  Bureaucrats reading the piece, if they are unaware of Anders Aeroe’s visit, may seek him out, as might small ambitious business enquire of the echelons of the State with which they are familiar.
Anders Aeroe covers a political requirement – not mandatory but always helpful – he does not criticize anybody.  He also praises what China is doing, hence does not threaten regime solidarity:
He said that the government's tackling of issues simultaneously from industrial development to education to infrastructure to urbanization "has been well planned and delivered, and in contrast to many Western economies, China's evolution is being handled with "long-term vision" in mind, not short-term gain.
 He said the "interplay between politics and economics" in China has played a hugely beneficial part in changing that business and economic model, and also reported that during his tour of the country he was enormously impressed by the number and standard of business graduates from universities.
 "The interplay ... has certain advantages and allows China to do certain things and help it move faster on its development path, which I don't think has been seen in any places elsewhere in history," he said.”
Now if that does not get him a banquet or two he is not trying.  I am Aeroe does know what he is doing; after all he “heads the ITC's key market development division”,  for which China is a clear priority target, and he has to be good at his job to hold that portfolio.
It seems we shall have to wait a little longer for the penny to drop in China that there is no “invisible hand” in a market economy in China or anywhere else; it is a fiction pushed by economists sympathetic to bigger business when we were under threat from Soviet Russia, as you once were too, to win over our State bureaucrats in market economies to the importance of leaving the market to bigger businesses.  In China the story is inverted: use our business special skills to improve what your bureaucrats are doing without an “invisible hand”.

Friday, July 27, 2012

Cracks in the Invented Invisible Hand Consensus?

I posted the following short comment on Daniel Kuen’s Blog, “Facts and Other Stubborn Things” HERE 
It is not clear to me just who Daniel in criticising
Daniel  writes: “I don't see how you can read Smith as implying some optimal general equilibrium. Smith argues that by pursuing private interests, economic agents promote general welfare. This is obviously true whether a "perfect" Arrow-Debreu general equilibrium holds or not. Identifying the two with each other is a mistake. The contribution of Arrow-Debreu was to rigorously demonstrate the general equilibrium outcomes of a certain type of model of the market that is (rightly) widely in use. Any departure from that optimum ought not to be confused with a non-existence of the invisible hand forces that Smith referred to.
The fact is that Smith's specific (only) reference in Wealth Of Nations referred to some, but not all merchants, from their concerns for the "security" of the capital if sent abroad in the "foreign trade of consumption", preferred to invest in "domestic industry" (mentioned four times by Smith, twice in the relevant sentence in para 9).  Their 'insecurity" led them ti invest domestically and his had the "unintended" consequence that it added to domestic "revenue and employment" arithmetically: the whole is the sum of its parts.  Smith considered this a public benefit. He didn't say anything beyond this.  It said similar consequences applied in "many other" situations, without specifying them.
To suggest that this is a general unintended consequence of self-interested actions, leading to "Pareto Optima", "General Equilibrium", as many modern economists do, or that even "selfish" motives lead likewise, is an absurd attribution to Adam Smith.  He details again and again how the "self-interested" actions of "merchants and manufacturers" lead to higher prices, less competition, and lower domestic employment in such “self-interested" policies as tariffs, protections, prohibitions, monopolists, colonial preferences, the one-sided Combination Acts, the Settlement Acts, Wages set by the magistrate allies of employers, established religions, Primogeniture, Entails, chartered Trading Companies, all of which self-interestes actions directly act against the general interest,  Yet, daily - nay hourly - modern economists are reported, and media sources, continue to pour out nonsense about the existence of an invisible hand in, variously, the market, price systems, supply and demand, and so on. 
That lay-people come to believe in such a fictitious "invisible hand" - let alone that credible figures from our ranks of economists also believe it - though cracks are appearing in the former monolithic consensus sparked of by Paul Samuelson from 1948 - is disappointing. 
I look forward to their recantations of their apparent belief in the fiction of Adam Smith's so-called invisible hand.
PS: I posted my reply and afterwards,when preparing my post for Lost Legacy, I realised I had mistaken the thrust of Daniel's original post.  The above is edited to make clear that I am criticising the thrust of modern economists, not Daniel's posted comments.

