THE INVISIBLE HAND HIDDEN BEHIND THE CURRENT ECONOMICAL REALITY

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1 THE INVISIBLE HAND HIDDEN BEHIND THE CURRENT ECONOMICAL REALITY OPREANA Alin Assistant Professor/Ph.D. student, Faculty of Economic Science, Lucian Blaga University of Sibiu, Romania, According to the invisible hand theory, stated by A. Smith, the economy, based on competitive market forces, can provide, spontaneously, equilibrium between production and consumption, supply and demand, which makes government intervention unnecessary. In the last century, the two most important schools of economic (The Chicago School and the Keynesianism) thought had an open confrontation regarding the most effective market economy system and which one should be adopted by the state in its policies for sustainable economic development and sustainable economic growth and today Friedman s critics recognize the beneficial effects of state intervention in the economy (deregulation, privatization, reduced public spending, reduced taxes, non-intervention in the currency market). Key words: the invisible hand, economic equilibrum, crisis, market freedom JEL classification: E13 1. Introduction "An individual who intends to win only for himself is determined by an invisible hand to promote a goal, which was not part of his initial intentions. And it is not always the worst case scenario that could happen to society if that aim was not part of the initial intentions. By not deviating from the personal interest, it frequently promotes the interests of society more effectively than when it only intends to support it." (Adam Smith) We can state that the central problem of economic science is given by the following question: How do the actions of a multitude of autonomous human beings reconcile? In this regard it can be claimed that one answer is the plan and the other one is the market. If we analyze the first response, throughout time, the systems which were based on central and imperative planning, proved to be unsuccessful and inefficient in terms of achieving a certain degree of prosperity. Thus, in the struggle between plan and market the result was that a sustainable growth can only be achieved within the system which revolves around the market, by applying a laissez-faire policy in which economic agents are free to make their own decisions and to take the best strategy, which they consider appropriate, in order to maximize their results. Following this confrontation of market traders in a free scenery, without any interference from other forces that could have negative influence, market equilibrium is achieved, and also the state of equilibrium of all participants, which further leads to maximized earnings and higher living standards. 2. The Invisible Hand Theory The problem of economic equilibrium concerns the political economy since its early beginnings, more precisely speaking since economic thinking was established as an independent science. Classic economic thinking of equilibrium can be found in works of A. Smith, D. Ricardo and St.Mill, to mention the most representative exponents of classic liberalism. In this context, publishing the book "The wealth of nations" by Adam Smith, in 1776, is considered to be the origin of economics as a science. Classics evolved their works in an era when the industry was going through an unprecedented development. Their main concern was economic growth and related issues such as distribution, value, international trade, etc. One of the main goals was denouncing the restrictive mercantilist ideas of free competition which were even more extensive in their time. For Adam Smith, the state must refrain from intervening in the economy because when people act freely in search of self-interest there is an invisible hand that transforms efforts into benefits. In fact, the theory of "the invisible hand", stated by A. Smith, can be regarded as a form of expressing a 499

2 concept related to economic equilibrium. According to this theory, the economy, based on competitive market forces, can provide, spontaneously, equilibrium between production and consumption, supply and demand, which makes government intervention unnecessary. Also under the theory of "the invisible hand", the interest game, which unfolds in a market, is sufficient to even economic life (Jessua C., Labrousse C., Vitry D., Gaumont D., 2006). Thus, the market represents a decentralized coordination process, which requires no intervention or control: the invisible hand justifies the laissez-faire policy. Also, it must be mentioned that the basic principles of Classical Liberal School were based upon the philosophical foundation of classical deterministic science, inherited from Newton and then used in all sciences, including political economy. In the Classical School of economic thought, economic issues were analyzed from the perspective of a model with ideal conditions of stable equilibrium, according to which, if economic freedom is ensured, then the system is accomplished and works by itself, being governed by natural laws. Classical economists did not remark the fact that between their model of thinking, which was perfectly justified, and economic conditions prevalent in real life was a huge difference and did not study with equal consideration the disequilibrium which dominates the economic realities. Also, they did not grasp the need for structural reforms, creating an ideal model where natural laws would govern. Over time, Classical School was the subject of various critics because of existing discrepancy between theory and practice; it considered physical, social and economic reality through the perspective of stable equilibrium. In other words, evolution is towards unity, harmony, symmetry, reversibility in the sense that if we consider ex-ante or ex-post, micro or macro has makes no difference, because the result must be the same. This presentation is narrows down to two ideas. The first idea regards the convergence of individual interests with the general interest, attributed to Mandeville and was also present in the works of Hume, Ferguson and Hutchinson, all inspired by Adam Smith; and the second idea consists of the fact that the result obtained through market is the most likely. This is not the result which could have been obtained by a perfectly rational individual. The presence of the invisible hand in the market requires permanent adjustments, adapting individual behavior based on information provided by relative prices and profits, which are also variables as the transactions take place. Thus, the market represents a process of continuous discovery, with unexpected and unpredictable results, unable to "simulate the market," as Lange and Kanda suggested and as today the supporters of "market socialism" claim. In this dynamic vision, economic agents play the fingers of the invisible hand (being motivated by profit ownership); they pay attention to the information conveyed throughout the market and then they manage the disequilibrium, which this information reveals. These entrepreneurial reactions ensure the better overall coordination of business than any adjustment through which hypothetical general equilibrium is searched. Invisible hand originates from a eighteenth century Scottish social philosophy, but also has roots in the works of Austrian School economists, according to whom the social order is the unwanted result of voluntary actions of individuals. In his studies, Adam Smith described the essential institutional framework: the invisible hand can function only if there are property rights, security contracts, currency stability, competition (i.e., freedom to enterprise and trade). Later, Hayek concluded an evolutionary theory of institutions, so that today we speak of an "invisible hand approach" (Ullmann-Margali) in order to characterize theories explaining the emergence and changes in institutions without the intervention of voluntary human action. Following the above statements we can say that the invisible hand is central to the fundamental debate on individual freedom and social harmony. 3. Market freedom between Friedman and Keynes Classical liberal theory is called into question by the Chicago School by one of its foremost exponents, Milton Friedman. In his book, Free to Choose, Milton Friedman points out, through a series of examples of several countries from both sides of the former "iron curtain", that the economy will not be functional as long as it is commanded and controlled by a center, by comparison with countries where the 500

