Monday, May 12, 2008

The Invisible Hand is the Actions of the People!

Bhekuzulu Khumalo writing for the Institute of Knowledge Blog (HERE) asserts that The Free Market Works (11 May):

People and societies have been trading for thousands of years, prices have risen and fallen for thousands of years. Economics trade was not brought about by colonizers and imperialists, this is one of the reasons for people being against the free market, they say it was brought by the imperialists. Not true, people have understood economics long before meeting with the white men, people have always understood that the price of grains rises in a drought, the value of cattle rises with droughts as they become fewer and therefore more precious, people have understood this fact for thousands of years, this fact was not brought about by an imperialist.

The market has always worked. It existed long before Adam Smith discussed it, Lao Tzu the Chinese philosopher, a man whose desire was that humans exist naturally, understood the concepts of the free market 2 000 years before Adam Smith and the European economists, though the peasants of Europe already understood that when there is plenty of grain the price of grain falls, when there is less grain the price of rises.

Lao Tzu’s understanding of the world can be summed in two quotes “Governing a great nation is like cooking a small fish, too much handling will spoil it”, and “A leader is best when people barely know he exists, when his work is done, his aim fulfilled, they will say “we did it ourselves.”” The less interference from government the better, let the people be, truthful people who believed in freedom have understood this forever. What is the invisible hand, the invisible hand is the people, the people will set the prices, that is all the invisible hand is, the actions of the people.
[My emphasis]

Comment
Note the last sentence:

What is the invisible hand, the invisible hand is the people, the people will set the prices, that is all the invisible hand is, the actions of the people.’

Brilliant. What insight! Bhekuzulu Khumalo is absolutely right and he states the proper meaning of Adam Smith’s use of the metaphor of ‘an invisible hand’ in Wealth of Nations (and his prior use of it in Moral Sentiments).

Why can’t modern economists trained in the finest schools by the finest tutors and published in the finest journals and approved by the finest academic referees get Adam Smith’s use of the metaphor correct?

What is it about the metaphor that made three Nobel prize winners turn it into ‘The profoundest observation of Smith’ (Arrow, K. 1987. ‘Economic Theory and the Hypothesis of Rationality’ in The New Palgrave: a dictionary of economics, Macmillan, London); ‘surely the most important contribution [of] economic thought’ (Arrow, K. and Hahn, F. 1971. General Competitive Analysis, p 1, Holden-Day, San Francisco); and ‘one of the great ideas of history and one of the most influential’ ( Tobin, J. 1992. ‘The Invisible Hand in Modern Microeconomics’, in M. Fry, ed. Adam Smith’s Legacy: his place in the development of modern economics, Routledge, London)?

How did Adam Smith’s casual metaphor achieve such high status when neither he nor contemporary readers noticed it? Why is that the unknown (to me, at least) Bhekuzulu Khumalo points out what is obvious to a few others (including myself: ‘Adam Smith and the Myth of the Invisible Hand’, 2007, and posts of Lost Legacy, passim: available from Lost Legacy: gavin@admamsithslostlegacy.com) that people’s decisions, following the basic laws of economics, are guided by their preferences, risk aversions, and supply and demand?

As Bhekuzulu Khumalo puts it so well: ‘people have understood economics long before meeting with the white men, people have always understood that the price of grains rises in a drought, the value of cattle rises with droughts as they become fewer and therefore more precious, people have understood this fact for thousands of years’.

There are no disembodied and invisible hands, ghosts, spirits, gods and fairies at work. Markets do not need mystified. They were not invented by capitalism in the 19th century (as argued unconvincingly by Karl Polanyi in his much lauded book, The Great Transformation, 1944); they go way back ten or more millennia.

It is such a breath of fresh air from Bhekuzulu Khumalo that I am awarding him the Adam Smith Lost Legacy Prize for May and, in recognition of his outstanding understanding of the much misunderstood metaphor, I will add to the normal prize, an oak-leaf cluster.

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