Thursday, February 03, 2011

Better to be Mostly Right Than Mostly Wrong (2)

[In the Comments to ‘Being Mostly Right is Better Than Being Mostly Wrong’ (yesterday), Jacob Levy questions my assertions about Smith’s meaning in using the Invisible Hand metaphor and I respond as below.

First, Jacob’s comment.]

Jacob Levy:

“While you seem to have dug much more deeply into this than I have, I have doubts about your late dating of the spread of "invisible hand" as a shorthand for Smith's economic thought, or of its use out of proportion to the importance the metaphor actually had for Smith. I have open in front of me F.W Maitland's A Historical Sktech of Liberty and Equality, 1875, pp. 130-31, which treats it as already the general received wisdom that "invisible hand" and "natural harmony of economic interests" are the same idea, and takes the trouble to show that Smith's belief in them was more limited than was (already, in 1875) widely believed.”

And my (long) response:

“Your thoughts on the importance to Adam Smith of his use of the metaphor of an invisible hand are challenging; they are not, in my view decisive. That F. W. Maitland (1850-1906), as a professor of the laws of England at the University of Cambridge, wrote about Adam Smith’s use of the invisible hand metaphor (IH metaphor), he reflects what is known of the existence Cambridge oral tradition (delivered in lectures and tutorials, rather than in print, which while interesting as a reflection of that oral tradition, they do not demonstrate that the oral tradition expressed Adam Smith’s meaning (Maitland’s ‘Historical Sketch’ is available from Liberty Fund)
.
The influence of Maitland, and a handful of others from the 1870s, was not comparable with the far more decisive explosion in daily references to the IH metaphor in its modern forms from the 1950s. This new 20th-century phenomenon started in the economics discipline after Paul Samuelson’s highly successful and ground-breaking Econ 101 textbook, Economics: an introductory analysis (1948), and took-off over its 19 editions. A wide spectrum of graduate economists, plus those many ‘one-semester only’ readers, took the IH metaphor to their campuses and professional work on a scale wondrous to behold – to sample this phenomenon, read for a week-or-two the free, daily ‘Google Alerts’ for ‘Invisible Hand’ in the world’s media each morning on your PC.

As Samuelson put it, his and earlier, generations, took:

This unguarded conclusion [“the mystical principle of the “invisible hand”] has done almost as much harm as good in the past century and a half, especially since too often it is all that some of our leading citizens remember, 30 years later, of their college course in economics (Economics, 1948, p 36)’.

Today, the IH metaphor is ubiquitous, and like a virus (simile) has spread well beyond the millions of attendees at a ‘college course in economics’. It has recently become more controversial, too. Stigler announced recently that ‘it does not exist’, and while encouraging, he was not for the ‘right’ reasons. Also the current the ‘anti-market’ tone of the questioning is disappointing, but so is the failure to realise that Adam Smith made no explicit references to the IH metaphor being a metaphor for markets (nor for perfect competition, the welfare theorems, or general equilibrium). For Smith it was a metaphor and is to be read as such, and the object of the metaphor in his use of it clearly stated when and where he used it.

Smith’s use of the IH metaphor, in contrast, was hardly mentioned until long after he died in 1790. Dugald Stewart, his close family-friend, used Wealth of Nations as the supporting text in his Lectures on Political Economy, delivered at the University of Edinburgh, from 1801. When his lectures were published in the 1850s, they included, in extensive footnote form, extracts from Wealth Of Nations. The IH metaphor passage is among these extracts, but is not commentated on in the lectures as significant. Nor do Smith’s critics in the 1800s mention it; Ricardo’s ‘Principles’ does not discuss it, and I have found no reference to it in Mill or Marx (factual corrections always welcome).

The few references, post-Maitland (1875) certainly show that the IH metaphor was around and understood as you suggest. But so was the alleged doctrine of ‘Adam Smith’s laissez-faire’, the roots of which were closer to Manchester School ideology (pressed on behalf of the mill and mine owners in the legislature) than Smith’s critique of mercantile political economy, which did not mention laissez-faire, nor the other assertions which your article correctly identifies (hence, my point about it being ‘Better to be Mainly Right’, which you are in respect of the bulk of your article).

