On the Need for a Major Revision of Investopedia’s Article on Adam Smith

Abstract

There is no Theory of the “Invisible Hand of the Market” in either of Adam Smith’s two major works, The Theory of Moral Sentiments (1759) or The Wealth of Nations (1776). Smith uses the terms on one page each of The Theory of Moral Sentiments and The Wealth of Nations as a literary devise only, as pointed out repeatedly by Gavin Kennedy over a twenty year period. None of the two references refers to market prices and wages moving up and down to clear markets.

The Invisible Hand appears one time in The Theory of Moral Sentiments as a metaphorical device used to explain why the rich nobles must supply their mass of servants with the necessities of life because, if they did not do so, then they would not have any servants to serve them on a daily basis in a wide variety of tasks. This has been pointed out numerous times by Gavin Kennedy. The Invisible Hand appears one time in The Wealth of Nations, again as a purely metaphorical devise to explain why merchants choose the domestic or home trade as opposed to the international or foreign trade, given equal or nearly equal returns, where, according to Benthamite utilitarian criteria, they should be indifferent between the domestic and international trade. The answer, given by Smith, was that the merchants choose the home trade over the foreign trade because they have a greater knowledge of, and expertise and experience in, the home trade relative to the international trade. They have greater confidence in their decisions in the home markets because they have greater knowledge of the home trade and far less knowledge in the foreign trade. This argument is an early version of J M Keynes’s weight of the argument analysis in his A Treatise on Probability (1921) in chapters 6 and 26. Thus, merchants benefit the home country through their desire to avoid the risk, ambiguities and uncertainties of the foreign trade, although that was never their intention, which was strictly a private concern. Thus, the home country gains greater GDP, as if by an Invisible Hand, by decisions made by private merchants who never planned to benefit the home country by their decisions. Again, as pointed out by Gavin Kennedy, there is no Invisible Hand of the Market operating here to equilibrate returns at the margin, since Smith had already made it clear that the returns were equal or nearly equal in both the domestic and foreign sectors.

Other quotations taken from the Wealth of Nation/Theory of Moral Sentiments to support the Invisible Hand of the Market claim fail to recognize that Smith’s rationale for maximizing behavior by the “sober” people is Smith’s Virtue Ethics approach, based on the Virtue of Prudence and not Jeremy Bentham’s Utilitarian view of the maximization of utility. In other words, just as a runner in The Theory of Moral Sentiments is planning on winning the racing competition contest and the first prize, so the sober people are planning to win the economic competition.

So who is the creator of the Invisible Hand of the Market concept? The creator of the Invisible Hand of the Market concept is none other than Adam Smith’s great intellectual rival, Jeremy Bentham, whose utilitarian views Smith, as a virtue ethicist, had to completely and totally reject. Bentham’s oscillating pendulum model represents the first application of a physics/engineering physics concept in economics, where the pendulum at rest is identified with an optimal position somewhere on the boundaries of the static and dynamic production possibilities frontiers. Only exogenous, external, outside shocks can create temporary disequilibriums which will gradually be self correcting through the market mechanism, which serves to naturally absorb the shocks like a cars shock absorbers through changing prices and wages.

Bentham asserts, in contradiction to Smith, that the economic system is internally harmonious, since there are none of Smith’s projectors, imprudent risk takers, or prodigals creating internal, endogenous shocks like speculative financial bubbles created with the aid of the private bankers.