A Wee Thought While For My Journey to Oz

It occurs to me in my new paper on the invisible hand, as it became in mid-20th century economics, that it is worth considering what happens after those merchants who are risk-averse to foreign trade and, in consequence, invest locally rather than take the greater risks (as perceived by them, but not all merchants - many do invest abroad, of course), which Adam Smith observed, benefitted the national economy (the whole is the sum of its parts), that the tale ought not to end there.

Modern economists generalise from the narrow case which Smith discusses in Wealth Of Nations (WN IV.ii.1-9) to make the bold - near heroic! - assertion that self-interested people end-up benefitting the public by acting on their self-interest. Milton Friedman (among many others) celebrated this assertion, supposedly attributed to Adam Smith.

However, consider the real consequences of a national policy of investing as much as possible domestically. True (absolutely true), the more merchants who invested in profitable projects domestically, the larger would be national output (and employment) on grounds of the 'whole is the sum of its parts'.

'Tis but a short step from such a conclusions for the same domestic merchants delivering their outputs locally for some of them (it only takes a few, even one) to realise that they can raise their profits yet more by curbing rival suppliers from competing in the same domestic markets.

One obvious target is foreign traders sending foreign outputs to doemstic markets - including those domstic marchants who exported abroad and returned with foreign goods to sell domesticlaly. Of domestic merchants, confined to the domestic market, having been 'led by an invisible hand', the temptation to go for retrictive tariffs and outright protection by prohibition must become real.

So, being led by an invisible hand to forego profitable trade with foreigners (Smith's narrow example), they are likely to promote protectionism, to narrow the competition for local consumers by widening the market for domestic merchants.

The question occurs to me: are they led by an invisible hand to take this step?

We can ask ourselves: which group of merchants usually prefer tariffs and prohibitions against foreign traders? Which lobbies their legislators and those who influence them to this end? Is it the domestic merchants primarily, or is it those merchants who invest in foreign trade?

I conclude (for short), that the merchants engaged in domestic trade only (driven by their risk aversion from foreign trade) are the most likely proponents of tariffs and prohibitions on imports, and not the less risk averse domestic merchants who do engage in foreign trade.

As there is unlikely to be an invisible hand at work leading domestic merchants to prefer tariffs and prohibitions (the latter also brought about by narrow national interests - 'jealousy of trade'), which must make the general interpretation of the doctrine of invisible hands, as a special, limited, and partial phenomena. Smith, of course, knew this, and he also knew he was not making a general recommendation against foreign trade. Modern economists, 200 years on, ought to know this too.

What went wrong?

Myths of Free Markets

Erik Kirschbaum writes in Cota 1061 HERE:

“German ‘cash for clunkers’ shows free market perils”

“THE INVISIBLE HAND
Scottish economist Adam Smith coined the term “the invisible hand” in the 18th century to describe the positive effects of the free market on individuals.
Yet the worst economic downturn since the Great Depression has led governments around the world to re-evaluate that belief in the “invisible hand” and to prop up sagging economies.”

Comment
In an otherwise reasonably sensible piece, Erik Kirschbaum, writes this nonsense about Adam Smith and the metaphor of ‘an invisible hand’.

Adam Smith did not ‘coin the term “the invisible hand”. The metaphor was well-known in the 18th century and widely used in literature, and had been known since classical times (Greece and Rome). It was used by Shakespeare (in Macbeth: ‘thy bloody and invisible hand’), and Defoe used in twice (Moll Flanders and Colonel Jack). Even Voltaire, among others. used it.

Adam Smith most certainly did not use the metaphor ‘to describe the positive effects of the free market on individuals’, which he discussed in detail in Books I and II of Wealth Of Nations (he only used in once, and not in reference to markets; it was about risk and uncertainty, Book IV of Wealth Of Nations).

Modern economists who ‘believe’ in the myth of the invisible hand have been misled by leading US economists (in Chicago in the 1930s; Oscar Lange (146); Paul Samuelson, 1948); Milton Friedman (serially from the 1950s); and hundreds of thousands of graduates from academe influenced by the scores of graduates who ‘believed’ what their tutors told them (without them, or their tutors ever reading Wealth Of nations for themselves.

That governments came to believe the myth of ‘an invisible hand’ is the fault of prestigious modern economists (including Nobel Prize winners) advising them.

Moreover, that they apparently believe that their economies are ‘free markets’ is astonishing, given that even a casual look at modern markets in economies with Big Governments would show they were as un-free as commercial markets were in Smith’s day, not just internaly, but also externally through tariff protection.