The invisible hand — invisible because it’s not there

17 Jul, 2016 at 22:13 | Posted in Economics | 1 Comment

Daniel Kahneman … has demonstrated how individuals systematically behave in ways less rational than orthodox economists believe they do. His research shows not only that individuals sometimes act differently than standard economic theories predict, but that they do so regularly, systematically, and in ways that can be understood and interpreted through alternative hypotheses, competing with those utilised by orthodox economists.

stiglitz3To most market participants – and, indeed, ordinary observers – this does not seem like big news … In fact, this irrationality is no news to the economics profession either. John Maynard Keynes long ago described the stock market as based not on rational individuals struggling to uncover market fundamentals, but as a beauty contest in which the winner is the one who guesses best what the judges will say …

Adam Smith’s invisible hand – the idea that free markets lead to efficiency as if guided by unseen forces – is invisible, at least in part, because it is not there …

For more than 20 years, economists were enthralled by so-called “rational expectations” models which assumed that all participants have the same (if not perfect) information and act perfectly rationally, that markets are perfectly efficient, that unemployment never exists (except when caused by greedy unions or government minimum wages), and where there is never any credit rationing.

That such models prevailed, especially in America’s graduate schools, despite evidence to the contrary, bears testimony to a triumph of ideology over science. Unfortunately, students of these graduate programmes now act as policymakers in many countries, and are trying to implement programmes based on the ideas that have come to be called market fundamentalism … Good science recognises its limitations, but the prophets of rational expectations have usually shown no such modesty.

Joseph Stiglitz

1 Comment

  1. First, I agree with the author, but I’d really like to clear something up, it’s unfair to credit Adam Smith with the modern idea of the “invisible hand” in the context it’s used today. In all his works he mentions it 3 times and never in the context it is used today. Today’s interpretation is right leaning socio-political interpretation that falsely uses Adam Smith as an authority to back up something he NEVER said. As a matter of fact, given his work, I would say if he were here today, he would acknowledge the damage done by the shift in wealth and income disparity that exists today.

    More writers should point this out and “take back” Adam Smith to support ideas that are contrary to the modern ideas of the invisible hand.

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