Friday, March 03, 2017

KENNETH ARROW AND THE INVISIBLE HAND

In THE ECONOMIST (2  March)  HERE
“An impossible mind: the late Kenneth Arrow
The world has lost one of its great economists”
“…The abstractions won him the Nobel prize at the age of 51. (He remains the youngest winner and the most cited by others in their prize lectures.) He established the conditions under which prices might successfully co-ordinate production and exchange, eliminating shortages and surpluses. Adam Smith provided the best metaphor for this underappreciated feat: the “invisible hand”, guiding resources to their best uses. Ken Arrow and his co-author, Gérard Debreu, provided the best algebra.” …
COMMENT
Yes, Indeed. A great economist, known to every economist who has graduated since the 1960s, and no doubt for a few more generations to come.
However, to suggest that “Adam Smith provided the best metaphor for this under appreciated feat: the “invisible hand”, guiding resources to their best uses”, confuses the INVISIBLE with the VISIBLE.
All prices are visible and it is their visibility that accounts 100 per cent for their role.  Without visibile prices markets would not work.
So how is that Adam Smith use of the metaphor of “an invisible hand” is supposed to be about VISIBLE prices?
Markets disperse information about their individual but visible prices. Customers search among VISIBLE prices of their potential purchases.
It is the dispersal of market information about visible prices that leads suppliers and customers to make sale/purchase decisions.
Again, what does the ‘invisible hand’ do?
This is a case of matching a metaphor applied for one role to another role made up for what purpose?
Yet for Smith, the metaphor referred to something else in the case to which he applied it. 
Consider the merchant who was motivated privately to avoid foreign trade because he did not trust either the foreign merchants, nor their legal systems, of which he was unsure of their probity if things went wrong. His aversion to foreign trade had nothing to do with prices, which are always VISIBLE!
Therefore the merchant invested his capital domestically. In doing so he simultaneously and unintentionally added his capital to domestic investment and to the domestic economy in wages that he paid to his workmen and other domestic suppliers. Of which purchases all prices were VISIBLE to him. 
His investment was intentional. However, the beneficial consequences for the domestic economy were unintentional. That was Adam Smith’s point. That was the purpose of the metaphor of ‘an invisible hand’; the merchant’s hidden and private motives (we cannot see into the minds of others) had consequences of which he was unaware
Now this is fairly obvious and was meant to be so by Smith’s use of the metaphor of an invisible hand (incidently a metaphor that was widely used in 17th and 18th century Britain; Smith did not ‘coin’ it!).
How do we know? Because none of Smith’s contemporaries - including fellow professors, such as Dugald Stewart who taught Smith’s political economy from the Wealth of Nations at Edinburgh and knew Smith well - never mentioned the ‘invisible hand’ metaphor.  It was even in a paragraph he quoted, of which his lecture did not mention!
Moreover, none of the leading poliical economists who followed him into the 19th century, such as Ricardo, Bastiat, Mill and the others, mentioned his use of the ‘invisible hand ‘metaphor. This silence continued right up to the 1870s and only a trickle of others followed until Paul Samuelson in his Economics textbook in 1948.
The question arises: why not? 
I suspect because the point that Smith made in his singular mention of “an invisible hand’ is actually faily trivial and hardly worth mentioning: a merchant’s intentional act of domestic investment for his own gain, simultaneously adds to the total of domestic revenue and employment, as Smith says it would.
The point was so obvious it was not worth mentioning by the professors who taught political economics for near on 100 years after Smith's death!
The whole is the sum of its parts! 
It does not require mathematics to establish the point - simple arithmetic suffices.
But after Samuelson (another brilliant mathematician) in 1948-2010: Le Deluge!
Even the genius of Kenneth Arrow got caught up in the myths of the invisible hand, as did all the other, albeit lesser worthies, who joined in to link it to the the higher maths of the Welfare theorems, General Equilibrium and the rest. 
Sad.

But thanks Professor Arrow for what you did for economics.

1 Comments:

Blogger GLH said...

The other day I started reading Peshine Smith's book "A Manual of Political Economy" and if I understand the preface correctly he says that Adam Smith's followers, especially Malthus, distorted his work. Could you tell me if that is a correct understanding? If that is the case, then is a lot of what we hear about Adam Smith simply propaganda?

1:03 pm  

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