Friday, July 27, 2012

Did you know that Smith's invisible hand and Arrow-Debreu General Equilibrium were the same thing?

Neither did I!

This guy really mangles Smith and confuses a lot of the claims of neoclassical economics (HT - Peter Boettke). It's assertions like this (by a non-economist, I should add) that feed Boettke's (in my view, wrong) criticisms of mainstream economics.

I don't see how you can read Smith as implying some optimal general equilibrium. Smith argues that by pursuing private interests, economic agents promote general welfare. This is obviously true whether a "perfect" Arrow-Debreu general equilibrium holds or not. Identifying the two with each other is a mistake. The contribution of Arrow-Debreu was to rigorously demonstrate the general equilibrium outcomes of a certain type of model of the market that is (rightly) widely in use. Any departure from that optimum ought not to be confused with a non-existence of the invisible hand forces that Smith referred to.

Confusing Smith's claim with Arrow-Debreu's claim leads to inappropriate conclusions that because we've departed from a neoclassical optimum it means that the market "doesn't work" or has "failed". That, I think, is the wrong way of looking at it.

11 comments:

  1. Indeed. The author of this article in the Harvard Business Review is incorrect regarding Adam Smith and Kenneth Arrow and Gerard Debreu.

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  2. "It's assertions like this (by a non-economist, I should add)"

    Joesph Stiglitz says pretty much the same thing.

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    1. Joe Stiglitz says some frustrating things about the free market and the invisible hand, which I think actually make him sound less market friendly than he actually is. I've mentioned this in the past too, and even Paul Krugman (though he doesn't do this as much as Stiglitz) shoots us in the foot with some off the cuff remarks.

      But he doesn't jumble Smith, Walras, and Arrow together inappropriately as far as I know.

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    2. "But he doesn't jumble Smith, Walras, and Arrow together inappropriately as far as I know."

      He does in places. For example on p.5 & p.7 of "Whither Socialism". Google for "the formalization of adam smith's famous invisible hand".

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  3. Re: "Smith argues that by pursuing private interests, economic agents promote general welfare."

    I don't think Adam Smith ever did that. In The Wealth of Nations, Smith applied the invisible hand metaphor to represent an individuals preference for the use of "domestic" industry over "foreign" industry to gain individual profit, and noted that this promoted the interests of the nation and society at large while at the same time enriching the individual. However, this is an unintended consequence in this specific example, and not a general statement.

    http://en.wikipedia.org/wiki/Invisible_hand

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    1. Certainly it's an unintended consequence - that's Smith's entire point. But why do you say "in this specific situation"?? Although the exact language "the invisible hand" did not come in elsewhere (in this book at least - it was used in Moral Sentiments), the logic of an unintended public good as a result of private pursuit of interest is in other discussions of exchange, including other passages on trade and the attack on the mercantile system, as well as the early references to bakers, brewers, etc.

      Why are you thinking this is specific to the discussion of protectionism that the passage is actually located in?

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    2. I apologize, for conflating two points. One that Smith's use of the IH metaphor describes something other than an "unintended consequence", and second that Smith asserted there exists a universal principle that by pursuing private interests, economic agents promote general welfare.

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    3. That's Gavin Kennedy's take on Adam Smith. It's an open debate if Smith was being specific or general.

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  4. Daniel
    The fact is that Smith's specific (only) reference in Wealth Of Nations referred to some, but not all merchants, from their concerns for the "security" of the capital is sent abroad in the "foreign trade of consumption", preferred to invest in in "domestic industry" (mentioned four times by Smith, twice in the relevant sentence in para 9). This had the "unintended" consequence that it added to domestic "revenue and employment" arithmetically: the whole is the sum of its parts. Smith considered this public benefit. He didn't say anything beyond this. It said similar consequences applied in "many other" situations, without specifying them.
    To suggest that this is a general unintended consequence of self-interested actions, leading to "Pareto Optima", "General Equilibrium", as many modern economists do, or that even "selfish" motives lead likewise, is an absurd attribution to Adam Smith. He details again and again how the "self-interested" actions of "merchants and manufacturers" lead to higher prices, less competition, and lower domestic employment in such self-interested" policies as tariffs, protections, prohibitions, monopolists, colonial preferences, the one-sided Combination Acts, the Settlement Acts, Wages set by the magistrate allies of employers, established religions, Primogeniture, Entails, chartered Trading Companies, directly act the general interest, Yet, daily - nay hourly - modern economists are reported, or media sources, continue to pour out nonsense about the existence of an invisible hand in, variously, the market, price systems, supply and demand, and so on.
    That lay-people come to believe that in such a fictitious "invisible hand" - let alone that credible figures from our ranks of economists also believe it - though cracks are appearing in the former monolithic consensus sparked of by Paul Samuelson from 1948 - is a disappointing. I look forward to your own recantation of your apparent belied in the fiction of Adam Smith's so-called invisible hand.
    Gavin

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    1. I find myself in the very odd position of agreeing with everything in a comment that concludes with a demand for a recantation on my part!!!

      Perhaps my newest post will clear this up, Gavin.

      I'm curious what you think of this post of mine from a few weeks ago, where I take issue with David Friedman's read of Smith: http://factsandotherstubbornthings.blogspot.com/2012/07/they-dont-own-adam-smith.html

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  5. Daniel
    “I do think Smith generalizes the invisible hand more than you imply. What is the point of the discussion of the butcher, the baker, and the brewer if not that private self-interest, in a market, generates public good?”
    Au contraire. Smith’s point is far more fundamental to his thinking than your comment above appears to suggest. Mere self-interest is not enough. That stops at ‘self-love’. More is required, which you can read in what he says in that paragraph – linked to his previous paragraph in Wealth Of Nations.
    Smith does not suggest we argue for, or demand, our self-interest; he advises against you merely telling them of your own "necessities"! Two egoistic self-interested would-be bargainers would never come to an agreement about the contents and price of their dinner, where neither would move or trade for the exchange.

    [Smith’s advice on bargaining and my observation of thousands of actual bargaining in business around the world led to my work in business, and at Edinburgh Business School, as a consultant/ practitioner in bargaining until I retired in 2005. Among various other books on business negotiation,I wrote the EBS MBA course, Negotiation (1997 –still in print) and The New Negotiating Edge, both based conceptually on Adam Smith’s “IF-THEN” bargaining model.]

    Note Smith’s insightful description of the nature of the Smithian bargain: “Give me this that I want and you shall have this which you want”. In short, bargaining is a process of mediation of each party’s wants to sufficient find an agreement, if one is possible and acceptable: “If you give me [some] of what I want, then I shall give you [some] of what you want”. The passage of Smith’s is not about naked self-interest generating some unquantifiable “public good”, nor about relying on their “benevolence”.

    Finally, I modified on Lost Legacy my posted and flawed comment on your Blog immediately I reviewed my post on your Blog, taking closer account of your original post. This is my first opportunity to apologise and correct my too hasty reading last night. I hope this clarifies my error in jumping in too quickly. We must always correct errors when we become aware of them – this happened either side of a family celebration while on holiday in France, then there was the olympic ceremony).
    Gavin

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