Invisible mishandling

by: Paul Rosenberg

Sun Nov 15, 2009 at 10:00

What if Adam Smith's "invisible hand" argument doesn't mean what we think it means?  What if it doesn't mean that everything else but the "free market" can and should be ignored?  What if if Smith actually depended on social and historical context in order to make his argument in the first place? What if it was an argument deeply dependent on what Harvard law professor Jon Hanson, co-creator of The Situationist blog calls "the situation"?

In fact, that's exactly what happened!

Recently, Berkeley economist Brad DeLong posted

"Yet Another Note on Adam Smith's 'Invisible Hand': What It Is and What It Is Not", in which he points out that the phrase "invisible hand" only occurs once in the whole of Adam Smith's The Wealth of Nations. He then quotes a good-enough chunk of text to give the full context in which the phase occurs-an argument that merchants prefer to ship goods through their home port, even though it costs more (even needlessly unloading cargo), and thus produce much the same result as mercantilism in promoting domestic economic activity.  DeLong then summarizes thus:

Note that Adam Smith's "invisible hand" argument is not the argument economists make today. Adam Smith argues that there are:

• political failures--uncertainty about how to access and indeed the prevalence of the rule of law in other countries.
• psychological failures--people are so anxious to have some of their wealth around them where they can touch it that they pay longshoremen to unload and reload goods at Amsterdam rather than drop-shipping them straight from Konigsburg to Lisbon.

And he argues that, as a result, merchants are good patriots--that they deploy their capital to "render the annual revenue of the [national] society as great as he can."

It is within this context-the argument above-that Smith writes, "By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain; and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention."  

This is, indeed, quite different from the invisible hand argument we are supposed to believe in.  The merchant's self-interest here is not the least bit rational in the abstract sense we normally suppose.  This is not the result of the merchant's reason (as later theorists might define it in terms such as "the rational actor" or "rational expectations theory", so much as it reflects the merchant's psychology-a clear deviation from abstract  reason--and the merchant's situation-explicitly his uncertainty over goods he cannot see, foreign laws and customs should things go awry, etc.

In this passage, Smith is overtly talking like a behavioral economist, rather than a more orthodox "rational actor" or related sort of practitioner.   However, there's an even deeper intellectual departure here, since his entire argument is based on a particular set of social institutions, expectations, past experiences and resultant practices, all of which contribute to his particular predilections that silently shape what is rational to him.

As at least two commentator point out, when these are altered-as they have been since Smith wrote-the individual self-interest of the merchant no longer produces the same result: He favors the foreign economy over his own.  Therefore, if was not the "free market" that produced a benefit for all from the self-interest of one, it was the specific set of institutional, historical, cultural/social conditions that produced that coincidence of individual and collective benefit.

Paul Rosenberg :: Invisible mishandling
Same Hands, Different Pockets

Here's the passage from The Wealth of Nations as DeLong quoted it, which you may read, skim, refer back to in light of what follows, or simply ignore, as you prefer:

Every individual['s]... study of his own advantage naturally, or rather necessarily, leads him to prefer that employment which is most advantageous to the society.

First, every individual endeavours to employ his capital as near home as he can, and consequently as much as he can in the support of domestic industry, provided always that he can thereby obtain the ordinary, or not a great deal less than the ordinary profits.... In the home trade, his capital is never so long out of his sight as it frequently is in the foreign trade of consumption. He can know better the character and situation of the persons whom he trusts; and if he should happen to be deceived, he knows better the laws of the country from which he must seek redress.... The capital which an Amsterdam merchant employs in carrying corn from Koningsberg to Lisbon.... The uneasiness, however, which he feels at being separated so far from his capital, generally determines him to bring part both of the Koningsberg goods which he destines for the market of Lisbon, and of the Lisbon goods which he destines for that of Koningsberg, to Amsterdam; and though this necessarily subjects him to a double charge of loading and unloading as well as to the payment of some duties and customs, yet, for the sake of having some part of his capital always under his own view and command, he willingly submits to this extraordinary charge; and it is in this manner that every country which has any considerable share of the carrying trade, becomes always the emporium, or general market, for the goods of all the different countries whose trade it carries on....

