Friday, July 17, 2009

Two Professors Argue About the Invisible Hand - And Both Get it Wrong too.

Dan Ariely, a behavioral scientist at MIT and the author of Predictably Irrational: The Hidden Forces that Shape Our Decisions, writes in Psychology Today HERE

“Irrationality is the real invisible hand”

Adam Smith first coined the term "The Invisible Hand" in his important book "The Wealth of Nations
."

[No he didn’t! Smith first used words, ‘invisible hand” once in his essay on the History of Astronomy, began around 1744 and complete before 1758, and used it once again in Moral Sentiments (1759), and once later in Wealth Of Nations (1776).

Smith didn’t ‘coin’ the phrase at all. It was a well-known phrase going back to classical times (Ovid), and was widely used in the 17th and 18th centuries in both religious tracts, sermons and books, and in literary works (Shakespeare, Defoe, Voltaire and others.]

"With this term he was trying to capture the idea that the marketplace would be self-regulating."

[No he wasn’t. He used the term not in his discussion and analysis of markets (Book I and II of Wealth Of Nations), but in a discussion of the choice of export/importing versus investing in domestic businesses (Book IV of Wealth Of Nations on his critique of mercantile political economy). It had nothing to do with ‘regulating’.]

The basic principle of the invisible hand is that though we may be unaware of it, an unseen hand is constantly prodding us along to act in line with what's best for the whole economy. This means that when this invisible hand exists, when we all pursue our own interest, we end up promoting the public good, and often more effectively than if we had actually and directly intended to do so. This is a beautiful idea, but the question of course is how closely it represents reality.”

[If Dan Ariely believes that “The basic principle of the invisible hand” represents reality he is totally mistaken. It was a metaphor Smith used only three times and he never said “that when this invisible hand exists, when we all pursue our own interest, we end up promoting the public good, and often more effectively than if we had actually and directly intended to do so.” That is a modern construction placed on the metaphor and has next to nothing to do Adam Smith].

We are now paying a terrible price for our unblinking faith in the power of the invisible hand.”

[The only ‘terrible price’ is that of embarrassment among those economists who preached the above nonsense about the invisible hand, and, worse, believed that their invented roles for the metaphor were actually written by Adam Smith; they weren’t; and because professors of economics seldom read Adam Smith, except in clipped quotations, they did not realize what they were doing.]

In my mind this experience has taught us that Adam Smith ‘s version of invisible hand does not exist …”

[Simply reading what Adam Smith wrote would have helped Dan and many others from making the mistake of believing what their tutors told them.]

In Adam Smith's world the invisible hand was a wonderful force, and the fact it was invisible made no difference whatsoever.”

[The invisible hand was never in Adam Smith’s world in the form invented in mid-20th century by some economists who created the Chicago version of Adam Smith, while ignoring the Adam Smith born in Kirkcaldy, Scotland in 1723.]

The irrational invisible hand is a different story altogether - here we must identify the ways in which irrationality plays tricks on us and make the invisible hand visible!”

[Yes, Dan has invented yet another version of Adam Smith – utterly ridiculous too – and talks nonsense.]

In the following issue of Psychology Today (HERE)

David Hirshleifer, who holds the Merage Chair in Business Growth and a professor of finance and economics at the Merage School of Business at UC Irvine responds to Dan Airely with this blast (equally wrong but for different reasons):

To Dan Ariely, the invisible hand---the market force that gets people to help others, even when that is no part of their intention---is a pleasant fantasy.”

[Yes it is, but David suffers from the same condition]

The most elegant statement of the idea he's whacking comes from Adam Smith himself:

“It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own self-interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages
.”

[This quotation comes from Book I (chapter 2) of Wealth Of Nations and is often quoted as being about the invisible hand, and usually is mistaken in their interpretation of what it is about. It is really about the bargaining that occurs throughout commercial market economies.

Smith advises you to barter for your dinner by addressing not your own needs, but by addressing the needs of the sellers.]

You can read the rest of Dan’s and David’s articles by following the links. However, you won't learn much about Adam Smith's use of The Metaphor.

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2 Comments:

Blogger michael webster said...

It has finally hit me what is really odd about using the Adam Smith quote to justify an interpretation of Debreu's theorem.

In the Arrow/Debreu world, individuals are acting to maximize there own utility with nary a thought about the other person's utility.

In the Smith world of trade, he advises the opposite: look to your trading partner's utility.

9:51 pm  
Blogger Gavin Kennedy said...

Michael

Sorry I missed your comment.

You are right, of course. But linking anything new to Adam Smith gives anything new a distinction, even if the new theorem has nothing to do with Smith.

What the professors should be saying is that their notion of harmony and goodness from their versions of self interest have been shown to be wanting in the real world, and on re-reading Adam Smith they now realise that he did not subscribe to Homo economicus and mystical social benefits coming from all human actions.

That notionwas always too good to be true, as Smith told them - 'vile masters' of manking, etc.

9:20 am  

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