Spare Us From the Invisible Hand

Patrick Kilbride writes in Chamber Post HERE:

“Free People, Free Minds, Free Markets”

‘In the 18th-century, Adam Smith left us with the indelible image of markets producing desirable social outcomes through the work of an "invisible hand." ’

Comment
In an otherwise neat argument for both liberty and free markets, Patrick Kilbride spoils his case with modern nonsense about Adam Smith and his use of the metaphor of “an invisible hand”.

Smith did not use the metaphor when explaining either how markets work generally (Books I and II, Wealth Of Nations) or how some, but not all, merchant traders preferred to invest locally following their concerns about the higher risks of investing abroad or in shipping (Book IV.ii, Wealth Of Nations).

In fact, a close reading of the only place in Wealth Of Nations where he used the metaphor of an invisible hand, shows that he first explains in detail the circumstances leading some, but not all, merchant traders to behave as they did (paragraphs 1 to 8, chapter 2, Book IV), and only then deploys the metaphor for the consequences of their specific behaviour (“intending their own security”), conforming to the arithmetic rule that the whole (the national annual output of wealth, including local employment) is the sum of its parts – the more merchant traders who are risk averse, despite the high profits from foreign and colonial trade, the greater the total annual wealth, including domestic employment.

Modern economists have invented a whole new meaning to Smith’s singular use of the metaphor, giving it the characteristics of a “law” of markets, though it was never stated as such by Adam Smith.

The modern invented meaning is commonly taught in first year economics courses and textbooks, and such is the effect of it on modern economists, it is extremely difficult to dislodge it – they seldom actually read Wealth Of Nations or even the relevant paragraphs (1 thru 8) and, by relying on a truncated extract from paragraph 9 only, they remain solidly convinced that Adam Smith explicitly stated what their tutors told them he wrote.

This gives succour to hostile critics of markets who throw the “invisible hand” back at them (“invisible fist” or, as seen recently, “invisible middle finger”, and such like). But there is no actual “invisible hand”, it does not exist and never did. The metaphor is just that, a metaphor, and one that was popular in literature, sermons, and poems in the 17th and 18th centuries – I have a list of 59 examples of its uses, besides Smith’s.

Mathematicians called it into being when “proving” that general equilibrium in an imaginary market, loaded with assumptions that removed all semblances of real world economies, was a theoretical possibility (Debreu, Arrow). Others (Samuelson, Freidman) and among them propagandists against Soviet communist planning, used the metaphor to good effect – Stalin needed the gulags to enforce planning, but free markets had an “invisible hand” that did its work without menace.

Editors of Time, Newsweek, Wall Street Journal, Financial Times and assorted media journalists loved the “invisible hand”, Nobel Prize winners sang it praises, and the epigones believed in its miraculous powers with the passionate certainties of Jihadists.

Worse, the invisible hand became an alibi of last resort, flaunted all round as if it existed. When it “failed”, the invisible hand was dumped among wails and the gnashing of teeth in wholesale “confessionals” (Alan Greenspan).

Markets suddenly became naked – they always were naked, but the veil of the invisible hand obscured their nakedness. It never was the answer to everything that could go awry in the normal condition of disequilibrium in all economies, much of it excited to crises by public policy interventions by legislators and those who influenced them.

Smith was right about them and the damage they could inflict – fortunately “there is a lot of ruin” in an economy, as he might have put it in another context...

A Small Step for Cubans?

The other evening, watching television, an item on the news caught my attention. Apparently, a group of Cuban farmers had been given permission from the Raul Castro government to produce lettuces for private.

This permission seemed to have shown early results, mainly in the form of more lettuces for people who wanted to buy them, in itself an unexceptional outcome to those among us who appreciate how markets work, but for those sceptics, living in the richest economies on the globe, whose impatience with markets leads to their condemnation of them (because they don’t solve all the problems they imagine that they should solve), the new Castro experiment is the thin of end of the wedge to perdition.

Now I have no illusions about Raul Castro, or his brother for that matter, nor for any of the Chinese communist leadership experimenting with capitalist incentives, nor their Vietnamese neighbours, but I do recognise sensible pragmatists who have realised at last that their idealist systems do not work.

Their ideological certainties may make them, and what Lenin< called their “useful idiots” overseas, feel superior to “bourgeois lackeys” like we classical economists, but the realities show them to be utterly wrong about doing away with markets.

The short film clip showed two brothers loading their lettuce harvest onto a waggon, already bursting at the edges with lovely, green lettuces destined for market (or government warehouses – it wasn’t clear which). The sudden rise in production looked phenomenal. Marxists can argue against markets but nobody can argue with an empty market stall under their system and a full one under the “permission” to produce for reward.

I have to say that I watched the changes before me – the brothers were laughing with pride – and I thought of Adam Smith describing how markets worked in Book I and II of Wealth Of Nations and their morality in Moral Sentiments. Instead of their sisters and daughters prostituting themselves to cater for sex tourism, they can work voluntarily in food production or whatever for the benefit of themselves and their customers, if only Castro’s bureaucrats – never short of lettuce under the socialist system – would only get out of the way.

Adam Smith No Ideologue

Baron Bodissey writes long articles in the “Gates of Vienna” (HERE)and is connected (how, is not clear) to The Fjordman Files HERE the themes of which are too complex, long and not related much to Lost Legacy’s focus on Adam Smith.

“The Scottish philosopher Adam Smith, professor at the University of Glasgow, published his famous The Wealth of Nations in 1776 where he argued in favor of freedom of enterprise. Government should interfere with commerce as little as possible and limit itself to three primary duties: Provide defense against foreign invasion, maintain civil order with courts and police protection, and sponsor certain indispensible public works and institutions that could not make adequate profit for private investors. Smith made the pursuit of self-interest in a competitive market the source of a natural harmony and equilibrium. The “invisible hand” of free competition would gradually lead to increased wealth for all.”

Comment
I take the view that if Baron Bodissey is wrong in both detail and in general about a small paragraph from his long histories of the world, such as Adam Smith’s role in his big-picture spectacular history of everything, I expect the rest of his article may well contain similar errors too.

When Adam Smith wrote Wealth Of Nations he was no longer a professor at a University of Glasgow. He left the university in 1764 to undertake tutorial duties with the Duke of Buccleugh in a tour of Europe (1764-1766, during which he commenced writing his famous book from lectures notes from his professorial stint (1751-64), published in 1980 as Adam Smith’s Lectures On Jurisprudence (1978; Oxford University Press) and possibly from notes of his Edinburgh lectures, 1748-51. Wealth Of Nations took from 1764 to 1776 to write and was published in 1776.

Smith did not write in favour of “enterprise”; he wrote in favour of “commercial society”. The former is a projection of a modern word onto the past; in fact, he displayed throughout Wealth Of Nations strong suspicions about the conduct of “merchants and manufacturers”.

To summarise Smith as saying that “Government should interfere with commerce as little as possible” is another back projection onto the historical facts. It conflates Smith’s “violent attack” on the conduct of political economy in mid-eighteenth century Britain, in the form of “mercantile”, government-sponsored, monopoly privileges granted as favours to special interests, as promoted by individual legislators, and those who influenced them, often associated with bribery and other favours (of which the East India Company was a prominent example), with modern misinterpretations of Smith’s legacy by his epigones.

Smith was not opposed to government-directed activities, and those he specifically advocated were not minor aberrations. Defence was a major expense in the annual budget – the seven-years war with France cost £120 millions – and it remained a major budget item well into the 19th century. The defence sector employed tens of thousands annually, both in the defence establishment (unproductive soldiers and seamen) and in productive defence employees, manufacturing defence supplies for a profit for the defence establishment. Technologies associated with defence, shipping, navigation, charts, overseas exploration and bases, and foreign relations, played a major role in the changing domestic economy and in British international trade.

“civil order with courts and police protection” was an absolutely crucial pre-condition for the development of a domestic commercial society. It was not just an “expense” to be minimised in a sort of 19th-century “watchman state”. Without justice, society would “crumble into atoms” and “a man would enter an assembly of men as he enters a den of lions” (Moral Sentiments II.ii.4: 86). With the growth of commerce, the role of contracts proliferated and was reflected in the administration of law, and the professions of lawyers.

Smith’s observation is inadequately stated as “indispensible public works and institutions that could not make adequate profit for private investors”. This is a major task, the scale of which is hidden in the brevity of Baron Bodissey’s sentence.

The appalling state of roads in 18th-century Britain required the building of thousands of miles of roads; the construction of canals, likewise; and the dredging of the hundreds of harbours around Britain added to a major capital investment in both the building and, crucially, the annual maintenance of this infra-structure on a scale that mocks the dismissive assertion that this policy was one requiring the government to “interfere with commerce as little as possible and limit itself” to a few minor tasks.