A. C. Pigou mentions the IH hand metaphor in his welfare economics lectures and text and points to the deficiencies of competition in respect of disagreeable externalities, which, he argued, require, correction by government taxes or subsidies. Others, for example, Alexander Grey in Edinburgh, who included the IH metaphor in his excellent History of Economics (1931, Longmans) when discussing Adam Smith; he placed a theological gloss on it. Oscar Lange, a Marxist, appropriated the Chicago oral tradition (alluded to by Samuelson, above) in 1938 and 1946, to incorporate the IH metaphor in his socialist economics as a task best left to socialist planners because of ‘market failures’ (a more authoritarian response than Pigou’s).

Now, what none of these authors, nor those who quote them with relief – as if secondary sources are definitive and are articulate what Adam Smith meant when he used it (I draw this conclusion with many debates in Lost Legacy with articulate and civilized exponents such as Daniel Klein and David Freidman). They reject my references to Smith on the use of metaphors (he was a long-standing lecturer on Rhetoric in Edinburgh, 1748-51, and in Glasgow 1752-64; we have student notes of his Lectures on Rhetoric and Belles Lettres’ [1762-3]). Klein and Freidman reject the critical key to Smith’s meaning – what was the object of the IH metaphor as he used it, not how they attribute it to him?

All references to wider meanings about ‘markets, prices, and systemic harmony’ are imputed, often by modern concepts of which Smith and his readers were unfamiliar, and by allusions to which he was, if anything, and certainly in the modern contexts claimed, hostile – such as ‘selfishness’ being overcome by it.

Markets operate, not by a ‘magical’, nor theological, invisible hand, but by a very visible price system, clearly delineated by Adam Smith in Books I and II of Wealth Of Nations – the dynamic supplied by the very visible (in Smith’s terminology) relationship of ‘natural’ prices and ‘market’ prices – the former based on costs, of which the producer is well aware and respectful – it’s his money; the latter based on variable effectual demand in the market each day, on which his profit – and survival – may depend. If he covers his costs (inclusive of his profit) he continues; if he doesn’t he adjusts his behaviour as quickly as he can. He is not ‘led’ by ‘an invisible hand’ to do this. The driver is very visible, not invisible, because in market prices have to be visible for buyers and sellers to enter into and conclude exchange transactions. They must address each others’ self-interests, not just their own.

The ‘invisible hand’ metaphor refers to what cannot be seen, such as the private motivations of the parties. To assume and assert that it is merely about global ‘self-interest’ that drives them is empty of explanation (no mathematical terms exists for the IH in all the equations). Smith makes this point well in Wealth of Nations.

The merchant’s self-interest may be to make a profit (he can’t make one if he suffers losses), but to make a profit he has to take risks when undertaking the costs of producing his items for sale. Risks are not equal or certain in all activities; some activities may be perceived more risky than others. The security of his capital outlays is important (in the 18th century, utter destitution awaited losers). If an activity is associated with higher risks than another that is available, some, but not all, merchants tend to avoid the more risky venture if they can.

In Smith’s sole example in Wealth Of Nations, some merchants are influenced to avoid foreign and colonial trades and prefer to trade locally. Smith details the reasons of their insecurity for this in the paragraphs preceding his use of IH metaphor and specifically states why they prefer to invest in ‘domestick’ trade. By thus avoiding their perceived risks of foreign trade, they are led to add to the only alternative of ‘domestick’ investment, which adds to the annual output of ‘necessaries and conveniences’. Only arithmetic is required to understand this – he was writing for legislators and those of who influenced them, not maths graduates, like himself, and we call that rule: the ‘whole is the sum of its parts’. Wealth consisted of the ‘annual revenue and employment’ from the ‘conveniences, necessaries, and conveniences of life’.

I venture to suggest that his mostly educated readers would likely have studied classical languages, English and rhetoric too, and they would be familiar with the role of a metaphor: to connect to its object, and to express it in a “more striking and interesting manner” (Smith: Lectures on Rhetoric and Belles Lettres, [1762-3) Liberty Fund, p 29). Yes – that’s all!
I would further suggest that the invisible hand was a very common figure of speech as a metaphor in the 17th-18th century, mainly in theology, sermons, and literature. Many before and after Smith used the same metaphor in scores of context. He did not invent it. He simply stated its object, as his students and educated readers would expect. The main reason why his contemporaries made nothing of Smith’s use of the IH metaphor, is simply because they could see what he was doing, and saw him use many other metaphors, some memorable (‘Daedalian wings of paper money’) and some execrable (‘waggon-way through the air’ (WN II.ii.p 321).

Practical business people today know they can see how markets work by the very visible instrument of prices. They do not need ‘an invisible hand’ to do that.

To paraphrase a Hollywood scriptwriter: “Show me the price! And only then I may decide whether to give you the money”.

Gavin"

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