How the Invisible Hand Was Corrupted by Laissez-Faire Economics

Smith’s invisible hand shows the limits of laissez-faire

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By Jeff Madrick

As I learned my economics and further explored the influence of the Invisible Hand, the power of ideas became clearer to me. Economic ideas have had enormous influence on economic conditions—and vice versa. Over the past thirty-five years, the ideas at the center of orthodox economics, did damage and laid the groundwork for the financial crisis of 2008 and the Great Recession that followed. The Invisible Hand, though alluring, is highly ambiguous—it does good and harm.

A beautiful idea can be described as one that explains a lot with a little. Such ideas are often simpler than previous explanations of a phenomenon. But they can be siren songs, and throughout history many such ideas have been found to be wrong: the Aristotelian belief that heavy items fall fastest to earth; the once-dominant idea that the veins and arteries are separate circulatory systems; the notion, which seemed undeniable to educated people at one time, that the earth is the center of the universe.

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The Copernican idea that the sun, not the earth, is the center of the solar system is a classic example of the best kind of beautiful idea. It is elegant and simple and, most important, ultimately correct. But time was still needed to break the shackles of the older, mistaken beautiful ideas. Once accepted, such ideas are hard to shed. They become part of us and color how we think.

Physical observation alone did not pave the way to the Copernican idea, which took some time to gain acceptance. There were also cultural and philosophical changes that opened paths to such thinking. Our sense of our uniqueness as a species may have already been diminishing culturally and intellectually before Copernicus’s astronomical theory took shape, making it possible to accept the radical notion that the earth was not the center of it all. History is more a circle than a line—a feedback loop rather than simple cause and effect. I’d argue that economists too often overlook that. Honest economists readily admit their oversimplifications; confused economists take them more literally.

The beautiful idea of the Invisible Hand enraptured economists as well as many political thinkers for more than two centuries. But it is not an idea with the power of, say, the Copernican discovery. It is more a loose metaphor for the way markets may work than an ironclad law. The Invisible Hand is believed by economists to demonstrate that markets where goods and services are freely exchanged will result in the greatest benefit to buyers and sellers alike, and as  noted direct investment where it is most useful, enhancing the rate at which the economy can grow. All of this takes place without any outside government intervention.

Orthodox economists have made the Invisible Hand the basic foundation of their work. They grudgingly agree that sometimes government intrusion in the market is necessary. Usually, though, government efforts are seen as harmful. Most extraordinary, many economists claim that just as the market for cornflakes is self-adjusting, so, too, is an entire economy. Supply and demand automatically adjust to a “general equilibrium” that satisfies as many people as possible. In a recession, prices, wages, and interest rates will fall. More goods will be demanded, and production will rise again. Excessively rapid growth will result in higher prices, which dampen demand and will perhaps create a recession that lasts until the economy readjusts. A recession will only be temporary, as will excessive growth.

Unlike the Copernican revolution, however, the Invisible Hand is an assumption, not a scientifically based law. Its obvious limitations have not prevented its supreme influence. The alllure of the Invisible Hand is its elegance. The profound weakness is that it is not nearly as complete a model of markets as many economists insist it is. Its underlying assumptions—that people have material preferences that don’t change, that they are rational decision makers, and that they have all the price and product information they need—are extreme. The Invisible Hand is thus a limited proposition, elegant but impure.

It especially draws theorists toward the laissez-faire model of governing, which holds that government intervention should be minimized. Indeed, the free market, not government, is accepted as the dominant organizing mechanism of society.

Smith used the term “Invisible Hand” just once in The Wealth of Nations and only once in his earlier work, The Theory of Moral Sentiments. The historian Emma Rothschild, in her book on Smith and the Marquis de Condorcet, two towering Enlightenment scholars, argues that Smith was more ironic than serious about the Invisible Hand, always assuming an active role for government in creating the rules and regulations of society and fully conscious of the need for compassion and community, which he outlined rather beautifully in The Theory of Moral Sentiments.

But Smith took the Invisible Hand very seriously, I’d argue, even as he assumed a large role for government. He was a complex thinker, breaking new ground in many areas, and too much time has been spent trying to make his abundant ideas consistent with one another. He could believe in limiting government in some ways but expanding it in others. Even though he explicitly mentioned the Invisible Hand only once in The Wealth of Nations, elsewhere in his masterpiece he addressed it at length.

Smith was formally a moral philosopher at the University of Edinburgh, and he had come to believe that individuals could often make their own decisions without help from a higher authority, a staple idea of the Enlightenment that was rapidly gaining cultural acceptance. A market undirected by government fit this philosophical disposition very well. Smith was determined to show that such self-oriented behavior on the part of individuals led to a common good. “Man has almost constant occasion for the help of his brethren,” he famously wrote, “and it is in vain for him to expect it from their benevolence only. He will be more likely to prevail if he can interest their self-love.” And then follows his most quoted line: “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.”

Emma Rothschild, appropriately skeptical of the Invisible Hand, emphasizes its “loveliness.” To many, she observes, it is “aesthetically delightful.” Rothschild notes that for the Nobel laureate Kenneth Arrow and his highly regarded coauthor Frank Hahn the Invisible Hand was “poetic.” Arrow and Hahn wrote that it is “surely the most important contribution of economic thought.” Another Nobel laureate, James Tobin, called it “one of the great ideas of history and one of the most influential.” The American conservative philosopher Robert Nozick is impressed by how it finds an “overall pattern or design” out of a seeming jumble of decisions.

Its simple elegance, as I’ve said, is part of the reason for its influence. Rebuttals of it tend to be intricate, but this does not make them wrong. A rare readable rebuttal of Smith’s moral contentions can be found in Adam’s Fallacy, a short book by the nonmainstream economist Duncan Foley. Others have built economic systems that give less credibility to the central proposition that economies are a collection of markets driven by the Invisible Hand and more to the influence of tradition, culture, power, war, and the development of the law, the banking system, and other institutions. Economic growth cannot, it turns out, be explained by the simple mechanism of the Invisible Hand, however key a role it played. These other less traditionally economic factors matter enormously. Foley is part of this tradition, as is the similarly nonmainstream Lance Taylor, whose Maynard’s Revenge is a variation on the failures of Smith’s theory. The Invisible Hand, however, overwhelmingly trumps all these insurrectionary ideas in the practice of economics today.

With the stakes so high, how could I not have wanted to understand the way economies create wealth? How could I not have embraced the Invisible Hand? Was there some set of conditions and choices that underlay prosperity, a set that could be maintained and enhanced? In short, was there a universal key to economic growth? Political decisions, the tides of history, scientific breakthroughs, the spread of literacy, the rise of rapid transportation—all these and more affect growth. But my college textbooks, even when they included sections on Keynesian government stimulus, by and large agreed that prosperity is mostly a consequence of the Invisible Hand—that is, a free market.

Adam Smith may not have been an economist per se, but to my mind he was an economic historian of his times. Better said, he was an economic sociologist. He wanted to understand the causes of the prosperity that existed in Scotland and the rest of Britain. History’s leading theoretical innovators were trying to make sense of what they saw as surprising and robust economic advances since the 1700s. They noted how wealthy many individuals were becoming; how cities were growing; how agriculture was feeding more people; how new water mills and factories were producing goods more cheaply; how many new businesses were being started; how canals and, over time, railway lines were proliferating; and how technology was advancing rapidly. Neither they nor their greatest successors created economic edifices out of theory; instead, they created theory out of the concrete edifices they observed. Unlike, say, Newton’s or Einstein’s theories, which offered predictions based on immutable laws of nature (within defined limits, granted), economic theories did not predict the Industrial Revolution or the fabulous wealth of today’s rich nations. John Maynard Keynes was a brilliant but mostly conventional economist until the devastating Great Depression; when the facts on the ground changed, he said, he had to change his ideas.