[A] capital employed in the home trade, it has already been shown, necessarily puts into motion a greater quantity of domestic industry, and gives revenue and employment to a greater number of the inhabitants of the country, than an equal capital employed in the foreign trade.... Upon equal, or only nearly equal profits, therefore, every individual naturally inclines to employ his capital in the manner in which it is likely to afford the greatest support to domestic industry, and to give revenue and employment to the greatest number of people of his own country.

Secondly, every individual who employs his capital in the support of domestic industry, necessarily endeavours so to direct that industry, that its produce may be of the greatest possible value.... As every individual, therefore, endeavours as much as he can, both to employ his capital in the support of domestic industry, and so to direct that industry that its produce maybe of the greatest value; every individual necessarily labours to render the annual revenue of the society as great as he can. He... neither intends to promote the public interest, nor knows how much he is promoting it. By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain; and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest, he frequently promotes that of the society more effectually than when he really intends to promote it...

Concerning, in effect, the difference that a different situation would make, the commentator Derek wrote:

The invisible hand of this story worked as long as information about foreign parts was uncertain, and the working class at home came cheap. The labor movement at home, making working class people expensive [note to middle class people: this is a GOOD thing], and the increasing quality of international business intelligence, has reversed the invisible hand so that it now sucks domestic capital abroad, as in Britain in the late nineteenth and early twentieth centuries, and America today.

And a similar point-though differently framed--was made by the commentator Gordon:

I'm surprised that the ideas of "political failure" and "psychological failure" aren't discussed as aspects of what any modern economist would describe as risk. Where there is no greater risk involved in employing your capital abroad than there is in employing it at home, or where the extra returns are sufficient to compensate for the extra risk, then the "Amsterdam merchant" would be expected to invest abroad and cease his trans-shipping. Today we would call it globalisation.

A Realworld Example:  Mishandling Port Pollution

Realworld economists know full well that markets don't generally work on their own-they have to be created, or protected (once created) from forces that would distort their functioning.  Smith himself commented various different times about how special interests would seek to distort how markets work.  I live in Long Beach and the paper I write for is in San Pedro-making me adjacent to the largest container port complex in the United States, a complex that's riddled with market failures.  The combined pollution from the two ports, and the goods movement transportation flowing from them is so deadly that by some estimates it kills more people in California than there are homicides in any given year.  Using the standard statistical value of a human life, these ports and those who serve them externalize costs of well over $10 billion, and arguably as much as $20 or $30 billion a year.  Considering that their annual budgets are each on the order of $1 billion a year (current lower because of the recession), it's clear that the vast majority of the costs involved are not part of the market-based accounting.

Broken down to a much smaller level, one of the chief pollution sources is the fleet of antiquated trucks serving the ports, a fleet now being modernized with a substantial subsidy from state and local air quality boards, as well as the two ports. Aside from the fact that the polluters in aggregate are being subsidized to stop killing people, there is another way in which the market is broken:  The trucking industry is fighting tooth and nail to maintain a system in which so-called "independent owner-operators" move the vast majority of the cargo.  Two different economic studies have concluded that this model is incompatible with the long-term goal of cleaning up the air, because individual truck owners simply can't make enough money in the "free market" to properly maintain their trucks, much less replace them when that eventually becomes necessary.

One of the studies made the further observation that individual truckers have the incentive, but not the power, to minimize the number of trips they make with empty loads, whereas if the trucks are all owned by sufficiently large companies, such wasted fuel-burning trips can be minimized.  In the abstract, the abstract model of Smith's invisible hand would be operating in both models.  But in reality, only the truck companies in the second model can actually maximize their income in a way that benefits others as a whole by reducing unnecessary pollution.  However much they might wish it, the "independent owner-operators" simply cannot be good little Smithian agents, benefiting the rest of society by only thinking of what is best for them.  The situation of the market they are part of simply does not allow it-even though it's much more profitable for those who employ them.

