Invisible hand explanations Roger G Koppl

The metaphor of the 'invisible hand' seems to have first been used by Adam Smith (Vaughn, 1987). Today, the term 'invisible hand explanation' identifies any argument that proposes to show how some regular social phenomenon emerged or could have emerged 'spontaneously' or 'unintendedly' from the actions of many persons. A social structure emerges 'spontaneously' or 'unintendedly' when the actions that bring it about were not fully coordinated in advance and the ends of those actions did not include the realization of that structure. 'Invisible hand' explanations describe the unintended consequences of individual action.

The unintended consequences of individual action may be beneficial or harmful. Austrian economists generally argue that a liberal social order, an 'open society', tends to produce beneficial unintended consequences, whereas central planning and interventionism are more likely to generate harmful unintended consequences. Austrians also tend to view the traditions that gave rise to the open societies of the Western world as being, themselves, unintended consequences of individual action. Among Austrian economists, the standard example of an 'invisible hand' explanation is Carl Menger's explanation of the origin of money.

Some 'invisible hand' explanations describe the operation of existing social and economic institutions. Others describe the emergence or evolution of social and economic institutions. An account of the operation of a system of fractional reserve banking is an example of the first type of 'invisible hand' explanation. A theory of the evolution of fractional reserve banking is an example of the second type. In a standard article on the subject, Ullmann-Margalit (1978) describes several features of ('aggregate mold') invisible hand explanations (pp. 277-8). (Ullmann-Margalit uses the term 'invisible hand explanation' to describe models in which the function of an institution is a part of thr explanation for its existence and in which no clear link is established between the 'invisible hand' explanandum and individual actions undertaken without legard to its existence. In keeping with the methodological individualism and methodological subjectivism of the Austrian school, the term will not be used for such 'structural-functionalist' arguments.) The features arc the following

I. The domain of explanation: 'invisible hand' explanation« I to explain social phenomena rather than natural phenomena (tilliiniiiii Maipilit

.' The explained phenomena: the social phenomena to be « * plain" >»• to be designed but are not. They are 'the results ol human <n lion hut mil of human design' (Hayek, 1967, pp. 96-105). V The nature of the explanation: an 'invisible hand' explanation h a netic' explanation: it describes a process unfolding in liuu- that Is up posed to account for the origin of the explained phenomenon I The mode of explanation: the explanation displaces an argumoiit that attributes the phenomenon to design with the process story mentioned under (3) above. This process story shows how dispersed actions ol individuals, seeking various particular ends and not any overall social result, may nevertheless result in the emergence and replication of the phenomenon being explained.

Idiosyncrasies of the explanation: the explanation does, indeed, explain the phenomenon. The explanation is plausible in the sense that each stage of the process story depicts an 'ordinary and normal course ol events'. 'It cannot hinge on the extraordinary and the freaky, or on strokes of luck or genius' (Ullmann-Margalit, 1978, p. 271). Morcovei, the explanation must contain an element of 'surprise' (ibid., pp, 111 2).

To construct an 'invisible hand' explanation, an analyst must do tin it things. First, he must provide a description or representation ol tin- 'Invisible hand' phenomenon to be explained. Second, he must provide a dest rlpllon oi representation of the actions that (unintendedly) brought about the phenom enon, together with an account of the causal linkages amongst lljow actions Finally, the analyst must provide an explanation of those actions showing how Ihey could have occurred in spite of the actors' supposed disregard loi the 'invisible hand' results of their activities.

Because 'invisible hand' phenomena are unintended, they can have no meaning. They may have considerable significance for human action in the sense that their existence influences the course of human events and the life chances of individuals, but they cannot be interpreted in quite the way we Interpret a written text or an individual action. In this sense they are 'mecha nistic'. Because of this mechanistic character of such phenomena it is often useful and appropriate to represent them with graphs and algebraic equations The models of 'neoclassical' economics, general equilibrium theory included may often be used for this purpose.

Just as the unintended consequences of individual action are 'mei Imiihin the causal linkages between individual action and these unintended ions» quences, being themselves equally unintended, are meaningless and may »»I••«•

he described as 'mechanistic'. Thus, when constructing an 'invisible hand explanation', it may be useful to represent individual actions and interactions with 'mechanistic' models such as the rational optimizing agent. However 'mechanistic' the analyst's representation of individual action may be, he will need to establish the causal linkages among actions. This will generally entail the use of 'adjustment models', as described by Machlup:

1. Initial position. The analyst first specifies the set of interrelated variables of interest to him and identifies a constellation of values for those variables that is self-consistent and thus embodies no 'inherent tendency to change'. This situation is the 'initial equilibrium'.

2. Disturbing change. The analyst introduces a change in one of the 'exogenous' variables specified in step 1. It is this cause whose effect(s) the model is intended to isolate.

3. Adjusting changes. The analyst now specifies the process whereby the 'endogenous' variables specified in step 1 'adjust', that is, the process by which those variables change in value in reaction to the change introduced in step 2.

4. Final position. This is the 'final equilibrium', a position in which the values of the variables are once again mutually consistent. It is 'a situation in which, barring another disturbance from the outside, everything could go on as it is. In other words, we must proceed until we reach a "new equilibrium", a position regarded as final because no further changes appear to be required under the circumstances' (Machlup, 1963, p. 48).