Assuming that Smith’s suggestions for government were adopted by an 18th or a 19th-century government, it would have required the substantial commercial activity of scores of commercial firms for the profitable building and maintenance of the infra-structure, spread over many decades.

That the building of these projects could never repay the projectors (Smith’s original point) did not mean that they could not make a profit for building and/or maintaining them if the government funded their erection. How they were to be funded was a matter for the public finances (fight fewer wars?), which does not in any way limit their economic impact given existing relationships between government funding (defence, is classic) and commercial suppliers of the means (infra-structure builders). Most ‘watchman-state’ attributors to Adam Smith miss the point.

[Of course, the notion of the ‘watchman state’ is wrongly attributed to Adam Smith; it was actually invented as an idea by Ferdinand Lassalle, the 19th-century, fire-brand socialist – Adam Smith, once again was innocent).

Baron Bodissey in identifying Smith’s “limited” role for government to “indispensible public works and institutions”, missed out saying anything about “public institutions” (even missing the adjective, “public”, as used by Smith in Wealth Of Nations), which is somewhat sad because the sheer scale of intervention that would have been necessary to put his recommendations into effect hides the extent of the prime role of education he envisaged for a commercial society.

Briefly, to erect a “little school” in every parish would have involved more than 60,000 such schools across the country – though Scotland already had “little schools”, having started on mass education in the 1600s). Add the teachers for such schools to the simple buildings, and book supplies, this was a formidable undertaking – if it had been taken up.

Smith discusses the role of government (Book V, Wealth Of Nations) under the heading of public finance – budget items and taxation. He does not disucss the role of intervention of a legislative kind. He was ferociously critical of much government legislative intervention – the creation of monopolies, protectionism and barriers to trade, jealousies of trade, and wars cause by such, and the imposition of various statutes (Apprentices, Settlement, Guilds, Patents of monopolies, and such like), and colonial policies. This does not mean he did not envisage a regulatory role for government.

Smith advocated certain other roles too. Among these there are his call for government intervention in special cases, even when such regulations are “a manifest violation of that natural liberty”, as the issuance of “promissory notes” for small sums (WN II.ii.84: 324), a small step in 18th-century banking, but one that was bound to expand with the expansion of commercial banking . Smith associated such interventions with the building of party wall to prevent the spread of fire, as common sense, not excluded by ideology.

Baron Bodissey ends his ommision-filled paragraph with “Smith made the pursuit of self-interest in a competitive market the source of a natural harmony and equilibrium. The ‘invisible hand’ of free competition would gradually lead to increased wealth for all.” Lost Legacy readers will recognise the multiple errors in Baron Bodissey’s summary of Smith’s view wrapped in two sentences.

The derivation of “free competition” from the “invisible hand” (or vice versa) uses a redundant metaphor, which explains nothing and, being a metaphor, is not required to do so, and misleads by inferring the actual existence of such a entity (see Lost Legacy passim).

The metaphor of “an invisible hand”, used only once in Wealth Of Nations (Book IV.ii.9: 456) was really about the arithmeticl rule - 'whole is the sum of its parts' – the more merchants who invested locally, in preference to foreign trade because of their aversion to the risks of losing sight of their capital, the larger would be total local investment and employment.

Many merchants continued trading internationally profitably despite the perceived risks. This outcome – larger local investment and employment would result whatever the competitive, or non-competitive, commercial society, ergo, the invisible hand metaphor had nothing to do with competition – it was to do with profitability tempered by risks.

Baron Bodissey links conclusions from modern general equilibrium theory (“free competition would gradually lead to increased wealth for all”) and not from Wealth Of Nations.

“Increased wealth for all” is not contingent on free competition; “increased wealth for all” would be greatly assisted by “free competition" but has not yet been experienced so far, except in tiny pockets for short periods of time. Mercantile distortions on commerce have long been prevalent and despite them, a gradual increase in wealth has been experienced by large proportions of the populations of all commercial societies over long periods (in Britain’s case, since the 16th century).

There are no “invisible hands” guiding commercial societies; there are only the powerful affects of markets, distorted, hampered, and inhibited by the local institutions and habits prevalent in particular societies. Markets work despite obstacles put in their way (ruinous interventions, wars, civil strife, cultural prejudices, politics and religions). Some work more efficiently than others.

Smith observed and understood. He didn’t expect the utopia of free trade to occur, he didn’t perceive that “natural liberty” was an essential pre-condition for the “progress to opulence”. He was not a visionary, nor a ‘man with a mission’. He was a moral philosopher, not ideologue.

Let Millions of Indian Street Vendors Flourish into Middle Class Taxpayers

Sauvik Chakraverti (Libertarian Opinion From Indyeah) posts in ANTIDOTE HERE:

Sauvik Chakraverti covers the eviction of Indian street vendors in Bangalore and discusses the effects of this behaviour on the development of the poor trading classes. He finishes by contrasting the experiences of poor traders in Singapore:

“When Singapore became independent in 1965 (after Nehru’s death) there were 2,50,000 street hawkers in the city-state. They are all part of the tax-paying middle class today. The same can – and must – happen here.”

This is by way of a debate with a senior economist on Adam Smith. Plenty of material for an illustrated session with students on the realities of economic development. Follow the link.

The Hesitant Hand by Steve Medema: Review Part 2

In the ‘Hands of Adam’ Steve Medema shows his class as an historian of economic ideas. I found his account of the role of self-interest in commercial society very fair, without the usual cliché errors found in many accounts.

Starting from the proposition in Moral Sentiments that our benevolence towards others diminishes as social distance increases without damaging the social fabric because all others have degrees of overlapping benevolence right across society, and benevolence is not, and cannot be, the sole, or even major force, for exchange behaviour, and, fortunately for human habitation and procreation, it is not necessary that it be so.

A society, we are reminded in TMS can exist with loving relationships, and it is well when it does, but it can also exist without such feelings provided there is a ‘mercenary exchange of good offices’.

Enter here the famous assertion by Smith of the ‘butcher, the brewer, and the baker’ and our need when engaged in an exchange transaction to appeal to their interests not ours (be ‘other centred’; never selfish). Steve shows that for Smith, self-interest is not a ‘one way street’ – what a lot of senseless twaddle would be saved if miss-readers of Smith would get that right!

Steve correctly sets out self-interest in Smith’s lexicon:

‘that the pursuit of self-interest serves the best interests of society as a whole, that self-interest and the social interests are partners rather than enemies’ (19). Self-interest should be facilitated rather than restrained.

The explanation of why this was true for Smith is wonderfully clear, though, Steve notes, ‘Smith is at once vividly descriptive and maddeningly vague’. Echoing Mirabeau (thinking you serve yourself, you serve others), the individual attempts to employ his capital where he expects to earn the highest return, and in doing so, he generally neither intends to promote the public interest, nor knows how much he is promoting it’, followed by the famous metaphor of ‘an invisible hand’.

Steve comments:

‘An invisible hand – this is a specific as Smith gets. What Smith meant by this is anyone’s guess, and plenty of guesses have been offered, ranging from God to government’. But whatever it is, Smith was convinced of its propensity to channel self-interest in socially useful directs’(20).

I can agree with that formulation as it encompasses Smith’s proper use of a metaphor, which is to explain something by adding ‘beauty’ when ‘so adapted that it gives due strength of expression to the object to be described and at the same time does so in a more striking and interesting manner’ (Smith: Lectures in Rhetoric and Belles Lettres, 1763).

A great deal of wasted ink and paper would be spared if only economists would read the nine paragraphs of Wealth Of Nations leading to the metaphor of the invisible hand and see how simply caps his technical description of economic and social process leading to people thinking they are serving themselves when in fact they serve general society, by his employing the common 18th-century metaphor of ‘an invisible hand’. Steve’s compromise treatment is masterly.

Smith develops the sense of ‘congruence’ (Steve’s word), even ‘harmony’ as ‘some would say’ (I prefer potential ‘congruence’) between private and social interests, to his critique of mercantile political economy and Physiocracy, both of which, Steve shows, inevitably distort by monopolies and misguided government interventions (those promoted by lobbying for special, especially corrupt, interests) and thereby interfering with the otherwise free actions of individuals judging their best interests in moral and legally constrained codes of behaviour and acting accordingly.

Here Steve highlights something that is worth developing (21). The absence in Smith’s work of a critique of the ‘internal logic’ of mercantile or Physiocratic thinking: on their own terms they promote the ends they seek (the accumulation of gold or the growth of agriculture output) – as China seems to be sliding towards in buying up the planet with its mountains of US treasury bills and hoping to hold down peasant incomes.

Smith disagreed with their consequences – state action by the former theories (necessarily at the sacrifice of liberty) versus growth of real wealth (the annual output of the ‘necessities, conveniences, and amusements of life’) through individual self-interest in conditions of liberty.

