What is Adam Smiths invisible hand

 Adam Smith didn't see the invisible hand but it was there alright and it has a name now. 

And it wasn't that invisible either.

It moved the world from medieval to modern and is still working away today. It's always been around from ancient times but it started to pick up momentum in its modern form around 1600. The English civil war gave it a boost. In fact, every war boosts the power of the invisible hand and it's even used to fight and win wars. By the 1950s it had become scientific by the 1990s it had become a social science and was taught in universities and has many sub specialisms.

It's the invisible hand that promoted fashion, pottery, tableware, furniture, home goods, theatre, arts, travel, good manners, politics and religion (and just about everything else we desire and buy).

It's stronger than ever today; Adam Smith's invisible hand is marketing.

What's wrong with Adam Smith's opening premise

The first known book on contemporary economics is Adam Smith's: An Inquiry into the Nature and Causes of the Wealth of Nations 1776.

Its opening premise is an increase in wealth comes through increasing productivity through a division of labour. He goes on to describe the more efficient making of a pin.

I'd just like to question this idea.

1. An increase in wealth (of a nation) must come through an increase in demand first in order to stimulate supply?

2. The division of labour with its increased productivity increases the wealth of the business owner or even the business owning class (capitalists) This does not necessarily mean an increase in the wealth of the nation because capitalists may keep all or most of the wealth to themselves?

3. One way or another profits, however they are made, need to be shared in order to benefit the nation? One way of sharing profits for the benefit of society is through tax.

An outline of Adam Smith

Adam Smith 1723 - 1790 Was brought up in a house overlooking a street market, this influenced much of his thinking and is a basis for some weaknesses in his economic theory. He was a moral philosopher and economist active during the Scottish Enlightenment. His two books mark the start of contemporary rational thinking.

Theory of Moral Sentiments 1759

Wealth of Nations 1759

He advised, do what you do best and trade for the rest.

Don't make (at home) what you can buy cheaper.

He wrote that we have internal conversations with an impartial spectator who is our moral compass.

He argued that the economic activity of humans is action but not design. Even if he was right in the mid 18th century this idea might not be so sound now.

He put forward the idea of a division of labour to increase productivity with the eventual aim of automating the production process

Describes making a pin as an example

During the period of his writing the industrial revolution was taking off and manufacturing technology was advancing rapidly. When Smith worked as a professor and administrator at Glasgow University he made room and facilities for James Watt to work on steam power.

He called the economy of his time 'commercial society. In 1707 Britain united into a free trade area and by the 1750s in company with the Netherlands, Belgium and parts of Italy had become capitalist.

Capitalism is where production is organised to make profits through selling into a market rather than manufacturing for the use of the producer with a small surplus sold locally. It involves the organised use of labour working for wages. Capitalism is organised by the people who own the means of production and distribution.

Smith believed competition would force producers to sell at the most competitive price and that this would benefit everyone. The British Conservative government still holds onto this idea.

In the early part of the industrial revolution, most factories were owned and run by individuals or small partnerships where the owners were personally involved in the day to day running of the process. Most people still worked in agriculture and agriculture was still mainly subsistence farming although change was happening. Slavery was still a major form of labour and wasn't abolished until well after Smith has passed away. Slavery is another inconsistency in his arguments for free and open markets.  As was child labour which was normal practice.

Smith was against limited liability companies, he said it was playing with other peoples' money. Throughout his economic thinking, he bases his ideas on small free markets but he does acknowledge markets will become oligopolies or even monopolies. He hated the East India Company. He continually stresses the need for markets to be free like the one he saw every day when he was growing up. In reality, his whole theory is based on his local street market applied nationally and even globally. Most markets at this time except sugar, cotton, wool and textiles, slaves and spices were still local, regional and rarely national.

Most firms were small so competition did exist. It was impossible for one firm to dominate a market but the economy was changing. Oligopolies and monopolies existed and were emerging. The monarch could grant monopolies for example and the East India Company is a prime example. Smith knew his arguments were idealistic and couldn't work.

A small business person, like a butcher in a local market, provides a product for sale that is not from benevolence, it is for the self interest of the provider. In acting such, he is promoting a wider end through other traders and manufacturers that promotes an end result that is not his intention. Buyers vote with their wallets and mould the trading activity of the market. All the individual small transactions happen automatically influencing the whole like an invisible hand. It's like an economic murmuration.

He knew that firms found ways of collaborating to form predatory oligopolies that snapped up and out produced the small firms. He argued for free markets knowing they couldn't be maintained. He argued that governments should keep out of the market other than passing laws to stop the growth of oligopolies and even worse monopolies.

His arguments were based over and over again on small businesses working in open and free markets.

He explained that monarchs can grant monopolies. That rich and powerful people oppress the powerless and the poor. Guilds and regulations prevent free trade. Ordinary working people are left out of the process.

He thought the East India Company was evil and an antithesis to free markets. In fact, the East India Company had become too big to fail and the government had to step in to bail it out with a tax on tea. Something that was to play a part in the American revolution.

Adam Smith's two main philosophical and economic insights are,

Governments should bring about peace, easy taxes and a tolerable administration.

The automatic summation of huge numbers of transactions is guided by an invisible hand.

Why a new start might be needed in Britain

 Forty years of  Thatcherism has caused so much damage to Britain that an incoming Labour government might need to start from scratch in rebuilding a viable industrial economy.

They could learn from the 'infant industry' support program instigated in America by Alexander Hamilton and practised from the 19th century to 1945. Infant or new American industry was protected, nurtured and supported by the government until it achieved world leading status during WW2. The infant industry program was reduced, but not stopped when it didn't need so much protection.

