Invisible Hand no 24

In the Tapei Times today there is an article without a bye-line of the author. It appears to be from the New York Times, 30 October, 30 October, page 12: see: http://www.taipeitimes.com/News/bizfocus/archives/2005/10/30/2003278045

It is headed: “Nobel-winning economist looks beyond the invisible hand” and the following paragraphs are included in what is, otherwise, an interesting read about aspects of the work of Thomas Schelling, an economist who was awarded the Bank of Sweden Nobel Memorial Prize in Economics this month (thoroughly deserved, I might add, for his work in games theory).

“Thomas Schelling studied Adam Smith's ideas, and now his findings have significantly changed the way economists think about competition and social welfare.

Adam Smith's celebrated theory of the invisible hand is the idea that individual pursuit of self-interest promotes the greatest good for all. When reward depends primarily on absolute performance -- the standard presumption in economics -- individual choice does indeed turn out to be remarkably efficient.

But when reward depends primarily on relative performance, as in hockey, the invisible hand breaks down. In such situations, unrestricted choices by rational individuals often yield results that no one favors.

The invisible hand assumes that reward depends only on absolute performance. The fact is that life is graded on the curve.”

With no blame attached to Thomas Schelling, the author manages to make several errors in respect of Adam Smith.

Adam Smith did not have a “theory of the invisible hand”, celebrated or otherwise. This is an invention of modern academe, the evidence for which is pure serial repetition by economists who have not read him, but who have, instead, taken this common attribution to be true merely because their tutors told them so.

Smith’s used the invisible hand as a metaphor and he used it only once in “Wealth of Nations”. It was never “theory” but as a once only illustration of how human motivations can have unintended consequences, which, in the case he was discussing, were, happily, benign consequences. He did never made it a general rule that “the idea that individual pursuit of self-interest promotes the greatest good for all.”

The pursuit of self-interest could just as easily promote malign unintended consequences, and a moment’s thought would suggest why, that this is the case. ‘Merchants and Manufacturers’, wrote Smith, tend, wherever they can, to promote monopolies and reductions in supply to raise prices against the interests of consumers. Self-interest does not automatically, or via an invisible hand, promote “the greatest good for all.” It all depends, and because it depends, on the circumstances, Smith did not make the metaphor into a ‘theory’. That is an inaccurate exposition and not Adam Smith’s.

Anyway, the metaphor was originally Shakespeare’s from Macbeth: 3:2 (“thy bloody and invisible hand”).

Unwittingly, the author of the article understands this (I am sure Thomas Schelling does). He or she distinguishes between ‘absolute’ and ‘relative’ performance in Hockey. By 'absolute' is meant what everybody might do (because they are compelled somehow but otherwise do not) and by 'relative' is meant what some individuals might choose to do because they value one outcome – safe play – over another – winning.

This distinction is close to Smith intended point: if everybody pursued their own self interest without detriment to anybody else’s (a big 'if' and one that never escaped Smith's attention) then doing so by everybody would promote “the greatest good for all.” But humans do not play the game this way, either in society or hockey. Smith knew that and his analysis never concluded that they would. It may be that something absolute like this is "the standard presumption in economics", but it never was a presumption of Adam Smith's, so whatever Schelling went 'beyond' it was not away from Adam Smith. It could more correctly be seen as a 'return' to Adam Smith's approach.

I believe this interpretation of Smith’s single use of the invisible hand metaphor is closer to being correct than it being a 'theory' as reported in today's the New York Times, via Tapei News.