Adam Smith did not begin The Wealth of Nations with the Invisible Hand. The general cause of increasing wealth is productivity, he wrote in his first chapter, the growing quantity of goods and services that can be produced per hour of work. More income was produced per worker as productivity increased. The persistent increase in productivity, accumulating over years, decades, generations, and centuries, is the cause of the economic benefits we enjoy today. This was accomplished through what Smith called the “division of labor.”

Smith started with the aforementioned pin factory, a classic example of rising productivity, both simple and highly illustrative. Smith may have called the manufacturing of pins “trifling,” but the availability of cheap pins was important to the burgeoning textile industry. Smith explained that one man could make one pin a day, perhaps twenty. But when manufacturers learned to divide and specialize the work, productivity exploded. Smith reported that there were up to eighteen separate operations—“ one man draws out the wire, another straights it, a third cuts it, a fourth points it”—and by dividing the labor, twenty men with specialized skills could now make an astonishing forty-eight thousand pins in a day. This huge multiplication of output was achieved even as the cost of labor remained low. Here, in a nutshell, was the miracle of modern wealth. But it was the Invisible Hand that directed business to make such investments as demand created opportunity; it was the guidance system, so to speak.

This primitive example of growing productivity is crystal clear. Smith went on to show how it characterized industry after industry. More than a century later, the division of labor became the basis of mass production, which made use of elaborate machines that, by  and large, worked on the same principle of breaking tasks down to their simplest level. Henry Ford took this to the extreme, paring down the multiple tasks involved in building a car to a degree that no one had imagined possible.

When Ford started out, a car with an internal combustion engine typically cost around $5,000. He eventually got the price down to a few hundred dollars, having figured out a way to make so many more cars with little change in labor time or costs. There have been countless examples in industrial history of this reduction in price. By the end of the 1920s, about three-fifths of American families had a car—compared to a little over one-fifth a decade earlier—and a huge number owned washing machines, radios, and telephones. The increase in television ownership in the 1950s was even more explosive—and even with TVs being relatively more expensive, adjusted for inflation, than the computer would later be. But since the 1980s, the price of a personal computer has dropped substantially, and now about three-quarters of Americans own one.

Division of labor was the central principle, but other factors were exploited to increase productivity. New sources of power made a significant difference by reducing labor time: wind and water at first, well before Smith’s day, then coal, oil, and, finally, the generators that produced the electricity (and, to a much lesser degree, nuclear fission) that powered the increasingly complex machines that produced more and more goods faster and faster with less and less labor. Another major factor was the rising speed of the transportation of raw materials, parts, and finished goods to producers and markets—first over the waterways, then by train, and soon on trucks and huge oceangoing vessels. The steam engine was key to these developments, but so were navigational techniques. Transportation costs were sharply reduced, which also radically enhanced the mobility of labor. Soon communication became faster, further  boosting productivity. The telegraph was critical to American economic development in the mid-1800s, as was the telephone by the end of the century. Lower costs of parts made it possible to produce countless newly invented products over the decades.

The size of the market was every bit as critical as output—and maybe more so—and has usually been overlooked by contemporary economists. The division of labor and other productivity improvements could only be made if the market was large enough. Smith knew this, giving the third chapter of The Wealth of Nations the title “That the Division of Labor Is Limited by the Extent of the Market.” What good would it be to make forty-eight thousand pins rather than two hundred if there was no need for those pins, even if the price dropped drastically? Markets had to expand beyond the village to the region, the nation, and the world. This was another reason that more efficient and low-cost transportation was so necessary to the advance of productivity.

The process that created the incentives to increase productivity and guide production and prices was itself driven by self-interest, Smith argued. He observed that it is merely a human “propensity” to want to barter and that the way to get what one wants is by giving others what they want.

How much to produce? At what price to sell? Is this really for the overall good? Shouldn’t somebody decide? This is the process of the Invisible Hand. “By directing that industry in such a manner as its produce may be of the greatest value,” Smith wrote, “he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was not part of his intention.”

The fact that Smith used the term “Invisible Hand” only once in The Wealth of Nations has, as noted, misled some scholars into thinking that he did not really care about or even fully believe in it.

Yet the chapter in which he described it without explicitly mentioning it—“ Of the Natural and Market Price of Commodities”—is the most important in the book. First of all, Smith assumed there was a “natural” price for every good, one ambiguously based on the long-term costs of producing the product. “When the quantity of any commodity which is brought to market falls short of the effectual demand,” he wrote, “a competition will immediately begin [among those who want to buy it], and the market price will rise.” In other words, as demand increases, the price rises until it reaches the point at which the entire quantity produced is consumed. If supply increases, the opposite occurs. As he wrote, “When the quantity brought to market exceeds the effectual demand . . . some part must be sold to those who are [only] willing to pay less, and the low price which they give for it must reduce the price of the whole.” Thus, more people can own the product at the lower price.

Supply and demand shift to strike a balance at a specific price, which is called the equilibrium point. If there is too much of a commodity or, similarly, too much labor or land, the employer will cut jobs or wages or the landowner will reduce the price or amount of salable land until the wage or the price reaches its so-called natural level. If there is greater demand, the employer will hire more workers or the landowner will prepare more land for use. Natural price and effectual demand are ambiguous ideas, but they were key, if unexplained, assumptions for Smith. Later economists would spend a lot of time trying to make these ideas more explicit. But they essentially accepted the assumptions without ever to this day devising a complete explanation of how price and demand are determined. Price always gravitates to its natural level, Smith said, so that demand is fully met and the resources of a nation are fully used. Economists assume as much today.

Smith acknowledged potential obstructions to the ideal functioning of markets. Producers can try to keep secret a rise in demand, thus avoiding competition. Lack of widespread information about prices and the availability of goods is an inherent problem. Similarly, anyone with a monopoly can keep the market understocked or prices too high. A tariff to keep exports out keeps prices too high to satisfy effectual demand.

Smith did not fully explore some other problems. Simply said, he believed market participants must know what they want and what they are willing to pay. Barring such (rather formidable) obstacles, the process is automatic. Government will only hinder it with taxes, product standards, and price regulations.

In his chapter on natural and market price, then, is Smith’s almost complete description of the Invisible Hand. So accepted and seemingly obvious is his theory that it is hard to believe that Smith did not conceive of the supply and demand curves that all first-year economics students learn. Alfred Marshall, the talented British economist, drew these about a century later.

In addition to the problems just cited, there is another major gap in the explanation of how the Invisible Hand functions. The main claim is that price sends a message to buyers and sellers on how they can adjust their consumption and production. But the countless buyers and sellers must communicate with each other, after all—in effect, bargain. This is no easy task.

Smith’s proposal that there is a natural price for a product is sketchy, to say the least. There is no convincing explanation of where this natural price comes from. Smith presumed that there exists for goods and services a price known by custom and practice and that the price goes down and more people buy as new and cheaper supply comes on the market. Within this set of narrow possibilities, the Invisible Hand can spread the benefits of productivity and induce businesses to invest more, expand capacity, increase production, and reduce labor costs. They may also hire more workers and even raise wages.

