Adam Smith, the Wealth of Nations, and the 'Invisible Hand': A Metaphor for Ambiguity-Uncertainty Aversion by Decision Makers
Scholedge International Journal of Management & Development, Vol.3, No.5, (2016)
25 Pages Posted: 25 Jan 2015 Last revised: 31 Aug 2016
Date Written: January 24, 2015
Smith’s use of the “Invisible Hand,” as pointed out by Gavin Kennedy, is a metaphor provided for the great percentage of readers of the Wealth of Nations whom Smith realized would not be able to grasp the nature of his argument, which was about the ambiguity-uncertainty aversion of the majority of 18th century English business men. Gavin Kennedy has pointed out that the term, “Invisible Hand,” had nothing to do with Laissez Faire, free markets, free trade, Natural liberty, etc., for Adam Smith. Smith’s argument is an application of his very advanced decision theory that regarded the standard mathematical laws of the probability calculus as a special case that had only limited applicability in the real world. In general, applications of the mathematical laws of the probability calculus required a complete information set that was rarely satisfied. Smith realized that probability, nevertheless, had to be taken into account. Smith advocated an interval valued approach to the use of probability under conditions of uncertainty/ambiguity.
Smith made great use of the concept of uncertainty. Uncertainty for Smith dealt with the quality of the information base upon which the probabilities were being calculated. Smith generally defined risk in the Wealth of Nations as an inexact and/or indeterminate estimate not based on the mathematical laws of the probability calculus. Risk could be calculated exactly only in conditions where there was a very high quality of evidence over which there were no conflicts and/or disputes of assessment regarding the relevancy of the data.
Smith’s major conclusion in Part IV of the Wealth of Nations is that businessmen are ambiguity and/or uncertainty averse. The quality of the information, data, or knowledge upon which the probabilities, which would be interval estimates, is a second factor that is completely independent of the probability estimates themselves. Only in a limiting case, where the evidence is great, stable, and invariant over time, as in the case of deciding to become a shoemaker, would the probability estimates be point estimates.
Smith completely rejects the ethics and decision theory of Jeremy Bentham, as well as all approaches built on it, such as the Subjectivist (SEU-Subjective Expected Utility) approaches of Frank Ramsey, Bruno de Finetti, L J Savage , Milton Friedman .and modern Bayesians, such as Patrick Suppes.
Keywords: ambiguity/uncertainty aversion, Ellsberg Paradox, weight of the evidence, J M Keynes, Adam Smith, Invisible hand
JEL Classification: B10, B12, B20, B22
Suggested Citation: Suggested Citation