Thursday, July 26, 2012

Is Nobody Ashamed?

“7 reasons Wall Street bankers’ brains act bizarre” Insatiable Gorilla,  Invisible Hand and fear of death
Paul B. Farrell reports iin MarketWatch HERE 
Our Insatiable Gorilla is actually a metaphor for something far more profound, that Gorilla is the all-almighty Invisible Hand of capitalism that Adam Smith deified in his works on “The Theory of Moral Sentiments” and “The Wealth of Nations.”
Yes, the Insatiable Gorilla we all know is the mysteriously cryptic Invisible Hand guiding capitalism in the new century:”
This particular piece of nonsense was destined for the next group of Loony Tunes to be posted, until I read further and found it referred to a speech by the President at a Morgan Stanley get together, where apparently the theme of the President’s speech was how “Working at Morgan Stanley” is like making love to a gorilla,” He was I assume only half joking.
The rest is too tiresome to repeat.  What a state modern economics is in when it leads to such silly comments from a major banking institution, presumably in charge of billions of dollars of investment upon which millions of jobs rely.  Let along the overall prosperity of US capitalism.
And this nonsense is laid at the door of Adam Smith, encouraged by my colleagues giving it intellectual respectability!  Are none of them ashamed even just a little at what they have done since 1948 to spread this direct falsification of Adam Smith’s life work?  And not just the neoclassical school is culpable, but also Hayek, et al, and assorted Austrians too.  Even Heterodox economists join the consensus spread the nonsense as well.

Give Credit Where Credit is Due

Doug Brady reports that Adam Gropnik in the New Yorker claims that ”that Adam Smith would have had no trouble with Barack Obama’s recent remarks about how the existence of public roads nullifies the significance of individual accomplishment and justifies the administrative state.
I noted this piece in a “Conservatives 4 Palin” Blog post  HERE   The piece originates from Yuval Levin in National Review  HERE 
Yuval Levin continues:
Count me a skeptic. Gopnik is certainly right to say that Smith believed that markets were created and sustained by public policy, and that building infrastructure is an important public purpose which government should pursue. Everyone else believes that too. Obama’s assertion that his opponents disagree with that is preposterous. But as Gopnik also notes, Smith was an ardent critic of what we today would call crony capitalism. His case for the approach he lays out in The Wealth of Nations begins from a critique of the then-reigning economic approach known as mercantilism, under which each of the European powers set market rules that served the interests of a few large domestic manufacturers and trading companies that worked closely with the government—putting economic policy in the service of what they took to be the national interest, in order to advance the nation’s trading position. Smith argued that legislators should instead govern the market in the interest of the common consumer, and that the interest of that consumer would be best served by intense, open competition among producers that did not privilege large and well-connected businesses over smaller and newer rivals.
Crony capitalism—and a preference for a few large companies in each part of the economy that will function as agents of the government and be rewarded and protected accordingly—is the core of the Obama administration’s approach to the economy. It’s the essence of Obamacare and Dodd-Frank, for instance. And it is decidedly not about open competition in the service of the common consumer’s interest. You can name your new agencies consumer protection bureaus all you like, what they’re doing is making the economy more consolidated and easily manageable from the center, rejecting competitive enterprises in favor of public utilities. That’s basically the opposite of Smith’s vision.
I agree with Yuval Levin and I acknowledge Doug Brady’s role in bringing it to our attention.  I think it is a perceptive rebuttal of the oft-heard view that the state is a natural ally of big business in a corporate-state relationship.
However, I must tread carefully here because, as the comments in the National Review on Levin’s piece show, it is risky to appear to get involved in the mist enveloping the politics of other countries, of which I do not know much and in which I do not vote.  Even mentioning controversial names, like Mrs Palin or President Obama, in an election year invites trouble from their respective 'enemies'.
My interest, however, is in what Adam Smith said about these issues.  He saw an important role for government (defence, justice, public works, education of all ages and treating “noxious diseases”).  All these areas of expenditure would expand as the country’s economy and the political requirements of the growing population increased, as we know happened.  Where and how much the state’s responsibilities would expand is, and remains, a prime political question, i.e., controversial.   Currently, we face a problem where expansion of the states has been fueled by borrowing beyond the creditors’ willingness, or capacity, to fund their ever-increasing borrowing.
But the point remains that Smith was not antagonistic to state spending, nor was he in favour of a “night watchman state”.  Such choices were open to the will of the legislature (not the King’s alone).  He was critical of politicians who though they knew best what people, or the economy, wanted or required, and of those who influenced them and who pursued narrow sectional interests (in his day, those of landed interests or of “merchants and manufacturers).