A bookseller, for example, might sell a book for $19.95 and see how many takers he gets, thus testing the market. But what if a $14.99 price would attract many more buyers, resulting in a greater total profit for the bookseller? A competitor might then sell a similar book as cheaply, and so the experimentation that led to an equilibrium price would continue. Léon Walras, the influential French economist who in the late 1800s used mathematics to expand the Invisible Hand as a model for the entire economy, did not have an answer to how the process would work in real life, either. Walras presumed that there was an economy-wide “auctioneer” who gathered all prices of goods and sold them to those willing to pay. That assumption about the process by which the Invisible Hand matches buyers and sellers has not been improved upon by contemporary economists. How the equilibrium point is reached remains a mystery.

This central ambiguity matters a lot. Prices can in fact be shoved around by powerful forces: big business, strong unions, and ubiquitous monopolies, or at least oligopolies with market power. In financial markets, prices can be manipulated by collusion or secret trading or access to inside information. In labor markets, wages can be affected by the ability of businesses to fire workers without cause or by stern government policies that restrain growth and keep unemployment high.

Belief in the Invisible Hand allows economists to minimize these concerns. The battle against unions, for example, is driven by a claim that the Invisible Hand guides business and labor to set fair wages. Union organizers believe that they are not set fairly and that workers need collective bargaining to level the playing field. Alan Greenspan, as Federal Reserve chairman, believed that bargaining power mattered. High unemployment, he realized, could keep workers insecure and therefore less willing to bargain hard for their jobs, giving business more power over wages than the Invisible Hand would dictate. One measure of insecurity is the rate at which workers are willing to quit their jobs. If the quit rate is high, workers are secure and might ask for higher wages, putting pressure on business to raise prices and stimulating inflation; if the  quit rate is low, workers don’t have the security to bargain hard. (Of course, unions sometimes have too much power, too, driving wages too high.) Greenspan kept a close eye on this and seemed to encourage worker insecurity.

Faith in the Invisible Hand led to the once-general belief that a higher minimum wage results in lost jobs. It presumes that the wage paid reflects the worth of the workers and that any wage increase resulting from a minimum wage law represents an overpayment to workers, reduces profits, and also reduces the hiring of new workers. But in fact often the wage can be too low because of a business’s power or generally restrictive government policies that keep unemployment high. In that case, a hike in the minimum wage would be healthy economically, restoring demand for goods and services, and would not cause jobs to be lost. At the turn of the nineteenth century, the American economist John Bates Clark made one of the first claims that, economy-wide, wages reflect the worth of labor. As we shall see, there is little serious empirical work to justify this conclusion, and recent studies—what I call dirty economics—have shown that increases in the minimum wage result in very few lost jobs, if any. Empirical analysis is at last changing economists’ minds.

Another concern regarding the labor and other markets is often referred to as asymmetric information. The classic example is the used-car salesman who has more information about the car than the buyer has, much of which is kept secret. As Smith feared, a market cannot work under these circumstances. Buyers cannot make proper bids without knowing what they are buying. This concern extends to markets in health care, insurance, and mortgages—and arguably to most other markets as well. It is not only the poor subprime mortgage buyer, for example, who will make errors, but almost all homebuyers who enter into such transactions only two or three times in their lives. How can they possibly be knowledgeable and informed? Even sophisticated pension fund managers clearly did not have enough information about the complex mortgage securities fashioned by Wall Street to make sensible decisions in the years leading up to the 2008 crisis. Countless pension funds and individual investors and the Department of Justice have been suing major banks like JPMorgan Chase and Goldman Sachs over alleged deceptive practices, and in several cases multibillion-dollar settlements have been reached. One Goldman Sachs banker—if only one—has gone to jail for selling the complex products without informing his buyers. A pure interpretation of the Invisible Hand suggests such easy fraudulent behavior should not be possible.

The Invisible Hand also depends on market participants knowing and understanding their self-interest well and therefore making rational decisions about buying and selling products. Behavioral economics has uncovered many examples of buyers being unable to make such rational decisions, a factor economists once minimized. An obvious example is herd behavior in buying stocks, in which buyers are lured into paying high prices because so many others are. The opposite, also damaging, is irrational risk aversion, with investors refusing to buy even when the odds of gains are good. Another example is susceptibility to misleading advertising. Still another is fashion itself, evident in surges in demand for new products like the iPhone or traditional ones like an Hermès Birkin bag. One can argue that there is some satisfaction in being a part of fashion, of course, but not if it leads to buying bad products or stocks whose prices will inevitably fall precipitously.

The seeming power of the Invisible Hand, however, enables many economists to neglect or set aside these concerns. Milton Friedman forcefully argued that competition will correct most wrongs. Fraudulent products or manipulated financial services will create opportunities for honest competitors, overpricing will create opportunities for sellers to reduce prices, and herd behavior leading to overspeculation will be counteracted by sellers who know better. There is no need for labor unions to offset the power of business, as John Kenneth Galbraith had claimed in his concept of “countervailing power”; unions will only keep wages too high by interfering with the Invisible Hand.

The Invisible Hand is a source of clean economics in a dirty world. Great castles can be built on the Invisible Hand, but a rising tide will wash them away. This is what happened in 2008.

Among the most important limitations of the Invisible Hand are economies of scale. The Invisible Hand presumes that it will eventually cost more to produce a good, not less. The supply curve rises to meet the demand curve. But the greatest productivity increases in the Industrial Revolution were arrived at as the volume of sales increased; this is what enabled Henry Ford and others to cut prices. The more you make, the lower the unit cost. The supply curve could actually fall when more units were demanded at lower prices, and it often did. Economies of scale are a major component of wealth creation and of the history of economies. Smith’s pin factory was a version of this.

The grandest leap of faith among economists, however, concerns more than how the Invisible Hand works in a single market. A general equilibrium was reached for all markets and the economy as a whole. This conclusion, arrived at by economists like Léon Walras, is remarkably convenient, but the assumptions required to make such a claim are extreme.

The many obstacles to the workings of the Invisible Hand amount to an overwhelming criticism. The Invisible Hand is an approximation, usually not applicable in the real world without significant modification. Dependence on it leads to major policy errors, most of them having to do with restraining government intervention. We assume away monopolies, business power, lack of access to information, the likelihood of financial bubbles, economies of scale.

The proof is in the pudding. Predictions about economies based on this generalized theory have often been proved wrong. The most important of these is that economies should be stable because they self-adjust to reach general equilibrium. Yet we have had countless deep recessions and financial bubbles and crashes since the start of the Industrial Revolution. The eighteenth century was rife with them, but so have been the past thirty years of the modern laissez-faire era. Simplistic, convenient belief in the Invisible Hand led to mindless financial deregulation beginning in the 1970s and an astonishingly misplaced faith—one that ignored asset bubbles and income inequality, among other things—that the Great Moderation would maximize prosperity. This is why the devout believer Milton Friedman could state in 2005 that the economy was stable; he couldn’t imagine that it wasn’t, and he never looked under the hood of Wall Street securities to see what was really going on.

If rightly read, Smith’s theory proposes the opposite of laissez-faire political practice, suggesting that there is a need for a visible hand of government. It describes both why markets work and why they fail, as well as how much guidance from an outside force is needed to keep them on track. The Invisible Hand is a brilliant idealization of markets that shows how limited laissez-faire theory is in reality.

madrickFrom the Book: SEVEN BAD IDEAS by Jeff Madrick Copyright © 2014 by Jeff Madrick Published by arrangement with Vintage Books, an imprint of The Knopf Doubleday Publishing Group, a division of Penguin Random House LLC.