Steve confronts the conundrum of self-interested actions can be malign. Some voices, bought and paid for, advocate absolute freedom for corporations and individuals, the consequences of which are discussed widely. Unfortunately, the remedies (especially from the environmental lobby) of which involve draconian interventions by uncontrollable governments, agencies and neighbourly busy-bodies, plus ‘that insidious and crafty animal, vulgarly called a statesmen or politician’ (WN IV.ii.39).

Steve recognises that Smith was never a one-track voice for everything changing at once. He was far more pragmatic; never an ideologue. He did not make many predictions, nor did he expect much to change, except ‘slowly and gradually’, perhaps in many cases never quite reaching its end goal. He said as much in respect of free trade ever becoming accepted in Great Britain this side of ‘utopia’.

His message was that competitive markets were generally better than state grand plans. He didn’t even consider that ‘natural liberty’, as was envisaged by the Physiocrats, was a necessary condition for the spread of opulence – if it was, he opined, it is unlikely that any country would ever have progressed towards it (WN ix.28: 674).

Nor, Steve observes, were the necessary roles of government minimal (23) – Smith was not a laissez-faire purist or even near being so. The list of proposed roles for the state, collected in Book V and elsewhere scattered throughout Wealth Of Nations, is quite long, and probably much longer than the purveyors of Smith, the laissez-faire advocate, realise. Steve covers this material with both conviction and economically.

Smith, says Steve:

‘was not, as some have imagined, a proto-modern. Smith’s view of man is not economic man with his rational, single-minded pursuit of his self-interest’. Furthermore, Smith did not argue that private action was optimal, in the modern efficiency sense, nor even that it was superior to governmental alternatives. Smith considered the link between private and social interests partial and imperfect, but he was also of the mind that self-interest, properly channelle, tended to engender positive results, rather than negative ones, and that government interference with its operation in the economic sphere would generally lead to inferior results’ (25).

I think we can sum up Smith’s approach as being: ‘markets where possible; the state where necessary’.

Steve’s last line in this chapter is evocative:

‘Self-interest, then, had finally found legitimacy’.

[In Part 3 we move on to the ‘Harnessing of Self-Interest’ with ‘Mill and Sidgwick and the evolution of market failure’.]

Markets as a First Choice

“There’s a real distinction between being in favor of free markets and being in favor of whatever business does”, from a heading in Death and Taxes Blog reporting a lunchtime talk and subsequent Q & A session between Milton Friedman and the audience HERE: http://politics.randomplayground.net/2009/06/02/theres-a-real-distinction-between-being-in-favor-of-free-markets-and-being-in-favor-of-whatever-business-does/

Comment
It’s not clear if Milton Friedman actually put it that way, but it is pretty clear from his talk and answers to questions that he did not exempt businesses from criticism for their actions in practice.

How could he? He already had the excellent example of Adam Smith noting almost unanimously in Wealth Of Nations the scheming monopolistic tendencies of ‘merchants and manufacturers’, small groups of tradesmen in the town Guilds system seldom meeting even for merriment and diversion and ending up conspiring to raise prices, and he knew how legislators and those who influenced them proposed legislation that benefited their business sponsors by curtailing supply with tariffs and prohibitions to widen their markets and raise prices.

In short, for over 250 years businesses pursued their individual self-interests precisely in their self interests. The antidote was not, is not, nationalisation or regulation; it was and remains extending competition through freer markets.

I remember listening in astonishment to an MP, shortly after Mrs Thatcher’s government deregulated the exchange in foreign currencies so that licensed people could open little Bureau du changes in the high street to compete with local banks. The MP complained that in his constituency these new licensed exchange bureaus were charging much more to trade foreign holiday currency than the local banks. ‘It is a rip-off’, he cried, and wanted legislation to stop it. And this was a Conservative Party MP!

The answer, instead’ surely was to publicize the higher prices and the profits. That’s all it would take to induce new entrants into the exchange rate business in pursuit of the alleged ‘high’ profits, and let competition do its work (which is what happened, eventually).

Freer market advocates do not defend all, or any specific actions, of business entrepreneurs; they advocate using markets were possible to allow the impartial gales of competition to discipline market behaviours and benefit consumers.

You don’t need to introduce battalions of inspectors (and their plus premises, supervisors, pensions, and expenses) to patrol the country looking for ‘excess profiteering’ – and battalions of lawyers to be engaged in prosecuting and defending alleged profiteers. Nor does it require business personnel to meet in lobbying organisations – with their expensive staffs and insider contacts – to look after their interests, monitor legislation proposals, and generally subvert the independence of the legislature (and compromise the integrity of 'insiders'. Competitive markets are the best available instrument.

In that prescription, Lost Legacy and Milton Friedman are in agreement with Adam Smith.

A Myth of Free Markets

Dan McLaughlin posts (17 April) a book review of “Free Lunch” By David Cay Johnston in Citizen Economists HERE: http://www.citizeneconomists.com/blogs/2009/04/17/free-lunch-by-david-

“Quotations from Adam Smith are generously sprinkled throughout the book, and made to sound as though the champion of free markets would have supported Johnston’s proposals for big government and heavy regulation of business.

According to Johnston’s analysis, the problems that modern America faces are due to alleged “deregulation”. The author summarizes his confusion early on when he says “In the past quarter century or so our government has enacted new rules that have created not only free markets, but rigged ones.” If the markets are “rigged”, they are not free in any sense. The regulators rig the market and make it un-free. It shouldn’t be that hard to make the connection. The regulation that he longs for has always been written by the regulated, to the detriment of competitors, taxpayers and the buying public.”

Comment
Dan McLaughlin makes a good point about ‘deregulation’. There is mantra circulating that ‘deregulation’ being bad and ‘regulation being good, wrapped in an assertion that the capitalist economies have been too laissez-faire and that the government has to intervene in the so-called ‘free markets’ supposed to exist all around us, summed as the government must introduce tighter regulation.

The problem with this debate is that the premise is incorrect. Markets are hardly free when the existing regulation (supported by laws, such as in the European Union, covering everything from hours of work, overtime, consultation over social issues, Health and Safety, discipline, redundancies, human rights, race, feminism, labelling, testing, supervision, insurance, minimum wages, pensions, copyrights, patents, planning procedures, banking and finance, and so on and on).

It’s not that these regulations are all bad – though some are barmy – it’s that their existence contradicts assertions about ‘free markets’, and I have only mentioned a few of them. Capitalist markets are dominated by Big Government, hence we do not have anything remotely like laissez-faire (which, contrary to assertion, never featured in Adam Smith’s political economy). It’s more accurately described as State Capitalism, with governments intervening with ever more legislation to impact on businesses, egged on or resisted by armies of professional lobbyists.

Not everybody who quotes from Adam Smith respects his legacy, nor do they all understand it. Dan McLaughlin appears to do so more than the author of the book he reviewed.

The Wonder, Not the Miracle, of Markets

Will Wilkinson, a research fellow at the Cato Institute and editor of Cato Unbound (an organisation I would expect normally to agree with broadly) writes:

“Obama's self-immolating capitalism”

“There are two capitalisms. There is mundane market capitalism and there is political capitalism. Markets regulated by the rule of law and governed by a freely functioning price system are post and beam in the architecture of prosperity. You step into a grocery and there in the freezer are your coveted waffles waiting as if someone knew you were coming for them. But no one is looking after your need for breakfast treats. Each looks after her own needs by looking to the free play of prices and there emerges a rough-but-remarkable convergence of the waffles wanted and the waffles supplied. As the great Adam Smith noted, it seems like magic, but it's not. It's just amazing -- in the way the evolution of the eye is amazing.”

Comment
Where does Will locate his last sentence is ‘noted’ in Smith’s works (as above): ‘As the great Adam Smith noted, it seems like magic, but it's not. It's just amazing -- in the way the evolution of the eye is amazing”?Markets may be amazing, but no miracles, nor magic, are involved (nor were they in the evolution of the eye).

How markets work is explained in Wealth Of Nations without relying on miracles or magic. The great 19th-century French polemicist for markets, Bastiat, dramatized the wonder of markets in providing Paris overnight with the items for its citizens’ breakfast.

We can appreciate the raw beauty of the rainbow without having to believe in miracles or magic. Smith called such outbursts ‘pusillanimous superstition’.

Amartya Sen's Two Brilliant Essays on the Relevance of Adam Smith Today

Amartya Sen writes two great articles of current relevance on Adam Smith. The shorter one is in the Financial Times HERE and the longer one is in the New York Review of Books HERE.