Wednesday, July 25, 2012

Amartya Sen on Mathematics

Over on Lars P. Syll's Blog HERE 
he reports an interview of Amartya Sen by Olaf Storbeck and Dorit Hess on the state of modern economics from 24 July.
Among the topics discussed by Sen he comments on the role of mathematics in economics in a far more positive slant than I often give it on Lost Legacy.
While I accept that mathematics is a useful gateway for students to gain admission to an economics degree course at Harvard, Cambridge, Oxford, etc., I question its overly prominent role for mathematics in economics theory and practice.
Statistics, yes, and perhaps  there is a role for elementary maths to assist reasoning, but rigorous higher maths?  I am less sure, especially when the maths take over and the economics becomse divorced from any resemblance with reality.
If economists cannot distinguish between a philosophical assumption of self-interest of an individual and miss the absolute requirement of Smith's assumption that the postulated self-interest of an individual requires to be mediated by concerns for, and attention to, the self-interests of others, as is the clear case with modern treatments of Adam Smith’s elementary example of bargaining with the  “butcher, brewer, baker” example, then I worry about the conclusions drawn by mathematical economists that Smith somehow postulated that self-interested individuals pursuing their narrow self-interests (tariffs, monopolies, pollution and such like) somehow leads to general pubic benefits, as asserted in the usual attribution to Smith's "invisible hand".  Such reasoning is an absurdity from which competence in maths does not save them
I suggest readers visit Lars P. Syll’s Blog and read it regularly. It is thought provoking.  

Loony Tunes no. 60

Paul Krugman was lying on the canvas, stunned by the invisible hand.”
David Bush HERE
Shaun Connell on Seeking Alpha HERE 
Prices can be seen as the writing on the wall by the invisible hand.”
By John Cole HERE
The Invisible Hand of the Free Market will provide a solution, as soon as it gets its Holy Fingers unstuck from the Gay Chicken Muppet-Puppet of excessive govt regulations.

Tuesday, July 24, 2012

The Delusions of Utopia

Gerrit Wiesmann and Chris Bryant write in The Financial Times about Berthold Huber, the head of Germany’s huge carworkers’ union, IG Metall. HERE 
“A German union of dogma  and pragmatism”
“The global crisis destroyed the intellectual foundation of the “recent type of shareholder-capitalism”, he says with quiet intensity. “No one believes in the selflessness of self-interest any more, in the invisible hand of the market, though to reduce Adam Smith to that is wrong.”
After some seconds of silence, he adds: “He was a highly moral person. I know, because I’m one of the few people to have read all of him.” …
He says that the performance of communism in East Germany compared to the performances of capitalism as far as the living standards and employment conditions of workers made a lasting impression on his outlook as a trade union leaders.
“That’s what finally convinced me one has to deal with real problems. It can’t be about forcing Utopias into existence, it has to be about shaping real life.”
I can concur with Berthold Huber’s observation from my limited experience of visits to East Germany in the early 1980s, and my comparatively more numerous trips to West Germany from the 1970s.   Visions of so-called utopias, be they economic, political or religious, are mainly delusionary and they can sometimes be dangerous too.
I am pleased that Berthold Huber is wide-awake to the myth of “the invisible hand of the market” and what appears to be its supposed relationship to the “selflessness of self-interest”.
Now, why are we lumbered in Britain with trade union leaders imbued with a passion for Marxist-Trotskyist delusions about a coming revolutionary utopia leading to a better kind of socialist utopia than the one already failed in East Germany?

Monday, July 23, 2012

American Thinker, Not Thinking?

