When Economic Principals became seriously interested in the financial Panic of 2008, he did what he was taught to do: he went back to the beginning of things. In this case, it was to Adam Smith, founder of modern economics. EP was looking for Smith’s views on money and banking. He found them, encapsulated in a metaphor.
Don’t worry. This is not just Dryasdust history. For followers of present-day economics – say, the Nobel Memorial Prize in Economic Sciences – it ends with a reward.
Smith’s ideas about money and banking are tucked away, far from the action, in the second chapter of Book II, of The Wealth of Nations (which consists of five sections, or “books). “Of money, considered as a particular Branch of the general Stock of Society, or of the Expense of maintain the National Capital.” After describing gold and silver as traveling in wagons on highways, he turns to paper money. This invention he describes as Daedalian Wings, suspended above the highways, vulnerable to accidents caused by unskilled conductors of the currency.
In fact, Smith was writing in the aftermath of a recent panic, the financial crisis of 1772. In an era of complexly unregulated banking in Scotland, the Bank of Ayr had issued too many notes backed by its reserves of silver and gold. There was a run. Failures ascended the British banking system to some of the bigger banks in London, until the Bank of England itself was threatened. The crisis ended, but by massive borrowings secured by the estates of the bank’s wealthy proprietors.
Did Smith write with the panic in mind, as his friend David Hume suggested he might? EP looked for an answer in Legislating Instability, Tyler Beck Goodspeed’s illuminating study of banking regulation leading up to the panic, and learned only that the Daedalian Wings didn’t appear in a version of Wealth written in 1763.
His curiosity havingbeen piqued. EP began searching for other metaphors in and around Smith’s writings. EP found six more metaphors, making seven in all, that seems to capture and convey all the major fields of the today’s economics as he understood them to be. Smith was no stranger to the use of figures of speech. He had lectured on rhetoric in 1762-63. Herewith a lightly annotated list of those other six.
A second metaphor EP already had in mind. It appears in Chapter Seven of Book One, perhaps the single most important chapter in the long book. In “Of the natural and market Prices of Commodities,” Smith describes the interaction of the forces of supply and demand (he calls these quantity and demand).
He takes black cloth as an example. A public mourning raises demand for it, because there is less of it than is needed, so prices go up. Merchants’ profits increase, but weavers’ wages remain the same, because plenty of undyed cloth is on hand. Bespoke tailors earn more, because there aren’t as many of them to dress the mourners. Prices of silk and colorful cloth fall, because less is demanded. Merchants cut their prices, hoping to liquidate inventory. Customers buy more, less black cloth is produced and sold, and gradually, the market returns to normal.
Smith writes:
The natural price, therefore is, as it were, the central price to which the prices of all commodities are continually gravitating continually. Different accidents may sometimes keeps suspended a good and sometimes force them down even somewhat below it. But whatever may be the obstacles which hinder it, from settling in this centered repose and continuance, they are constantly tending towards it.
There, in a single gerund, a noun turned into a verb, is the heart of the matter. Here Smith is speaking of averages. Competition comes into the matter a few paragraphs later, in the guise of “secrets of trade.” But about the comparison of universal gravitation to what economists today call general equilibrium,” it seems to EP there can be little doubt. Nor is he alone. Smith scholars Duncan Foley, Eric Schliesser, and Deborah A. Redman have discussed gravitation before. Smith was thoroughly familiar with Newton’s great discovery of a century before. He had read the Principia Mathematica in Latin. But what about the Invisible Hand? We’ll come to that later.
A third metaphor was hidden in plain sight, at the start of the book. Smith’s account of the pin factory demonstrates the basics of what we know about economic growth. The division of labor, or course. But Plato had known about that. What Smith added was the proposition that the division of labort is limited by the extent of the market. (Geore Stiler, of the University of Chicao, called it the secont most theorem in all of economis.) Smith writes,
There are some sorts of industry, even of the lowest kind which can be carried out, no matter where but in a great tow. A porter, for example, can find employment and subsistence in no other place… In villages in the remote highlands of Scotland, every farmer must be butcher, baker, and brewer for his own family.” A blacksmith, a carpenter, or a mason may be twenty miles away. Water-carriage means a far larger market. What goods could bear the expense of land-carriage between London and Calcutta?
A fourth metaphor is mentioned briefly to dismiss it. Smith writes, “I have no great faith in political arithmetic, and I mean not to warrant the exactness of either of these computations….” He had read Sir William Petty’s book of the same name, and, probably, Petty’s Political Anatomy as well. Arithmetic, of course, means measurement; Petty devised many ingenious way of estimating national income, population, income distribution, and tax burden. Some authorities think of him as the true founder of economics. Smith clearly didn’t.
The fifth and sixth metaphors are missing from The Wealth of Nations. The first is Smith’s own, only other book. The second is that of his long-forgotten rival.
Smith’s The Theory of Moral Sentiments, appeared in 1759. It is not so much as mentioned in Wealth of Nations, which was published in 1776. The first chapter of Moral Sentiments book is called “Of Sympathy.” Its first sentence states,
How selfish soever man may be supposed, there are evidently some principles in his nature, which interest him in the fortune of others, and render their happiness necessary to him, though he derives nothing from it, except the pleasure of seeing it.