2106 April 15

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  • Adam Pierce

    An economist doesn’t say “the free market is inefficient”, he says “the free market is inefficient COMPARED TO X” where X is some set of programs and policies. The worst and most extreme depressions and recessions happened under the Fed’s watch. True (total) monopoly is almost always the result of government intervention.

    Your article is a smear with nothing to back it up but vitriol.

    • Hardy Seher

      as is your comment.

      • Adam Pierce

        Let’s look at the facts. What horrible economic crises occurred in the 1800s? There were “panics” and short depressions or recessions, but no long-term economic crises occurred at all. Within 100 years, the Fed oversaw the Great Depression, the Great Recession, and a string of lesser economic downturns. Each of the economic crises in the 1800s without Fed help faced a rapid recovery. Each crises under the purview of the Fed has dragged on more or less interminably. The recovery after the 2008 financial crisis in particular has been less robust than virtually every other recovery in US history. If this were a totally private firm, you would have Senators look at that record and go rail on TV every day about how it’s too greedy and it isn’t serving the public. It would probably be nationalized if it were this central and this poorly-performing.

        • Hardy Seher

          you make my case. a classic missunderstanding between correlation and causality, logical fallacy. please read more here –>
          the question would be: how could you know how it would be without the fed? for that you need a different methodology:

          causlity would be more like this:

          further, comparing privat and public sector in your manner is –>
          since they have different goals and existential rules inherent, the analogy must not hold per se.

          what do you think?

          • Adam Pierce

            I’m not arguing there is a hard deductive argument, I’m arguing that the historical evidence is all on one side and that side says “free markets work better for people”. To throw out all the historical evidence because it doesn’t form a strict deductive principle is as unscientific as it gets.

            Even if you were correct:

            Additionally, correlation does not imply causation but it does rule out anti-causation and suggest a possible causal link. If you have a program that is supposed to totally stop teen pregnancy and instead it skyrockets, the program was ineffective. Maybe you can plead that it was ineffective because circumstances got ridiculously worse, but the claim that that program simply stops teen pregnancy is ruled out, and the claim that the program in some way caused teen pregnancy should be seriously considered.

            Here, the claim is that the Fed stabilizes prices and evens out the business cycle. When prices continuously rise for a century and business cycles get worse, the claim that the Fed “fixes” those problems has to be thrown out. That causal relationship is disproven, and the opposite may well hold.

            The fact that A is different from B in some ways does not mean that no analogy can be made at all. It simply means that you can’t go overboard with it. The analogy I made was: “The Fed is performing badly. When institutions perform badly (like this other class of private institutions), we look at fixing them or getting rid of them. Therefore, we should look at fixing the Fed or getting rid of the Fed.” If that analogy holds a little less tightly it does practically nothing to derail the argument.

            My analogy tars the Federal Reserve as performing poorly, not as “being like” a private institution. It does not qualify as a false analogy, unless you believe that public institutions should never be held to any particular standard of performance whatsoever.

          • city zen

            You’re making a straw man argument. The claim isnt “the fed fixes these problems,” the claim is “these problems are worse without intervention”.

          • Adam Pierce

            I’m perfectly happy to take that argument on and in fact my reply already does so. All of the available historical and econometric (meaning statistical) evidence suggests that the Fed causes and worsens economic downturns, and that things would be drastically better without ongoing, perpetual intervention in the money system.

          • Mankind Global Media

            I’m perfectly happy to take that argument on and in fact my reply already does so. All of the available historical and econometric (meaning statistical) evidence suggests that the Fed causes and worsens economic downturns, and that things would be drastically better without ongoing, perpetual intervention in the money system

            I know someone who’s willing and able to take you up on that. Feel free to hoist your dick on the chopping block any time:


    • Derryl Hermanutz

      So the big bad Fed forced all those simpering little bankers to make all those irrationally exuberant loans that enriched the bankers with billions of bonuses but bankrupted their banks? If the Fed is responsible for the actions of private bankers, then the Fed should be getting the bonuses, because the bankers are just doing what the Fed “makes them do”. Right?

      • Adam Pierce

        It’s a non sequitur, but I’ll respond anyway. If you’re talking about the 2008 financial crisis, the blame lies squarely in Washington DC. There was a huge push to get more Americans to own homes. Regulators made banks lower lending standards that banks had had in place for decades. The main mechanism to accomplish this was threatening legal action on diversity/discrimination grounds. When the 2008 crisis finally hit, three quarters of subprime loans were held by government agencies (Fannie, Freddie, and Ginnie).

        Perhaps instead of blaming lenders you blame interest rates? All those speculators getting “teaser” rates on mortgages they never expected to pay off were responding to artificially low interest rates established by the Fed.

        Perhaps the issue is not subprime lending or interest rates, but the fact that mortgage-backed securities (which government-controlled Ginnie Mae had an outsized role in creating) were rated AAA despite being less than sound? Even here the government is primarily to blame. The ratings agencies exist in a legalized cartel, enshrined in regulatory law, established by the government.

        Okay, so suppose that the real issue is not the government push to destroy lending standards, or to depress interest rates, or to legally require companies to hold whichever securities its cartel blesses, but instead irresponsible risk-taking on the part of secondary financial institutions like Lehman Brothers? If so, how could the lesson possibly be to bail out these institutions?

        • Reaz Ali

          Deposit Insurance is much maligned, but it can alleviate the risk taking to a certain extent. Can reduce the moral hazard problem of bank deposits being used for lending purposes to borrow for speculative purposes. Just like Basel Committee, maybe FDIC and other countries corporations can come together to form a supranational organization to contribute to bailing out those institutions partially. Maybe if credit rating agencies have to share information with these organizations as well(apart from government and banks), then costs of monitoring on part of central bank on what is being done with customer deposits can be reduced. The possibility of moral hazard due to banks having more information about deposits than credit rating agencies(in the former’s interactions with government) will reduce. The principal agent problem will not be as acute.

          • Adam Pierce

            Depository insurance has the potential to deal with risk, but in the 2008 financial crisis in particular most of the affected institutions were not ordinary savings banks where Joe puts his paycheck. You certainly have your WaMu and your NetBank, but the institutions that struggled the most were buried deep in the financial sector. There’s a reason you hear about Mortgage-backed securities and credit default swaps (instruments your ordinary depository banks are and were forbidden from holding) as the evils of the crisis.

            I find it incredibly unlikely that the FDIC is the best we can do in terms of depository insurance. It seems much more likely that private firms on an auto insurance model could effectively price risk, based on how well basically every other insurance monopoly has performed.

        • city zen

          Excuse me? More evidence you do not have a CLUE!

          3/4 of subprime loans were NOT held by govt agencies! That is 100% BS.

          “More than 84 percent of the sub-prime mortgages in 2006 were issued by private lending. These private firms made nearly 83 percent of the subprime loans to low- and moderate-income borrowers that year. Out of the top 25 subprime lenders in 2006, only one was subject to the usual mortgage laws and regulations. The nonbank underwriters made more than 12 million subprime mortgages with a value of nearly $2 trillion. The lenders who made these were exempt from federal regulations.”

          Just stop, Adam Pierce. You dont know what you are talking about and you dont seem to care. Go back to the drawing board.

          • Adam Pierce

            Unfortunately you did not grasp my argument at all.