I recommend them both to you (following correspondents asking if I had read them, and, presumably, looking for my comments on Lost Legacy). As I have been busy completing my paper on ‘Adam Smith’s Alleged Religiosity’, I chose not to post a comment last week, but to generate more publicity for an approach with which I agree and I am pleased now to recommend them and I provide links to the two articles and a very short extract:

‘Adam Smith’s market never stood alone’

“For example, the pioneering works of Adam Smith in the eighteenth century showed the usefulness and dynamism of the market economy, and why—and particularly how—that dynamism worked. Smith's investigation provided an illuminating diagnosis of the workings of the market just when that dynamism was powerfully emerging. The contribution that The Wealth of Nations, published in 1776, made to the understanding of what came to be called capitalism was monumental. Smith showed how the freeing of trade can very often be extremely helpful in generating economic prosperity through specialization in production and division of labor and in making good use of economies of large scale.

Those lessons remain deeply relevant even today (it is interesting that the impressive and highly sophisticated analytical work on international trade for which Paul Krugman received the latest Nobel award in economics was closely linked to Smith's far-reaching insights of more than 230 years ago). The economic analyses that followed those early expositions of markets and the use of capital in the eighteenth century have succeeded in solidly establishing the market system in the corpus of mainstream economics.

But Smith's defense of private trade only took the form of disputing the belief that stopping trade in food would reduce the burden of hunger. That does not deny in any way the need for state action to supplement the operations of the market by creating jobs and incomes (e.g., through work programs). If unemployment were to increase sharply thanks to bad economic circumstances or bad public policy, the market would not, on its own, recreate the incomes of those who have lost their jobs. The new unemployed, Smith wrote, "would either starve, or be driven to seek a subsistence either by begging, or by the perpetration perhaps of the greatest enormities," and "want, famine, and mortality would immediately prevail...."

Smith rejects interventions that exclude the market — but not interventions that include the market while aiming to do those important things that the market may leave undone.

Despite all Smith did to explain and defend the constructive role of the market, he was deeply concerned about the incidence of poverty, illiteracy and relative deprivation that might remain despite a well-functioning market economy. He wanted institutional diversity and motivational variety, not monolithic markets and singular dominance of the profit motive. Smith was not only a defender of the role of the state in doing things that the market might fail to do, such as universal education and poverty relief (he also wanted greater freedom for the state-supported indigent than the Poor Laws of his day provided); he argued, in general, for institutional choices to fit the problems that arise rather than anchoring institutions to some fixed formula, such as leaving things to the market.”

Amartya Sen received the 1998 Nobel Prize in economics; he teaches economics and philosophy at Harvard University and he has written an introduction for the anniversary edition of ‘The Theory of Moral Sentiments’ (Penguin Books, 2009) in which he discusses the contemporary relevance of Smith’s ideas.

How To Make a Problem Worse

Abdullah Waheed’s Blog HERE: carries this:

“Fishermen’s Demonstration”

“From an academic point of view the results of the demonstration was spectacular. Some of the participants rediscovered the theory of supply and demand, more than 200 years after Adam Smith described it in his Wealth of Nations. "When we catch more fish the price goes down; when we catch less the price goes up," a young participant said.

Umar's main demand was to empower fishermen to set their own prices. He does have a point here. Currently the market is a buyer's market where a cartel of monopolists decides the price because they are better organized with more resources. Fishermen could get better prices if they had collective bargaining power.

On the other hand, Umar's demand for base prices of Rf 45/kg for yellow fin tuna and Rf 10/kg for skipjack may not be feasible without government subsidies. The question is can the Maldives afford more subsidies in the present economic crisis?”

Comment
I found this snippet interesting. The problem is the “cartel of monopolists” which pays fishermen a price much lower than the desired price the fishermen want (presumably they can see how much their ‘yellow fin tuna’ and their ‘skipjack’ sell for at wholesalers’ cartel prices).

Their ambition is to secure, somehow, ‘collective bargaining power’, presumably by a new law or by collective action to break the cartel., and then to raise their prices to Rk 45/kg and Rf 10/kg respectively. The retail prices of the fish are not stated, but there are bound to be distribution costs and profit to be added.

If the government is to subsidise from taxation to bring the retail price down to what is currently affordable it seems this policy would open up other problems, not least of which is: to whom is the subsidy paid? The fishermen, the wholesale buyers, the consumer?

In the context of general subsidies already (‘can the Maldives afford more subsidies in the present economic crisis?’), distorting an already distorted market (the prevalence of the ‘buyers cartel’) is not a sensible policy.

Supply and demand at this level cannot be ignored. If the ‘participants’ take note of supply and demand (with or without Adam Smith’s cumbersome analytical structure) and it operates in the Maldives fishing sector, it suggests that the fishermen’s collective buying power will also rise and fall in its negotiated price, and so will government subsidies, and the retail price of fish.

The problem is caused by the buyers’ cartel and the fishermen’s submission to it.

Without knowledge of the geography of the Maldives I cannot suggest the appropriate response to implement the Smithian remedy of breaking monopoly powers on both sides of the market. But the answer lies in that area rather than in government (taxpayers’) subsidies.

As a correspondent reminds me, Adam Smith commented on the practice of subsidies and bounties for the fishing sector from government in Wealth Of Nations:

"Secondly, the bounty to the white-herring fishery is a tonnage bounty; and is proportioned to the burden of the ship, not to her diligence or success in the fishery; and it has, I am afraid, been too common for vessels to fit out for the sole purpose of catching, not the fish, but the bounty" (WN IV.a.32: p 520).

A Classic Example of the Misuse of a Metaphor

John McCarthy writes in Florida Today HERE:

“Gas-price rise 'illogical'
AAA spokesman can't equate it with the fall in demand and crude oil cost”

One supposedly inviolable law of classical economics is that when the supply of a resource is greater than demand for it, the price of that resource will fall. The "invisible hand" of the marketplace should see to that, the father of economics, Adam Smith, said.

Comment
I know of no ‘inviolable law of classical economics' that ever mentions ‘an invisible hand’ and I am sure that John McCarthy or anybody else does not know of one either.

I do know of countless statements since the 1950s that says there is a ‘theory’, ‘concept’, even ‘paradigm’, and now a ‘law’ that Adam Smith believed that market places were managed by ‘an invisible hand’, but that is not the same as Adam Smith actually having done so.

In fact, he didn’t; he mentions the 18th-century literary metaphor on ‘an invisible hand’ only once in Wealth Of Nations, but not in reference to his theory of markets, which he analyses and elaborates in Books I and II of his classic work.

His sole reference to ‘an invisible hand’ occurs in Book IV in his brilliant critique of mercantile political economy – the very same economic system practised by Georgian Britain, which caused the American rebellion in 1776-83, and produced eventually the United States of America.

And for the record, Smith didn’t mention the metaphor in the other two books of Wealth of Nations (Books III and V).

His reference to ‘an invisible hand’ occurs after he has explained how the risk- avoidance behaviours of some merchants prompts them not to send their scarce capital abroad to the British colonies in North America (dangerous sea passage, unknown trading partners, backed by local colonial laws and practices, and uncertain, though high, profits).

Their risk avoidance prompted these merchants (but by no means all, of course – those prepared to trade in the colonies did well because of the British monopoly of colonial trade, backed by the Royal Navy’s enforcement of the Navigation Acts) to invest their capital domestically, without the risks of sea voyages, where they knew with whom they traded and had knowledge of the reliability of the local courts, and were more certain about their, albeit perhaps lower, profits.

So, risk-avoidance, and the obvious arithmetical law that the whole is the sum of its parts, led to domestic British capital formation to be higher than it would be if more merchants had sent their capital abroad. Additional domestic capital invested locally added to the total of domestic investment, which in turn added to local employment and to national output.

Having said all these over several pages in Book IV, Adam Smith added the metaphor that these merchants – but clearly not the others! – were ‘led by an invisible hand’ to add to domestic investment and output, though they only intended ‘their own security’.

Look it up in Wealth Of Nations (WN IV.ii.9: p 456). That is all Adam Smith meant by the invisible hand- a summary explanation of what he had explained in straight economic terms, but never a ‘theory’, and certainly not a ‘law’, except, perhaps, of arithmetic.

Indeed, John McCarthy uses the rest of his article to explain with potential facts what is causing gas prices to remain high – real prospects of a refinery strike by the US Steel workers Union in Florida, causing retail gas companies to stock-pile gas inventories in the event of the strike. The higher the price of gas at the pump at present, the more of their future supplies will remain in their inventories for use during the strike. That will keep gas customers driving for longer during a strike.

Correct analysis from John McCarthy without any need to misuse Adam Smith’s literary metaphor. He could have re-cast his wrong reference to Adam Smith by, perhaps, suggesting that the oil companies are being restrained by an ‘invisible hand’ from reducing their prices in the prospect of the strike-bound near-future situation! (Just joking.)

But that is not how modern economists, and those influenced by them, see how Smith’s use of the famous metaphor was quite different from their 20th-century invented attribution to him.

