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    The Invisible Hand

    | 19/04/2012

     
    Stiglitz says: “Adam Smith’s invisible hand may be invisible because, like the Emperor’s new clothes, it simply isn’t there; or if it is there, it is too palsied to be relied upon”.[1] Does Smith claim anything different?

    He mentions the invisible hand three times.[2] Once in The History of Astronomy:

    “For it may be observed, that in all Polytheistic religions, among savages, as well as in the early ages of Heathen antiquity, it is the irregular events of nature only that are ascribed to the agency and power of their gods. Fire burns, and water refreshes; heavy bodies descend, and lighter substances fly upwards, by the necessity of their own nature; nor was the invisible hand of Jupiter ever apprehended to be employed in those matters. But thunder and lightning, storms and sunshine, those more irregular events, were ascribed to his favour, or his anger. Man, the only designing power with which they were acquainted, never acts but either to stop, or to alter the course, which natural events would take, if left to themselves. Those other intelligent beings, whom they imagined, but knew not, were naturally supposed to act in the same manner; not to employ themselves in supporting the ordinary course of things, which went on of its own accord, but to stop, to thwart, and to disturb it. And thus, in the first ages of the world, the lowest and most pusillanimous superstition supplied the place of philosophy.”

    The second time in The Theory of Moral Sentiments:

    “The produce of the soil maintains at all times nearly that number of inhabitants which it is capable of maintaining. The rich only select from the heap what is most precious and agreeable. They consume little more than the poor, and in spite of their natural selfishness and rapacity, though they mean only their own conveniency, though the sole end which they propose from the labours of all the thousands whom they employ, be the gratification of their own vain and insatiable desires, they divide with the poor the produce of all their improvements. They are led by an invisible hand to make nearly the same distribution of the necessaries of life, which would have been made, had the earth been divided into equal portions among all its inhabitants, and thus without intending it, without knowing it, advance the interest of the society, and afford means to the multiplication of the species.”

    The third time in The Wealth of Nations:

    “But the annual revenue of every society is always precisely equal to the exchangeable value of the whole annual produce of its industry, or rather is precisely the same thing with that exchangeable 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 may be of the greatest value; every individual necessarily labours to render the annual revenue of the society as great as he can. He generally, indeed, 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. I have never known much good done by those who affected to trade for the public good. It is an affectation, indeed, not very common among merchants, and very few words need be employed in dissuading them from it.”

    In the first case Smith argues that the invisible hand is employed out of ignorance: when events cannot be explained by regularities they are referred to the action of the invisible powers, which, clearly, do not exist. The presumption is that this invisible hand is motivated in the same way in which the visible hand of people is motivated. That raises the question of whether there are some laws that govern human behaviour that cannot be immediately applied to irregular events and thus out of ignorance are ascribed to, the visible hand of, human action. Smith does not say, as often quoted, also by Stiglitz, “as if led by an invisible hand”, because the term “invisible hand” is already a metaphor, which is to say that it means that it is like the hand exists, but it does not.

    The two other references to the invisible hand are really about the fallacy of explanations by actions of the visible hand.

    In the passage from the Theory of Moral Sentiments Smith argues that the rich cannot consume all that much so that either their moral reformation or redistribution of resources could lead to an appreciable increase in the consumption of the poor. So, the distribution of wealth does not matter for the determination of the inequality of income and consumption.[3] The actions and the motivation of the rich and the poor do not matter for the distribution of welfare, which is determined by the invisible hand, which is just a metaphor for the laws of distribution, which unlike the invisible hand exist.

    In the most often quoted passage from The Wealth of Nations, Smith uses the invisible hand as a synonym for deductive explanation (one could say that invisible hand leads one from premises to conclusions, though of course the latter are implied in the former). He first argues that in an accounting sense, if individual income is increased, national income is increased too. Then he argues for the same conclusion in the causal sense: if the aim of the individual enterprise is to increase one’s income, the unintended effect will be an increase of the national income. This applies to a closed as well as to an open economy. Clearly the latter case has been debated the most, but Smith argues that not much improvement will come from additional reliance on the visible hand of political intervention.[4]

    So, Smith uses the term invisible hand to suggest that it is misguided to look for the act of a hand in whatever goes on because the hand that determines the outcomes of individual and political actions does not exist. Regularities or laws, however, which govern individual and political actions, do exist.

    How about the argument that the invisible hand is too palsied to be relied upon? First, Smith does not say that the invisible hand works for the individual and common good only, which is what most of the interpretative discussion, by Stiglitz too, is about. He says that this is so in some instances and that the invisible hand does not always lead to bad overall outcomes. He is sceptical about the possible outcomes of political actions for the very reason that the invisible hand, that is law-like regularities, may lead to bad outcomes of political actions, that is of actions that have the increase of the public interests as their primary objective. In both cases: of individual actions with public consequence and of public actions with individual consequences, the outcome may be different from that which was intended – different in quality, i.e. good or bad, as well as in quantity.

    However, second, Smith does believe that there are law-like regularities and that for that reason they are not palsied, i.e. not robust. Individual and political actions indeed can appear palsied, as not being led by the invisible hand, if their outcomes are explained by their motivations and not understood to follow from general laws.

    So, yes the invisible hand does not exist and for that reason cannot be palsied.

     
    Peščanik.net, 19.04.2012.

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    1. J. Stiglitz (1991), “The Invisible Hand and Modern Welfare Economics”, NBER Working Paper No. 3641. More on the palsied hand in J. Stiglitz (1985), “Information and Economic Analysis: A Perspective”, The Economic Journal 95 (Supplement): 21-41. For a detailed survey of the incentive economics as an alternative to a Smithian economics J. Stiglitz (2003-2004), “Information and the Change in the Paradigm in Economics Part 1 and Part 2”, The American Economist 47: 6-26 and 48: 17-49.
    2. E. Rothschild (2001), Economic Sentiments: Adam Smith, Condorcet and the Enlightenment. Harvard University Press. She thinks that Smith’s use of the term invisible hand is ironic. That is probably correct if it is taken to aim at chiding the ignorant. Also E. Rothscild, A. Sen (2006), “Adam Smith’s Economics” in Knud Haakonssen (ed.), Cambridge Companion to Adam Smith, 319-365. Cambridge University Press. In addition, it is worth reading J. Tobin (1991), “The Invisible Hand in Modern Macroeconomics”, Cowles Foundation Discussion Paper No. 996 and R. Coase (1976), “Adam Smith’s View of Man”, The Journal of Law and Economics 19: 529-46.
    3. An important exploration of this issue is in R. Dworkin (1981), “What is Equality? Part 1: Equality of Welfare” and “What is Equality? Part 2: Equality of Resources”, Philosophy and Public Affairs 10: 185-246; 283-345. Stiglitz criticises this theory of distribution, though he does not refer to Smith, in many places including in J. Stiglitz, “On the Economic Role of the State” in A. Heertje (ed.), The Economic Role of the State. Basil Blackwell.
    4. For a Smithian type of an argument see P. Krugman (1987), “Is Free Trade Passé?”, Journal of Economic Perspectives 1: 131-144. Keynes interprets classical economics as arguing for negligence of the changes in the trade balance and that clearly applies to Hume and Smith.

     
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