10 Logical Reasons Why Free-Marketeers Don’t Understand the Invisible Hand

Blinded by an economic doctrine

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By Jag Bhalla

Many market lovers are so bewitched, they’re blind to their beloved’s faults. Worse, they hate what their love needs to work. Seen clearly, “invisible hand” logic is incomplete and cuts both ways.

1. Adam Smith wasn’t market smitten: “He who intends only his own gain … is … led by an invisible hand … [and] frequently promotes” society’s interests. That’s “frequently promotes” — not always ensures.

2. The “invisible hand” metaphor predates Smith (he got it from William Shakespeare, Saint Augustine used it). Economists mostly ignored it until Paul Samuelson’s 1948 textbook preached to millions that it ensured “the best good of all.”

3. If selfishness in markets has unintended benefits, aren’t unintended harms logically possible? Perhaps inevitable?

4. Markets, as complex wholes, risk “fallacies of composition”: The properties of parts needn’t apply to wholes. Silly example: All atoms in an apple are invisible; therefore, the apple is invisible. Likewise markets composed of voluntary, desirable, and locally “rational” transactions don’t always combine for rational and desirable outcomes overall. Unsilly example: Few buy products intending to pollute; yet producers pollute.

5. Pollution shows why free markets have built-in incentives to obstruct voluntary fixes. Manufacturers gain by avoiding cleanup costs; buyers by the resulting lower prices. What’s collectively bad “benefits” voluntary sellers and buyers.

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6. Such “costs that people impose on others … yet have no individual incentive to” fix are called“negative externalities.” They’re not always safely ignorable or small (e.g. $200 burger). Markets, without accurate prices, are like doctors without reliable tests. They can’t dependably decide what’s best.

7. Two cures are known: Either regulate, or tax to adjust incentives. Yet many market-lovers resist both, often for non-market ideological reasons (believing governments are unavoidably bad).

8. Markets could collectively optimize if prudently avoiding collective harm reliably trumped profit, or if prices perfectly included full costs (no externalities). But neither condition applies in any real market.

9. Only a non-market entity can police and manage real markets. Otherwise markets coordinate mindlessly (see “Markets Dumb as Trees”).

10. Joseph Stiglitz says the “invisible hand often seems invisible” because “it is not there.” Better to say it’s not reliably benign. The claimed automatic alchemy of solo greed becoming social good is love-struck, logically incomplete, and impractical. Real lovers of real markets must deal with their real disorders. Without the medicine of regulation and taxation, however bitter, our beloved markets can’t thrive. Let’s be market realists.

Illustration by Julia Suits, The New Yorker Cartoonist & author of The Extraordinary Catalog of Peculiar Inventions.

2015 september 28

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  • A thoughtful critique… yet it misses the ways in which entrepreneurially-developed communities are using contracts to deal with negative externalities, in the interest of maximizing land values.

    More than 300,000 homeowner associations – up from fewer than 1000, five decades ago – today rely on deed-based agreements (created by profit-maximizing developers) to keep owners from acting in ways that impinge upon their neighbors. They also create formulas for automatically sharing the cost of infrastructure and services, without recourse to taxation.

    Land values act as a hedonic index, reflecting the net of positive and negative externalities. As Joseph Stiglitz has noted, a polis has rent-maximizing incentives to ensure that negative externalities are kept in check. The invisible hand of rent maximizing can work with states, such as Singapore and Hong Kong, that fund operations through social ownership of land, as well as entrepreneurial developers of private communities (e.g. Freeport in the Bahamas, Zonamerica in Uruguay, and Songdo in South Korea).

    “Geoist” approaches along these lines offer a proven, replicable path to overcoming state and market failures. Local outcroppings of the new system can be encouraged through community land trusts and contractual self-help groups in a range of settings, as outlined in

  • Swami Cat

    Strange article. Basically it reads like a sarcastic dismissal of juvenile interpretations of economic fundamentalism. If you take the most absurd views by the dimmest bulbs and then critique them it is pretty easy shooting.

    Markets are problem solving systems for a particular type of problem. This problem solving system is embedded in other problem solving systems including that of science and political institutions.

    The key insight of the invisible hand is that through properly functioning institutions you can channel most creativity and problem solving to be mutually beneficial. Once the institutions are set up correctly, people can pursue their own needs and desires but are channeled to do so in ways which are on net beneficial to others. I wait tables for tips but in going so provide a valuable service to anonymous diners. Billions and trillions of such positive sum interactions grow and accumulate into massive prosperity for most participants and can also fund safety nets for those harmed via the creative destruction inherent in the system (which can be market or non market based).

    If this article is a reflection of the level of writing to expect in evonomics, then I will be extremely disappointed. The reality is few people understand markets at all. Reading this article is not likely to improve matters further.