A Classic Spoiled by Mysticism

‘Chief’ posted (18 January) on Tragedy of the Commons (HERE):

the text of the near brilliant, but slightly flawed, short outline of the powers of markets, identified by Leonard Read’s essay “I, Pencil”, as a process of disconnected coordination, without planning, central directions, or anything other than human beings acting, reacting, and pro-acting, to opportunities signalled by prices, rumours, and probabilities.

Chief, however, tops his post with a short paragraph by Milton Friedman, complete with his mystical allusions to the metaphor of an ‘invisible hand’, which detracts from the ordinariness of human endeavour, as if markets contain pure and innocent spirits, sometimes attributed to the will of a living Deity.

Friedman’s introduction spoils the softer power of Read’s ‘I, Pencil’, leaving it trapped in what Adam Smith had called ‘Surprise and Wonder’ but well short of ‘Admiration’, which comes from knowledge, the final step of human understanding (See Adam Smith, posthumous, ‘The Principles which lead and direct Philosophical Enquiries; illustrated by the History of Astronomy, [1744-58: 1795], in Essays on Philosophical Subjects, pp 5-129; 1980, Liberty Press).

‘Savages’ claimed their lives were ruled by invisible beings in everything they could not understand. Philosophers, wrote Smith, uncover the ‘connecting’ and ‘invisible links’ of events and, as a result, science marches on.

Milton Friedman and Leonard E. Read, both of whom made outstanding contributions in their writings, in this matter, however, both of them unintentionally led their readers away from understanding towards mysticism, only a step of two away from what Smith called ‘pusillanimous paganism’.

They became responsible in part for an unscientific sediment in political economy which wraps the ordinariness of human markets that are perfectly understandable within economics and without invisible body parts.

Markets operate without the mumbo jumbo of divine purpose (an unholy notion, I would have thought, linking the honest man from Galilee with the global market economy), and without the widespread populist belief in, not the simple literary metaphor used by Adam Smith for another purpose (see Lost Legacy passim), and without actual ‘invisible hands’, as if they really exist in the world in general and in markets in particular.

You can (and should) read Leonard Read’s ‘I, Pencil’ HERE:

Leonard E. Read (1898-1983) founded FEE in 1946 and served as its president until his death.

"I, Pencil," his most famous essay, was first published in the December 1958 issue of The Freeman. Although a few of the manufacturing details and place names have changed over the past forty years, the principles are unchanged.

'I, Pencil' reported that his ‘official name is "Mongol 482." My many ingredients are assembled, fabricated, and finished by Eberhard Faber Pencil Company’

'Fair Trade' Made Possible by Globalisation

Mike Veseth, Robert G. Albertson Professor of International Political Economy at the University of Puget Sound, writes on the Wine Economist Blog on “Fair Trade Wine” (HERE):

“Fair Trade products attempt to use globalization to offset some of the negative potential effects of globalization. Global market forces can sometimes lead to the exploitation of natural resources and unskilled labor, for example. The “sympathy” that Adam Smith thought would condition market relations breaks down when producer and consumer are separated by thousands of miles and multiple commodity chain links.

“…because consumers are often better informed and more interested in the origins of and production conditions associated with wine than for most other consumer goods.”

“Wine enthusiasts are thirsty for information about where wines come from, who made them and how. Fair Trade provides this information in a way that informs, educates and potentially produces social and economic change.”

Comment
I do not think it is the case that ‘The “sympathy” that Adam Smith thought would condition market relations breaks down when producer and consumer are separated by thousands of miles and multiple commodity chain links.’

In fact, I am not sure that Adam Smith thought of “sympathy” quite in the way that Mike Veseth presents it. It is clear in Moral Sentiments that sympathy was both a general and a local phenomenon associated with how humans live in societies (as they always have).

We can be concerned about events that affect complete strangers, as well has have intense sentiments towards a close relative, with diminishing degrees of intensity as persons are more ‘distant’ in their relationship with us, for example, second and third cousins, through to strangers.

Indeed, that is how we would expect it to be. The circles of people with whom their immediate relationships overlap is an effective bonding force for society (of which the ‘six degrees of separation’ is a crude illustration). Your friends and acquaintances have their own and quite distinct friends and acquaintances, and, like the ‘little fleas’ in the poem, so on ‘an infinitum’.

Smith links these points well in Moral Sentiments, when discussing the connection between man the social animal, who knows a few others well and most others less well or not at all, and how this still stabilises society, both inter-personally and economically:

“It is thus that man, who can subsist only in society, was fitted by nature to that situation for which he was made. All the members of human society stand in need of each others assistance, and are likewise exposed to mutual injuries. Where the necessary assistance is reciprocally afforded from love, from gratitude, from friendship, and esteem, the society flourishes and is happy. All the different members of it are bound together by the agreeable bands of love and affection, and are, as it were, drawn to one common centre of mutual good offices.

But though the necessary assistance should not be afforded from such generous and disinterested motives, though among the different members of the society there should be no mutual love and affection, the society, though less happy and agreeable, will not necessarily be dissolved. Society may subsist among different men, as among different merchants, from a sense of its utility, without any mutual love or affection; and though no man in it should owe any obligation, or be bound in gratitude to any other, it may still be upheld by a mercenary exchange of good offices according to an agreed valuation.”

[TMS II.ii.3.1-2; 1872 ed. Kessinger Rare Reprints, pp 78-9;]

These remarkable, and not often noted, passages are the root of Adam Smith ideas about societies. Our need for the ‘assistance of others’ is universal, ever present, and unavoidable, no matter the size of our society or the age within which its acquires its means of subsistence.

Of course, from the vantage of the 21st century, our dependence on others is far greater that it was for the likes of Ghengis Khan in the 12th century – he was unaffected by the tribes of North America, Australia, and Western Europe – but in the global economy, developed since the 15th century onwards, ever wider and ever deeper circles of sentiment and influence have developed along the inter-twined influences of both “the agreeable bands of love and affection … drawn to one common centre of mutual good offices” and by “by a mercenary exchange of good offices according to an agreed valuation”.

It is the characteristic of commercial economies that their supply chains can operate without persons knowing much or anything about players two or a few links further on and back (and beside them) in any inter-locked supply chains that make up our mode of susbistence.

It is also not the case that the “sympathy that Adam Smith thought would condition market relations breaks down when producer and consumer are separated by thousands of miles and multiple commodity chain links.” It is the “a mercenary exchange of good offices according to an agreed valuation” that conveys the necessary information for markets to work.

By ‘good offices’ Smith means people exchanging services to each other, not necessarily confined to commercial transactions – there are no limits to exchange relations in Smith’s world, whether it is the development of language and conversation (think of today’s Internet), of political and religious ideas, of literature and arts, of information and knowledge and, in practice, almost all human activities.

The separation of consumers from producers, which almost always has been the case since individuals began to transact with relative strangers in the early, larger bands and then with complete strangers in other bands, and finally tribes and then ‘nations’, has always been the basic facility that ‘mercenary exchange’ made possible.

Exchanging wool for pewter in medieval Europe did not require intimate or any knowledge of who provided the merchants with the wool or the merchants with the pewter. The early humans who received stone ‘Venus’ figurines in exchange for decorative beads, say, most certainly did not know the members of a supply chain stretching hundreds of miles from where the stone originated.

Mike Veseth makes the interesting point that wine consumers are interested in “where wines come from, who made them and how”. This, of course, is the marketing message of ‘Fair Trade’ suppliers, who justify higher prices for wine because the original producers are in relative poverty and Fair Trade “provides this information in a way that informs, educates and potentially produces social and economic change”.

This is not an aberration of how markets work (always remember, exchange by markets is the fastest information processing method created by human societies), it is how any student of markets would expect them to work.

All along all supply chains, people make decisions to enhance their performance in their particular bit of it under the motivation of reducing their costs to enhance their supply capacity and increase or maintain their share of the profits.

When the spice trade showed such fantastic profits in medieval Europe, several seafaring nations competed (often bloodily) to identify the sources of spice and transport it back to Europe to sell at mark-ups that began at several thousand per cent.

Globalisation is the cause of well-meaning Fair Trade sympathies, not the enemy of them. The vast charitable NGOs conform to what Adam Smith expected from the ‘mercenary exchange of good offices’. He preferred, but did not expect in mid-18th-century Britain, that:

“Where the necessary assistance is reciprocally afforded from love, from gratitude, from friendship, and esteem, the society flourishes and is happy.”

But ‘should’ those conditions did not obtain, in their absence:

“Society may subsist among different men, as among different merchants, from a sense of its utility, without any mutual love or affection; and though no man in it should owe any obligation, or be bound in gratitude to any other, it may still be upheld by a mercenary exchange of good offices according to an agreed valuation.”

