Why Smith's Invisible Hand Is No Longer Applicable

Discussion in 'Economy' started by diptherio, Dec 4, 2011.

  1. diptherio
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    diptherio Rookie

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    We've all heard of the "invisible hand of the market." The idea is that each person, acting solely in their own best interest, with no consideration of others or of society at large, will be led, as if by an invisible hand, to do that which is socially the most desirable. It is worth going back to Adam Smith's original formulation of this concept, since Smith is often cited by both conservative and liberal (or neo-liberal) economists and politicians. Here, edited for length, is the original quote from Smith's Wealth of Nations:

    Every individual is continually exerting himself to find out the most advantageous employment for whatever capital he can command. It is his own advantage, indeed, and not that of the society, which he has in view. But the study of his own advantage naturally, or rather necessarily, leads him to prefer that employment which is most advantageous to the society.

    First, every individual endeavours to employ his capital as near home as he can, and consequently as much as he can in the support of domestic industry; provided always that he can thereby obtain the ordinary, or not a great deal less than the ordinary profits of stock.

    Thus, upon equal or nearly equal profits, every wholesale merchant naturally prefers the home trade to the foreign trade of consumption, and the foreign trade of consumption to the carrying trade...a capital employed in the home trade, it has already been shown, necessarily puts into motion a greater quantity of domestic industry, and gives revenue and employment to a greater number of the inhabitants of the country, than an equal capital employed in the foreign trade of consumption: and one employed in the foreign trade of consumption has the same advantage over an equal capital employed in the carrying trade. Upon equal, or only nearly equal profits, therefore, every individual naturally inclines to employ his capital in the manner in which it is likely to afford the greatest support to domestic industry, and to give revenue and employment to the greatest number of people of his own country.

    Secondly, every individual who employs his capital in the support of domestic industry, necessarily endeavours so to direct that industry that its produce may be of the greatest possible value...As every individual, therefore, endeavours as much as he can both to employ his capital in the support of domestic industry, and so to direct that industry that its produce may be of the greatest value; every individual necessarily labours to render the annual revenue of the society as great as he can.
    [emphasis added]

    We can see that Smith bases his assertion on a few necessary assumptions. One, that the capitalist will employ his capital in the domestic market; two, that said investment will result in employment for the greatest number of people; and three, that each capitalist will seek to produce that which has the greatest possible value. Of these three assumptions, only one, namely the last, can be argued to still be valid in our modern, globalized economy.

    The first assertion, that capital will be employed in the domestic market, is obviously no longer valid, as should be apparent from the "out-sourcing" of ever more American jobs to countries with lower wages and fewer safety and environmental regulations. Somewhat ironically, Smith points this out when he adds the condition "upon equal or nearly equal profits" to his assumption. The situation now being that equal or nearly equal profits are not to be had in domestic investment of capital, Smith himself can be said to point to the current break-down of the "invisible hand".

    The second assumption, that a greater investment of capital will necessarily lead to increased employment is also no longer valid in our modern economy. As one can see from the logging industry, for instance, it is now quite often the case that greater outputs and profits can be realized by investing capital resources in labor-replacing machinery (helicopter logging) than in the hiring of more workers. This is not a development that Smith seems to have foreseen.

    The third assumption, that capital will be invested in those industries whose product has the greatest value, still seems applicable. However, producing a product with the greatest monetary value need not necessarily be the most conducive to the well-being of society at large. This assertion simply points out that capital will be invested in such a way as to maximize monetary value, while saying nothing of other values that members of a society may have, such as clean air and water, decent-paying jobs, etc.

    At any rate, when we look at Smith's original formulation of the causes of the "invisible hand of the market," we can see that most of these causes no longer exist. Economists and politicians who make use of this trope, then, either have no idea regarding the genesis of this idea or (more likely) are simply making hay from an emotionally-charged phrase that now has little, if any, actual meaning.
     
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  2. Baruch Menachem
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    Baruch Menachem '

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    You have the mistaken idea that the goal of the merchant is to create the maximum number of jobs. This is a mistake. It is to provide the best possible return for the most efficient allocation of assets.

    The invisible hand still applies. A merchant by choice will choose to do his production as close as he can so he can best supervise it, but even in Smith's time there was a global economy. He noted that the mines of Chile regulated the price of Copper in Japan. And Even in 1776, transatlantic commerce was common. Despite the fact that it took 6 months for a ship to do the round trip. These days you can send parts to Taiwan and have the completed product back in three days. The modern merchant has an easier time of supervising production than they did in Smith's time and returs are immensely faster.

    As to point two, the method of national enrichment was the ever higher levels of automating production, so the cost of the product sank very rapidly. Smith's pin factory didn't increase the numbers of workers in the pin industry so much as produce thousands of pins for very small prices. Smith also noted that the factories were soul deadening pits. But that society was improved by having the pins at lower cost.

    Your arguments are exactly backwards.
     
  3. Vengeance
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    Vengeance Romans 12:19

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    Smiths' lnvisible Hand' has been obsoleted by the conditions you've mentioned, but he could not have foreseen the rise and preeminence of the multinational corporations and global econony we operate in today- it is a matter of economies of scale and liquidity. And too, the invisible hand has been consistently redirected and thwarted in its actions and effect by the not nearly so invisible hand of governments seeking to engineer outcomes.
     
    Last edited: Dec 4, 2011
  4. Baruch Menachem
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    Baruch Menachem '

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    Please guys... Smith was writing in the days of the East India company. He knew about multinationals that were far more oppressive and annoying than the ones we deal with today. With the possible exceptions of North Korea and Cuba most countires today are a lot freer of government interference than they were in Smith's day. If you actually read the book you would see some of the really dumb laws in place then that were supposed to supplant the invisible hand.

    That government interferes and causes problems is not an argument that governments ought not to be less stupid and arrogant. The invisible hand works at all time and all placed whether the government be wise or not, honest or not, honest or not.

    A merchant working in his own interest will do a better job of resource allocation than the wisest legislator. That is the point.
     
  5. expat_panama
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    expat_panama Silver Member

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    Twisting reality for political gain is how the left wants to replace Smith's invisible hand--
    [​IMG]
    --with Marx's visible fist...
    [​IMG]
    Let's clear the air and expose this distortion for the strawman it is. Those three assumptions aren't from Smith, they're crazy loony leftist nonsense. Smith's view was that of today's free people everywhere, that one, import taxes are stupid, two that we're all better off with greater worker productivity, and three that all benefit when free people produce whatever advances their prosperity.

    Replacing Smith's invisible hand with Marx's visible fist is madness.
     
  6. Brutus
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    Brutus Senior Member

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    In fact nothing about capitalism changes as an economy grows between 2 people, 2 cities, 2 states, 2 countries, 100 countrys.
     

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