Adam Smith & the Invisible Hand

In response to a comment by David Chester regarding Adam Smith and the Invisible Hand, I am reproducing the section in the paper which deals with this issue. This answers his question about how what is attributed to Adam Smith differs from what he actually said.
[Excerpt from the paper: Failures of the Invisible Hand]

Section 6: Recent Vintage of the Invisible Hand

The main goal of this section is to show that the modern interpretation of the IH is relatively recent. The idea that Mankiw (together with other modern economists) attributes to Smith is not actually present in Smith’s writings. In fact, modern writers borrow the authority of Adam Smith to provide weight to a very dubious idea of recent coinage.

We first note that modern interpretation of the “IH” is radically different from any interpretation of this concept that existed before the second half of the twentieth century. There is a growing body of literature (e.g., Grampp, 2000; Minowitz, 2004) which insists that the metaphor used by Smith was never meant to be anything more than a metaphor, and that the meanings inferred from Smith’s idea of IH by the modern economists support only their own interpretation of economic policies. Kennedy (2009) shows that three leading modern economists laud the IH as the “profoundest” and “most influential” contribution of Adam Smith. Nonetheless, their interpretation of the term and its significance is not supported either by Adam Smith or by readers of Adam Smith until the late nineteenth century.

In a corpus of over a million words, the terms IH appears only twice in the economic writings of Adam Smith. It is used only once in the Wealth of Nations in very limited and narrow context. Rothschild (1994) analyses the controversy surrounding the meaning of IH and concludes that what Smith meant by this metaphor was only a “mildly ironic joke.” Blaug (2007) also shows that Adam Smith cannot be blamed for these ideas. He cites other references which state that:

Some economists regarded the Arrow-Debreu results [on the existence of general equilibrium] and the fundamental theorems of welfare economics as the modern expression of Smith’s invisible hand . . . . But Smith would be surprised at what is attributed to him today . . . . On careful reading Smith does not say that selfish behavior is praiseworthy, is bound to pay, or necessarily promotes the best interests of society . . . . The passage containing the invisible hand metaphor is not about general equilibrium theory: its purpose is to explain why merchants would continue to buy British products even if tariffs were removed.

Ashraf, Camerer, and Loewenstein (2005) make a detailed analysis of Smith’s pioneering work The Theory of Moral Sentiments to conclude that “For Adam Smith, a mixture of concern about fairness . . . and altruism played an essential role in market interactions, allowing trust, repeated transactions and material gains to occur.” In sharp contrast to the modern economists’ unwarranted understanding of the IH metaphor as a sanction for selfish behavior, Smith explains that justice is in fact only a rational behavior. Fear of retribution is likely to deter the people from committing injustice. He says: “Nature has implanted in the human breast, that consciousness of ill-desert, those terrors of merited
punishment which attend upon its violation, as the great safe-guards of the association of mankind, to protect the weak, to curb the violent, and to chastise the guilty.” See Smith (1759, p. ii, iii, 125). Realizing the crucial role of justice, especially in ensuring just behavior, he believes that justice is the “main pillar that upholds the whole edifice. If it is removed, the great, the immense fabric of human society . . . must in a moment crumble to atoms.” Fairness and justice have only recently attracted the attention of economists as providing justifications for many observed human behaviors in conflict with standard utility maximization theories, see Karacuka and Zaman (2012) for a brief survey.

REFERENCES:

Ashraf, N., Camerer, C. F., & Loewenstein, G. (2005). Adam Smith, behavioral economist.
Journal of Economic Perspectives, 19, 131–145

Blaug, M. (2007). The fundamental theorems of modern welfare economics, historically
contemplated. History of Political Economy, 39, 185–207

Grampp, W. D. (2000). What did Smith mean by the invisible hand? Journal of Political
Economy, 108, 441–465

Kennedy, G. (2009). Adam Smith and the invisible hand: From metaphor to myth. Econ Journal Watch, 6, 239–263

Minowitz, P. (2004). Adam smith’s invisible hands. Econ Journal Watch, 1, 381–412

Rothschild, E. (1994). Adam Smith and the invisible hand. The American Economic Review, 84, 319–322

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Failures of the Invisible Hand

Rafi Amir-ud-Din and Asad Zaman “Failures of the ‘Invisible Hand’”
Forum for Social Economics Vol. 45, Iss. 1, 2016 pp 41-60.