Mike Veseth, and Fair Traders, are not bucking the market, nor finding a new form of trade. They are finding another way, using the price mechanism, to enrich the “agreed valuation” for “the mercenary exchange of good offices”.

Indeed, it remains true still that the majority of consumers buying ‘fair trade’ products need to know nothing about the original suppliers or the others between them and the local supermarket, to complete their transactions to enjoy their wine. That is the power of global branding, which only globalisation makes possible.

Markets and Morals

Mike Masnick writes on the market in techdirt (HERE):

“Free Market Capitalism, Moral Character And Doing Good All Work Hand In Hand” - from the can-we-get-over-this-already? Dept."

“I've never quite understood the complaints of some that free market capitalism somehow goes against morality or good deeds. As we've discussed in the past, moral questions shouldn't even come up at all in scenarios where everyone is better off. Moral questions only arise in scenarios where some are worse off and some are better off, and a decision needs to be made about who is worse off and who is better off. The nice thing about free market capitalism is that it tends to increase the overall pie, allowing a much larger number of people to be better off, and tends to do so in a more efficient manner than other systems…

… But, still, there are some who suddenly question whether or not the free market takes away a moral backbone -- but the only situations in which that would clearly be true are in cases of either outright fraud, or where you're dealing with a zero-sum game. In an economy that has the potential for growth, then one should encourage more growth to increase opportunities for everyone. There may be additional moral questions later concerning overall allocation, but increasing the wider opportunity, which is exactly what free market capitalism does, seems ridiculous to question.

In the end, it seems that some have this odd guilt associated with money -- as if because one person has made a lot of it that it somehow takes away from others. That's simply not true. Adam Smith, who wrote the original book on free market capitalism, The Wealth of Nations, only did so after first writing a book on morality, called The Theory of Moral Sentiment. Free market economics and morality go hand in hand. To think that they're mutually exclusive shows both a misunderstanding of morality and economics.”

Comment
I quoted from the piece because it encapsulates ideas that are going the rounds at present, though the confusion about ‘profit’ is of long lineage.

Wealth Of Nations is not about “free market capitalism”, except to those who have never read it.

It is critique of an 18th-century state-managed commercial society, governed by major landowners, and provides an historical analysis of how a growing commercial economy operates in that milieu.

The separate dates of their publication, Moral Sentiments, 1759, and Wealth of Nations, 1776, mislead many commentators, who are unaware that both of Smith’s books were based on his lectures on ‘Ethics’, ‘Rhetoric’ and ‘Jurisprudence’ to students at Glasgow University in the years 1751-64 (and previously mainly to University of Edinburgh students, off-campus in a winter series of public lectures from 1748-51).

Their main ideas were developed and delivered together (and definitely “go hand in hand”) to the same students each session [Adam Smith, Lectures in Jurisprudence, 1762-3, including ‘Early Draft of Wealth Of Nations’, 1763; Adam Smith, Lectures in Rhetoric and Belles Lettres 1763, Oxford University Press/ Liberty Fund].

Adam Smith wrote about how markets worked and was not confined to only writing about ‘free markets’. In fact, he criticized the French Physiocrats, whose economic models required and assumed ‘a state of perfect liberty’ (which nowhere existed, and certainly didn’t exist in absolutist France in the 1760s):

“Mr. Quesnai, who was himself a physician, and a very speculative physician, seems to have entertained a notion of the same kind concerning the political body, and to have imagined that it would thrive and prosper only under a certain precise regimen, the exact regimen of perfect liberty and perfect justice. He seems not to have considered that, in the political body, the natural effort which every man is continually making to better his own condition is a principle of preservation capable of preventing and correcting, in many respects, the bad effects of a political œconomy, in some degree, both partial and oppressive. Such a political œconomy, though it no doubt retards more or less, is not always capable of stopping altogether the natural progress of a nation towards wealth and prosperity, and still less of making it go backwards. If a nation could not prosper without the enjoyment of perfect liberty and perfect justice, there is not in the world a nation which could ever have prospered. In the political body, however, the wisdom of nature has fortunately made ample provision for remedying many of the bad effects of the folly and injustice of man, in the same manner as it has done in the natural body for remedying those of his sloth and intemperance.” [WN IV.ix.28: p 674; Canaan, ed 1937, Random House, p 638]

Smith did not write a treatise on a free-market economy; he did write on human behaviour – his theory of moral sentiments – but he had no illusions about the ‘perfectibility’ of men or society. He was no ideologue; no man with a mission to solve all problems.

He wrote frankly about ‘merchants and manufacturers’ (and the need never to legislate in their interests without the most careful scrutiny of their proposals), and about the limitations of the majority of the population (the labourers and their families), for as long as they remained uneducated (‘unless government take some pains to prevent it’ WN V.i.f.50: p 782), and about the landowners, who owned much and ran everything, and ‘like all other men’ (this part is often overlooked by those who quote the sentence), ‘love to reap where they never sowed’ [WN I.vi.8: p 67; Canaan ed. 1937 p 49, Random House].

Adam Smith was not writing about ‘free market capitalism’ and nothing that has happened to the governance and political economy of all societies, since his time, suggests that it would be worthwhile to pontificate on moral sentiments and modern markets as if something fundamental had changed.

People are no more nor less ‘moral’ than in Smith’s day (or in any other previous age or place) and economies are no ‘freer’ than they were in the 18th century.
If anything the State has grown from powerful governments into bigger and more powerful Governments, and they are susceptible, as they ever were, to the blandishments, false theories, and blatant sectional interests of powerful legislators and those who influence them.

That the discourse of public life is dominated by ideological assaults on the idea of freer markets, and the supposed blessings of ‘regulation’ by bureaucracies, instead of by the justice system, is a symptom of the misjudged tendency to blame markets, which are not free, for the failings from political interventions that are not capable.

Throwing good money after bad is a weakness of poor management; ever tighter regulation to cover the deficiencies of regulations that don’t work as intended is congenital to micro-regulators.

In business markets, incompetence is terminated by losses; in political regulation, incompetence is cushioned by the public purse.

A Debate 'Rages' on Modern Economics

Richard Murphy Blogs at Tax Research UK HERE:

Readers are recommended to follow the link and see whether you agree with Richard Murphy that economics is not a science or with his protagonist, Tim Worstall, that Richard is striking at straw men and missing the point (that his caricature of modern economics is empty of relevant content). Richard keeps claiming that he has ‘won’ and that Tim has ‘lost’, though Tim keeps coming back with credible arguments in support of his propositions and in opposition to Richard’s. At which point Richard unilaterally called the debate off.

Now, I have an interest in this ‘debate’, as regular readers would note, in that I am concerned at the obsession of modern economics of understanding their models rather than the real economy. I am not too fond of notions of general equilibrium either. But modern economics has developed some useful tools to aid policy making, a point tellingly made by Tim, and studiously avoided by Richard.

There is an extensive comments section between Richard and Tim, which must be read as it elaborates many of the themes raised in the debate, most of them revealing what is at stake.

Richard seems to be firmly convinced by the Green arguments about man-made climate catastrophe and the prediction that the world is collapsing from over-consumption by the richer economies (which leaves the poorer economies future somewhat bleak). Richard doesn’t say anything about what he would do about that appalling problem, other than it’s all the fault of ‘neo-liberals’, a shadowy group which everybody can believe in if it is repeated often enough (replacing the Jews as the scapegoats of the last big depression in the 1930s?).

What was an intelligent debate seems to have slid into wild accusations towards the end; it all going one way in fact.

As a Smithian economist, I take the view that human kind is unlikely to decide about these matters by some sort of scientific agreement. Plans to ‘save’ the world will give the would-be planners comfort, but not much else, and is already this decade’s political title, self-awarded by the Prime Minister, and probably mumbled by Al Gore too.

Of course, ‘activism’ (like sitting on runways, blocking traffic, digging up GM crops, or worse) will happen. But if the ‘remedies’ of the activists are inappropriate, they may well be worse than adjusting to the discomforts of climate change (a less directional prediction to the former title of ‘global warming; it takes in a new ice-age too, and one of them of bound to be right, eventually).

So follow the link and make your own mind up, HERE:

Disclosure: I too am a Fellow of the Adam Smith Institute, but I do not follow a strictly ‘neo-liberal’ agenda, at least as presented by Richard. I favour competitive markets where possible and state intervention where necessary, as Adam Smith did.

In view of Richard's limited view of exchange relations, I recommend that he downloads my paper, "The Prehistory of Bargaining: a multi-disciplinary treatment", from the Home Page of Lost Legacy (in red near the top).