The Conservative party has lost almost all British industry to China and counties like South Korea.

All of the countries that have taken British industry used high levels of government support, and still do. One of Keynes' students (I forget his name) advised the Chinese government.

Labour seems afraid to challenge Thatctherism or neoliberalism for some reason but it's, or should be the fundamental difference between Labour and the Tories.

Whether you are Keynesian Labour or Socialist Labour we are diametrically opposed to the dog eat dog, grasp and grab freemarket buccaneering Tories.

A fresh start may be needed after covid and Brexit and the Tories have done their worse.

How Britain became a manufacturing economy

Britain became a manufacturing economy during the reigns of Henry VII, VIII and Elizabeth. The monarchs may have been directly involved in this, quite probably Henry VII was, and or their fixers such as Wolseley and Cromwell. Or unknown merchants of the time. (There's a PhD in this)

Prior to the 1480s when Bill Stanley grabbed the crown for Henry, Britain was a major supplier of wool to manufacturers in the low countries. The wool was made into garments there and sold across Europe. Much of the finished goods were exported to England. In a situation like this, the manufacturer of the finished products has the advantage and is the one who makes the money.

Let's assume Henry initially took command of this aspect of the English economy and trade.

He wanted England to be a manufacturer of finished wool goods as well as a supplier of raw wool. Manufacturing woollen goods was a highly skilled and technically advanced process involving machinery and craft skills not available in England. So Henry had to develop and nurture this manufacturing process.

Perhaps he set up looms, trained the craftspeople and mechanics and competed on the open market like the Thatcherite myths would have it. No, he didn't!

He put embargoes on the exported raw wool and limited imports. He used import taxes and quality regulations to protect the fledgling English industry. This forced technology and skills to grow rapidly in England with the help of Flemish weavers tempted over here. (It's where the name Fleming comes from)

The Henry's and Elizabeth didn't stop when they were competing on equal terms with the low country manufacturers. They hardened the tariffs, taxes, regulations and embargoes until they ruined the low country woollen industry. Once English manufacturing led the way, quality regulations were put in place to stop unscrupulous entrepreneurs setting up to make lower quality goods and out compete the established industry.

There was no free market about this. Although the state and government of England was different to what it is now, the first manufacturing in England was done with full state support both in the market and in nurturing the skills and technology over many years.

Years later just before and during the industrial revolution, Great Britain forced the colonies to be limited to supplying raw materials or base goods, pig iron from America and calico from India for example.

Britain was ruthless, especially under Walpole, in using military might, seapower, tax, embargoes, customs, direct state support, subsidies and all the rest to promote and protect British trade.

There's never been a free market.

The big daddy of the free market Adam Smith was an outspoken supporter of the 'Navigation Acts' These forced overseas exporters, of raw material, to Britain to use only British ships. If you didn't use a British built ship flying the British flag you didn't land your goods in Britain.

How animal Spirits point the way to behavioural economics

Keynes seemed to use odd terms such as sticky prices and animal spirits.

The notion of animal spirits was just as important to Keynesian analysis as sticky wages and prices. He uses the term to mean the emotions humans feel when making decisions. Economists prior to Keynes, and the current UK Conservative government consider humans to make rational decisions in their best interests. If this was the case almost no one would vote Conservative.

It's not a made up term, it does show Keynes philosophical leanings and it's straight out of the Eton/Cambridge thoroughbred stable.

The term animal spirits was first known to be used about 300BCE. It's from the Latin spiritus animalis and it means 'the breath that awakens the human mind'. In Roman anatomy, it refers to what they thought was fluid surrounding nerve endings and can result in events like mass mania and mass hysteria, human herd behaviour.

The term animal spirits doesn't appear in psychology or consumer psychology but it does figure in finance. It represents emotions like hope and confidence, fear and pessimism. It's also considered to be socially infectious so a mood can be generated among a group or even a large section of the financial sector. Whether the collective mood is high or low can affect the decision making in investment and banking. The mass mood can act against logical expectations. Mistakes are made because of 'animal spirits' acting contrary to common sense.

Keynes knew this and knew the same herd behaviour can happen to consumers. This is one of the reasons he realised the classical laissez faire economic ideology that had preceded his theory was wrong (and is wrong today)

Keynes was pointing the way to behavioural, economics and consumer psychology. A low or pessimistic mood would now be called cognitive dissonance.

Two contemporary American economists, Akerlof and Shiller recommend governments take 'animal spirits' into account in their economic planning. They present strong Keynesian arguments in their 2009 book, Animal spirits how human psychology drives the economy and why it matters to global capitalism. (quite a title for a best selling book).

The two foundation stones of Keynesian economics

Demand is key not supply. 

Wages and prices can be slow to adjust to change.

Keynes explained why recessions occur and put forward a set of measures to keep an economy on an even keel. Earlier economists thought the market would balance the ups and downs of business cycles and the market should be left alone to work through what Adam Smith called the invisible hand. Keynes disagreed with this and argued that recessions can turn into depressions and become permanent.

Two foundation stones of Keynesian theory.

1. Aggregate demand (AgD) might not be enough to allow firms to employ people resulting in layoffs and high levels of unemployment. 

Aggregate demand is the total demand for products and services in an economy including consumers, business and government.

2. The macroeconomy (the whole economy) adjusts slowly to the reduction in demand because wages and prices are 'sticky'. Demand falls but wages and prices tend to stay the same and this fuels even more job losses and makes a recession worse.

These two factors can set a downward spiral in motion.