The Invisible Hand And Economic

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Ever since Adam Smith, economists have applied two theoretical constructs - the "Invisible Hand" and the "Economic Man" - to understand the functioning of an economy. The theory of the Invisible Hand explains "how within a specific set of institutional arrangements the power of self-interest can spontaneously generate patterns of social order that simultaneously achieve individual autonomy, generalized prosperity, and social peace."55 According to this approach, the economic problem is one of coordination in relation to information implicit in prices, rather than one of valuation in relation to a conception of the good defined as WTP within economic science. The problem for economic theory is not to posit and then measure "value" as an intrinsic quantity, whether as labor surplus (as Smith and Marx believed) or as consumer surplus (as is assumed today). It is to analyze "how the spontaneous interaction of a number of people, each possessing only bits of knowledge, brings about a state of affairs in which prices correspond to costs, etc., and which could be brought about by deliberate direction only by someone who possessed the combined knowledge of all those individuals."56

Economic Man is a theoretical construct used to explain how price signals coordinate choices in ways that promote overall economic performance. All Economic Man does is exchange goods with other Economic Men within an income constraint in view of prevailing prices. "About the only thing this person is reported to be doing is buying and selling goods in markets where prices are given."57 He tries to buy low and sell high. All we know about Economic Man is that the constraints he faces "are shaped only by market prices and the earned and unearned incomes he is able to command."58 Otherwise he is a Black Box. The maximum Economic Man is willing to pay for a good is irrelevant in most instances. If he buys a good, he pays the lowest price he can conveniently find. If one insists on introducing the concept of "value" with respect to ordinary consumption goods, one may construe the price Economic Man pays as a lower bound on how much he "values" that good. His maximum WTP (how much more he would pay if he had to) is unlikely to be known even to him.

Price signals lead Economic Man as a producer to opportunities for profit. These signals lead him as a consumer to bargains. By a "bargain" I mean a good a person wants and is able to purchase at a price significantly lower than that person expects to pay for it. (The concept of maximum WTP remains inscrutable, hypothetical, and nearly always irrelevant.) As less expensive goods of higher quality force more expensive goods of lower quality out of the market, firms constantly innovate to remain competitive. Innovation, insofar as it develops and applies knowledge to knowledge, continually creates new kinds of goods and redefines which kinds of assets are considered resources. Price signals -even though they do not equate with the maximum WTP that welfare economics associates with value - lead market players to coordinate their activities in mutually beneficial ways. It is a virtue, not a fault, of this theory that it seeks to know the price of everything but the value of nothing.

Economic Man may not possess a preestablished preference function. On the contrary, the theory of the Economic Man recognizes the extreme contingency of preference. An Economic Man may not have a well-defined preference for apples, for example. Rather, one can only say that, given a price for apples and a very wide range of other prices and available objects of consumption, for example, oranges, he prefers an apple at the moment. The individual, insofar as he has any preference-ordering, changes it constantly as he obtains more information about what is on offer at what prices. On this approach, the epistemic problem is not that of determining stable, exogenous, or "given" preference-orderings. The epistemic problem is getting to economic actors, firms as well as consumers, the immense amount of information that price signals gather and convey. It is the "problem faced by economic actors whose beliefs about the possible consequences of their actions are invariably subjective, incomplete, partial, vague and even on occasions (and viewed with the benefit of hindsight) just plain wrong."59

A reader may object that Economic Man and WTP Man come to the same thing - that the theory of the Invisible Hand and the theory of Kaldor-Hicks efficiency are two sides of the same coin. These different theories may remind one of the "duck" and the "rabbit" which are two perspectives on the same cartoon. I have no opinion about whether this objection is correct. I believe that even if it is true, however, we are much better off with the classical "duck" than with the "neoclassical "rabbit." The theory associated with Adam Smith allows us the metaphors we need to deal with contemporary problems such as energy policy and climate change. This approach encourages the rhetoric of innovation, technological change, competitiveness, decentralization, expansion, liberty, and the kind of consent - actual consent - basic to the protection of personal and property rights.

The theory of Kaldor-Hicks efficiency and WTP Man in contrast allocates fixed or "given" resources according to a collectivist rule that permits losses to any one individual if they could hypothetically be offset by gains to another. The neoclassical approach allocates the resources we have but does not help us create the resources we need. This approach transfers political power to experts versed in measuring WTP - experts who are likely to appeal to different constituencies by awarding them the WTP they are willing to pay for. The classical economics of Adam Smith celebrates the spontaneity and creativity of competition and consent. The neoclassical theory of WTP Man, in contrast, favors the rhetoric of market failure, transaction costs, dirigisme, and the zero-sum game.

IS PROSPERITY GOOD?