Bruce Johnson writes 23 July on American ThinkerOn Schooling Liberals HERE 
Which 'invisible hand' do we prefer?  The one referred to by Adam Smith and Milton Friedman?  A 'hand' that acts as people act for themselves?  An arrangement in which individuals, in an effort to improve themselves financially, provide goods and services or improve goods and services, to the betterment of all.  Or, another type of  'invisible hand' ?  One which is in your pocket and extracts money for use by the government, as the government sees fit?”
As a populist statement of the benefits of markets “to provide good and services or improve goods and services, to the betterment of all” over government taxation for political purposes that may not be beneficial to tax payers it seems a no brainer.
However, it misses important realities of life experienced by all of us (and observed by Adam Smith in the Eighteenth century too).  This description by Bruce Johnson, written in good faith I have no doubt, makes no mention of Smith’s other, equally valid, observations that some, but not all, individuals who provide goods and services, do not always do so for the “benefit of all”, or indeed anybody but themselves and the minority who purchase them. 
These less positive facts of experience should also be weighed in the balance, otherwise Bruce Johnson (and Milton Friedman) might be found wanting and called to account for discrediting the thrust of their better points.  Adam Smith pulled no punches in highlighting how some, but not all, merchants behaved well short of the ideal asserted by Bruce Johnson, and less blatantly by Milton Friedman.
Consider the behaviours of those “merchants and manufacturers” in Wealth Of Nations who clamoured loudly for tariff protection, even prohibitions, against imports from rivals. Such agitation was not aimed at “the betterment of all”.  It was cynically aimed at the “betterment” of the individuals who “provide[d] good and services or improve goods and services” for higher prices because competitive imports were curtailed or excluded altogether. Such producer of goods and services used governments (from their politicking with legislatures) to fix markets against the interests of consumers.  They manipulate markets to “extract money for” their own benefit and not for the benefit of their customers. 
Worse still, they decry government taxation for political ends with which they and we may not sympathise, but they and their lobbyists also use governments to legislate against competition to the detriment of consumers.
On this occasion, American Thinker is not thinking.   Adam Smith was not impressed by such behaviour.  Neither are we. They discredit the case for markets where possible and government where necessary.

