Cracklins: September 2009

It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages. –Adam Smith, The Wealth of Nations

Adam Smith held the Chair of Moral Philosophy at Glasgow University from 1752 to 1763. While there, he lectured on human nature, the development of societies’ systems of ethics, legal systems, and their relations to the economy. He also wrote and published The Theory of Moral Sentiments, a work that explored the nature and motive of morality, and would inform all of his subsequent work, including An Inquiry into the Nature and Causes of the Wealth of Nations, his most famous work and a foundational text of classical economics. Neoclassical economists cite Adam Smith as the primary intellectual force behind free market economic policies and laissez-faire capitalism. Instrumental to this view of Smith is the idea of the “invisible hand” of the marketplace as a regulatory force for overall social good, premised upon self-interested individuals making rational choices, epitomized by the “butcher-baker-brewer” passage above. Adam Smith was, however, a much more complex thinker than that. As Amartya Sen argues, “the fact that Smith noted that mutually advantageous trades are very common does not indicate at all that he thought self-love alone, or indeed prudence broadly construed, could be adequate for a good society. Indeed, he maintained precisely the opposite” (Sen 1987, p.23). How can we account for this profound difference in interpretation? This paper will trace the arc of Adam Smith’s intellectual contributions to philosophy and political economy, paying special attention to his use of the “invisible hand” metaphor. It will also discuss the variations of the “invisible hand” metaphor throughout Smith’s work in order to flesh out what he meant, and in what context. Finally, the paper will argue that there is more in Adam Smith’s moral philosophy to support “heterodox” economic theories than those of the neoclassical mainstream, which has appropriated his work as its theoretical framework.

The three main essences of neoclassical theory, as described by George DeMartino, are the consumption proposition, the production proposition, and the scarcity proposition. By “consumption,” neoclassical economists assume that “individuals are endowed with the ability to choose rationally from among the sets of opportunities they confront.” This will ensure that individuals make rational, self interested decisions based on what will increate their pleasure, or utility. Furthermore, a system of preference ordering drives individuals and guides their market transactions, regardless of moral or ethical concerns. “Production” means that “humans are endowed with the ability to transform elements of nature (through work or labor) so as to produce goods that meet human needs, and they do so rationally.” This implies a preference for efficiency and higher yields in producing these goods. Finally, the scarcity proposition implies that “all output (in the form of goods and services) requires inputs from nature, and since nature’s bounty is finite, output must also be finite.” This third proposition highlights the importance of rational choice in measuring opportunity costs when exchanging for goods and services, as well as demonstrating the inherently competitive nature of economics (DeMartino 2000, pp. 38-41). The origin of this view of human nature is never explored by mainstream neoclassical economists, it is simply accepted as a given.

Neoclassical economists view their endeavor as highly scientific, on par with the natural sciences in its objectivity. They construct models based on assumptions of rational choice, self-interest, and scarcity to predict economic outcomes deemed Pareto-optimal, and therefore beneficial to society as a whole. Normative judgments of individual choices are withheld in favor of viewing any action as an ordered, rational preference. The free market is reified as the ultimate, disinterested, arbiter of all matters economic and social. The intellectual foundation of many of these assumptions can be traced back to Adam Smith and his concept of the “invisible hand” of the marketplace. Indeed, it is widely acknowledged by neoclassical economists that Smith provides the theoretical basis for what they do and who they are. This link is, however, more tenuous than what contemporary economists may think. A closer examination of Adam Smith, the moral philosopher is in order. For this, we will turn to Jerry Evensky and William Grampp, two academic economists who have attempted to “rescue” Smith from the neoclassical economists and reveal the complexity of his thought.

In “Ethics and the Invisible Hand,” Evensky looks at the various ways that Adam Smith used his most famous metaphor. Contrary to the popular conception of the term, Evensky argues, “In Adam Smith’s moral philosophy, the invisible hand has a much broader responsibility: if individuals are to enjoy the fruits of a classical liberal society, the invisible hand must not only coordinate individuals’ choices, it must shape the individuals into constructive social beings—ethical beings” (Evensky 1993, p. 197). While the phrase “invisible hand,” appears only three times in all of Adam Smith’s work, Evensky contends that the concept is central and consistent to the entire canon. The invisible hand makes its first appearance in Smith’s work in his “History of Astronomy,” an essay on Isaac Newton. Smith references the “invisible hand of Jupiter,” in describing the role of the Deity in designing the universe, a concept shared by both Smith and Newton. For Smith, Evensky argues, “The Deity is to the universe as the watchmaker is to a watch. In each case, it is the hand of the designer that arranges the springs and pins and wheels, and sets the system in motion. But in both cases that hand is invisible to the spectator who observes only the product of the effort . . .” (Evensky 1993, p. 199). The Deity is not only a designer, but is benevolent in giving Man the conception of self-love and, more importantly, virtue. It is individual virtue, not interest that makes for a good social outcome in economic transactions. Smith notes in The Wealth of Nations:

As in any other beautiful and noble machine that was the production of human art, whatever tended to render its movements more smooth and easy, would derive a beauty from this effect, and, on the contrary, whatever tended to obstruct them would displease upon that account: so virtue, which is, as it were, the fine polish to the wheels of society, necessarily pleases; while vice, like the vile rust, which makes them jar and grate upon one another, is as necessarily offensive. (Smith, 1976 p. 316)

In order for the perfect liberal society to flourish, then, virtue must be integral to the daily conduct of Man. Furthermore, Smith acknowledges human frailty and the virtual impossibility of reaching the perfect liberal society by simply leaving the “beautiful and noble machine” alone. In his moral philosophy, Smith believes it is the degree to which humans approach their ethical limit that will determine the overall good of society.

In The Theory of Moral Sentiments, Smith explores the ways in which society evolves in accordance with the ethics and values of each individual. Social evolution is achieved in stages, corresponding with economic development, from early hunter-gatherer economies to a commercial society. Evensky argues:

Since each stage requires a progressively more refined system of human values, the movement of a society from stage to stage is simultaneous with the development of that society's value system. For human progress to occur, each generation must refine the values it inherited from the last, and then must pass those enhanced values on to the next generation through the socialization of its children. Smith sees each individual as being shaped by and in turn, given that person's experience, shaping society (Evensky 1993, p. 201).

For Smith, this evolution is guided by the invisible hand toward the ultimate goal of a free and just society. He was well aware, however, that this perfect society was a largely unattainable goal. The invisible hand may be able to guide individuals, but individual actors are ultimately responsible for the kind of society they end up with. Furthermore, nothing is set in stone, and there can be regressions and detours along the path toward society’s evolution to the liberal ideal.

At the time he wrote The Theory of Moral Sentiments, Smith had not yet been exposed to the full range of mercantilist economic policy and its characteristic emphasis on accumulation of wealth. His experience in London, just prior to the publication of the first edition of The Wealth of Nations, showed how the dynamic power of factions and commercial interests affected the English government. This profoundly affected Smith’s optimism regarding the invisible hand. In his later years, Smith made several additions and corrections to both The Wealth of Nations and The Theory of Moral Sentiments to reflect his increasing pessimism regarding the market’s ability to foster a good society due to the unintended consequences of economic exchange. The revisions to The Wealth of Nations included a strong criticism of mercantilism, and how it distorted commercial society, which was “the last stage in the sanguine dynamic Smith had envisioned as guided by the invisible hand.” In revising The Theory of Moral Sentiments, Smith added a chapter entitled “Character of Virtue,” which “appeals to all citizens to put the well-being of the society before that of any particular faction to which they might belong, and he makes a special plea to those who might be statesmen to step forward and construct a moral society by deed and example” (Evensky 1993, p. 202). When viewing Smith in this light, it is surprising to see how the “invisible hand” metaphor has been taken by neoclassical economists to mean something as narrow as the unintended consequences of free market transactions.

Evensky is confident that Smith’s “invisible hand” represents the influence of a benevolent designer, the Deity. He sees this as a consistent theme in Smith’s work from his “History of Astronomy” through The Wealth of Nations. He contends: “Smith believed that the deity had a purpose, that that purpose was embodied in the design, and that by observing the product of that deity’s hand—nature—he could imagine, at least in general contours, the shape of that design and, in turn, its purpose” (Evensky 2005 p. 31). This interpretation, however, is somewhat reductionist, as it assumes a theoretical consistency in Smith that is rare among great intellectuals. One always has to take account of the evolution of great ideas when confronted with new evidence and greater sophistication. Evensky himself acknowledges a change in Smith’s attitude toward the invisible hand when he saw mercantilism in action. It is quite possible that the invisible hand can mean many things to many people, including Smith himself.

