Failures of Invisible Hand

For a collection of writings presenting critiques of conventional economic theories, see: Guide to Economics.

Backup Collection of References and Links for this article: FIV

Listing in AZ Articles: FoFIH

You-Tube Video of Talk: (1 hr)

Hard Copy Publication:

Rafi Amir-ud-Din and Asad Zaman “Failures of the ‘Invisible Hand’” Forum for Social Economics Vol. 45, Iss. 1, 2016 pp 41-60.DOI:10.1080/07360932.2015.1019536 Pre-Publication Draft Available at SSRN: http://ssrn.com/abstract=2293940 or http://dx.doi.org/10.2139/ssrn.2293940

Published ONLINE: 2015 ---

Rafi Amir-ud-Din & Asad Zaman (2015): Failures of the “Invisible Hand”, Forum for Social Economics, DOI: 10.1080/07360932.2015.1019536

Download Published Version: attached at bottom of page: FIV4ForumSocEcon.pdf

Our goal in this paper is to show that all four of these claims are wrong. Textbooks, like Manikiw, state that these claims are at the center of modern economics.

1. Participants in market economies are motivated by self-interest. (SI)

2. Decentralized market economies work very well, and maximize the welfare of society as a whole. (FM: free markets)

3. The reason for excellent functioning of decentralized market economies is that all participants are motivated by self-interest. This self-interest works better than love and kindness in terms of promoting social welfare. (GG: greed is good)

4. The principles listed above were summarized in the concept of the “Invisible Hand” by Adam Smith. (AS)

Correspondence regarding publication of paper in various journals.

01-Jul-2014: Dear Dr Amir-ud-Din:

Your manuscript entitled "Failures of the "Invisible Hand"" has been successfully submitted online and is presently being given full consideration for publication in Forum for Social Economics.

Your manuscript ID is RFSE-2014-0031.

You can also view the status of your manuscript at any time by checking your Author Center after logging in tohttp://mc.manuscriptcentral.com/rfse.

Thank you for submitting your manuscript to Forum for Social Economics.

Sincerely,

Forum for Social Economics Editorial Office

There are now over 1050 Taylor & Francis titles available on our free table of contents alerting service! To register for this free service visit: www.informaworld.com/alerting.

Latest Version FIV14, submitted to Kyklos on 22 May 2014, is attached below

Invisible Hand is a central doctrine of modern economic theory. I have written two papers arguing that it is wrong. One is called Death of a Metaphor: The Invisible Hand. This is to be published in International Journal of Pluralism and Economic Education. The second is called Failures of the Invisible Hand. This is attached below. It is written jointly with Rafi Amir-ud-Din Toor. References relevant to this paper are attached on a separate subpage.

One relevant reference is: The Free Market Experiment in Latin America:

Duncan Foley argues that the convergence to equilibrium is path dependent. Along the path, transactions take place at disequilibrium prices. Once this is taken into account, nice properties of competetive equilibria vanish. There were several lines of argument which were dropped in the final version, which concentrates SOLELY on Mankiw's claims about the invisible hand. The lines may be picked up later, and are available in version FIV11 below, which has been heavily cut down for the final version

IDEA: Interpreting Welfare Theorems --- How to translate mathematical theorems into real world economic ideas. Sent a note to Ali Khan on this idea 26 Jan 2014

EMAIL from GAVIN Kennedy, commenting on this paper:

Dear Asad

Comments on your paper:

General impression: A lot of work has gone into the paper, evidenced by references to wide-ranging literature. That is always good in academic papers (providing, of course, the refs are relevant) and they appear to be used well.

However, I am disturbed by what amount to ideological attacks on elements of the other ideologies that you criticise. This weakens both cases, pro and contra and distracts from the main case against conventional modern economists. I assume you seek support for your ideas among fellow academics and too many, I fear, will be distracted into defensive knee-jerk hostility by simply labelling you as a “leftist” ideologue arguing with “rightist” ideologues (along lines of it’s a case of “pots calling kettles back”).

The cases of both Russia (sudden transformation”) and Chile’s (too sudden ambitious transformation) are cases in point. Russia was reeling from the collapse (not too strong a word) of the Soviet enforced state-run economy and its political apparatus, which precluded a long and gradual optimal economic and political transformation, with the results that you outline, though it has generated through recent oil wealth some welcome politico-economic stability with, of course, an authoritarian government. Chile was in political chaos following the murder of Allende, into which some Chicago ‘hot heads’ – far from humble – flew in to enforce their prescriptions, based on little experience of Chile nor of the pragmatic realities of the country or the Continent (having met with CIA political operatives knowledgeable of South America, I am surprised that this basic error was allowed - ‘promoted”? - it was destined to fail). Knowledge of economics of any school of thought is insufficient for transforming an economy while looking for – expecting – rapid results. I suggest a ruthless purge of the essentially political and ideological language in your paper, if it is to be widely read.