Textbooks, like Mankiw, state that the four claims listed below are at the center of modern economics. Our goal in this paper is to show that all four of these claims are wrong.

1.      Participants in market economies are motivated by self-interest. (SI) – In fact, cooperation, service, recognition and status in community, and reciprocity are very strong motivators of human behavior.

2.      Decentralized market economies work very well, and maximize the welfare of society as a whole. (FM:  free markets). As illustrated by the Global Financial Crisis, unregulated markets lead with regularity to disasters and crises.

3.      The reason for excellent functioning of decentralized market economies is that all participants are motivated by self-interest. This self-interest works better than love and kindness in terms of promoting social welfare.  (GG:  greed is good). This is absolutely false, and the opposite of the truth – love and kindness work much better at promoting social welfare.

4.      The principles listed above were summarized in the concept of the “Invisible Hand” by Adam Smith. (AS). Adam Smith can be blamed for many wrong ideas, but this is not one of them. In fact, free market economists attribute this theory to Adam Smith to create legitimacy for their ideas. 

Detailed presentation of the paper is available in the following 1 hr. video.

Engaging students in the Law & Economics WEA Conference

The WEA Online Conferences format, designed by Edward Fullbrook and Grazia Ietto-Gillies, makes full use of the digital technologies in the pursuit of the commitments included in the World Economics Association Manifesto: plurality, competence, reality and relevance, diversity, openness, outreach, ethical conduct, and global democracy. The WEA On-line Conferences seek to also engage graduate and undergraduate students considering: (a) the variety of theoretical perspectives; (b) the range of human activities and issues which fall within the broad domain of economics; and (c) the study of the world’s diverse economies.

The current WEA Conference Public Law and Economics: Economic Regulation and Competition Policies  aims to:

(i) discuss how sector regulators and competition authorities are interacting post-crises and how the economic analysis of law can help countries reach better regulation and competition policies;

(ii) contribute with practical and theoretical references on the limits of economic power and forms of state intervention;

(iii) deal with the uncertainties and challenges of the digital economy;

(iv) gather relevant case studies and

(v) identify new trends in Law and Economics that have arisen post-crises.

 

We invite you all  to read the following conference papers at http://lawandeconomics2017.weaconferences.net/papers/ and send your comments

• Predatory Innovation: The Definite Need for Legal Recognition
• Deepening versus Widening the EU: Where to go?
• Should competition authorities care about conglomerate mergers?
• The Efficiency-Growth Dilemma: An Analysis of Regulation’s Impact on Short and Long-Term Development
• Competition Assessment in developing countries: Policy challenges after the global crisis
• Opportunism by Competition Authorities in Ireland, Portugal and Greece in the Wake of Economic Crisis›
• The Internationalization of Merger Review: Extraterritoriality, Conflicts and Convergence
• Structural Change and Protection: Non-Tariff Measures in ASEAN

 

 

The Mathesis Universalis and Neoclassical Economics

As Edward Fullbrook highlights in his recent book Narrative Fixation in Economics, the Cartesian view of human reality has deeply shaped the way Neoclassical Economics theorizes about the economic and social existence (2016, p. 45). Indeed, while emphasizing the relevance of the pure thought of a disembedded human subject,  Neoclassical Economics has reinforced the relevance of the Cartesian method of inquiry  that moved the so called scientific (true) knowledge  out of the general flux of experience.