3 implementation of measures such as price liberalization and free exchange, have acted as a propellant engine, ensuring a functioning economy. Among other interesting topics considered in this book, the renowned professor emphasizes the importance of clear delimitation of the powers assigned to the state and to the government, revealing how certain economies, which practiced a centrally planned economy, could not function, like for example the former Soviet Union. Of course, analyzing this fact, we understand even more as our country was led, in the past, by a government that applied such an ineffective system. Obvious ineffectiveness which resulted from the centralized economy system is exposed broadly, as the author manages to show through some examples how it has failed. It is clear that countries whose economy was based on free exchange had only to gain, benefiting from both human prosperity and freedom. Of course, in a society mutually agreed exchange, competition and free choice have a positive impact on the economy and on increasing living standards; as obvious examples are the countries which today have a strong economy. In relation to the price system which works so well when it is free, the author talks about the oil crisis of 1974, when the U.S. government, trying to intervene by adopting measures in order to prevent domestic oil price increases, had the opposite effect than the one expected, leading to long queues for gasoline and supply shortages even in the U.S., the country that produced most of its oil. Meanwhile, countries like Germany and Japan dependent on imported oil, were not affected. Friedman manages to show how the transmission of price information may be one of the most harmful effects of inflation. In contradiction with concepts of "the invisible hand" and the "laissez faire" policy is a Modern School (which argues through Keynesianism correcting market imperfections solution through state intervention in the economy) which brings an important contribution in terms of achieving economic equilibrium. Thus, within the Modern School, economic problems are seen exclusively through the perspective of a model which assumes conditions of disequilibrium or deviations from the classical model, but with the premise that government intervention through fiscal and monetary policy implementation can promote the overall prosperity and stability, as recommended by Keynes. The peak of the modern school was achieved through the formulation of the Law of Full Employment regarding natural and human resources, stated by John Maynard Keynes, in his book that became famous during the last century "The General Theory of Employment, Interest and Money" (1936). This represents the modern concept of stable equilibrium through government intervention from outside the system. 4. The invisible hand hidden behind the current economical reality In the last century, the two most important schools of economic thought had an open confrontation regarding the most effective market economy system and which one should be adopted by the state in its policies for sustainable economic development and sustainable economic growth. Also, when analyzing the pros and cons of the invisible hand from the perspective of the two concepts of economic thinking, the two major economic crises, that have marked economic developments in the last century, must be taken into. Thus, the crisis of , which had overproduction as the main cause, supported the idea of state intervention policies. And yet, after a number of years later, clear observations show that the most liberal states, regarding their market economy system, are the strongest economies in terms of economic growth and sustainable development (United States and United Kingdom), and today Friedman s critics recognize the beneficial effects of state intervention in the economy (deregulation, privatization, reduced public spending, reduced taxes, non-intervention in the currency market). Friedman says that it is essential to leave people the freedom to make their own decisions, even though many will experience loss as a result of their decision - because whether an individual loses or wins, we, as a society, have only to gain from the fact that someone has taken some risks. The economic crisis inspired courage among many not only to doubt the virtues of free market and globalization, as they have been theorized by Friedman and by the Chicago School, but also to call into question the old ideas regarding Keynesian s origin - stimulating the economy by increasing public spending and state involvement in regulating the economic disequilibrium, rather than allowing the market to adjust itself. Paul Krugman sees as the obvious solution for the crisis introducing more capital in the system. In fact, this is a standard response in crisis situations. Krugman also offers a set of examples to highlight this 501