            My argument is that Washington regulators took extraordinary measure to push for greater lending, and actively eroded lending standards. US Representative Barney Frank (of Dodd-Frank repute) famously said he was willing to roll the dice by further subsidizing the housing market :

            So, yes, private lenders did originate the overwhelming majority of subprime loans. They had distorted incentives created by the regulators who were supposed to be watching over them.

            Investors took these loans at a higher rate than in the past because they were responding to historically low interest rates created by the Fed.

            The secondary market responded to the credit rating agencies (i.e. institutions were legally required to hold AAA securities and the government cartel erroneously rated Mortgage-Backed Securities as AAA) as well as to Fannie, Freddie, and Ginnie. These Government-sponsored enterprises implicitly guaranteed the subprime mortgage-backed securities. In 2005 (by widely accepted measures) these agencies either owned or guaranteed $5.5T of the total $11.2T mortgage market. When that market dramatically failed, pointing to these agencies is not a conspiracy theory. It is instead the height of prudence.

            As to the claim about holdings of subprime mortgages, you are unfortunately confusing issuing a loan and holding a loan. As I’m sure you’ve heard countless times by now, these private lenders would issue a loan and immediately sell their stake in it. The buyer on the other end? In many cases it was Fannie, Freddie, and Ginnie. Unfortunately the numbers don’t lie:

          • Adam Pierce

            I’m going to add a second reply because the article you link makes a dangerous and fundamental mistake. The narrative is this: “Government caused the crisis by doing A, C, E, and F. Independent business caused the crisis by doing B, D, G, and H. The bad stuff the government did should be blamed on the businesses because business wanted those things.”

            This makes an incredibly dangerous mistake about the role of government. Government is not supposed to follow the arbitrary whims of businesses or individuals, but to level the playing field between all businesses and all individuals. The role of government is to restrain business from performing fraudulent or violent actions by which they would take advantage of the less powerful and the less well-off.

            If you state that the government failed because businesses convinced it to act in their interest and against the interest of the common man, you have condemned not business but government, and in the strongest possible terms. You have admitted as the premise of your argument that government cannot fulfill its basic and necessary functions.

          • Mankind Global Media

            If you state that the government failed because businesses convinced it to act in their interest and against the interest of the common man, you have condemned not business but government, and in the strongest possible terms. You have admitted as the premise of your argument that government cannot fulfill its basic and necessary functions.

            No that’s childish. Theft is still theft and still wrong even if the government participates in it. If it does, then you make a case for stronger laws and a better/different government – even a better government structure. To make it an argument against government as a concept is based on presuppositions of your own. That’s why Libertarians can never claim that they just observe and report with no glasses getting fogged in the process.

          • Adam Pierce

            I said the government was supposed to level the playing field and you concluded I opposed “government as a concept”… that’s pure dishonesty.

          • Mankind Global Media

            Nope, because it was you who wrote:

            you have condemned not business but government, and in the strongest possible terms

            Now if you care to revise your statement to say “the government,” I’ll concede you have a point.

          • Adam Pierce

            Should I also revise it to say “a business” or “these businesses” ?

          • Mankind Global Media

            Nope. Do I need to explain why?

        • Mankind Global Media
    • Jan de Jonge

      This is an act of “how to misread an article”. This is an academic article. The essence in my view is that economists after Smith’s seminal work have constructed all kinds of theories that build on the idea of the Invisible Hand. One of these theories is General Equilibrium Theory, an elegant, mathematical construction. The author doubts its validity and argues that it does not follow by necessity from Adam Smith work. You may not agree with this interpretation and you can give your theoretical counter arguments. What you cannot do is discrediting an academic argument because it might lead in your mind to policies you disgust. With the last sentence you have made a fool of yourself. Science does not need a thought-police.

      • Adam Pierce

        I’m sorry, it’s not an academic article. If economists misunderstood Smith, nothing flows from that. The later work and later conclusions stand or die on their own merits, not based on whether they match the authority of Smith. There are only two reasons to tell everyone they misinterpreted Smith: 1) To smear economists who take a stronger view of the “Invisible Hand” (which is basically none of them, the Invisible Hand is a metaphor used to explain things to non-economists) or 2) to promote new research and work based on the revised understanding. This article is quite transparently the former.

        • Jan de Jonge

          I have qualified it as an academic article. Maybe, I should have said as a popular academic article. It discusses the WN of Adam Smith with a focus on the Invisible Hand. It has several references to chapters. It is not very original and profound; it doesn’t discuss articles of other authors about the WN nor does it open new avenues of research. It is not a scientific article. It is the kind of article you usually find in magazines like this one. It is meant to inform non-economists about the idea of the invisible hand and as such it is informative. The title is a little bit misleading maybe, but there is no doubt that Smith saw a need for market regulation.

          And of course, Madrick is promoting his book. He sees a market for books about economic science since so many non-economists wonder how economists could be so surprised by the financial crisis. And quite right so; even the House of Represen-tatives organized a Hearing on July 20, 2010 to “examine the promise and limits of current economic theory in light of the economic crisis”. Greenspan revealed that he was in a “shock of disbelief” now the theory of efficient markets had failed.

          Your own arguments do not explain why your criticism derails. You write that Smith’s work is irrelevant to current theories (what I challenge) and that the invisible hand is just a metaphor to explain things to non-economists. Thus why bother? What remains of your comment is that the article is not original and does not promote new research. That is correct. I agree and think that also Jeff Madrick agrees. But this does not justify the view that this article is written in vitriol.

          The real cause is the conclusion of Madrick that “(..) Smith ‘s theory proposes the opposite of laissez faire political practice, suggesting that there is a need for a visible hand of government.” This conclusion has touched an open nerve and you could not maintain decorum.

          • Adam Pierce

            What breakdown of decorum? I called a spade a spade, and I don’t care if it offends your delicate sensibilities.

            “The grandest leap of faith among economists”

            “This conclusion, arrived at by economists like Léon Walras, is remarkably convenient”

            “Faith in the Invisible Hand led to the once-general belief that a higher minimum wage results in lost jobs.”

            “Simplistic, convenient belief in the Invisible Hand led to mindless financial deregulation beginning in the 1970s and an astonishingly misplaced faith—one that ignored asset bubbles and income inequality, among other things—that the Great Moderation would maximize prosperity.”

            “Honest economists readily admit their oversimplifications; confused economists take them more literally.”

            Belief in the “Invisible Hand”, according to the author, is as pervasive among economists as it is mindless, convenient, and based on faith rather than evidence. This not just a smear, but an obvious smear.

          • Jan de Jonge

            The second till the fifth quote I could find in the text. The fifth I could not find; this leaves the fourth which is indeed critical and belongs to the conclusions. You find it in the one but last section. You are splitting hairs.

            In magazines like these you meet people with very different opinions. Discussions can be instructive, but only when you keep to the rules of a polite and honest exchange of arguments. Else it is a waste of time.

          • Adam Pierce

            “Simplistic, convenient belief… ” is in the paragraph starting “The proof is in the pudding”

          • Jan de Jonge

            I did not finish my comment yet

          • city zen

            It may be a smear – whatever that means – but it’s absolutely correct.

          • Adam Pierce

            That’s not an argument.

        • city zen

          It’s amazing the degree to which you dont know what you are talking about.

          • Adam Pierce

            That’s also not an argument.

        • Emmef


          … the Invisible Hand is a metaphor used to explain things to non-economists …

          implies that economists do know how this auto-equilibrium mechanism works. Can you show me where this is explained? And how it overcomes the Sonnenschein-Mantel-Debreu theorem in practice?

