Wednesday, March 22, 2017

Clarifying The Invisible Hand

Reply to story: The “Helping Hand” vs. The “Fighting Fist” by J.G. Sandom


The Invisible Hand isn’t primarily about selfishness. It’s primarily about using our money to communicate just how helpful a producer is being. The fundamental assumption is that nobody is a mind-reader.

Here I am spending my time and using my brain to try and help you. But obviously I can’t “divine” whether you consider my effort on your behalf to be truly helpful. The only way that I can possibly have this information is if you share it with me.

For example…

“Hey guy, you were helpful!”

“Hey guy, you weren’t helpful!”

If you do benefit from my help… then the issue is quantifying your benefit. Quantifying your benefit is necessary because there are plenty of other people that I can spend my time trying to help.

Here are some examples of quantifying your benefit…

“Hey guy, you were fairly helpful!”

“Hey guy, you were very helpful!”

“Hey guy, you were extremely helpful!”

The problem with this method is that talk is cheap. Therefore… you gotta provide some supporting evidence…

“Hey guy, you were fairly helpful! Have a penny!”

“Hey guy, you were very helpful! Have $5 dollars!”

“Hey guy, you were extremely helpful! Have $100 dollars!”

Except, why buy the cow when you can get the milk for free? This is why taxation is compulsory rather than voluntary.

Quick review…

  1. Because I’m not a mind-reader, it’s necessary for you to inform me whether or not you find my behavior helpful.
  2. Because there are other people that I could be helping, it’s necessary for you to quantify your benefit.
  3. Because words are cheap, it’s necessary for you to spend your money in order to prove just how much benefit you’re deriving from my help.
  4. Because of the free-rider problem, if I freely offer you my help then you clearly have an incentive to hide your true estimate of my help’s value.

Let’s say that each month every member of Medium paid $1 dollar. However, we’d be free to choose which stories we spend our fees on. In this case, if you did benefit from my help, then you might as well use your money to communicate and quantify your benefit. The more of your fees that you were willing to spend on my reply, the more helpful that you found it to be.

Imagine every member of Medium using their fees to accurately communicate how much benefit they derived from each other’s stories. Then we’d know the relative importance of each other’s stories. We’d know just how relatively important economic stories were and we’d use this information to make more informed decisions.

The relative importance of all the stories would be determined by the Invisible Hand. So the Invisible Hand is primarily about everybody using their money to identify and reward beneficial behavior.

Is selfishness relevant to the Invisible Hand? Well yeah. We all want to be rewarded. Clearly we’re going to have a strong incentive to write about the most important/valuable topics. But this is a good thing because these are the topics that people are most interested in reading and learning about.

With all of this in mind, here is the most relevant passage from the Wealth of Nations

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

In a nutshell, the Invisible Hand is the decentralized process by which people use their money to identify, quantify and encourage beneficial behavior.

I hope you found this helpful! Please let me know if you have any questions.

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