Adam Smith's Legacy: His Place in the Development of Modern Economics

By Michael Fry | Go to book overview

7

THE INVISIBLE HAND IN MODERN MACROECONOMICS

James Tobin


THE INVISIBLE HAND AND THE KEYNESIAN DICHOTOMY

The 'invisible hand', one of the great ideas of history and one of the most influential, is Adam Smith's most important legacy to macroeconomics, as to all economics. It is particularly important today as the ultimate inspiration for the new classical macroeconomics and the real business cycle theory. These are intellectual movements that engage many of the best brains in the profession, especially among younger cohorts and especially in the United States. They dominate the agenda even of theorists and econometricians who are sceptical or hostile to their methods and conclusions.

These movements are revolutions counter to Keynesian economics, itself a revolution against invisible hand orthodoxy. Keynes claimed to have detected a massive market failure. Workers were involuntarily unemployed; workers who were willing to work at real wages not exceeding their marginal productivities. Employers did not hire them because of insufficient effective demand for what they would produce. The employment and output of the idle workers would enhance social welfare. Yet the market mechanism could neither prevent this failure nor correct it—could not correct it, that is, in good time and without government assistance. Keynes alleged this market failure to be an endemic flaw in capitalism.

The Great Depression lent credibility to Keynesian theory. So did the postwar prosperity of the advanced capitalist economies, which was widely attributed to the use of Keynesian stabilization policies. In the profession something of a reconciliation was achieved between Keynesian macroeconomics and classical or neoclassical microeconomics. Paul Samuelson called it the 'neoclassical synthesis'. At least

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