Wicksell & Hotelling on the limits of Adam Smith’s invisible hand

7 Aug, 2014 at 12:47 | Posted in Economics | 3 Comments

It might look trivial at first sight, but what Harold Hotelling did show in his classic paper Stability in Competition (1929) was that there are cases when Adam Smith’s invisible hand doesn’t actually produce a social optimum.

With the advent of neoclassical economics at the end of the 19th century a large amount of intellectual energy was invested in trying to formalize the stringent conditions of obtaining equilibrium and showing in what way the prices and quantities of free competition constituted some kind of social optimum.

That the equilibrium reached in free competition is an optimum for each individual – given prevailing prices and income distribution – was not, however, seen by some economists as making a very strong case for a free market economy per se. It wasn’t possible to prove that free trade and competition gave a maximum of social utility. The gains made in exchange weren’t a manifestation of a maximum social utility.

wicksell2Knut Wicksell was one of those who criticized the idea of regarding the gain in utility arising from free competition as an absolute maximum. This market fundamentalist idea of harmony in a free market system didn’t live up to Wicksell’s demand for objectivity in science – and  “the harmony economists, who endeavoured to extend the doctrine so that it might become a defence of the existing distribution of wealth” were judged severely by Wicksell (Lectures 1934 (1901) p. 39).

When propounders of the new marginalist theory – especially Walras and Pareto – overstepped the strict boundaries of science and used it in ascribing to the market properties it did not possess, Wicksell had to react. To Wicksell (Lectures 1934 (1901) p. 73) it was

almost tragic that Walras … imagined that he had found the rigorous proof … merely because he clothed in mathematical formula the very arguments which he considered insufficient when they were expressed in ordinary language.

But what about the Pareto criterion? Wicksell had actually more or less anticipated it in his review (in Zeitschrift für Volkswirtschaft, Sozialpolitik und Verwaltung, 1913: 132-51) of Pareto’s Manuel, but didn’t think it really contributed anything useful. It was just the same old doctrine in a new disguise. To Wicksell the market fundamentalist doctrine of the Lausanne School obviously didn’t constitute an advance in economics.


  1. According to Adam Smith expert Gavin Kennedy, Smith’s very sparse use of the phrase “invisible hand” doesn’t support the neoclassical interpretation of it. Attributing the later to Smith is not historical, but rather an example of argument from authority. Not only is their theory wrong, so is their history.

  2. Adding to Tom’s comment:

    So is the often blatant misrepresentation of Smith by neoclassical economists the result of a failure to read Smith, a widespread reading disability, or part of a conscious propaganda?

    • Some would argue that neoclassical (marginalist) economics was at least in part a conscious and intentional reaction to classical economics and the emphasis of classical economists on rent, owing to the growing influence of Karl Marx and Henry George. A key figure in this was John Bates Clark of Columbia University, who had started his career as a socialist and then became one of the foremost advocates of capitalism.

      John Bates Clark was a teacher of Thorstein Veblen, who criticized him and other marginalists on institutionalist grounds for failure to take finance into account.

      See Michael Hudson, The Social Economics of Thorstein Veblen

      “The new economics was that of John Bates Clark and his colleagues who rejected the classical concept of economic rent as prices and income with no counterpart in socially necessary costs of production, these post-classical writers (whom Veblen coined the term “neoclassical” to describe) insisted that everyone deserved whatever revenue or wealth they managed to obtain. By definition, this payment was for providing an economic service equal in value to their income and rise in wealth.”

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