The Importance of Market Entrepreneurs

Mark Engler, a writer based in New York City, is a senior analyst
with Foreign Policy In Focus and author of How to Rule the World: The Coming Battle Over the Global Economy (Nation Books, 2008), writes in Portland independent media center (HERE):

“Adam Smith was not an economist. In the 1750s, when he was a professor
at the University of Glasgow in his native Scotland, Smith served as
the Chair of Moral Philosophy. The designation is telling. The rise of
modern economics departments in universities was a late-nineteenth and
twentieth century phenomenon. Economics in its infancy, characterized
by the pursuits of Smith, Ricardo, John Stuart Mill, and Marx, was not
a matter of graphs and econometric models. It was a broader
investigation into social life, a look at how society structured
labor, production, and exchange. And it concerned itself greatly with
the ethical implications of this structure.

As early as the 1950s, economists began establishing a greater role
for socially accumulated knowledge in mainstream understandings of
growth. During that decade, Nobel-Prize winning economist Robert Solow
argued that advances in knowledge are, in fact, the primary driver of
today's growth. Alperovitz and Daly write, "Solow calculated that
nearly 90 percent of productivity growth in the first half of the
twentieth century (from 1909 to 1949) could only be attributed to
'technological change in the broadest sense.'" This suggestion was a
radical shift away from accounts that stressed the more specific
agency of capitalists and entrepreneurs—or of laborers, for that matter
—in expanding our economy.”

Comment
On theories of economic growth I agree with Mark Engler and I suggest that Solow, and others, went 'astray' because their models are 'closed' and their aggregated variables are better thought of as open processes, with increasing returns (lowering costs) in their constituent parts (see Alyn Young, Economic Journal, 1928).

Mark Engler's article develops a theme and while I agree with some parts I also find parts of it unconvincing. The discoverers of knowledge – a cumulative process, if passed on – have a more justified claim to the rewards from development because without their crucial role as discoverers, inventors, innovators and educators is more relevant than the “agency of capitalists and entrepreneurs”.

Well, there is a specific historical example of a society that was the most advanced in the world in inventive science and technologically, which also stagnated. I refer to the old Empire of China which by the 15th century was ahead in so many inventions that they are still being catalogued today by enthusiasts for Chinese history.

But over several decades in the 15th century, China fell into stagnation (partly reported by Adam Smith in the 18th century in Wealth Of Nations), and didn’t really recover until the 19th century (after which there was another interregnum under, first the depredations of the western colonial imperial powers and then, in the mid-20th century, the violent failings of the communists.

The missing ingredient was demonstrated convincingly by the turn away from world trade by the Chinese Emperor, whose writ in these matters ran far and wide. The entrepreneurs and merchants turned inwards and away from the exploitation of scientific knowledge, and no progress was made thereafter in inventions, technology or science. China did not advance into a commercial age; if it had the entire history of the world would have been quite different.

As knowledge revolutions broke through and spread across the backward West, especially in that part of Europe left devastated by the fall of the western Roman empire in the 5th century (of which Adam Smith writes a great deal) that had presaged the thousand-year interregnum, or the ‘dark ages’, which began to end in the West, fortuitously just as China was entering its own self-imposed dark ages.

This development, catching up with old China was accompanied by the age of commerce (‘at last’), as Smith described it in his lectures in 1762), the appearance of ‘entrepreneurs’ and ‘commercial’ adventurers, who turned knowledge into innovative products on scales unimaginable ever before also produced funded feedback (economic growth) to boost a continuing scientific and technological advance of all knowledge without precedent.

Knowledge of the configurations of the stars was interesting, but long-distance overseas trade on a regular basis drove the need for both accurate timekeepers for safer navigation from knowing longitude as well as latitude and for accurate charts for safer seamanship, once the ‘secrets’ of discovery gave way to the less dramatic open-seas of regular trade routes. Knowledge is necessary (three cheers to the discoverers!); but not sufficient. What made the difference are the entrepreneurs and the creators of industry.

Markets were not discovered by a scientist; they operated millennia before the science of economics appeared (and their merits are still hotly debated). Scores of ideas are dormant until somebody finds a use for them and somebody markets those uses successfully.

The Long History of Markets and Exchange

Peter Foster writes in National Post (here):

“Where anti-capitalists hang themselves”

A few lines quoted from a debate arranged by the John Templeton Foundation on markets and whether they morally corrode participants:

“All-too-typically, he attempts to recruit Adam Smith to the left, noting Smith's concern with the "subversive dynamism of the market." But that was nowhere near the Sage of Kirkcaldy's concern about the "folly and presumption" of the likes of Mr. Gray. Mr. Gray does eventually admit the greater moral corrosion of centrally-planned economies but makes the astonishing claim that "actual life in Soviet societies was more like an extreme caricature of laissez-faire capitalism."

Comment
It is the corruption of markets that attracted Adam Smith’s ire, and not markets as such. Adam Smith did not write a textbook of doctrine about markets; he wrote about what he observed, not what philosophers, both contemporary (example, J. J. Rousseau’s condemnation of improved society and its failings, of which he was hardly a shining moral example) and long-past luminaries of the ancient world (example, Plato), made of the quite enormous possibilities of wealth, the ‘annual output of the ‘necessaries, convenience, and amusements of life’, for the real lives of really poor people.

Smith’s historical, ‘looking backwards’, perspective, showed all too clearly the moral corruption of ‘the rulers of mankind’ as individuals in all societies, those with nothing, those with next to nothing, and those with a few artifacts, trinkets, and ‘baubles’ that made them ‘great’ compared to societies still running ‘free’ in the forest.

He wasn’t too impressed with the purveyors of superstition, the misleaders of men and their pusillanimity, the posers who pandered to their pathetic tastes for undeserved praise from their ‘inferiors’, and legislators and those who influenced them with patently false doctrines of political economy, civil government and ‘divine’ rule.

But about commerce, he had few doubts. He debated Rousseau’s ideas, those of Bernard Mandeville, and those of mercantile political economists like Sir James Steuart and, instead, he saw commercial markets and exchange relationships in all areas of his Works, including in the origins of language, the progress of natural philosophy, the evolution of civil justice and the process by which moral sentiments were exchanged and agreed within society (and not through the senses), as being the cause and the consequence of the unintended, uncontrollable, and unforeseen actions, not plans, of human individuals relating through exchanges with each other since they finally began to secure themselves in their societies from the primitive, near animal, horizons of their earliest modes of subsistence.

Smith knew from his friend, the geologist James Hutton, how the world had evolved over ‘unimaginable’ long time periods (and not from 4004 BC!), and he achieved much a hundred years before Darwin discovered natural selection and before political economy began the long march away from how and why markets worked, and towards abstractions upon which there is still no agreement as to how they correspond to the real world of human societies.

Mr Gray, a lovely man no doubt, is forgiven because he does not know what he is writing about in respect of Adam Smith.

Behaviours, Not Rationality, Drive Markets

Peter Foster writes on “The dangers of behavioural economics” in Financial Post, Toronto (25 November) HERE about the alleged dangers of big bonuses on decision-making – apparently they are do not improve performace. (For the details, follow the link).

Peter Foster writes:

“What is perhaps most fascinating about the rise of behavioural economics is that it reminds us that “conventional” academic economics somehow became sundered from human nature. We might remember that 17 years before he published The Wealth of Nations, Adam Smith published The Theory of Moral Sentiments. Smith never for a second imagined that humans were rational calculating machines. Similarly, the greatest economists of the twentieth century — von Mises, Hayek, Schumpeter and Keynes — all regarded homo economicus as a nonsense. Keynes was the odd man out, however, because he believed in an even more fanciful construct — homo politicus — a brilliant individual motivated solely by the public good.

The power of the market meanwhile does not derive from human rationality but from the fact that it rewards or punishes commercial behaviour on the basis of its contribution to society. It is doling out a whole mess of punishment right now, despite the attempts of government to shove cushions down everybody’s shorts.

Man is fatally flawed and periodically subject to Extraordinary Popular Delusions and Madness of Crowds, but a far great delusion is that there is a political solution to his shortcomings.

Unfortunately, behavioural economics is regarded as a new tool with which our political masters might improve us. That is far more potentially damaging than the most elaborate of bonuses.”

Comment
On the whole I agree with Peter Foster in his disdain for the fanciful theories of Homo economicus and Homo politicus, because I am not too fond of the idea of human rationality driving all behaviour in the economic models common among modern economists, other than in the sense we can rationalize any decision into it being rational for that person in those circumstances.

The fad for ‘explaining’ why some (it’s always some, never all, though the obvious caveat is often ignored in the admiration of the ‘rationalist’ for the beauty of the alleged explanation) behaviour can be seen to be ‘rational’.

For instance, teenage girls becoming pregnant is supposedly a rational search to qualify from welfare payments (but why don’t all girls who might believe they would benefit from welfare become pregnant?), or teenage boys develop criminal tendencies to enhance their prestige among their peers (but why do so many more boys in the same circumstances of broken families, slums, unemployment and poor education, not become criminal recidivists?).

