The invisible hand is a metaphor coined by the economist Adam Smith. Once in “The Wealth of Nations” and other writings, Smith demonstrated that, in a free market, an individual pursuing his own self-interest tends to also promote the good of his community as a whole through a principle that he called “the invisible hand”. He argued that each individual maximizing revenue for himself maximizes the total revenue of society as a whole, as this is identical with the sum total of individual revenues. Smith used the term ‘invisible hand’ only three times, but the metaphor later gained widespread use
Several new interpretations of Adam Smith’s invisible hand have recently been published in leading general-interest economic journals. These interpretations attempt to bring Smith forward in time, to make him more modern, and to fashion him in the image of the modern welfare theorist. Here we go back in time and find the source for both of Smith’s economic applications of the invisible hand in Richard Cantillon’s model of the isolated estate. With this connection established, we know what Smith read and dubbed the invisible hand. Introduction We now know a great deal about the intricacies and details of Adam Smith’s life and economics.
Scholars have, for example, poured over his views on the organization of religion, his views of the corporation, and even his tenure as a tax collector, and have established definite conclusions. In contrast, Smith’s most famous concept—“the invisible hand”—has in recent years been placed in an intellectual quagmire as a result of a surprising resurgence of interest in the meaning of the concept. Several new interpretations of the concept have been published in the leading general-interest economic journals, as well as those that specialize in the history of economic thought.
This widespread effort to discover the “true” meaning of the invisible hand appears to have muddied the conceptual waters almost beyond recognition. There are now at least a dozen different versions of the invisible hand ranging from the more traditional interpretations to those which attach the phrase to such things as slavery and national defense. Smith’s invisible hand now suffers from multiple-conception disorder and the lack of an acceptable definition could render Smith’s concept scientifically useless.
The opening quote from Khalil represents one of the few sensible modern interpretations of Smith (the process theorist) because it shows both how far modern interpreters have gone astray—painting Smith forward in time as a modern neoclassical welfare (end state) theorist, and why there is so much confusion—Smith’s three different uses of the phrase. To resolve the mystery of the meaning of the invisible hand, I would like to go backward in time and show that Smith discovered the general conceptual framework for the invisible hand in Richard Cantillon’s Essai sur la Nature du Commerce en General (hereafter, Essai).
Cantillon’s model of the isolated estate represents a revolutionary breakthrough in economic theory and both of Smith’s economic applications of the invisible hand—which hitherto have been understood to be disconnected—can be found in it. This linkage between Smith and Cantillon permits us to describe the invisible hand as the processes that constitute price theory, competition, and distribution. First, however i will briefly describe the heated debate in the general-interest journals over the meaning of the invisible hand and then present the broader connections that scholars have made between Cantillon and Smith.
Part I Understood as a metaphor Smith uses the metaphor in the context of an argument against protectionism and government regulation of markets, but it is based on very broad principles developed by Bernard Mandeville, Bishop Butler, Lord Shaftesbury, and Francis Hutcheson. In general, the term “invisible hand” can apply to any individual action that has unplanned, unintended consequences, particularly those which arise from actions not orchestrated by a central command and which have an observable, patterned effect on the community.
Bernard Mandeville argued that private vices are actually public benefits. In “The Fable of the Bees” (1714), he laments that the “bees of social virtue are buzzing in Man’s bonnet”: that civilized man has stigmatized his private appetites and the result is the retardation of the common good. Bishop Butler argued that pursuing the public good was the best way of advancing one’s own good since the two were necessarily identical. Lord Shaftesbury turned the convergence of public and private good around, claiming that acting in accordance with one’s self-interest will produce socially beneficial results.
An underlying unifying force that Shaftesbury called the “Will of Nature” maintains equilibrium, congruency, and harmony. This force, if it is to operate freely, requires the individual pursuit of rational self-interest, and the preservation and advancement of the self. Francis Hutcheson also accepted this convergence between public and private interest, but he attributed the mechanism, not to rational self-interest, but to personal intuition, which he called a “moral sense. ” Smith developed his own version of this general principle in which six psychological motives combine in each individual to produce the common good.
In “The Theory of Moral Sentiments”, vol. II, page 316, he says, ““By acting according to the dictates of our moral faculties, we necessarily pursue the most effective means for promoting the happiness of mankind. ”” Contrary to common misconceptions, Smith did not assert that all self-interested labour necessarily benefits society, or that all public goods are produced through self-interested labour. His proposal is merely that in a free market, people “usually” tend to produce goods desired by their neighbours.