Adam Smith's Morals

Chief Rabbi Lord Sachs writes “Profits and Prophets HERE 
There used to be a belief among superficial readers of Adam Smith, prophet of free trade, that the market economy did not depend on morality at all: “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.” It was the brilliance of the system that it turned self-interest into the common good by what Smith called, almost mystically, an “invisible hand.” Morality was not part of the system. It was unnecessary.
This was a misreading of Smith, who took morality very seriously indeed and wrote a book called The Theory of Moral Sentiments. But it was also a misreading of economics. This was made clear, two centuries later, by a paradox in Games Theory known as The Prisoner’s Dilemma. Without going into details, this imagined two people faced with a choice (to stay silent, confess or accuse the other). The outcome of their decision would depend on what the other person did, and this could not be known in advance. It can be shown that if both people act rationally in their own interest, they will produce an outcome that is bad for both of them. This seems to refute the basic premise of market economics, that the pursuit of self-interest serves the common good.
The negative outcome of the Prisoner’s Dilemma can only be avoided if the two people repeatedly find themselves in the same situation. Eventually they realise they are harming one another and themselves. They learn to co-operate, which they can only do if they trust one another, and they will only do this if the other has earned that trust by acting honestly and with integrity.
In other words, the market economy depends on moral virtues that are not themselves produced by the market, and may be undermined by the market itself. For if the market is about the pursuit of profit, and if we can gain at other people’s expense, then the pursuit of profit will lead, first to shady practices (“your silver has become dross, your choice wine is diluted with water”), then to the breakdown of trust, then to the collapse of the market itself.”
Arguing with a distinguished religious scholar is not something I do regularly (though I commented last week on something Lord Sachs wrote) but he strikes me as a person with which one can discuss differences without rancour. 
He certainly knows more about Jewish theology than I do, given that what little I do know came from a Presbyterian upbringing that included fair slices of the Old Testament (I know even less of Islam). Hiowever, Lord Sachs demonstrates knowledge of economics, including Games Theory, and I am qualified to take issue with him on that which he demonstrates, in the quotation above.
On his broad theme that morality and market behaviours are important – perhaps decisive – I entirely agree with Lord Sachs.  I am not so inclined to agree with his interpretations of Adam Smith in Wealth Of Nations and of more recent ideas such as Prisoner’s Dilemma.  In both cases, with respect, I suggest he has missed the moral point.
First take the now famous, and as widely misunderstood, reference of Adam Smith to: “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.”  Humans in no economic or social system has ever been able to survive on the total benevolence of other people alone.  That is an impossible aspiration, dare I say, this side of heaven. 
Whereas God, by theological assumption, has all the resources of the world, indeed of the universe, at his disposal and therefore could be benevolent in the extreme towards all living creatures and still have resources to spare, no humans have access each day of their lives to supply everybody’s else’s human needs – somebody has to labour to acquire whatever resources are needed for her (since the expulsion from the Eden Garden) to benevolently dispose of a proportion of them to satisfy everybody else’s needs.  This is not a particular moral failing of today; it’s been a fact of life since Genesis (in theological terms).
The moral issue comes down to how resources are distributed for our dinners.   Why do “butchers, brewers, and bakers” enter into Adam Smith’s equation?  Because, he opined, it was in their self-interest to do so.  He advised those searching for the wherewithal for their dinners to enter into a dialogue (not a one-sided monologue!) with those whose self-interest brought them into consideration by those searching for their dinners in their own self-interests.
How is this dialogue to be conducted?  Smith advised potential diners not to “talk of their own necessities” but to “address the self-interests of the “butcher, brewer and baker” (and, of course, vice versa).  This point seems to have escaped the attention of Lord Sachs and all those many others who draw the same wrong moral conclusion. 
Self-interest is not a license to be “selfish” or “greedy”.  Far from it.  It is an admonition to serve our own self-interests by mediating with the self-interests of the “butcher, brewer and baker”.  In this, each of us becomes a merchant.
In short (Smith’s previous paragraph), the nature of each bargain is summed by the expression “Give me this that I want and you shall have that which you want”.  (In modern negotiating, I express this as “IF you do this for me, THEN I shall do that for you”). The exact contents of each such bargained dialogue is determined by how each party adjusts his own self-interest to the other party’s self-interest.  That is a very moral proposition.  Two egoistic self-interested demanders, uninterested in the self-interests of each other would never reach an agreement. That was the moral and pragmatic point of Smith’s parable. Morality was part of the system. It was absolutely necessary. 
On Prisoner’s Dilemma, I am not sure that Lord Sachs has got this post-War theorem (1950) correctly formulated, though, of course, it was not an idea considered by Adam Smith 174 years earlier (1776).  The two prisoners were offered a deal to chose separately without consultation among: both confess (10 years each in jail); one confessed but the other didn’t (the confessor serves 20 years, the silent one, goes free, there not being enough evidence to convict him); both stay silent (both go free).   What do they each do individually? It depends on what they think their partner will do!
Having supervised real-world negotiators thousands of times playing single-shot and multi-shot Prisoner’s Dilemma games, I can concur that most pairs were stumped at playing what was in their best interests as pairs.  They either ended up serving 10 years each or one serving 20 years and the other going free.  Very few chose the option that meant they both went free, mainly because they did not trust the other to choose not to confess.   But note that law observance in society, gained from one or both serving prison terms.  However, consider if they was a trustworthy ‘honour among thieves’, and they both chose to ‘not confess’, society would not have benefitted and their criminal immorality would have been rewarded.  (I have not the space to discuss this further in respect of observing many thousands of plays of the ‘Red-Blue’ game – perhaps another time?). But the gist of the moral conclusions of Prisoner’s Dilemma game illustrates the conflict between personal morality and the healthy morality of society.
Lastly, I have not commented on Lord Sachs’s remarks about the attribution of a moral role to the “invisible hand”: Lord Sach’s writes ”It was the brilliance of the system that it turned self-interest into the common good by what Smith called, almost mystically, an “invisible hand.”   Regular posts on Lost Legacy challenge this attribution to Adam Smith, so I shall not repeats them here.  Lord Sachs can cast his eye over many posts on the subject. Suffice to say, Adam Smith had no such ideas as expressed by many modern economists and there was nothing “mystical” in his use of the popular 17-18TH century metaphor.  That there was is an wholly modern invention from Paul Samuelson (1948) and others.