While it is impossible to know exactly what Smith meant by the “invisible hand,” William Grampp subjects the metaphor to careful textual scrutiny as related to Smith’s The Wealth of Nations and also to the variety of ways others have used it. In “What Did Smith Mean by the Invisible Hand?” Grampp explores the use and misuse of the term by scholars and economists by subjecting their claims to a careful reading of what Smith actually wrote. He lays out his main argument by stating:

In my interpretation, the invisible hand is more interesting than it is important. It is a part of an argument for free trade that is astute in several places, is shrewd in a few, specious in some, and in its entirety makes one believe Smith adapted his discourse as much to the misconceptions of his readers as to the truths he wanted them to hold. Or, briefly, the argument shows Smith could be the buncombe artist as well as the professor. Another reason the invisible hand is interesting is that it has become a rhetorical device in the polemics over economic policy, used more often than not as a pejorative to dismiss a simple-minded (or any other kind of) belief in the market. Still another reason is that there is little or no support in what Smith wrote that can substantiate the interpretations it has been given, thus offering another example of how the words of a great man can mean different things to his readers and can be made into something that he himself would not recognize (Grampp 2000 p. 442).

Grampp asserts that, throughout Smith’s work, he used the invisible hand metaphor differently in each instance. The invisible hand of “History of Astronomy” is distinct from that in The Theory of Moral Sentiments that in turn, is distinct from that in The Wealth of Nations. In his essay, Grampp identifies no less than nine widely held interpretations of the invisible hand and subjects each to a rigorous analysis based on what is actually stated in Smith’s works. He is not interested in conjecture, or leaps of faith, but rigorous textual analysis. His methodology is straightforward: “I should like to propose a way to get things straight about Smith or anyone else. It is to begin by distinguishing between (a) what the author actually said, (b) what is implied by what he said, (c) what can reasonably be inferred from it, (d) what we may conjecture he meant, (e) what he conceivably could have meant, and (f ) what it would be convenient to believe he meant.” For Grampp, too many economists and scholars have ventured into the territory of (d), (e), and (f), which makes the study of the history of economic ideas “a work of the imagination” (Grampp 2000 p. 443).

The reference to an “invisible hand” in The Wealth of Nations occurs when Smith describes a condition in which an individual actor who intends to benefit himself in a particular way may, in procuring that benefit, produce a different benefit for everyone, including himself. The relevant example of this is the decision of an individual to engage in domestic trade instead of foreign trade, where capital is more secure and no less profitable. In this case, it strengthens the defense of the nation by increasing domestic capital, thus becoming a source of military power. Grampp goes on to show how this brief passage has produced several divergent interpretations of what Smith meant by the “invisible hand,” including:

1) The force that makes the interest of one the interest of others

2) The price mechanism

3) A figure for the idea of unintended consequences

4) Competition

5) The mutual advantage in exchange

6) A joke

7) An evolutionary process

8) Providence

9) The force that restrains the export of capital

Since it is unlikely that Smith could have possibly intended all nine of these interpretations to be true, Grampp subjects each to his methodological model in order to get to the essence of what Smith intended to say. For the purposes of this essay, it is helpful to examine Grampp’s analysis of most of these interpretations.

The first implication, where the self-seeking actions of an individual have the effect of benefiting others, corresponds with the assumptions of neoclassical economists about market actions being mutually beneficial among rational actors. Grampp acknowledges that this is what Smith says, but only to a certain extent. In the passage about the invisible hand, Smith describes this relation as being true, but only to the extent that wealth is being kept within the country. Furthermore, there are certain passages in The Wealth of Nations (Smith 1976 pp. 346, 123, 907) where Smith describes the ways that individuals do not always act rationally in their own interest, such as when they overestimate their chances of success, or when the pursuit of pleasure drives them to ruin. The self-interested actions of individuals can have the effect of mutual gain, but only if certain conditions are met beforehand.

The second implication is that the invisible hand is the price mechanism, a force that brings markets into equilibrium and harmony without the intervention of government controls. Although Smith does discuss the price mechanism, it is not in the context of the invisible hand. Grampp states: “It is self-interest operating in the fortunate circumstance in which a merchant finds that keeping his capital at home is profitable, the consequence of which is to increase the ability of the nation to defend its people (including the merchant). That is different from what directs markets” (Grampp 2000, p. 446). Many welfare economists trace the “First Fundamental Theorem of Welfare Economics,” where all firms and individuals are price takers resulting in Pareto optimal competition, back to the invisible hand argument. Although this is in agreement with certain other arguments Smith made about markets, Grampp finds no connection to the specific discussion of the invisible hand.