          • static

            Emmef, the “invisible hand” is a microeconomic concept. It is quite simple to explain from that perspective. S-M-D is pointing out the general flaws in things like Keynes General Theory, which postulates that the economy can be managed by something like “aggregate demand”. There is nothing to suggest that aggregate demand is an adequate representation of the complex network of supply and demand relationships. Rather, it is an oversimplification which ignores the mismatches between particular supplies and particular demands.

          • Emmef

            So where is this mechanism described then, the mechanism that describes why it can be assumed than an equilibrium is always reached?

            Second, S-M-D is pointing out that micro economic reasoning cannot be applied to macro-economic problems in general, unless certain outrageously unrealistic preconditions are met.

            It does not only apply to Keynes, but to all theory that applies, say, micro economic reasoning about the market, to the actual market. Which basically discards much of economic theory.

    • Yes, when “Compared to X” we find that the Free Enterprise system is the most effective, and one should note that the Great Depression began because of poor Federal policies, and continued until FDR deaths when Truman repealed most of FDR economic policies. The Great Recession was the result of Federal policies, and continued as a result of Obama policies. One of these days we may luck out and have a team that understands Free Enterprize Economics. Think how foolish it is to tax employment and then complain that we have unemployment and the workers need more take home pay? How foolish it is to tax Goods produced in the USA more than Goods produced in foreign lands! And then complain that companies are going overseas to produce Goods for the USA>

  • stephenverchinski

    Adam is not too far off but I would argue that if you do not like the monopoly board you have to be involved in the creation of the rules. In New Mexico we have Article 4, Section 37 of our constitution that says it is a duty of the Legislature to prohibit monopolies, trusts and other restraints on trade. So our problem is we have the law, the legal construct but not political will. It is why Bernie Sanders is catching on that we are all being given the worst of governing. Many like Clinton see the problem as making it better…better for the 1%. Bernie says this is not working for the true majority and has to go a bit different to get fixed. Not a Better ACA for health but a Single Payer Health system, Not a better patch on the minions of Wall Street like more fines to Jaime Damon that the man just laughed about but different, a breakup so their shadow banking doe not collapse us again. etc.

  • Gol… Jeff, you academic’s are either really smart or just plain stupid or perhaps so smart you are made stupid by the choices at hand. ( or is that the invisible hand)
    1. Equilibrium is yesterday news.Equilibrium is a past tense measurement. It only exists after the fact.
    2. Business today is so fast it only wants to buy a product after a sale is made.Business life is always non-equilibrium. There is an idea in the middle it is called LAG. The time between processes.
    3. Invisible hands is just a understanding that .99999999999999999999999999999999> of life happenings are invisible and they do cause our future in wonderfully mysterious ways.

    Life always starts Simple-goes complex by the number of relationships involved- made simple again by the Awareness and Presence of each being. “Invisible made Visible”…JDS

    • city zen

      No. That is not what invisible hand means in economics. It means something very specific. Gawd, the arrogance of the ignorant.

  • Reaz Ali

    I would like to quote Isaac Newton, ‘If I have seen further than others, it is by standing upon the shoulders of giants.’ Even someone like Smith, was influenced by his great friend David Hume, Bernard Mandeville, the French Physiocrats. One has to just look at books of economic history to be aware of this fact. I don’t think the analogy with Smith and Copernican Discovery is appropriate. Just like the Aristotleian belief, just because their ideas were ultimately proved wrong, it does not necessarily undermine their insights. History maybe looked at linearly, if Hegel is any guide, he stated that there is an ongoing dialectic which is the result of a triad of forces interacting with each other, through ideas that cause contradictions in the system, which bring about the synthesis(as a result of conflict) in any epoch of history. But, it is strange that many of the economists of his day, like Ricardo, Malthus, etc. who were living in the times of advances in agriculture could not forsee the changes in technology at the time(e.g from hand mill to steam mill, etc.) Only Marx had deciphered these changes. Regarding criticism of Smith regarding prices, wages, etc. He actually had various versions of the labor theory of value, which he espoused through wages fund doctrine. He got trapped in his own circular reasoning that higher wages should be paid to individuals with highest skill, or those who work the hardest and longest and yet he claimed that if labor comprises a significant portion of a good, it should be paid a wage(price) that reflects it’s contribution. He did actually acknowledge big business and monopoly, hence he claimed that labor should organize to have higher bargaining power over these businesses(to get fair wage). So to criticise Smith wholesale for not considering monopoly is somewhat of an injustice. Just like aforementioned, it should not undermine his insights even though he was proved wrong later. Lastly, Keynes broke away from Smith, Ricardo and the like, on the aftermath of the Depression, and not before it. He was not conventional, but he was most definitely not radical either. He did not want huge changes in society, but only those necessary to preserve the benefits of capitalism. He believed that individuals would lose more if they renounced capitalism due to it’s demerits rather than the gain from it, if capitalism was corrected. That was the spirit of Keynes.

  • John M Legge

    In a real market price does NOT tend towards average or marginal cost, but to the point of maximum earned margin. This is hardly a contradiction of Smith, but it does demolish rubbish about optimal equilibrium. Jeff Madrick may not be radical enough. For a short, scholarly account of the distortion of Smith’s ideas see Gavin Kennedy:

    • Adam Pierce

      Gobbledygook. Re-read an Econ 101 textbook. Supply and demand curves are already aggregates, not the conditions facing individual sellers and buyers.

      Take your version of the model and apply it to sellers – it says that if they choose to pay a lower price, they can do so but find less of the good available. In both reality and the model, sellers will not sell below the going market price.

      • John M Legge

        The gobbledegook in in the Econ 101 textbook, with rising marginal costs, no economies of scale, no fixed costs, and P=MC equilibrium. The aggregate, my friend, is the sum of individual behaviour, and at P=MC even in the textbook case individual sellers have an incentive to reduce supply. The Econ 101 text and the laws of mathematics can’t co-exist in the same universe.

        • Adam Pierce

          The textbook will cover multiple possible cases. In a monopoly, or in Cournot competition, sellers will generally sell a lower quantity of a good, priced above marginal cost. This is in the textbook, not some mysterious exception you discovered. In other types of markets, a reduction in quantity produced does not lead to a higher price (the economies of scale you cite are actually a good explanation for this phenomenon) and sellers instead compete by lowering prices. This is called Bertrand competition.

          Seriously, Google Bertrand competition and Cournot competition. Economists are not so obviously blind as you seem to think.

          • John M Legge

            I spent twenty years selling expensive things, ten of them with marketing (and price setting) responsibilities. Reading Samuelsson and Nordhaus (the most popular Econ 101 text in history) shocked me with its complete lack of any grounding in the real world. My Chapter 3 survived extensive review by a multiply published and well regarded Professor of IO.
            Please don’t tell me what I think

          • Adam Pierce

            Well, you and your IO professor can be wrong together, then.

            When you take a model and throw away its assumptions, it’s normal that you get counter-intuitive or wrong results.

            When the assumptions of a model are met, the results it predicts follow logically and mathematically.

            If you have a situation of oliglopoly or monopoly (i.e. you can reduce output in order to raise price) then a model which assumes it is not a monopoly or oliglopoly is going to fail. There’s no big mystery there.

          • John M Legge

            I accept that professors may be wrong, but I doubt it in this case.
            Have you ever considered the possibility that you might be wrong?
            Just curious.

          • Adam Pierce

            I try to. Obviously we are all subject to biases and misunderstandings.