Sunday, July 22, 2012

Does General Equilibrium Theory Make Economics a Hard Science or a Fantasy?

Lars P. Sylls Blog carried a post on “Why general equilibrium economics is a dead end” by Franklin M. Fisher
(21 July, 2012) HERE
Almost a century and a half after Léon Walras founded general equilibrium theory, economists still  have not been able to show that markets lead economies to equilibria.
We do know that – under very restrictive assumptions – equilibria do exist, are unique and are Pareto-efficient.
But after reading Franklin M. Fisher‘s masterly article The stability of general equilibrium – what do we know and why is it important? one has to ask oneself  – what good does that do?
As long as we cannot show, except under exceedingly special assumptions, that there are convincing reasons to suppose there are forces which lead economies to equilibria - the value of general equilibrium theory is nil.  As long as we can not really demonstrate that there are forces operating – under reasonable, relevant and at least mildly realistic conditions – at moving markets to equilibria, there can not really be any sustainable reason for anyone to pay any interest or attention to this theory.
A stability that can only be proved by assuming “Santa Claus” conditions is of no avail. Most people do not believe in Santa Claus anymore. And for good reasons. Santa Claus is for kids, and general equilibrium economists ought to grow up, leaving their Santa Claus economics in the dustbin of history.
Continuing to model a world full of agents behaving as economists – “often wrong, but never uncertain” – and still not being able to show that the system under reasonable assumptions converges to equilibrium (or simply assume"
I am inclined to agree with the above comment/review by Lars Sylls, from his Blog and with the reported skepticism of Franklin M. Fisher about the value of theories of general equilibrium as taught in neoclassical economics departments. The relatively simple maths (to physics majors) of economics allegedly ‘prove’ to social science majors at least that economics is a hard science and worthy of the admiration of real scientists.  It certainly can be hard for less numerate students but whether it is a real science is another matter. There are reports of physicists smiling indulgently at such claims by some economists.
Mathematically minded economists, in my experience seldom indulge their fellow economists who prefer to study the real world rather than the imaginary world of general equilibrium.  Adam Smith, no mean mathematician himself – it was his favourite subject at Glasgow University and afterwards – studiously avoided applying his mathematical skills to his treatment of political economy. Hence he did not make presumptions about aspects of general equilibrium applying to his approach to Wealth Of Nations.
Franklin M. Fisher appears to agree coming at general equilibrium from another angle – it is disconnectedfrom the real economy. Lars P. Sylls also seems to be skeptical of its value too. So do I.

Friday, July 20, 2012

Falsehoods No Guide to Adam Smith

Micah Murphy speaks of “falsehoods” undermining empires but commits (unintentionally, I'm sure) a falsehood about Adam Smith while doing so in a post in ‘Truth and CharityHERE 
The Hersey of President Obama”
“Adam Smith, for all the good his thought may have done, believed that it was man’s greed and self-love that should drive the economy.
The Adam Smith who was born in Kirkcaldy in 1723, as opposed to the invented “Adam Smith”, lauded by some modern economists at Chicago University in the 1930s, did not articulate “beliefs that it was man’s greed and self-love that should drive the economy” (see Paul Samuelson’s account in Economics: and introductory analysis, p 36, 1948)
The Adam Smith who wrote Moral Sentiments and Wealth Of Nations spent considerable efforts to dissuade readers from accepting the writings of Bernard Mandeville (‘Fable of the Bees’, 1724) in praise of selfishness, which he described as “licentious”.   Mica also may be confusing Ayn Rand and her sympathy with “selfishness” with Adam Smith’s philosophy of self-interest as a driver of behaviour (a common mistake of modern commentators).
Adam Smith’s self-interest theory was clearly constructive when it was mediated by concern for the self-interests of others as specified, foe example in  “the butcher, brewer, and baker” example in Wealth Of Nations.  Two egoistic self-interested neighbours would never agree to anything.