In the second part of the Discourse of Method, Descartes presented some principles that should be followed in order to acquire knowledge: 1) human beings cannot  admit any ideas that are not absolutely clear; 2) human beings must divide each problem in so many parts as appropriate for its best resolution; 3) human beings should apply deductive reasoning to organize their  thoughts from the simplest to the most complex ones 4) the analytical-synthetic process of reasoning leads to true knowledge.

According to Descartes, the first principle of his method focuses the importance of “never accepting something as true that I clearly don’t know as such” (Discourse of Method, Part II). Indeed, Descartes inspired himself in Geometry as a model of Science. As a result, he considered the postulates of Geometry not only as universal and necessary but also as clear and distinctive ideas related to intellectual intuition. Only these clear and distinctive ideas  are considered to be the pillars of true knowledge.

Based on the second principle, Descartes builds his research method of analysis that isolates the clear and distinctive ideas from the most complex ones. His emphasis on the order of thoughts strengthens the role of Mathematics in the Cartesian method of pure inquiry. Moreover, the third principle of his method leads to a special kind of organization of thoughts. In his own words, the organization of thought should start “with the simplest and easier to gradually rise, as if by means of steps, to the knowledge of the more composed, and assuming an order between the ones that don’t precede naturally each other” (Discourse of Method, Part II).

Departing from the mathematical method of reasoning, Descartes arrives at the notion of order in scientific thought, that is to say, once the human subject knows the simple elements of a problem, he can assume all the consequences that derive from those first ideas considered as absolutely certain. Those first ideas have the characteristics of clarity and distinction. Besides, they are known intuitively and constitute the pillars on which relies true knowledge.

Finally, Descartes reinforced the analytical-synthetic process of reasoning. Following the deductive method of pure inquiry, human knowledge grows throughout a rigorous chain of ideas. As a consequence, new thoughts arise while the human subject applies deductive reasoning so as to create a chain of ideas that links the most simple to the most complex ones. In this attempt, true knowledge can be obtained.

As a matter of fact, the Cartesian method presents the intellectual intuition and the deductive reasoning as crucial elements of the discovery and construction of true knowledge. Moreover, clarity, distinction and order overwhelmed the mathesis universalis that turned out to be considered as the pinnacle of the epistemo-ontological construction of Cartesian thinking.  The mathesis universalis is, according to the Cartesian epistemology, a general method of pure inquiry able to explain everything, regardless of the nature of the objects to be studied.

As E. Gilson (1945) highlighted, the Cartesian method represents an attempt to extend the mathematical method of inquiry to all of human knowledge in the form of the mathesis universalis.  Indeed, this extension is at the center of the a priori foundations of scientific knowledge in Neoclassical Economics.

 

 

 

References

DESCARTES, René.  Discurso do Método. São Paulo: Abril Cultural, 1973.

FULLBROOK, E. Narrative Fixation in Economics, WEA Books, 2016.

WILLIAMS, Bernard. Descartes: The Project Of Pure Enquiry. UK: Penguin, 1978

The Human Development Revolution

Because of Western dominance, brilliant thinkers from the East get very little attention in global media. Even though brilliant economists from East Asia and China have created globally acknowledged economic miracles in their countries, none of them have received a Nobel Prize. On the other hand, Western economists whose theories were demonstrably in conflict with the events that took place in the global financial crisis — like Lucas, and Fama — have received Nobels. One of our greatest un-sung Eastern Heroes is Mahbubul Haq. My recently published article describes the revolution he created in economic thought:

Goethe starts his famous East-West Divan with a poem about the journey (Hegire), both physical and spiritual, from the West to the East. In this essay, we consider the analogous journey from Western to Eastern conceptions of development. This involves switching from viewing humans as producers of wealth, to viewing wealth as a producer of human development. To start with the Western conceptions, both Adam Smith and Karl Marx defined economic growth as the process of accumulation of wealth. The range of diversity of Western thought is bounded by the Left-Right spectrum. Ideas on which both extremes agree command widespread consensus in the West. Consequently, a core concept of modern economic theory is that wealth is the means and ends of the process of economic development. Unfortunately, due to the dominance and influence of Western paradigms, this concept has been widely accepted and adopted in the East today.