            When a market is aggregated over individuals it doesn’t mean that the shape of the demand and supply curves is the same as the demand and supply facing each individual. Housing is a great example – most people will not purchase two or more homes until the price gets very, very low. The smooth downward slope is the product of aggregation. Smith is willing to buy his first home at $180,000 or less. Jones is willing to buy his first home at $179,000 or less. Add up a lot of individuals with preferences like that, and you get a smooth slope. Similarly, in the model you are critiquing, if an individual firm raises their price by one penny, they will sell zero units of the good. It is not modeling the type of market where reducing quantity to increase price is even possible, and you have badly misinterpreted the meaning of the supply and demand curves. There are other models where that action is possible, and under many conditions in those models you will see price above marginal cost. This is why many otherwise laissez-faire economists will support the government breaking up monopolies (a policy I disagree with, but oh well)

          • John M Legge

            You introduced Econ 101. The stuff that you are now reciting comes from later years, and has been thoroughly debunked by Steve Keen
            The more theory you describe the further from reality you go. Cournot competition breaks down with less than five competitors (as are 80% if US industries). Product differentiation also establishes a degree of monopoly power. Bertrand competition is an economic tontine: the winner is the last survivor as fixed costs send every competitor towards bankruptcy,
            This is my last post on this thread.

          • city zen

            Lol. Most people will NEVER purchase a single home, let alone two. The determinate isn’t housing prices – it’s wealth.

            And it’s a question more of “able” than “willing”.

          • Adam Pierce

            If I had twice as much currency but all prices were exactly twice as high, would I be better off, worse off, or the same as before?

          • static

            By age 65, over 80% of Americans have owned a home at some point in their life. You live in a world of BS.

          • city zen

            And I mean – wow – opposing the break up of monopolies. Could you be any more adolescent?

            “Ooh let me come up with most inane policy imaginable to show how smart and out of the mainstream I am, even if it makes no sense and no economists support it.”

            Still wearing your cap and gown?

          • Adam Pierce

            There’s no argument here, just indignation that I would mention in passing support for a position you dislike.

          • Emmef

            Aggregation is exactly the reason that it is not possible to ensure any shape of a demand or supply curve at all, unless one is willing to accept utterly ridiculous boundary conditions. This was mathematically proven in the Sonnenschein–Mantel–Debreu theorem. This also has the consequence that there might not even exist a market equilibrium and certainly not one that can be predicted theoretically.

            It is unfortunate that the majority of 101 and other textbooks on economy omit this result, that ironically was derived by mainstream economists.

            Mathematics can only describe consequences of what you model with it. An untrue model will likely give untrue results. But if a science chooses to continuously ignore mathematical consequences and boundary conditions within their own models, it should loose the status of being a science. Which makes a textbook on it just lecture that is not fit to lecture others with.

          • city zen

            He’s wrong about nearly everything he’s written here. I’m guessing he’s 23 years old and essentially thinks he’s the smartest guy around because he read one book or had one particularly erudite, maverick professor pontificate at him for a semester.

            But he has no clue what he’s talking about.

          • static

            Funny, every single thing you have written here is wrong!

          • city zen

            Do you even listen to yourself?

            This whole article is about questions those assumptions!

      • city zen

        Sellers often DO sell below market for a variety of reasons – to hurt competition that cannot afford a short term loss (a la walmart), to drum up new customers, to keep revenue flowing in a recession, and for many other reasons.

        You are just an incredible bafoon.

        • Adam Pierce

          The point was that a seller would not sell below the going market price to a single individual on the basis of that individual promising to buy less of a good. It makes no sense at all, and in fact we routinely see the opposite, which is discounts for larger-volume purchases.

  • Geoff

    I’d like to point out another questionable assumption, which is that advocates of free market capitalism believe in the perfection of free market outcomes. Of course free market outcomes aren’t perfect. Nor are they always better, in the short-term, than government directed outcomes. But bad outcomes get overturned more rapidly in free market economies than they do in government directed ones, and in the long-run, free markets always yield more optimal outcomes. This is not even a controversial assertion.

    Would you rather leave the direction of something as complex as the economy to a parcel of geniuses, with their blunt instruments, or to the teeming millions whose activities remain the very stuff that constitutes the economy, whether or not they are assisted (short term) or impaired (long-term) by a few very smart, nevertheless flawed, geniuses?

    • John M Legge

      What on Earth makes you think that geniuses get to the top of major corporations, or that a few hundred corporate executives don’t determine the broad parameters of the economy?

      Jon Ronson suggests (with evidence that the current economic, legal and political environment favours psychopaths like Al “Chainsaw” Dunlap over honest executives. How can you believe that an economy run by psychopaths “always yield more optimal outcomes”? For whom?

  • Duncan Cairncross

    Excellent article
    The Invisible Hand is like Darwin’s theory – very useful but also subject to great abuse

  • In general I can see that everyone is fond of blaming the banks and lending institutions instead of the individuals participating in the fraud. The Federal Government was not party to this, nor did it anticipate such a crash. The prime goal for these fraudsters was to make money off the backs of borrowers, but the banks as corporate entites were lacking in communication sufficient to track every transaction. We can blame people like Bernie Madoff for trying to make a quick buck, but we cannot blame the banks for encouraging such behavior because there is actually no tangible evidence they had done so.

    Individuals without the ethics or the moral fortitude to be honest are to blame for everything that happened. Yet they continue to be paid millions of dollars to maintain their fraud because the banks are working with their hands tied behind their backs. Nothing is done with a mere handshake. Now things are done on paper, where the terms are negotiated. Things are not the same in the market of the Invisible Hand anymore. It is not free. It has been manipulated into a grotesque form of snake oil sales by amoral men (and women) who don’t care what happens to anyone else. It is not Adam Smith’s world anymore.

  • Hannes Radke

    It seems to me like an economist saying “The Free Market fixes the economy” equals to a dentist saying “Your teeth will fix themselves”. If a scientist would say “The science works itself out”, it would be the end of his discipline. Either the Free Market paradigm is way too abstract to mean anything at all for policy making, or it doubles as a convenient excuse for a hands off approach to very difficult social problems. In the second case all it does is clear the way for people who are more hands on about things. Like powerful corporations. A corporation doesn’t do anything hands off. A corporation is used to being highly proactive in everything. So to me, in the end, promoting laissez faire in economic policy is equal to handing the power over the economic system over to the ones willing to wield it.

  • A lot of words to say very little. In today’s world our worlds are .9999999999999999> invisible. Smith used the invisible hand according to you once. It seems all these hundred of years later there was a guiding hand of thought maybe even invisible.

  • I align with most of what is written, and a lot of “almost got it”s in this article.

    There are three major aspects to the growth of productivity:

    Energy available;

    Materials available; and

    Technology available (knowledge/information).


    Initially, the energy was only that of human labour, but that was then added to by domesticated animals, buffalo and horses in particular, and by fire, then by water and steam, then coal, and more recently oil powered combustion engines.

    Lots of other sources.

    Almost all our energy is some form of solar energy, either direct or indirect. Fossil fuels (oil and coal) are in all cases (as is wind or hydro), by some series of indirect steps and stages, in largest measure some form of stored solar energy (even the limestone involved in deep synthesis is biological in origin).

    Solar energy hitting the planet directly is equivalent to a layer of oil over the entire planet some 6 inches (15cm) deep every year. Solar dwarfs all other energy sources by a significant margin. When one considers the energy available in orbit, it is easy to conceive of every person having access to as much energy as humanity as a whole currently uses.

