Friday, April 6, 2012

Milton Friedman and the Invisible Hand

Milton Friedman claimed to be a big fan of Adam Smith. Here's Friedman explaining Smith's famous "invisible hand."

So a man seeking his own gain really ends up bettering society as a whole, even though that wasn't his intention. Apply this to neoliberalism. If I can go overseas and get better labor rates I do it really because I want to maximize my own profits, but in doing so I really promote the good of society as a whole.

So I'm listening to a discussion from Chomsky and he makes a rather astonishing claim. Smith does mention the invisible hand. It's within a passage that you might describe as a critique of globalization and neoliberalism.

Apparently the phrase "invisible hand" occurs only once in the whole book. Take a look at it. Search for "invisible hand" then back up a few pages and start reading. What is Smith saying?

A merchant could look to foreign markets and possibly make more profits. But he's not going to do that. He'd prefer to take lesser profits and stay at home. Why? Because he knows that if he employs more people at home this induces further domestic industry, and he has a bias in favor of his own country. By improving the lot of his home country he really seeks the security and betterment of himself. In this sense there is an invisible hand that guides the merchant towards acting in a manner that is for the betterment of the public. He'll stay at home. He won't outsource.

Isn't that a direct refutation of Friedman's preferred neoliberal policies? And according to Chomsky this is a constant thing in your economics departments. Take the issue of the division of labor. Sure, it's a great thing according to Smith. Friedmanites pretend to care what Smith thinks and so we can understand why it makes sense to have a guy on an assembly line that does mind destroying work driving a single screw over and over.

Once again, take a look at Smith. He says you don't want to take this too far because if you do the man will become "as stupid and ignorant as it is possible for a human creature to become." This will have all kinds of disastrous consequences and hence state intervention is required to prevent us from getting to that point.

Well that doesn't fit well into the Friedmanite paradigm. So it's intolerable. The University of Chicago put out a scholarly edition of the Wealth of Nations for the bicentennial. According to Chomsky if you go to the index and look for "division of labor" you find that this entry is in fact omitted. Too unacceptable.

Search for "vile maxim" and read Smith's discussion of the "masters of mankind" that want "all for ourselves, nothing for other people." Apparently Smith is regularly going off the neoliberal script.


Gavin Kennedy said...

Critics of people holding to ideological positions with which they disagree often make the same mistake that they claim the other side makes in respect of their ideological stances on Adam Smith. Jon’s is a typical case of the pot calling the kettle black.

Yes, Jon is right to be unhappy (as I am) with Friedman’s caricature of Adam Smith on the role of the “invisible hand”. Smith was making no such reference to the alleged benefits of “better labour rates” abroad, which, anyway, was not true in respect of the British colonies in North America, where 18th-century labour rates were higher than those in Britain, due to the shortage of labour in these colonies and the plentitude of cheap land. However, Jon goes on to muck-up Adam Smith’s use of the invisible hand metaphor.

Given that ‘globalisation was in its infancy and that neoliberalism’ was unknown, it is a gross exaggeration to suggest that Smith was criticising either phemomenon. For good reasons, Adam Smith welcomed international trade throughout Wealth Of Nations because he considered such trade beneficial to each country’s absolute advantages.

Jon goes completely wrong about Adam Smith’s observation. The issue of the comparative profits was not that he felt a patriotic obligation to do so “because he knows that if he employs more people at home this induces further domestic industry, and he has a bias in favor of his own country.” The merchant trader may have been indifferent to such considerations (remember, he did not trade “intentionally”for the “public good”).

He preferred to invest his capital in “domestick industry” because of what he perceived as greater risks of the “foreign trade of consumption”. These perceived risks are spelt out by Smith three paragraphs before he got to the “invisible hand” and the clearly identify that the merchant’s personal motives are about his risk and his insecurity.

Smith’s point was that the trader’s “insecurity” leads him to stay at home in the ‘domestick trade”, which had the arithmetical but unintentional consequence that his capital added to domestic investment, revenue and employment (the whole is the sum of its parts). Smith used the metaphor of “led by an invisible hand” to better describe, as good metaphors do, their objects “in a striking and more interesting manner”. This definition of the role of a metaphor is from Smith’s lectures on Rhetoric. It can be found in a relatively unknown Work of Adam Smith, discovered in 1958 in a house-contents sale in Aberdeen in Scotland, which was published as Adam Smith’s “Lectures on Rhetoric and Belles Lettres”, page 29, given at Glasgow University in 1763, Oxford University Press, 1983. The definition of metaphors by Smith corresponds to that of the standard definition given in the definitive Oxford English Dictionary (see the 1983 edition).