Tied to, yet separate from the second implication, is the argument, held by most Neo-Austrian economists, that the invisible hand is a metaphor for how a beneficial social order results from the unintended consequences of free market transactions. Smith does not share the unbounded enthusiasm of Friedrich Hayek or Milton Friedman for the unfettered liberty of capital. In the case of the invisible hand, the unintended consequence is not a beneficial social order, but a lesser benefit, that of defense of the nation. In addition, Smith’s advocacy of certain market controls throughout his work indicates that he did not intend that the market, by itself, could produce social good.

Others assert that the invisible hand is competition, a force that compels actors to pursue their interests wisely and use their resources effectively and efficiently in promoting an overall good, or the public interest. Although Smith stated that competition is good for management and that monopolies are a bad thing, he did not say these things in the context of describing the invisible hand. For Smith, the invisible hand is not present in all forms of competitive markets or in all self-interested action. It is only present when conditions induce merchants to keep their capital at home. Competition, on its own, does not provide for the defense of the nation. Grampp reinforces this assertion by citing Smith’s statement that “defense . . . is of much more importance than opulence” (Grampp 2000, p. 447).

Another interpretation of the invisible hand is the notion that it is the process by which individuals gain the knowledge, skills, and habits for efficient economic conduct. This is a view advocated by evolutionary psychologists and, to an extent, Evensky when describing the socialization and evolution of morals in The Theory of Moral Sentiments. Grampp does not deny that skills and knowledge are socially acquired or that they evolve, but he argues that Smith never states or implies that the invisible hand is a result of an evolutionary process.

Grampp then discusses the conception that the invisible hand is a beneficent power beyond the will of Man, be it the prime mover, an omniscient monitor, or the cause of all human behavior. It is here where Grampp takes issue with Evensky’s conception of the invisible hand. Grampp is unequivocal in his assertion that the invisible hand of The Wealth of Nations and that of The Theory of Moral Sentiments are two different things. In The Theory of Moral Sentiments, Smith clearly references the deity in formulating his moral philosophy, arguing that there is a grand design behind human society and human nature. This, however, is not the case in The Wealth of Nations. Grampp argues:

To make [the invisible hand] this in the Wealth of Nations calls for a suspension of belief or for ignoring what Jacob Viner called ‘‘a substantial measure of irreconcilable divergence’’ between the two books. In the Wealth of Nations the invisible hand leads to a beneficial outcome, as this interpretation quite correctly states, but it does so only in particular circumstances. To believe this means the invisible hand is a providential force calls for assuming, first, that providence has made men self-interested (endowed perhaps with the propensity to truck and barter) and, second, that self-interested behavior is always beneficial (Grampp 2000, p. 449).

Whereas Evensky argues for consistency throughout Smith’s writings, Grampp allows for the evolution of Smith’s thought throughout his intellectual career. He considers The Theory of Moral Sentiments to be an inferior work to The Wealth of Nations in many areas, but especially in the articulation of economic matters. He argues that Smith’s use of the invisible hand metaphor is completely different in “History of Astronomy,” The Theory of Moral Sentiments, and The Wealth of Nations and does not begrudge Smith the repeated use of an extremely pithy phrase. Grampp believes: “Until it is demonstrated, the three invisible hands will continue to be, in the mind of at least one reader, three distinct ideas, each of them denoted by the same words” (Grampp 2000, p. 464).

What can we infer from this analysis that has relevance to the normative issues surrounding global neoliberal policies? One might be inclined to believe that Evensky and Grampp are merely quibbling about semantics at the expense of Smith’s overall contribution to the canon of economic thought. There is merit, however, in a close examination of Smith’s work as a useful critique of neoclassical assumptions about economic behavior. As demonstrated by Grampp, a superficial understanding of The Wealth of Nations has given rise to the dominant understanding of the free market economy by neoclassical economists, who seek to remove all barriers to the export of capital, motivated by the idea that the invisible hand of the marketplace will bring about an equilibrium between supply and demand, or Pareto optimality. That this process is understood as scientific or devoid of ethical connotations reveals a disturbing normative contradiction underlying neoclassical economics.