    We are not really short of energy, just appropriate technologies to harness it.


    In the past, we relied mainly on biological or geological process to produce what we needed.

    Thus we would grow things, catch things or mine things.

    We are now starting to understand chemistry and manufacturing technologies to the point that we can work with elements in almost any concentration.

    Within a few years we will have the technology to mine and manufacture at the atomic level.

    At that point, there will be no scarcity of any material.

    We live on a vast ball of matter.

    Matter is not a problem.


    Technology is about information. What we know how to do.

    Initially we had to each learn things by trial and error, or be shown how to do something by someone who knew how.

    Once we developed writing, we could store and retrieve that sort of information.

    Now we have automation, and our ability to process information is doubling in under a year.

    So we are seeing ever more efficient ways to harness energy, to process materials, to automate processes so that people do not need to be involved much if at all.

    So we are not now constrained by our ability to produce stuff, either goods or services.

    The major constraint we now have is our ways of thinking about things, and the goals and values we have.

    So that brings us to a theory of value.

    What is value?

    I am now clear, beyond any shadow of doubt, that just as most of our energy is ultimately solar, so most of our values are ultimately about survival.

    Why do we have the likes and dislikes we have?

    Ultimately because either at the genetic, or at the cultural, level, those values survived better than all the other variants, and ended up in us.

    That’s it in a nutshell.

    Many variations on themes in there.

    Liking sex is pretty obvious, if our ancestors didn’t then there isn’t much chance of us being here.

    Liking sweet foods is similar, plants that developed the trick of putting high energy sugars near their seeds managed to get their seeds dispersed more effectively by animals than those that didn’t. We need the high energy content. Our big brains in particular use a lot of energy.

    Bad smells are associated with things that were dangerous to our ancestors.

    Good smells things that were advantageous to our ancestors. On average, over time, in both cases.

    When it comes to culture, the same general theme applies. We get to hear the stories that other people tell us. Lots of factors involved in what gets told in what contexts and what doesn’t – really complex, and ultimately all about the stories that survive by being told.

    So those philosophers that claim that one “cannot derive an ought from an is” simply have not considered the “is”s of the many levels and contexts of games theory and evolution more generally.

    Each of us as humans has to find some way to survive.

    We put in effort doing things we may not enjoy much at all, if we can see a survival benefit in doing so (at some level).

    So for each of us, value comes down to a variety of measures:

    how much time (a temporal measure of survival) does it take to get something one way verses another way?

    what are the likely risks associated with this and known alternative strategies?

    what contexts are we likely to encounter in the future?

    what sort of discount rates seem appropriate on future over current benefits?

    what are the likely survival values of past strategies (genetic or cultural) in our current exponentially changing world?

    how likely is it that technology will achieve full automation sometime soon?

    how likely is it that indefinite life extension will become a reality?

    Different people address the assumptions and heuristics implicit in these (and other) sets of questions at different levels.

    We are very complex entities.

    We have very complex sets of values that are highly context sensitive – each and every one of us.

    Fraudulent behaviour is not only possible, it seems to be the norm at higher levels.

    In a very real sense, the whole of economics is fraudulent, in as much as it claims to be of general benefit to the majority of humanity. That cannot be so.

    Market based systems require scarcity to deliver value.

    No market system, in and of its own internal incentive structures, will ever deliver universal abundance of anything.

    Universal abundance always has zero or less market value!

    Much as I respected and admired Milton Friedman, he was wrong to assert that competition will right most wrongs, and he admitted as much to me on 15th March 2003, once he understood the power of technology to deliver universal abundance.

    Compared to automating and decentralising production to the point that we all have our own fully automated nano-tech factories (not yet technical reality and not that far away) any form of market exchange is inefficient.

    The age of markets is drawing to an end.

    The age of abundance if dawning, if, and only if, we can get over the scarcity imposed by market thinking, and liberate both our creativity and technology from artificially imposed scarcity.

    We have some real issues.

    There are some individuals for whom hate and destruction is more abundant than love and creativity.
    And they can be relatively easily identified, and constrained sufficiently that they do not pose a significant risk to anyone else.

    And some issues really are complex, extremely complex.

    Freedom must logically result in diversity.

    Things can only get even more strange, even more complex, even with the best will in the world.

    We need to get over markets, and start delivering technologies that support life and liberty universally.

    And liberty is not licence, it contains responsibilities to show reasonable care and attention to the reasonable needs of others (no hard boundaries there, all flexible in many dimensions and highly context sensitive).
    Reality is very complex, with a great deal of uncertainty – we need to accept that, and learn to dance with it in a sense. And there is no need for anyone to have to be in need of the basic necessities of life, and there is a need to constrain human reproduction.

  • chrisyakimov

    It is so refreshing to discover a voice questioning the overly simplistic assumptions underlying such powerful ideas. Thank you. I particularly like this bit: ““This central ambiguity matters a lot. Prices can in fact be shoved around by powerful forces: big business, strong unions, and ubiquitous monopolies, or at least oligopolies with market power. In financial markets, prices can be manipulated by collusion or secret trading or access to inside information. In labor markets, wages can be affected by the ability of businesses to fire workers without cause or by stern government policies that restrain growth and keep unemployment high…. Belief in the Invisible Hand allows economists to minimize these concerns.”

    What strikes me in conversations about deregulation is the other very faulty assumption: that if we call a “market” “free”, and act to remove regulation from it, we somehow therefore practice some kind of pure “economics” in support of the Invisible Hand. But just because our flimsy definition of market may be “free”, doesn’t actually mean that, truly, the Market (in which this pure Invisible Hand is supposed to operate), is free. If it were, there would be no legal or moral frameworks preventing people from acting in their own self interest as rational decision makers, either. Why pay for a widget if I can just punch you in the face and take it? That’s a MUCH more free “market” than the one we operate now, even in an era characterized by increasing deregulation. Surely that’s not where we want to go, and clearly this is not increasing overall prosperity for everyone.

  • codyac


  • LeftOrLeftOut

    An economy is a set of rules to allow for efficiency, and a currency is a mechanism to allow more sophistication than simple bartering. In a level playing field, it is like traffic signals, but today’s capitalism is like big SUV owners rigging the red light so smaller cars wait longer.

  • “Over the past thirty-five years, the ideas at the center of orthodox economics, did damage and laid the groundwork for the financial crisis of 2008 and the Great Recession that followed. The Invisible Hand, though alluring, is highly ambiguous.” THIS IS COMPLETELY UNTRUE ….. It was the ACTIONS of the very visable hand of Federal Government that lead to the financial crisis of 2008, and it is the action of the current President that extended what should be a two year recession into the GREAT RECESSION of the past eight years.

  • John Nott

    It seems to me quite obvious that increased wages increases -in effect- the size of the market, therefore promoting consumption, ditto for production

  • static

    What a simplistic view of things, a strawman of laissez faire. Trying to explain 2008 without mentioning the consumer driven housing bubble, aided by government subsidized mortgages and artificially low interest rates is silly. Since the fine humanities professor has finished reading “The Wealth of Nations”, one might suggest that he next read Hayek. He might begin to understand that the fundamental flaw in his reasoning is his assumption that we can design rules that are superior to markets. It’s not that markets are perfect, it is just that attempts to distort them frequently have disastrous unanticipated consequences.

  • Edson Eustachio Azevedo

    I’d like to understand what is the monetary theory that supports the evonomics point of view. Can someone help to find some reading about that?

    Thanks in advance.