The Invisible Hands Smith Knew

I emailed Hanson about DeLong's post and he directed me to a brief section of a law review article he had co-authored with Ron C. Chen, "The Illusion of Law: The Legitimating Schemas of Modern Policy and Corporate Law", where they discuss what some others have said on the subject.  I was chagrined that I'd forgotten some highly relevant observations from Emma Rothschild in her excellent book, Economic Sentiments: Adam Smith, Condorcet, And The Enlightenment. In the article, Hanson and Chen write:

More recently, economic historian Emma Rothschild devoted a chapter of her book to the beginnings of the "invisible hand imagery." According to Rothschild, there are good reasons to believe "that Smith did not especially esteem the invisible hand."496 By researching the contemporaneous "invisible hand" metaphors that Smith was probably familiar with, Rothschild discovers that they tended to have negative, sometimes gruesome, connotations.497 Reexamining his work with that meaning in mind, she concludes that "[t]he image of the invisible hand is best interpreted as a mildly ironic joke."498

The first footnote cites Rothschild's book, while the second elaborates as follows:

In addition to other evidence, Rothschild points to three examples of the invisible hand that likely influenced Smith's use of the imagery. Describing the first, Rothschild writes:
    The earlier intellectual history of invisible hands turns out to be generally grim. The most famous invisible hand in Anglo-Scottish literature is that of Macbeth's providence. "And with thy bloody and invisible hand," Macbeth apostrophizes the night in Act III, in the scene immediately before the banquet and Banquo's murder; he asks the darkness to cover up the crimes he is about to commit:
      Come, seeling night,
      Scarf up the tender eye of pitiful day,
      And with thy bloody and invisible hand
      Cancel and tear to pieces that great bond
      Which keeps me pale.

ROTHSCHILD, supra note 496, at 118-19. Rothschild argues that Smith "is likely to have known Macbeth well," having "lectured on Shakespeare's use of metaphor." Id. at 119.

Similarly, she writes:
    Smith was a great admirer of Voltaire's tragedies, and Voltaire, too, invokes several invisible and disagreeable hands. . . . In Act IV, Oedipus recounts the memorable day in Corinth when, as he arrived at a temple with offerings to the gods, the altar began to shake, a terrifying voice was carried to him by the winds, and "an invisible hand pushed away my presents."

Third, Rothschild explains:
    There is an earlier invisible hand which is even more unpleasant, and which Smith probably also knew; it appears in one of Ovid's Metaphorphoses, in which the hero (the warrior Caeneus, who is at the time surrounded by centaurs, one of whom is taunting him because he had been born a woman, Caenis), "twisted and plied his invisible hand, inflicting wound within wound." The hand is invisible here because it is behind the victim's back; in the edition of Ovid which Smith owned there is an illustration, as a frontispiece to this particular book of the Metaphorphoses, of a gloved hand stabbing a soldier between the shoulder blades with a long spear.

Thus the meanings of the "invisible hand" that Smith himself was familiar with were already quite various and situationally determined, so it's entirely consistent that his meaning should be situational as well, rather than being context-independent.

There are even broader contexts that should be considered as well.  One is that of small-scale market societies vs. that of corporate capitalism, which is touched on as well in this law review article.  The other is the contrast between The Wealth of Nations and Smith's other major work, The Theory of the Moral Sentiments  In that work, Smith is greatly concerned with altruistic motivations, under the rubric of "benevolence."  This was a concern Smith shared with other philosophers of the Scottish Enlightenment, which Garry Wills has written about extensively in a number of his books with  the founding of America.  Suffice it to say, when all these contexts are considered in concert, one cannot escape the realization that Smith would have nothing at all to do with the likes of Ayn Rand and her disciple Alan Greenspan, or even the Summers/Giethner crowd.  But this is just a tease for future diaries only dreamed of now, not yet written.

End notes: There is more from the brief passage in this paper that I wish to comment on, but it will fit better within another post I've been mulling over for some time now, maybe next weekend, if all goes well. But one more thing deserves noting: the passage from The Wealth of Nations I quoted in my first diary of the day is an expanded passage that includes a shorter passage also quoted in this article.  

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Children playing with matches (4.00 / 2)
It's rather like what the Social Darwinists did with Darwin, the Comintern did with Marx -- or, God forbid, what General Groves did with the mass/energy equation.

This is the part of the dialectic that I've always hated. Once an idea is set loose in the world, there always seem to be more swords beaten out of it than plowshares.  