Adam Smith may help you here with the substance of your paper. You are correct that Smith did not advocate nor excuse selfish behaviour. He writes thus in ‘Moral Sentiments’ and in ‘Wealth Of Nations’. Moreover, and most relevant, he was quite clear on your basic theme: humans everywhere depend on the voluntary co-operation of thousands of others (WN I.ii.). That is the essential feature of any economy in any society.

Anthropologists show how small bands depend on each other for their sustenance, sharing in times of need and in many cases institutionalising this natural ‘insurance’ behaviour in (observed not conjectured) band-wide pooling of their labours each day which brings reciprocal sharing behaviours that empirically substantiates Smith’s point (in his case conjectured, not necessarily observed). See Christopher Boem, 2012. ‘Moral Origins: the evolution of virtue, altruism, and shame’. Basic Books. (Based on scores of cases of field-work and specialist observations).

However, Smith’s conjectured point led to his asserted advice in his famous passage in Book 1, chapter 2, of the “butcher, brewer, and baker”, widely misread (if read at all), specifically that the buyer, in search of his dinner (more likely his female relative!) must “address the interests (‘self-love’)” of the seller, and specifically not his own! The needs of the buyer are not the explicit part of the persuasive transaction – that would mean the buyer relying on the seller’s benevolence, already excluded as benevolence being an “insufficient” resource (basically nobody has enough of the means to be totally benevolent towards everybody else for everything).

In short, Smith advised addressing our self-interests necessarily by addressing the self-interests of others, that is self-interests are realised on a daily basis by each individual party to the transactions mediating their self-interests through persuasion, conversation, and bargaining, not by egotistically demanding others surrender to ours. This is fundamental to the doctrine of self-interest.

George Stigler’s 1976 opening admonition that economics is founded on the “granite of self-interest” needed to be modified by the inclusion of the words “the granite of mediated self-interest”! Smith might have saved the Chicago ‘boys’ from embarrassment if they had read Smith properly and not been enthused by Stigler’s enthusiasms for a half-understood idea that wasn’t Smith’s anyway.

I hope the above is useful for you.

Very best regards

Gavin Kennedy

14 November 2013: Rejected by JPKE -- paper is superficial -- Submitted to Lahore Journal of Economics, via Nina Gera: Nina Gera <nina@lahoreschool.edu.pk> .

New paper on REGULATION of Financial Markets is planned -- based on Bali Conference presentation. Could tie in to UNREGULATED MARKETS themes discussed below.

Paper was finalized and submitted to JPKE. The submitted version is: FIV13.doc, attached below. It rebuts the FOUR claims of Mankiw cited in the opening paragaphs. These are reproduced below, for readers convenience, to indicate what the paper is about.

PAPER also uploaded to SSRN: See http://ssrn.com/abstract=2293940; Return to Original Paper The Invisible Hand -- many parts of this have not been picked up in the two papers published. However, now we need to take out invisible hand out of title -- two papers already have this. Instead, let us put: UNREGULATED MARKETS. start from Polanyi

ABSTRACT: Despite many failures of the invisible hand both empirically and theoretically, it continues to be vigorously asserted and widely believed. We document the failures and explain why it continues to be asserted despite these failures.

Keywords: invisible hand, market economy, traditional society, East Asian financial crisis, trade barriers

JEL CODES: A13, B41

INTRODUCTION

One of the central goals of modern economic theory is to establish that free markets work very well, and the government interventions cause ‘distortions’ and loss of efficiency. An extremely important tool in achieving this goal is the idea of the “invisible hand” which is fallaciously attributed to Adam Smith by most modern economists. As a typical illustration, Mankiw and Taylor (2007, pp. 7-9) write that:

In his 1776 book An Inquiry into the Nature and Causes of the Wealth of Nations, economist Adam Smith made the most famous observation in all of economics: Households and firms interacting in markets act as if they are guided by an "invisible hand" that leads them to desirable market outcomes that, in many cases, maximize the welfare of society as a whole…

… Why do decentralized market economies work so well? Is it because people can be counted on to treat each other with love and kindness? Not at all. Modern interpretation of Smith's "invisible hand" metaphor says that participants in a market economy are motivated by self-interest, and that the ‘invisible hand’ of the market place guides this self-interest into promoting general economic well-being. Many of the insights of “invisible hand” theory remain at the center of modern economics.