Smith then constructs a fascinating and elaborate moral philosophy, similar but utterly opposed to Thomas Hobbes contention in Leviathan that life is a war “wars of all against all.” The core figure in Smith’s book is an internalized Impartial Spectator. Some see the Spectator as a conscience, judging right from wrong. Others argue that the weight in the Spectator’s balance is emulation, that is, how a man’s behavior measures up to that of those in the next rank above. Whichever the case, it is a far cry from Wealth’s homo economicus whose only motive is self-interest, sometimes called greed.
How could the same man have written both books? German philosophers called this “Das Adam Smith Problem.” University of Chicago professor Jacob Viner argued that Moral Sentiments reflected the youthful idealism of a 36-year old man, while Wealth of Nations was, written when Smith was 53, presented a more realistic view of a grown man. EP’s supposition is that Smith realized that with Wealth of Nations, he had produced a coherent system, what today we call a paradigm, (or, in EP’s view, three separate paradigms, loosely joined together, one of which came to dominate the others.) That Smith understood the basics of the modern concept is clear from his remarkable essay, “The History of Astronomy.”
The sixth metaphor is The Statesman, the creation of Sir James Steuart, Smith’s long-forgotten rival. A fellow Scot, though higher-born, Steuart was a Jacobite, as Catholics called themselves at the time. As advisor to the Pretender to the crown, Bonnie Prince Charles advisor, he might have become finance minister of Britain, Scotland, had the 1745 rebellion succeeded. It didn’t, and Steuart spent the next fifteen years traveling around Europe, studying markets, public works, and economic development. In 1767, An Inquiry into the Principles of Political Economy, was Steuart’s attempt to develop a science. He expressed various ideas that Smith was developing, but his preoccupation was economic policy, and his Statesman had many more ambitions than those Smith entertained.
The book was politely received. A perspicacious reviewer wrote, “[T]he grounds he works would require to become cleared before they can be cultivated.” Smith wrote a friend; I have the same opinion of Sir James Steuart’s Book that you have. Without once mentioning it. I flatter myself, that every false principle in it, will meet with a clear and distinct confutation in mine.” Steuart suffered the insult with dignity, and continue writing about philosophy and finance and until he died, in 1780.
And the seventh metaphor? At last we return to the Invisible Hand. It appears just once in Wealth of Nations. Here is how Smith put it in Wealth’s fourth book.
[By his advantageous purchase and sales] 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 no part of his intention.
Good books have been written exploring the mysteries of the invisible hand metaphor, which was employed by many different authors in many different ways over the centuries. Here’s an alternative way to interpret it that is quite outside the cloud of meanings usually advanced.
Many explanations of how the pursuit of self-interest can produce unintended effects have appeared since Smith wrote. One of the simplest has an unhappy outcome. In the “tragedy of the commons,” farmers employ nitrogen fertilizer to enhance their harvests. Run-off when it rains pollutes the lake below. Algae blooms, oxygen is depleted. The fish die.
Another invisible hand explanation was advanced by Charles Darwin sixty years after Smith died. In The Origin of Species, he prounded a theory in which new species appear when random mutations among members, at least those who live long enough to reproduce, with coping qualities to those who members were unable to cope. By this mechanisms, new species emerged while old ones died out Natural selection was Darwin’s invisible had. The source of the species, as opposed to species, was the hand of God. “I had no intention to write atheistically,” Darwin wrote a friend in 1860, but, he continued, “I cannot see as plainly as others do … evidence of design and beneficence on all sides of us. There seems to be too much misery in the world.”
In an essay, “What’s Wrong with Invisible Hand Explanation?,” the late David Hull, an eminent philosopher of biology, wrote that, “in the economic literature, the distinction between intentional and non-intentional behavior is of secondary importance. What really matters is that the invisible hand must move a system toward equilibrium,” a final state of balance between contending forces. Equilibrium seems profoundly uncharacteristic of modern economies. “Interdependendent” at all levels is closer to the nature of evolution.
Suppose economists were to take a leaf from the books of legal scholars and interpret Smith’s great book as a living document – that is, subject to new interpretations i.e. the U.S. Constitution with respect, say, slavery? Smith’s phrase, “in many other cases,” seems to EP sufficiently expansive to permit his invisible hand has to be conceived of as a selection process. That interpretation would go a long way towards underpinning the producing an oft longed-for evolutionary economism. The alternative would seem to be to stick with economic originalism.
These seven metaphors have a practical application. They can serve as bins in which to sort advances in economics knowledge, represented, by no means entirely, or example, by awards of Nobel Memorial Prizes. Most of the first 55 seem to fit in one category or another.
Not only that; those bins can accommodate histories of economic thought as well: Henry Thornton, Walter Bagehot, Irving Fisher, Milton Friedman and Douglas Diamond, for example, in the bin marked Daedalian Wings; David Ricardo, T.R Malthus, Léon Walras, Henry George, Kenneth Arrow, Gerard Debreu, Lionel McKenzie, John Nash, Leo Hurwicz in the Gravity bin; and in the Pin Factory bin, Charles Babbage, Karl Marx, John Stuart Mill, Allyn Young, Robert Solow, Kenneth Arrow (again!), and Paul Romer; and so on with the rest….
These seven metaphors of Adam Smith are a mnemonic device, helpful in distinguishing fields of economic inquiry that even today are fairly separated. They have their uses, though, or Smith wouldn’t have employed these seven to convey his related but disparate thoughts.