Guide the market's invisible hand with a higher principle?




Above is a video of a Presidential address to some members of Congress after a meeting with Treasury Secretary Tim Geithner this past Wednesday, February 25.

In the last sentence of the speech (beginning at about 5:50 into this particular clip), the President declares: "I have the utmost confidence that, if these outstanding public servants standing beside me are working in concert, if we all do our jobs, if we once again guide the market's invisible hand with a higher principle, our markets will recover, our economy will once again thrive, and America will once again lead the world in this new century as it did in the last."

The famous phrase "invisible hand" comes, of course, from Adam Smith's 1776 work, An Inquiry into the Nature and Causes of the Wealth of Nations. There, he explained that:

"every individual necessarily labors to render the annual revenue of the society as great as he can. He generally, indeed, neither intends to promote the public interest nor knows that he is promoting it. [. . .] 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. Nor is it always the worse for society that it was no part of it. By pursuing his own interest, he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good to be done by those who affected to trade for the common good" (IV.2.9).

Smith had earlier used the term in similar manner in his 1759 book, The Theory of Moral Sentiments. In both cases, he was expressing the truth -- proven over and over in the twentieth century -- that the best distribution of labor and wealth is achieved, not by those who claimed to be working for "the common good" but rather by allowing the individual who "intends only his own gain" to pursue it.

That this "invisible hand" works better than any other method seems on its face incredible to many, and there have been those throughout history who have put into action their belief that it is better to centrally "plan" or "guide" the economy than to allow such a risky idea as to leave individual to pursue "only his own gain."

Austrian economist Friedrich A. Hayek, in his classic 1944 work The Road to Serfdom explained that this long-running debate is often depicted as being between those who want "planning" and those who do not. But this is actually not true, he wrote. In fact, both sides want planning -- it is just a question as to whether planning is more effective when it is done by a central body of governing individuals, or whether planning is actually better effected when it is left to the plans of the millions of free individuals who are left to pursue their own interests for their own gain.

Hayek said, "it is not a dispute on whether we ought to employ foresight and systematic thinking in planning our common affairs. The question is whether for this purpose it is better that the holder of coercive power [i.e. the government] should confine himself in general to creating conditions under which the knowledge and initiative of individuals are given the best scope so that they can plan most successfully; or whether a rational utilization of our resources requires central direction and organization of all our activities according to some consciously constructed 'blueprint'" (41).

To say that "our economy will once again thrive" if we "guide the market's invisible hand by a higher principle" is to move towards the second position -- "some consciously constructed 'blueprint'" -- and away from the first. In fact, it also implies that a failure to "guide the invisible hand" is somehow responsible for the catastrophic financial events of 2008, which in fact the President has also asserted.

We would strongly disagree, and would note that this should be an issue not of politics, but of economics. Adam Smith, Friedrich Hayek, and their descendants in the economics profession have been shown time and again to have put forward sound economics, and the seductive idea that "outstanding public servants . . . working in concert" could somehow guide things better has been shown time and again to be most unsound economics.

As the late Nobel Laureate Milton Friedman wrote in an introduction to a 1971 edition of Hayek's Road to Serfdom, "Experience in the past quarter century has strongly confirmed the validity of Hayek's central insight -- that coordination of men's activities through central direction and through voluntary cooperation are roads going in very different directions: the first to serfdom, the second to freedom. That experience has also strongly reinforced a secondary theme -- central direction is also a road to poverty for the ordinary man; voluntary cooperation, a road to plenty."

We have advanced several arguments which demonstrate that the financial panic and related recession of the last four months of 2008 were not a failure of "the invisible hand" or a demonstration of the idea that individual self-interest needs to be guided with "a higher principle," in previous blog posts such as "Taking stock of 2008," "A failure of government, not of private enterprise," and "This week is not an indictment of free markets."

We believe very strongly that understanding this critical issue is of vital importance to every investor -- in fact, to every human being. We would urge you to take the time to read and appreciate the thinking of Adam Smith, Friedrich Hayek, Milton Friedman, and others who believed as they did, and to spread this message in any way you can.


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For later posts dealing with this same subject, see also:

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