The conceptual constructs of the Invisible Hand and Economic Man have a normative side; in contrast the conceptual constructs of WTP Man and Kaldor-Hicks Efficiency do not. The normative significance of the Invisible Hand and Economic Man has nothing to do with "value" or "benefit" as microeconomists use these terms today. The point of Invisible Hand theory is to promote overall prosperity. If one needs a more explicit characterization of overall prosperity one can consult Richard Musgrave. "Economists distinguish three criteria for assessing performance." The first involves "aggregate or macro-efficiency, measured principally in terms of total output, employment and price stability." The second criterion concerns the degree to which an economic system expands to meet the "manifold and constantly changing demands of individuals for public and private goods." Musgrave included "the distribution of income and wealth" as a third indicator of economic performance.60

Why is economic performance a good thing; why might it be thought to be normative? One answer lies outside economics, for example, in the uncontroversial findings of social psychology. Social psychologists have shown that the performance of an economy - as distinct from WTP -strongly affects perceived or subjective social well-being. Stutzer and Frey summarize the factors that relate to happiness:

When people do get to be better off, higher income scarcely raises happiness, and then only for a limited period of time. Other determinants of happiness more strongly affect it, particularly the condition of unemployment, which strongly depresses; whereas, institutional factors, such as political participation rights and the extent of government decentralization, raises people's satisfaction with their lives.61

Carol Graham has written, "Most studies find that inflation and unemployment have negative effects on happiness."62 R. J. Shiller found that people associate inflation with nonpecuniary costs such as exploitation, lowered morale, and loss of status or prestige.63 The nonincome effect of involuntary unemployment on well-being exceeds by many times the effect of lost income alone.64 According to other investigators, when "individuals are asked in surveys how happy they are with life... their en masse answers move systematically with their nation's level of joblessness and rate of price change." They add that from a societal perspective, "inflation and unemployment belong in a well-being function."65

Insofar as economists agree with commonsense moral intuitions and settled political convictions about the goals of an economy - enlarging the pie, increasing job opportunities, improving the lot of the poor, subsidizing education, health, and merit goods - they do not need to discuss the normative purpose of economic analysis because "to do so would be to state the obvious and sound grand at the same time."66 The economic goals of a society, such as employment, price stability, and productivity, are uncontroversial; the task is to determine how to achieve them. This requires economists to debate facts, not measure values. Economists suggest how institutions can be reformed, property rights can be better defined, and incentive structures could change, so that new, better, and less expensive goods will appear. Economists can and should help find policies that "grow" the economy in the ways that Musgrave described while responding to environmental challenges such as climate change.

A consensus in society and among empirically minded economists suggests that prosperity is a good thing largely because prosperity (unlike Kaldor-Hicks efficiency, aggregate WTP, the area under the demand curve, consumer surplus, and other proxies and stand-ins for WTP) in fact correlates with happiness. While this justification of prosperity might appeal to a Utilitarian, it will not necessarily convince a Kantian like me. For a Kantian, it is not enough to say that meaningful employment - "gd jbs w hi pa" - correlates with happiness. It must also be "worthy of happiness," that is, the idea of meaningful work must have some sort of intrinsic value - it may appeal to a sense of duty or to a sense of one's self-worth - if the happiness it affords has moral value. To show that prosperity not only leads to happiness but is also worthy of it -that the happiness is appropriate to its cause - would probably require an argument that refers to concepts of freedom, responsibility, community, and personhood ultimately traceable to a broad religious tradition. I touch on these issues in a later chapter; I cannot pursue them here.

CONCLUSION

Many economists today have lost interest in choice as a kind of moral agency, responsibility, and accountability. In place of choice in this moral sense, these economists establish a morally neutral conceptual construct, preference, which refers to a passive mental ordering associated with WTP Man. This chapter has asked whether preference is normative. How would one show that preference-satisfaction in the aggregate or any of its proxy terms - such as "WTP," "welfare," "well-being," "utility," "well-offness," "consumer surplus," "the area under the demand curve," or "benefit" - possesses a normative significance, that is, a connection to an independently definable and socially cognizable conception of the right or the good?

I have argued that the conceptual framework of the Invisible Hand and Economic Man suffices to explain why the government may intervene when markets fail to allocate resources in ways helpful to the performance of the economy, which is to say, in ways broadly responsive to competitive or equilibrium prices. Moral, aesthetic, spiritual, and ethical goods - ranging from rights against the trespass of pollution to the protection of endangered species and pristine vistas - cannot be captured by this conceptual framework because the social commitments or principles involved concern the self-respect or dignity of the society and not the performance of its economy. A principle of cost-effectiveness and a principle of diminishing returns, however, apply even to noneconomic goods. Accordingly, we often need to know about the lowest price at which a good could be supplied - as distinct from the highest price it could fetch in the absence of competition.

Our political theory, founded on concepts such as equity, liberty, and autonomy, requires that people should have the greatest freedom consistent with the like freedom of others to make choices through and on behalf of economic, legal, and political institutions. Economists can play a useful role by helping society to define property rights in common pool resources and to design legal and political processes so that people can coordinate their actions in more transparent and less costly ways. The Invisible Hand then may lead to prosperity and peace. Choice is an activity; individuals are agents; they are not sites where preference or WTP may be found.

Whatever preferences we may ascribe to the lottery winner, they led him nowhere and made no claim on social recognition. There is no way to associate his preferences or preference per se with any good, such as happiness, that society has a reason to value or individuals have a reason to want. By postulating WTP as an objective measure of value, a vanguard party of economists empowers itself to second-guess market outcomes - to treat any as a "failure" - in favor of their own metaphysics, morals, and personal convictions. Their science then tells society what is valuable and thus what to do. The difference between welfare economics and communism, then, may be an elusive one. I do not take up the question of whether environmental economics, insofar as it is based on conceptual constructs such as Kaldor-Hicks efficiency and WTP Man, may succeed as a positive science, that is, a science that makes testable predictions. I question only whether environmental economics may present itself as a normative science, that is, as a science of valuation.

Chapter 5

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