When constructing an 'invisible hand' explanation, the analyst may wish to use several concatenated adjustment models to explain the sequence of causal linkages to which he attributes the 'invisible hand' phenomenon.

While the 'invisible hand' consequences of individual action are without meaning by virtue of their unintended character, the actions themselves are meaningful. We may hope to understand them in something like the way we understand the Book of Job, a letter from home or the instructions on a tube of toothpaste, An analyst cannot claim to have 'explained' an 'invisible hand' phenomenon if he cannot provide us with such an understanding of the actions that generated the phenomenon.

The actions chronicled in an 'invisible hand' explanation may be considered 'explained' il the analyst has made them '"understandable" ... in the sense that we could t onccive of sensible men acting (sometimes at least) in the way postulated' (Machlup, 1955, p. 17). To this end, it is sufficient that these actions appeal in an 'understandable* adjustment model. For an adjust inent model to be mulei ^laudable', it must satisfy the following conditions, discussed in Koppl (I'JO,») and in I anglois and Koppl (1991):

I Methodological individualism. The sequence of nd|u*liiig • hnngi •• must ut the same time be a sequence of individual ai lions I'im Insiaiu • llu change in price level brought about by an increnne m quantity ••!

must be accounted for in terms of the buying ami lllng tin i dons "I individuals.

? Subjective interpretation. The individual (re)aclioiiH thai hilug ulttmi the changes chronicled in the model must themselves he explained hi accounted for in terms of the knowledge, preferences and rspet lain ins the individuals doing the acting. V Subjective plausibility. The actions and reactions involved must serin reasonable and understandable in commonsense terms to both the aclois themselves and their fellow men. (This is similar to Ullmann Margaht's requirement that the 'invisible hand' story depict an 'ordinary and normal course of events'.) I Anonymity. The richness and specificity with which the knowledge, preferences and expectations of the actors are characterized must be neither greater nor less than required in order to ensure that the actions take place and are plausible in the sense explained earlier. (For a discussion of anonymity, see the entry on 'Ideal Type Methodology' in this volume.)

Causal adequacy. The requirement of causal adequacy is a double requirement. On the one hand, it requires that the knowledge, prelei ences, propensities, purposes and expectations attributed to the actors provide sufficient cause for their actions. On the other hand, these in lions must in turn provide sufficient cause for the specified effects (In both cases the analysis presupposes an invariant institutional regime within which these causes operate.) (> Complete determinateness of the result. If the condition of causal ad equacy is satisfied, both the individual actions and the overall effects specified in the model will be the only ones possible.

Explanations of the origins or evolution of institutions, too, should be understandable adjustment models. They should be 'understandable' in the sense indicated above to ensure that the actions creating the institution may be considered to be explained. They should be adjustment models to ensure that the proposed causes of the institution are sufficient and that, in consequence, the institution may be said to be 'explained'. Understandable adjust inent models explaining the origins of social and economic institutions will generally fit the following scheme, described in Koppl (1992):

I Initial institutional regime. The analysis begins with a dtfst i lptlou ol an initial constellation of action patterns or institutions.

2. Identification of unexploitedprofit opportunities. The analyst then identifies profit opportunities available to at least some of the individuals in the model. The profit opportunity is exploited by acting on a new ends/ means framework, by innovating.

3. Innovation. The analyst then supposes some of the actors to recognize the opportunity before them and to act on it.

4. Reaction and imitation. The analyst then identifies the sequence of adjustments, reactions and imitations that follow from the innovative action(s) identified in step 3.

5. New institutional regime. The sequence of actions detailed in step 4 is pursued until no further acts of imitation or adjustment are called for.

The use of understandable adjustment models to explain the unintended consequences of individual action allows Austrian economists to combine radical subjectivism with causal accounts of the origin and operation of many orderly social phenomena. The dispersed actions of many individuals, each animated by the spontaneous activity of an independent human mind, may produce orderly and, often, beneficial overall results even though there is no overarching design intended to realize such results.

See also:

Chapter 14: Competition; Chapter 21: Profit and loss; Chapter 28: Self-organizing systems; Chapter 30: Spontaneous order

Bibliography

Hayek, F.A. (1967), Studies in Philosophy, Politics, and Economics, Chicago: University of Chicago Press.

Koppl, Roger G. (1992), 'Invisible-Hand Explanations and Neoclassical Economics: Toward a Post Marginalist Economics', Journal of Institutional and Theoretical Economics, 148, (2), 292-313.

Langlois, Richard N. and Roger Koppl (1991), 'Machlup and Methodology: A Réévaluation',

Methodus, 3, (2), 86-102. Machlup, Fritz (1955), 'The Problem of Verification in Economics', Southern Economic Journal, 22. (I), 1-21.

Machlup, Frit/. (1963), Essays on Economic Semantics, Englewood Cliffs: Prentice-Hall. Ullmunn Margalit, E. (1978), 'Invisible-Hand Explanations', Synthese, 39, (2), 263-91. Vaughn, Karen I (1987), 'Invisible Hand', in John Eatwell, Murray Milgate and Peter Newman (edl), The New Val grave: A Dictionary of Economics, London: Macmillan, pp. 997-8.

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