Mahbubul Haq was indoctrinated into the Western development paradigm which gives primacy to wealth at leading universities, Yale and Harvard. He got the chance to apply these economic models as the chief economist in Pakistan during the ’60s. However, because of his Eastern upbringing and heritage, he was able to see the murderous message at the heart of the cold mathematics of the Solow-Swan growth models. These models focus on savings, created by reducing present levels of consumption, as the only route to the accumulation of greater future wealth.

Mahbubul Haq realised what is not mentioned in the economics textbooks: obsession with production of wealth requires us to use the sordid and cruel tactic of making workers produce wealth, and refusing to allow them to consume it, in order to buy machines and raw materials. He was clear-sighted enough to see the consequences of these policies: wealth did indeed accumulate, but it went into the pockets of the 22 families, without providing relief to the misery of the masses. Today the global application of capitalist growth strategies has led to a dramatic increase in inequalities both inside nations and across nations. Just one among many horrifying inequality statistics is that the top 13 individuals now have more wealth than the bottom 3.5 billion on the planet.

Dissatisfaction with state-of-the-art Western growth theories led Mahbubul Haq to a revolutionary insight, taken from the heart of the traditions of the East, and having no parallels in current Western economic theories. Instead of capital, Mahbubul Haq placed human beings at the centre of the process of economic growth, returning to the ancient wisdom that “human beings are the means and ends of development”. Even though he was called a heretic for going outside the boundaries of contemporary economic thought, the pragmatic genius of Mahbubul Haq sought to minimise differences and create bridges to conventional thinking in order to achieve acceptance for his radically different approach to development.

His Human Development Index (HDI) was a master stroke, combining two inherently incompatible conceptions of development in a compromise which ceded ground to wealth in order to create international visibility for poverty. His friend and classmate Amartya Sen was reluctant to accept the HDI because of certain inherent flaws in this marriage of fire and water, but eventually agreed to its practical necessity. The pragmatic approach of Mahbubul Haq paid off handsomely when the HDI measure achieved global recognition as rectifying major defects in the standard GDP per capita. Widespread acceptance and use of HDI has led to a radical change in the discourse on development, by adding poverty, health, education and other soft social goals to the pure and simple-minded pursuit of wealth. The revolutionary ideas of Mahbubul Haq have led to improvements in the lives of millions, as global consensus developed on the social goals embodied in the MDGs and SDGs.

The Human Development approach of Mahbubul Haq was carried further by Amartya Sen, who defined development as the freedom to develop human capabilities. This notion, closely aligned with Eastern thought, was so alien to orthodox economists that they rejected it. Consequently, a new human-centred field of development studies emerged, which combined many streams of dissent from orthodoxy. Unfortunately, leaders at the helm of policymaking in the poor countries of the world are trained in orthodox economic theories, and have not assimilated the radical lessons of Mahbubul Haq, acquired from bitter experience. The paths to genuine development lie open, but with their backs to the doors, they are unable to see them.

Conventional growth theories create the mindset that the game is all about wealth creation. We will worry about our poor population only after we acquire sufficient wealth to feed them. The poor are a burden on the development process because providing for them takes away from money desperately needed to finance development of infrastructure, purchase of machinery and raw material, and industrialisation. We cannot afford to feed the poor, if we want to grow rapidly. The human development paradigm stands in dramatic contrast to this currently common mindset among planners. Instead of utilising humans to produce wealth, we utilize wealth to develop human capabilities. Our human population, our poor, are our most precious resource. This point of view receives strong support in the empirical findings of a recent World Bank study entitled “Where is the Wealth of Nations?” The study finds that the wealthiest nations are rich because they spend money to develop their human resources, and not because of natural resources.