And Yet (4.00 / 2)
The only thing worse than bloody progress is bloody stagnation or bloody regress.

"You know what they say -- those of us who fail history... doomed to repeat it in summer school." -- Buffy The Vampire Slayer, Season 6, Episode 3

[ Parent ]
michael hudson talk (4.00 / 2)
paul, i was going to wait until i'd made a transcript (something i hope to do this week) before recommending a recent michael hudson talk to you and your readers. but your post today prompts me to post the audio links now.

as i'm sure you recall, hudson, along with steve keen, was one of the 12 economists you wrote about in your post, The Crash: Who Saw It Coming--And Why.

hudson was recently in australia and gave a talk partially sponsored by keen and promoted on keen's blog. someone was kind enough to record the talk (and excellent q&a) for posting, and while it's not professional quality the audio, except for the intro, is quite sufficient for listening.

here's a link to the mp3 for downloading:

here'a a link to keen's post and the embedded vid:

hudson puts the current neoliberal period in the context of an economic and ideological attack on the enlightenment and of neoclassical economists against the classical economists, and everything fought for in progressive era, by the labor parties and social democrats. i found the talk both provocative and interesting (and there are some side references to adam smith).

Okay, You've Got Me All Hot And Bothered (0.00 / 0)
but there's no way I have time to listen today!


Looking forward to the transcript, I am.

"You know what they say -- those of us who fail history... doomed to repeat it in summer school." -- Buffy The Vampire Slayer, Season 6, Episode 3

[ Parent ]
so sorry! (4.00 / 1)
i would have waited if it hadn't been for this post of yours. knowing that you are interested though will provide some extra motivation to me in finding the time to make the transcript soon.

[ Parent ]
Bad Bumper Sticker? (4.00 / 1)
Wall St beat the shit out of me with Adam Smith's "Invisible Hand"!

Mistaking beauty for truth... (0.00 / 0) the title of the first chapter in Paul Krugman's explanation of what happened in his field.

One of the other commenters in that DeLong thread claimed that attempting to discern Smith's meaning was the sign of an insecure science.  I happen to think that understanding his meaning is relevant, and DeLong's and your post are great in that regard, but I think Krugman's article gets to the most important problem with respect to the science itself:  It became completely unmoored from reality.

Not Particularly Beautiful, Actually (4.00 / 1)
"Neat" is more like it.

As in "tidy", not as in "cool."

As for the unmooring, Keynes himself warned about that from the very beginning.

"You know what they say -- those of us who fail history... doomed to repeat it in summer school." -- Buffy The Vampire Slayer, Season 6, Episode 3

[ Parent ]
Beauty is in the eye of the beholder :-) (0.00 / 0)
Seriously, while I agree that "neatness" explains some of the appeal, it's the "beauty" of that "neatness" that blinds some to the theory's ineffectiveness.

This is why, while the utility of Occam's Razor holds up well, I think the arrival at it was inevitable -- it's human nature to see beauty in simplicity.  There's even a more specific word for it: elegance.

Agreed about Keynes.  Further evidence of the unmooring is that his name isn't on the lips of every pundit and politician.  It's as if people think the World Is Flat or something.

Oh, wait...

[ Parent ]
It's Not So Elegant (0.00 / 0)
That's my point.  I have a math background.  And for something to be truly elegant, it has to be... well, true.  Now, I know things are different in science.  Newtonian physics is elegant, even though it's not true. But it is true within its set of assumptions, and the limits of applicability are well understood, and that whole package all tied together preserves its claim to elegance.

Not so neo-classical economics.  It describes a tendency towards stability and equilibrium that's totally at odds with the dynamic capitalism that was exploding all around the theorists who first cobbled it together.

Classical economics, OTOH, did fundamentally correspond to what those folks saw going on around them.  Neo-classical economics was, at bottom, a reformulation of classical economics with a cleverer mathematical foundation, which utterly ignored the profound changes in realworld economics that had taken place since classical economics was launched.

"You know what they say -- those of us who fail history... doomed to repeat it in summer school." -- Buffy The Vampire Slayer, Season 6, Episode 3

[ Parent ]

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