4 issue. Thus in 1933 the Roosevelt administration created the Reconstruction Finance Corporation, which was used to recapitalize the banks by buying preferred stocks. Swedish Government intervened in the crisis in the early 1990s and provided the banks with an extra capital, equal to 4% of the country's GDP. In 1998, the Japanese government purchased preferred stocks of 500 billion US dollars, in order to save the banks. In each case, the additional capital contribution helped restore banks capacity to provide loans and thawed the credit market. A financial rescue operation takes place, in similar conditions, in present times, in economies which are heavily affected by the crisis, from the United States (where an intervention plan worth $ 700 billion was applied) to Ireland (where a rescue plan for the banking system worth 81 million was applied). Also Greek s economy, the most affected one out of the euro area, seeks emergency measures that will most likely result in a capital injections program into the economy. Just as considered by Krugman in his work entitled The Return of Depression Economics and the Crisis of 2008 still seems quite doubtful that this will be enough to topple the whole situation. The Nobel laureate also comes with the solution to this uncertainty: the recapitalization will eventually have to get bigger and broader, and that there will eventually have to be more assertion of government control in effect, it will come closer to a full temporary nationalization of a significant part of the financial system. This assumption that Krugman made, since 2008 became a certainty in the rescue plans of national economies; financial markets received capital injections in exchange of a temporary nationalization. However, this is a short term solution and should not represent a long-term goal, otherwise the positive effects of the rescue plans will be insignificant. Thus, the financial sector must be reprivatized as soon as it is safely to do so, just as Sweden did when the banks got restored in the private sector, after the rescue operation, in early (Krugman, 2009) Even if the rescue operation of the financial system begins to revive credit markets, there is a danger that savings could face further global decline. Regarding this aspect, the answer seems to be traditional Keynesian fiscal stimulus. United States tried a fiscal stimulus in early 2008; that the Bush administration touted it as a plan to jump-start the economy. The actual results were, however, disappointing, for two reasons. First, the stimulus was too small, accounting for only about 1 percent of GDP. Second, most of the money in the first package took the form of tax rebates, many of which were saved rather than spent. The usual objection to public spending as a form of economic stimulus is that it takes too long to get going that by the time the boost to demand arrives, the slump is over. Also, the cost for the taxpayers would still be a concern - any government intervention in a market almost always involves socializing losses and privatizing earnings. Therefore, it extends the moral hazard - the inclination of private participants towards the markets where there are explicit or implicit warranties, to take risks that under other conditions would have avoided. Thus, further market regulation the will not lead to improvements of markets performance. (Greenspan, 2008) The crisis is seen, by many economists, as an inevitable consequence of past excesses in the economy and indeed as a healing process. Recovery, as stated by Joseph Schumpeter, is only sound if it does come from itself. For any revival which is merely due to artificial stimulus leaves part of the work of depression undone and adds, to an undigested remnant of maladjustments, new maladjustments of its own. " 5. Conclusions The current economic crisis context offers positive prospects in developing a synthesis of various models regarding the aggregate market equilibrium, which could lead to a stable general equilibrium with a sustainable framework for re-launching and then developing the global economy. In other words, getting the economies out of the crisis will be achieved through concerted action by state and by market forces, as long as it is taken into consideration the fact that the market represents a system based on the principle of selfregulation, and the state should not interfere in its functioning mechanism; it must remain a "partner" in order to ensure a consistent fiscal policy and a regulatory framework for markets, enabling traders to express freely in a legitimate competition, so that the desired benefits can be obtained. Regarding the results of the economic crisis we can state that the answer can be found within classical liberal thinking. In fact, the economic crisis caused a sharp decrease in demand in almost all 502

5 markets. In this case, the principle of physics according to which every action has a reaction, undertaken from the Classical School, we can say that it perfectly applies in these circumstances. Thus, the power of the self-regulating market ("the invisible hand") will lead the markets to equilibrium through the readjustment and the decrease of the supply so that new market equilibrium conditions can be provided. Certainly the state has an important role in developing the strategies that would lead to the solving of the economic crisis, but eventually "the invisible hand", that determines the behavior of market trades, will have the last word. 6. References Krugman, P. (2009) Intoarcerea la economia declinului si criza din 2008, Editura Publica Friedman, M.; Friedman, R. (2009) Libertatea de a alege. O declaratie personala, Editura Publica Jessua, C.; Labrousse, C.; Vitry, D.; Gaumont, D. (2006) Dictionar de Stiinte Economice, Editura ARC Krugman, P. (2010) Constiinta unui liberal, Editura Publica Greenspan, A. (2008) Era turbulentelor. Aventuri intr-o lume noua, Editura Publica Smick D.M. (2008) The World is Curved. Hidden Dangers to the Global Economy, Penguin Group, NY, USA 503