Thus, instead of being a burden, our poor are our most efficient means to development. If we use available wealth to improve their lives, to empower them, to educate them, and to provide them with the support they need, they can rapidly change the fate of the nation. Furthermore, they are also the end of the development process — that our goal is NOT to produce more and more wealth, a la Adam Smith and Karl Marx — but to ensure that our people lead rich and fulfilling lives. If we use our energies to achieve this goal, we have already arrived at the destination — we do not need to wait for a distant future where sufficient wealth will accumulate to enable us to take good care of our people.

Published in The Express Tribune, May 20th, 2017.

Meta-Theory and Pluralism in the Methodology of Polanyi

Currently, I am teaching a course in Advanced Microeconomics where I have started with the premise that conventional economic theory, both Micro and Macro are fundamentally wrong. The number of ways in which they are wrong cannot even be counted. Instead of enumerating errors, the course is devoted to providing a constructive alternative. A lot of the early lectures deal with the basic concepts of optimization and equilibrium, the fundamental building blocks of conventional courses, and explain how these are wrong. I also explain how economists are using a wrong methodology, and how they misunderstand the concept of a theoretical model, and the relations between models and reality. The video-taped lectures, PPT slides, and some supporting materials, are available from my website: https://sites.google.com/site/az4math/

Originally, I had not planned to teach Karl Polanyi because his theories are significantly more complex than those of Karl Marx and Adam Smith. However, because the class has been very receptive, and has understood the what I have been teaching, I have decided to explain his ideas. We have already started discussing his ideas starting from Lecture 13, and have finished Part I of the Great Transformation in Lecture 16. In order to prepare for the complexities of Part II, I have distributed the following handout to the class, to explain the complex general methodological framework which underlies Polanyi’s analysis.

Realism in Economics

A relevant feature of the current crisis in economic knowledge is the recurrence of the  Ricardian Vice. Joseph A. Schumpeter coined this term in his book History of Economic Analysis when he criticized the habit assigned to Ricardo to represent the economy by a set of simplified assumptions and to use tautologies to develop practical economic solutions. Indeed, Schumpeter rejected the kind of economic thought that mainly favours deductive methods of inquiry – based on mathematical reasoning- because the  habit  known as the Ricardian Vice generates analytical unrealistic results that are irrelevant to solve the real-world economic problems.

Also Keynes warned that the understanding of the economic phenomena demands not only purely deductive reasoning, but also other methods of inquiry along with the  study of other fields of knowledge- such as History and Philosophy. In his own words:

“The study of economics does not seem to require any specialised gifts of an unusually high order. Is it not, intellectually regarded, a very easy subject compared with the higher branches of philosophy and pure science? Yet good, or even competent, economists are the rarest of birds. An easy subject at which very few excel! The paradox finds its explanation, perhaps, in that the master-economist must possess a rare combination of gifts. He must reach a high standard in several different directions and must combine talents not often found together. He must be mathematician, historian, statesman, philosopher – in some degree. He must understand symbols and speak in words. He must contemplate the particular in terms of the general, and touch abstract and concrete in the same flight of thought. He must study the present in the light of the past for the purposes of the future. No part of man’s nature or his institutions must lie entirely outside his regard. He must be purposeful and disinterested in a simultaneous mood; as aloof and incorruptible as an artist, yet sometimes as near the earth as a politician.” (Keynes, Collected Writings, vol. X: Essays in Biography)

Today, Schumpeter’s and Keynes’s criticism could be certainly addressed to those economists whose beliefs ultimately privilege the deductive method of inquiry in Economics. Due to these beliefs,  mainstream economists favour the adoption of a nominalist bias. And as a consequence, the trouble is that the dialogue between economic theories and the economic reality turns out to be abandoned not only in academic research but also in the policy making process.

This dialogue is complex and should be considered in any attempt to build realistic economic theories, as Keynes warned. Indeed, the changing environment of real-world markets through time -that is irreversible-  refers to a certain degree of ontological indeterminacy that should be considered in realistic economic theories and in the study of Economics.