Adam Smith’s lessons from The Theory of Moral Sentiments and The Wealth of Nations continue to have relevance to today’s economic policies of globalization. In fact, there are several striking examples of congruence between his views and those of heterodox economists and other critics of neoliberalism. Take, for example, Smith’s critique of mercantilism, which had shaken him so much as to revise his views in The Wealth of Nations. Evensky shows how Smith lost faith in the invisible hand’s ability to produce just outcomes in economic affairs, indeed it led to a major reformulation of his ethical outlook. If the invisible hand could not guide society toward the ethical ideal, it would fall to political leaders to construct a moral society by deed and example. As Grampp notes, some of these deeds come in the form of the 35-40 types of government intervention that Smith advocates, such as the taxing of spirits, the regulation of certain markets, the redistribution of income through taxation, and currency regulation, to name just a few. Contrast this more subtle view of Smithian economics than that offered by Milton Friedman in Capitalism and Freedom, where he argues for separation between the political and economic spheres:

Viewed as a means to the end of political freedom, economic arrangements are important because of their effect on the concentration or dispersion of power. The kind of economic organization that provides economic freedom directly, namely, competitive capitalism, also promotes political freedom because it separates economic power from political power and in this way enables the one to offset the other (Friedman 1962).

In this sense, Smith’s advocacy of government intervention in the economy undermines the dominant neoclassical view of the free market as ultimate arbiter of social welfare and reflects more of a concern for social justice in the face of dominant factions that undermine the welfare of a nation’s citizens.

Heterodox economists, such as George DeMartino, who advocate careful regulation of the global economy through tariff and labor mobility regimes can find some of the elements of a commitment to justice in Smith’s work, especially in his later period, as he reassessed the ability of the market to produce just economic outcomes (DeMartino 2000 pp. 218-236). Other critics, such as J.K. Gibson-Graham, who advocate economic alternatives to global neoliberalism in the form of highly localized economies can also look to Smith’s explicit discussion of the invisible hand in The Wealth of Nations, which argues in favor of limiting the mobility of capital under the correct circumstances (Gibson-Graham 2003).

When discussing the legacy of a revered intellectual figure such as Adam Smith, one must be careful when describing the full depth of his contribution to the social sciences. It is in the interest of accuracy that writers such as Jerry Evensky and William Grampp seek to present their versions of Smith’s philosophy, yet they reach differing conclusions. History, and especially intellectual history is far from being a hard science. It is laden with prejudices, context-dependent, and subjective. In other words, it is the opposite of what neoclassical economists claim that they do. Through the course of this essay, the legacy of Adam Smith has been shown to be mutable and often contradictory. I argue that this is not necessarily a bad thing; people evolve in their views and their outlooks throughout the course of their lives and this is natural. Intellectual historians need to recognize this about their subjects: that they are enigmatic. It is a fool’s errand to try to find concrete or universal similarities throughout any great author or artist’s canon, because it assumes a level of intellectual stagnation. In Grampp’s conclusion to his article, he compares the work of Adam Smith to Elgar’s Enigma variations in classical music, concluding: “Smith believed property rights should be protected, except when they should not be, and that is another enigma” (Grampp 2000, p. 464). Looking at the intellectual contributions of “classical” economists in this way de-essentializes them, which may in turn complicate our understanding of them, but it opens the way for substantive criticism of the so-called hard science of neoclassical economics. This is not a destructive endeavor, but one that can act as an agent for constructive change.

References

DeMartino, George. Global Economy, Global Justice: Theoretical Objections and Policy Alternatives to Neoliberalism, New York: Routledge, 2000.

Evensky, Jerry. Adam Smith’s Moral Philosophy: A Historical and Contemporary Perspective on Markets, Law, Ethics, and Culture, New York: Cambridge University Press, 2005.

Evensky, Jerry. “Ethics and the Invisible Hand,” Journal of Economic Perspectives, Vol. 7, No. 2, 1993.

Evensky, Jerry. “Adam Smith’s Theory of Moral Sentiments: On Morals and Why They Matter to a Liberal Society of Free People and Free Markets,” Journal of Economic Perspectives, Vol. 19, No. 3, 2005.

Friedman, Milton. Capitalism and Freedom, Chicago: University of Chicago Press, 1962.

Gibson-Graham, J.K. “An Ethics of the Local,” Rethinking Marxism, Vol. 15, No.1, 2003.

Grampp, William D. “What Did Smith Mean by The Invisible Hand?” Journal of Political Economy, Vol. 108, No. 3, 2000.

Sen, Amartya. On Ethics and Economics, Malden, MA: Blackwell, 1987.

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