Part 1 of a Discussion of Peter Foster’s Why We Bite the Invisible Hand Chapter 9 “The Invisible Metaphor”
Foster dives deeper in this chapter into the significance of the Invisible Hand metaphor credited to Adam Smith.
In this blog, we will concentrate on what is meant by the Invisible Hand, and in the next one we will look more at those who do question it.
I have said before that the Invisible Hand was one of the things that made me fall in love with economics originally, though Foster is here to tell me that is not a typical reaction.
The concept of the Invisible Hand is not mystical, but it is counterintuitive, and requires intellectual effort to grasp. The point at which they “see” the Invisible Hand often represents the eureka moment for economists.
Yes, exactly! I am surprised to hear it is counterintuitive, but I am learning from Foster the many ways I am odd in my reaction to economics. But Foster continues,
Many never get it. One reason why many intellectuals and politicians consciously or unconsciously resist getting it is that it is potentially lethal to their interventionist pretensions. (p. 194)
This reminds me of the quote attributed to Upton Sinclair, “It is difficult to get a man to understand something, when his salary depends on his not understanding it.”
In the article linked above, one of the assumptions many carry with them about economics is the idea the economy needs to be planned by governments. It just feels right. Letting people just run around in freedom feels more chaotic.
But I think the second part of the quote about “interventionist pretensions” may play a larger role. It reminds me of the Upton Sinclair quote.
It is difficult to get a man to understand something, when his salary depends on his not understanding it.
If the Invisible Hand works without guidance to achieve the optimal outcome then where is the role for the politicians and policymakers?
Promoters of ever bigger government, by contrast, refuted the notion that even good results — let alone the best ones — could come from myriad disjointed individual decisions being guided by some mystical-sounding metaphor. People with capacious intellects and good intentions just had to be able to come up with something superior to a system based on “greed,” and which produced inequality and cyclical slumps. (p. 187)
As much emphasis as we put on the Invisible Hand concept today, the phrase was only used twice by Smith, one time in each of his big works, The Theory of Moral Sentiments and The Wealth of Nations.
The idea encapsulated in The Invisible Hand does show up throughout his works. Foster notes one quote from Smith about the behavior of the merchant from “The Wealth of Nations.”
Smith went on to write of the merchant, “By pursuing his own interests he frequently promotes that of 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.” (p. 187)
We see here the idea of public good coming from the pursuit of self-interest, which is the Invisible Hand at work.
However, Smith’s primary concern in “The Wealth of Nations” was to demonstrate that the interventionist mercantilist government of his time was not providing for the public good as well as free individuals would have.
Hayek and Read
Friedrich Hayek’s work explained how the Invisible Hand works in his 1945 essay, The Use of Knowledge in Society.
Smith wrote against the mercantilist management of the economy; Hayek was writing to refute the socialist/communist management of the economy.
To the smart set, it seemed something as important and complex as the economy had to be planned out.
That points out one of the problems inherent in the Invisible Hand.
However, there is a downside to this unconscious aspect of the natural order. If you don’t have to think about it, you don’t have to understand or appreciate it, and you become more vulnerable to taking “thoughtful” actions — or pursuing policies — that might damage or destroy it. (p. 188)
Hayek pushed back on the wannabe planners by saying the real question is who is doing the planning?
He noted that everybody plans according to their own perspectives and desires. The sort of knowledge people use in such planning is not analogous to scientific knowledge. It is “knowledge of the particular circumstances of time and place.” It cannot be known by others, much less in toto by any individual or group. It cannot be structured by statistics or fed into government economic plans. (p. 188)
The Invisible Hand guides the market, which is capable of distilling all this dispersed knowledge into prices, and it is the prices that guide consumers and producers to optimizing their decisions.
I will leave inflation out of the discussion for the moment because inflation is a distortion of the price signal, which is one reason it is such a problem for an economy.
If you go to the store and see the price of chicken has risen, you can choose to substitute away from chicken to pork or shrimp or maybe canned chicken. Only you know what your budget is, your tastes and preferences are, and a myriad of other factors that impact your decisions. No central planner can know that for each buyer.
Producers face similar challenges as they pull together inputs and labor to make a product.
All these decisions are made by individuals based on the information each has, and that is what Hayek is saying — no central planner can gather this information to be able to make a plan better than the market.
Another illustration that captures the power of the Invisible Hand comes from Leonard Read’s 1958 essay, “I, Pencil,” which you can read or watch.
He asserts that no one person alive today knows how to make the classic yellow #2 pencil by detailing all the materials that have to be assembled together to make a pencil. You may think you could assemble a pencil and prove him wrong, but he means that you have to go mine the graphite and gather all the other ingredients it is mixed with to produce the pencil lead.
Read is pointing out the vast, complex web of interdependent markets that are required to manufacture something seemingly as simple as a pencil.
And all the people involved in the various steps do not have to know that their end product is going towards making pencils. All they have to know is they go to work and get paid for it.
Behind the unprepossessing combination of “some wood, lacquer, the printed labeling, graphite lead, a bit of metal, and an eraser,” lay complex technology and organization that were nevertheless effortlessly facilitated by the market at myriad levels via the incentives of price and profit. (p. 190)
We saw the challenges of trying to create from scratch the complex interdependence effortlessly managed by the Invisible Hand of the market inside of a planned economy in an earlier chapter when McDonald’s went to Moscow.
Economist Milton Friedman recognized the beauty of Read’s essay for illustrating the power of the Invisible Hand to solve Hayek’s knowledge problem.
In 1976, the Nobel Laureate economist Milton Friedman wrote of I, Pencil, “I know of no other piece of literature that so succinctly, persuasively, and effectively illustrates the meaning of both Adam Smith’s invisible hand — the possibility of cooperation without coercion — and Friedrich Hayek’s emphasis on the importance of dispersed knowledge and the role of the price system in communicating information that ‘will make the individuals do the desirable things without anyone having to tell them what to do.’” (p. 191)
“Cooperation without coercion.” Whenever we choose regulation over the Invisible Hand we are coercing people’s behavior away from cooperation.
Yet people cannot shake that inborn assumption that “someone should be in charge.” Add a dash of power seeking or reputation burnishing, and you have a lot of people choosing to coerce people in their chosen direction.
Next blog we look more at those who do not trust the Invisible Hand.
Reference: Foster, Peter, 2014. “The Invisible Metaphor” Chapter 9 of Why We Bite the Invisible Hand, Pleasaunce Press.
