Wednesday, March 15, 2017

A SAD CONSEQUENCE OF A MODERN MISUNDERSTANDING

Brian Francis posts (13 March) on Nation News (Barbados) HERE 
As I See Things: Economic Redeemer, no 1”
“Arguably, one of the most highly debated issues in the history of economic thought has to be the efficacy of free markets and their capabilities in generating “best” possible outcomes in relation to inter alia the prices at which commodities are traded, the levels of output, the maximisation of consumer and producer surpluses, and the enhancement of competition among firms.
Discussions along those lines would more than likely begin with the wisdom of Adam Smith and his hotly mooted concept of the “Invisible Hand”.
Indeed, in his most widely recognised contribution to economic discourse, The Wealth Of Nations, Smith’s philosophical perspective is reflected in the fact that he “was guided by one universal principle; namely, self-interest.
Every individual has the desire to better his own lot. It was on this belief that he regarded the entire economic world as a big workshop created by the division of labour.
Indeed, Smith believed that human conduct was governed by self-love, sympathy, the desire to be free, a sense of propriety, a habit of labour and the propensity to satisfy his wants with the help of others. Each man is the best judge of his own interest. If complete freedom is given, a man would make efforts not only to better his own lot, but also would make efforts to promote the general good. Thus, “an invisible hand is behind all human motives”.
But Smith was only one of several economic thinkers whose contributions are reflected in the classical school. No doubt, classical economists believed sincerely in laissez faire. It is no wonder, therefore, that they have advocated “that Government is best which governs least."
COMMENT
What a mixture of occasional insight and popular error!
The History  of Economic Thought long pre-dates Adam Smith’s contributions, insightful and thoughtful as they were. Wealth of Nations, his most famous Work is about that history and decidedly not about the futures, of which he wrote very little. 
Smith did not make predictions, other than his isolated comment on the prospects for the North American, former British colonies, specifically ,that in ‘100 years’ the newly independent colonies would exceed the economic power of the UK (Smith, Wealth of Nations, Book IV, chapter vi, i.c. page 625 (Oxford University, Glasgow Edition, page 625).
Smith’s so-called “hotly mooted concept of the “Invisible Hand” is itself a major misunderstanding of his use (once) in Wealth of Nations to describe the sensible actions of a merchant, who did not trust trading with foreigner’s, nor the probity of their foreign legal systems, who therefore confined his investments to domestic opportunities.
Smith noted that the economic consequences of this situation was that his profitable domestic investment served the merchant’s “own gain”, which was what he was interested in. In addition, his actions led to the economy’s gain. The merchant was “led by an invisible hand” to benefit society which was “no part of his intention” (WN IV.ii.9 p 456).
This simple statement has grown into a almighty mysterious theory - even a solid and certain belief - touted by modern economists as if it is significant, even a law of economics. The facts are much simpler: 
By investing his capital domestically there are two obvious effects: the merchant’s investment adds to the total of domestic investment, just as any consequentual employment adds to the total aggregate of domestic employment. These two effects are inseparable consequences of the merchant’s motivated actions to which the ‘invisible hand’ refers. 
Now this is so clear as to be virtually obvious, even trivial. This alone explains why none of Smith’s contemporaries, who knew him personally, such as Professor Dugald Stewart, the son of Professor Michael Stewart, who was a student at Glasgow University with Adam Smith, mentioned the ‘invisible hand’. Nor did any of the major political economists of the early 19th century - both friends and critics - mention Smith’s ‘invisible hand’. 
The question is why? Because it was so obvious as to be trivial! The whole is the sum of its parts. Of course individual actions add to the whole of domestic investment! So what?
Indeed, it was first discussed in the 1870s, as if the IH was something special. Though mainline economists steadfastly ignored it, until the brilliant Paul Samuelson led the way to a misreading of Smith’s metaphor in 1948 in his Economics textbook (McGraw-Hill) - 5 million sales - and those millions passed on the misinformation to generations of Econ 101 sudents and the invented meaning became an absolute truth and their future careers spread the misunderstanding across the world’s media and into the minds of tens of millions of belivers, including Brian Francis, in deepest Barbados …

Sad.

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