Leftist critics of rightist ideologies, use their misinterpretations of Adam Smith as a counter-foil to rightist misinterpretations of Adam Smith, like those made in this instance by Milton Friedman.

I think Adam Smith deserves better from people on both sides of these ideologies, but his Works are unlikely ever to achieve such proper treatment from exponents of either ideology. They have seen their version of the truth and that’s that.

Jon said...

What Chomsky is saying is not that Smith is addressing modern globalization and neoliberalism. In his day the phenomenon was different. But it was also similar in important ways. It's a critique of a centuries old Friedmanite like policy.

Smith says that a merchant would sooner accept a lesser profit rate at home than a greater profit rate abroad. I translated that to a modern equivalent. Better labor rates abroad. That's a major means of improving profits today via globalization. That's not Smith's focus and I didn't mean to suggest it was.

I agree Smith says that a man prefers to stay at home because of risk. But then he says this:

Home is in this manner the centre, if I may say so, round which the capitals of the inhabitants of every country are continually circulating, and towards which they are always tending, though, by particular causes, they may sometimes be driven off and repelled from it towards more distant employments. But 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.

As I read this he seems to be saying that because more capital in a home country provides certain benefits (revenue and employment to more people) the merchant will be content to accept even a lesser profit in order to stay at home because he prefers the betterment of his home country. This is part of the invisible hand, and it's not Chicago School economics.

So I'm seeing a both/and argument here. Yes, he prefers to stay home because capital in a foreign country is more risky. But he also prefers more revenue and employment for those around him. That's only self-interest, but it provides a public good in any case.

Sheldon said...

Putting aside the dispute on the interpretation of Smith. Apologists for capitalism argue that by pursuing their own self interest the individual owner of capital invests and provides benefits to society as a whole. But clearly this contradicts actual experience of American based Multinationals who de-industrialize the home country to move production overseas for lower labor prices and reduced environmental regulation. The benefits in the foreign country are limited, and much of the profits are not reinvested for the receiving countries' development. Back in the old days maybe an individual capitalist had some loyalty to the home country, but corporations do not.

Gavin Kennedy said...


You accept that Smith did not write of globalization as experienced in the 20th-21st centuries. You challenge my reading of Smith in Book IV, chapter 2 of Wealth Of Nations, and I am grateful for your observations and comments.

In paragraph 1, Smith gives examples of the consequences of ‘Restraints upon the Importation from foreign commerce of such goods as can be produced at home’. That these restraints, Smith says in paragraph 2, benefit domestic industry and employment “cannot be doubted”, but whether that benefits society “is not, perhaps, altogether so evident”. His general proposition is that “general industry” can “never exceed what the capital of the society can employ”, but regulations cannot increase the employed capital; they can only divert it, which may not be as “advantageous to the society than that into which it would have gone of its own accord” (paragraph 3).

He switches to consider the individual exerting himself to “find out” the most advantageous employment for his capital, and this “finding out” process is naturally “most advantageous to society”, even though he seeks his own “advantage” (paragraph 4). He seeks to invest locally “as near home as he can”, which supports “domestick industry”, guided by “ordinary, or not a great deal less than ordinary profits” (paragraph 5). You quote part of paragraph 6 part. The other part, unquoted, says

In the home–trade his capital is never so long out of his sight as it frequently is in the foreign trade of consumption. He can know better the character and situation of the persons whom he trusts, and if he should happen to be deceived, he knows better the laws of the country from which he must seek redress. In the carrying trade, the capital of the merchant is, as it were, divided between two foreign countries, and no part of it is ever necessarily brought home, or placed under his own immediate view and command’< (paragraph 6, lines 3 to 5).

These express considerations of risk in trading outside “domestick industry”, including that of the “foreign trade of consumption” and “the carrying trade”, which were more riskier than distant parts of “domestick industry”. Smith gives over the long rest of the paragraph to give examples from distant foreign trade (paragraph 6, lines 8 – 32). The merchant, to avoid risks and trouble, when engaged in foreign trade, will always be glad to sell his cargoes domestically, and as a consequence will “put into motion a greater quantity of domestick industry [that] gives revenue and employment to the greatest number of people of his own country”. It is this convenience and security (lower risks) that leads to the consequence of ;"home being the centre, if I [Smith] may say so, round which the capitals … continually circulate”. The “natural” inclination to employ his capital in this manner, driven by risks of foreign or distant trade “gives revenue and employment to the greatest number of people in his own country” (paragraph 6 and 7). he whole is the sum of its parts.

This is clearly a consequential outcome of his risks, concerns and trouble of foreign trade, which also has the necessary consequence of slower turnover of his capital overseas – instead of turning over his capital for profit in months, the merchant may have to wait years (Smith discusses this elsewhere in Wealth Of Nations).