Of course a ‘rational’ explanation for these girls and boys not covered by the initial explanation can be advanced too on other grounds, but if every variation is ‘rational’ too then ‘rational’ is no longer the explanation. People do what they do because that’s what people do when they do whatever they do!

Markets are the net effect of all behaviours, not just rational ones. And many of these behaviours are not captured in the rational calculus. Adam Smith understood that truth.

Its Called Scare Marketing and Adam Smith Knew Why

Paul Midler in Forbes.com writes (26 July):
“Dealing With China's 'Quality Fade'

“If Adam Smith were around today, he would have had to write a separate chapter on global outsourcing. Because it takes importers a long time to find suppliers and to get them up to speed, importers keep their suppliers a secret. The last thing that an importer wants to do is let his competitors know the source of any supply chain advantage he may have. Even when it is in their collective interest to share information, importers keep to themselves.

As a result, factories pay little, if any, reputational cost for production shenanigans. The invisible hand doesn't work well when the manufacturers themselves are unseen.”

[Paul is the founder and president of China Advantage, a services firm that provides outsourcing and supply chain management to U.S. and European companies. He has been involved with China for more than 15 years, and in the course of his manufacturing career, has had dealings with thousands of Chinese factories.]

Comment
As expected an article in Forbes is authoritative and worth reading. And this one is no exception. It is about the perils for US businesses which source off-shore in China. Problems of quality are among the topics and the usual effect of growing trade on improving quality does not work quite like it should. Because US firms keep their import sources secret, a poor-to-bad quality Chinese supplier is not penalised by publicity; it just changes its customers and carries on producing shoddy goods.

US businesses in these conditions need reliable information about the quality standards of Chinese manufacturers, and the author of the article is in that business, running 'China Advantage’. Fine; that’s a useful service and deserves its market niche.

My problem is with the obligatory paragraphs on Adam Smith. That aims to hit the readers'‘recognition’ buttons, fair enough, but happens to be unwarranted. Would Adam Smith need “to write a separate chapter on global outsourcing. Because it takes importers a long time to find suppliers and to get them up to speed…”?

If you think about it, Wealth Of Nations would have to contain a lot of new chapters because the world has moved on through European imperialism, the industrial revolution, the communist failed experiments, and such like. But even in outsourcing, why would it need a new chapter?

Trade over large distances – and trade within Britain in mid-18th century was truly 'distant' – it took three weeks to travel by ‘road’ from Edinburgh to London, which is as long as a factory-to-factory cargo from China to the mid-west or California.

Smith wrote about these and related problems and the perils of distant, including foreign, trade in Wealth Of Nations. If the author had read all of the chapter from which he borrows the metaphor of the ‘invisible hand’ (WN IV.ii. ‘Of Restraints upon the Importation from foreign Countries of such Goods as can be produced at Home’, pp 452-72), he would have found plenty of comments about the risks, perils and costs of what is called today ‘outsourcing’, a word invented and promoted by those who oppose foreign trade (also known as competition) among businesses, trade unions, tv demagogues and those who fear they are about to fail to be elected.

Hence, when the authorwrites: “The invisible hand doesn't work well when the manufacturers themselves are unseen…”, he misses the reason why domestic merchants prefer the home to foreign trade which was discussed by Adam Smith:

“In the home trade his capital is never so long out of his sight as it frequently is in the foreign trade of consumption [importing]. He can know better the character and situation of the persons whom he trusts, and if happens to be deceived, he knows better the laws of the country from which he must seek redress.” (WN IV.ii.6: p 454)

To which part of that sentence would the author add something different? Of course, he could expand it (as I could) but Wealth Of Nations does not need expanding!

A US manufacturer buying in Chinese manufactured parts (computer chips) and being sold duff products, will soon know if her computers don’t work, because her customers will tell her, the trade press will report her quality problems and her customers’ suppliers will cancel orders.

Secrecy about her Chinese supplier becomes irrelevant at the most important level; the US business woman’s loss of business, perhaps terminally. If her testing procedures were operating properly (‘what do you mean she hasn’t got any?) that batch of chips, or whatever else it consists of, would have been rejected.

Similarly if Chinese manufactured chairs collapse, or items do not survive their first wash, or customers suffer from toxic poisoning, or for that matter, US based suppliers act similarly selling down the road or across the states, the US manufacturer suffers legal redress from its customers, plus loss of business.

I think I shall put this author's article down to ‘scare marketing’ of his excellent services. US firms looking at foreign supply chains would do well to call on his services if they are embarking on outsourcing in China, or his equivalents in Indian or European outsourcings. They would be wise also to check carefully a local outsource supply across town. Its called ‘due diligence’ and you don’t need to read Wealth Of Nations to know this in business, though if you do, you’ll find references to it.

PS: There are no invisible hands in markets (see archives for plenty of explanation of Smith’s use of the metaphor).

Markets as Part of the Solution

The Foundation for Economic Education (FEE) publishes a daily email service with relevant stories from around the world. While not agreeing with everything it reports, I find little gems about the economic illiteracies of sections of rich world thinking.

Today’s FEE has one such gem:

“The best help for the poor is unrestricted market opportunity.
Nike Ends Labor Contract with Supplier Over Child Labor Concerns

"By severing its contract with Saga, Nike is likely to score moral points with its customers in the West. But it's also likely, observers agree, to sink Saga, a corporate giant that makes about 6 million of Pakistan's annual production of 40-million soccer balls. Saga estimates that as many as 20,000 families could be affected, since 70 percent of the local market relies on them for work." (Christian Science Monitor, Friday)

Comment
This kind of report always worries me. We want desperately to help the poor in the world to move from desperate poverty to opulence. We also have wage labour in our opulent economies much higher than in poor countries. Nike will ‘score moral points’ with the opulent families in rich countries for further reducing the living standards of thousands of already poor families in poor countries. But the rich folks won’t see that, except as famine victims when it’s too late to develop a market economy.

Development takes time. Markets are a long-term fix. Poverty is the consequence of a lack of markets. Smith expressed this clearly when he wrote about the income of the common labourer in the 18th century being higher than the income of labourers in the 17th century around the time of Charles II’s restoration, which were higher than the time of William the Conqueror in the 12th century, which, in turn, were higher than at the time when Caesar ‘visited’ Britain in 54 BC.

With globalisation we are not talking about it taking centuries to raise world living standards, but nor are we talking about decades. World markets are spreading fast enough to raise the incomes of 20,000 Pakistani families by the second or third generations. Interrupting economic growth is not part of the process.

If the ‘moral’ urge in rich, protectionist countries is to undertake development in poor countries as fast as possible, the energies of the rich moralists should be directed at reducing protectionist barriers against agricultural and manufacturing produce of the poor countries.

Nike is not part of the problem; it is part of the solution. So those with heavy moral boots should tread carefully. They could start, for example, by lifting tariffs on footwear, underwear, and such like from poor countries, which would do much to expand production facilities in poor countries and by increasing demand for labour, raise their wages and allow them to keep their jobs.

Subscribe (free) to FEE--In brief [inbrief@fee.org]

Dr Drummond's Students in Good (but not invisible) Hands

Accounts of markets are always interesting to economists, especially those emerging markets which are in transition from simplicity to complexity. Economic development, as in China, tracks the emergence of markets from within the statist society that was communism.

Dr Drummond provides an excellent example of the genre, reporting on his stay in BeiBei (in connection with an academic exchange visit). I quote the opening paragraphs and strongly recommend that you read the whole piece at:
http://drummondinbeibei.blogspot.com/ :

“Markets
Adam Smith, generally considered to be the father of economic thought, was mystified by the operation of markets. How could they be so efficient without some sort of managerial oversight? Smith concluded that markets were coordinated by the “propensity in human nature…to truck, barter, and exchange.” That is, to engage in commerce is just as much a part of the human experience as to engage in survival or reproduction.
Each Thanksgiving we celebrate the bountiful harvest of almost 500 years ago when the first successful colonists arrived in the “new” world. As I walk the streets of Beibei [China], I frequently wonder what it looked like five thousand years ago as the early inhabitants of this river valley pursued their “propensity…to truck, barter, and exchange.” My initial guess is that not much has changed.”

Comment
What follows is fairly modern Adam Smith, without it being overtly so. When I read the first paragraph I thought it was about to burst into praise of the invisible hand fable, but my heart lifted when it raised the truly Smithian idea of ‘truck, barter and exchange’.

The closer you get to real markets with real people, and away from the abstractions of so-called general equilibrium neo-classicism, the less likely you will fall into the stupor of belief in mystical or miraculous invisible hands (which have nothing to do with Smith’s theories of markets).

Dr Drummond’s students are in good hands.