Wednesday, 27 June 2012

The past and present of the invisible-hand proposition

There is always much discussion of what Adam Smith meant or said about this or that. One of the most discussed ideas is the "invisible hand". (Take a look at Gavin Kennedy's blog for extended discussion.) A new working paper looks at The Past and Present of the Invisible-Hand Proposition: From 'Scottish Political Economy' to Axiomatic General Equilibrium Analysis. It is by Arash Molavi Vasséi. The abstract reads,
The present study raises the following questions: To what extent is axiomatic general equilibrium analysis a rational reconstruction of Scottish Political Economy as defined by the writings of David Hume and Adam Smith? How much is gained and how much lost by the axiomatic transformation of the invisible-hand proposition? What are the implications of negative results like the Sonnenschein-Mantel-Debreu demonstrations for the Scottish point of view? Did it reach deadlock, or is there still hope for the dominant trajectory in the history of economics? In contrast to the rich historical literature on the invisible-hand proposition, the present study does not level any paradigmatic criticism at neo-Walrasian analysis. Rather, by focalizing the most important results against the backdrop of Scottish Political Economy, it provides some flesh to the bones of axiomatic economics and, insofar, may inform theory choice within the neo-Walrasian paradigm. Naturally, the answers to the questions raised are complex and do not fit into an abstract. Instead, the reader is referred to the final section, which lists, interrelates, and discusses the major results of the study.
I'm not sure that Smith would have believed in any invisible-hand proposition so I'm not sure that its even meaningful to ask what is "lost by the axiomatic transformation of the invisible-hand proposition?" In a working paper of my own I write,
For Smith competitive markets were the most prominent mechanism for coordinating and motivating people to maximise the grains that result from increased specialisation and an expanded division of labour. Well functioning market institutions leave individuals free to pursue self-interested behaviour, but guide their choices by the prices they pay and receive. For economists, the 200 years following Smith involved a search for conditions under which the price system would function well, conditions under which it would not descend into chaos.

The formal (neoclassical) model that arose from this search is one which abstracts completely from any form of centralised control in the economy.
But I add the footnote,
For Adam Smith this would be an abstraction too far. Smith knew of the importance of institutions to the proper functioning of the market economy. Mark Blaug points out that “[ . . . ] Smith’s faith in the benefits of ‘the invisible hand’ has absolutely nothing whatever to do with allocative efficiency in circumstances where competition is perfect `a la Walras and Pareto; the effort in modern textbooks to enlist Adam Smith in support of what is now known as the ‘fundamental theorems of welfare economics’ is a historical travesty of major proportions. For one thing, Smith’s conception of competition was, as we have seen, a process conception, not an end-state conception. For another society, a decentralised competitive price system was held to be desirable because of its dynamic effects in widening the scope of the market and extending the advantages of the division of labour - in short, because it was a powerful engine for promoting the accumulation of capital and the growth of income”. (Blaug 1996: 60-1).
Thus the question "[t]o what extent is axiomatic general equilibrium analysis a rational reconstruction of Scottish Political Economy as defined by the writings of David Hume and Adam Smith?" would have the answer, very little.

1 comment:

airth10 said...

"How much is gained and how much lost by the axiomatic transformation of the invisible-hand proposition? "

That sounds like a thermodynamic question, pointed at the second law - entropy.

Adam Smith's invisible hand metaphor, as Gavin explained, is about insecurity, businessmen being insecure about investing abroad, hence they invested domestically, all led by an invisible hand.

The investing domestically does established a sort of equilibrium by keeping jobs and innovation at home. But in present economics conditions investing only domestically is not that prudent an idea. Domestic returns on investment have not always been ideal since workforces in mature economies have grown stagnant, become overpaid and less productive. Under such conditions business investors would be foolish not to invest elsewhere, where costs are lower and returns on investment are better.

So today's invisible hand has become bias in the other direction by also investing non-domestically, thus creating a disequilibrium for domestic economies. But there is a silver lining in that the investing abroad creates competition for domestic industries, thus motivating them to reinvent themselves by improving production and lowering costs.

The invisible hand metaphor in the modern world explains the phenomena of roaming investment capital, fleeing entropy and disequilibrium in one place in search of security and equilibrium in another. It plays a revitalizing role by pitting markets against each other.

Another thing the invisible hand has done, in its perverse movements, is integrate the world through capital flows and the expansion of capitalism. In this way it has united the world, made it more stable and thus less likely for nations to go to war with each other, all unintentionally.