Sunday, December 18, 2016

Clarifying The Invisible Hand

My response to: The Myth of the Invisible Hand by Jonathan Kolber

I love stories about the Invisible Hand (IH). It’s plain to see that you’ve definitely done quite a bit of homework on the topic. In fact, I even learned something!

However, despite all the homework that you’ve done, you haven’t quite grasped the essence of the IH. Here’s the most relevant passage…

It is thus that the private interests and passions of individuals naturally dispose them to turn their stocks towards the employments which in ordinary cases are most advantageous to the society. But if from this natural preference they should turn too much of it towards those employments, the fall of profit in them and the rise of it in all others immediately dispose them to alter this faulty distribution. Without any intervention of law, therefore, the private interests and passions of men naturally lead them to divide and distribute the stock of every society among all the different employments carried on in it as nearly as possible in the proportion which is most agreeable to the interest of the whole society. — Adam Smith, Wealth of Nations 

Clearly this passage doesn’t include the term “Invisible Hand”. But that’s exactly what this passage is all about.

Accountants, for example, are certainly “advantageous to society”. So it’s profitable to become an accountant. But if too many people become accountants… then the supply of accountants will be greater than the demand for accountants… which means that it will become less profitable to become an accountant… and less people will become accountants. Instead, they will go into more profitable professions.

High profits are a green light. Low profits are a red light. The greater the disparity between profits… the greater the incentive for faulty distributions to be automatically altered.

We all subjectively perceive shortages and surpluses and we spend our money accordingly. We influence each other and are simultaneously influenced by each other. We direct each other and are simultaneously directed by each other. We encourage beneficial behavior and are simultaneously encouraged to behave beneficially.

Therefore… no need for government intervention/interference? Well… not quite. Even though Samuelson was an idiot who clearly didn’t grasp the IH… he did grasp that the free-rider problem was a problem.

Like I said, I love stories about the IH. In other words, I subjectively perceive that there’s a shortage of stories about the IH. However, I have never even once spent even a penny on any stories about the IH.

valuation = my perception of the relative scarcity of IH stories
sacrifice = the amount of money that I’ve spent on IH stories

valuation > sacrifice

I truly want there to be more stories about the IH… but, by not spending any money on stories about the IH… I fail to provide any real incentive for people to write stories about the IH. In other words, I basically shoot myself in the foot by essentially lying to producers. Producers really aren’t mind-readers.

The solution is the pragmatarian model. Each month we’d each pay $1 dollar… but we’d be free to choose which stories we spend our pennies on. For sure I’d spend my pennies on stories about the IH. The more people who did so… the greater the incentive for people to write stories about the IH. The greener the light… the brighter the value signal… the sooner there would be an abundance of stories about the IH. The feedback loop would be accurate.

And if too many people started writing stories about the IH? Well… this is definitely hard for me to imagine! But I suppose it’s theoretically possible. If it did happen though then the light for stories about the IH would turn from green to yellow to red and the faulty distribution of topics would be automatically corrected without any intervention of law.

Incentives matter just as much for public goods as they do for private goods…

Public services are never better performed than when their reward comes only in consequence of their being performed, and is proportioned to the diligence employed in performing them. — Adam Smith, Wealth of Nations

So no, the IH really isn’t a myth. Values are subjective. Nobody is a mind-reader. Incentives matter.

Please let me know if you have any questions! It’s entirely possible that my interpretation/understanding/grasp of the IH is faulty. As the saying goes… two heads are better than one…

More heads are occupied in inventing the most proper machinery for executing the work of each, and it is, therefore, more likely to be invented. — Adam Smith, Wealth of Nations

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