The tragedy of the commons is an example where self-interest tends to bring an unwanted result. Moreover, a free market arguably provides numerous opportunities for maximizing one’s own profit at the expense (rather than for the benefit) of others. The tobacco industry is often cited as an example of this: the sale of cigarettes and other tobacco products certainly brings a very good revenue, but the industry’s critics deny that the social benefits (the pleasures associated with smoking, the camaraderie, the feeling of doing something “cool”) can possibly outbalance the social costs.
Part II Economists’ Interpretation of The Wealth of Nations quote The concept of the Invisible Hand is nearly always generalized beyond Smith’s original discussion of domestic versus foreign trade. Smith himself participated in such generalization, as is already evident in his allusion to “many other cases”, quoted above. Notice that the invisible hand is here considered a natural inclination, not yet a social mechanism as it was later classified by Leon Walras and Vilfredo Pareto.
Many economists claim that the theory of the Invisible Hand states that if each consumer is allowed to choose freely what to buy and each producer is allowed to choose freely what to sell and how to produce it, the market will settle on a product distribution and prices that are beneficial to the all individual members of a community, and hence to the community as a whole. The reason for this is that greed will drive actors to beneficial behavior. Efficient methods of production will be adopted in order to maximize profits.
Low prices will be charged in order to undercut competitors. Investors will invest in those industries that are most urgently needed to maximize returns, and withdraw capital from those that are less efficient in creating value. Students will be guided to prepare for the most needed (and therefore most remunerative) careers. And all these effects will take place dynamically and automatically. It also works as a balancing mechanism. For example, the inhabitants of a poor country will be willing to work very cheaply.
Entrepreneurs can make great profits by building factories in poor countries. But since they increase the demand for labor, they will increase its price. And since the new producers will also become consumers, local businesses will have to hire more people in order to provide for them the things that they want to consume. As this process continues, the labor prices will eventually rise to the point at which there is no advantage for the foreign countries doing business in the formerly poor country. Overall, this mechanism will cause the local economy to function on its own.
In The Wealth of Nations Smith provides a metaphor that illustrates the simplicity of the principle: It is not from the benevolence of the butcher, the brewer or the baker that we expect our dinner, but from their regard to their own interest. We address ourselves not to their humanity but to their self-love, and never talk to them of our necessities but of their advantages. Nobody but a beggar chooses to depend chiefly upon the benevolence of their fellow-citizens.
Part III Examples and arguments A very simple real world example of how the invisible hand is supposed to ork is the queue for a supermarket checkout. Each customer getting in line selfishly chooses to maximize his own interest, that is to checkout in the shortest time, regardless of the other customers. Their utility maximizing choice is to get in queue in the shortest line, this means that eventually customers queue up in lines all of the same length.
Therefore even without the slightest direction and by following only their selfishness, the lines are all of the same length, which is clearly the most efficient disposition. (This examples also illustrates the ties between economics and game theory. Note that to reap these benefits, the market should at least exist — in the total absence of regulation, if people were allowed to cut the queue, the result of selfish pursuit of interests would be a crowded mess. Also, as this example also illustrates, economists have a particular understanding of efficiency. If a woman in the supermarket seeking to checkout is pregnant, carrying a crying child who is diabetic and who needs to eat dinner in the shortest amount of time possible, then it may be more efficient to allow her to jump the queue.
Since Smith’s time, the principle of the invisible hand has been further incorporated into economic theory. Leon Walras developed a four equation general equilibrium model which concludes that individual self-interest operating in a competitive market place produces the unique conditions under which a society’s total utility is maximized. Vilfredo Pareto used an edgeworth box contact line to illustrate a similar social optimality. Ludwig von Mises, in Human Action, claims that Smith believed that the invisible hand was that of God.
He did not mean this as a criticism, since he held that secular reasoning leads to similar conclusions. The invisible hand is traditionally understood as a concept in economics, but Robert Nozick argues in Anarchy, State and Utopia that substantively the same concept exists in a number of other areas of academic discourse under different names, notably Darwinian natural selection. In turn, Daniel Dennett has argued in Darwin’s Dangerous Idea that this represents a “universal acid” which may be applied to a number of seemingly disparate areas of philosophical enquiry (consciousness and free will in particular).