Eco-know-mics #2: Rethinking the "Invisible Hand"
- Nottingham Economics Society
- Jul 21, 2023
- 4 min read
Rethinking the “Invisible Hand”
The term “invisible hand” was first coined by Adam Smith, the father of modern economics. The tercentenary of Adam Smith’s birth is an opportunity to ponder how a rhetorical device employed has been interpreted and reinterpreted, which continues to shape our understanding of the world today.
Introductory Economics — the “invisible hand”
For anyone learning economics, they most likely have come across the term “invisible hand” in the introductory chapter of a textbook. The “invisible hand” is commonly interpreted as the price mechanism that guides the free market to reach equilibrium, leading to efficiency results (allocative and productive efficiency) achieved from perfect competition (Bamford & Grant, 2015).
It is not surprising that the metaphor is often linked with free market efficiency as another famous statement by Adam Smith about appealing to the self-interest of the butcher, brewer and baker,
“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.”
also appears in the same book the metaphor does, The Wealth of Nations. The above statement encapsulates the idea that we rely on the self-interest of individuals to get our dinner. Instead of appealing to their altruism, we appeal to their self-interest, providing them with something in exchange (usually money), which serves as an incentive for their continuous supply.
However, Adam Smith did not directly connect these two concepts in his work — the “invisible hand” and the self-love of the butcher, brewer, and baker — as they appear in separate parts of the Wealth of Nations, Book 4 and Book 1, respectively.
How did Adam Smith use the “invisible hand”?
Did you know that the “invisible hand” only appeared once in his work, The Wealth of Nations? Adam Smith’s original use of the metaphor in the book was as follows:
“Every individual... neither intends to promote the public interest, nor knows how much he is promoting it... By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.”
The appearance of the metaphor was about the potential of local businessmen to use foreign trade as a means to enrich themselves at the expense of their nation. Nonetheless, “invisible hand” has come to mean differently nowadays.
A step back from what Adam Smith meant
The modern interpretation implies that the economic system functions best when left alone, to let the “invisible hand” does its magic, leading to optimal outcomes.
However, as scholars like Craig Smith and Dennis Rasmussen have pointed out in an episode of the Freakonomics podcast, the original use of the term “invisible hand” by Adam Smith in The Wealth of Nations was not a blanket endorsement of the free market. Instead, it was deployed as a metaphor for the unintended consequences arising from individual actions. These byproducts are later known in Economics as externalities, and apparently, negative ones can also occur as unintended consequences in Adam Smith’s work. For example, if local businessmen want to reduce cost with cheaper imports, which may hinder local trade and result in job losses. In any case, the “invisible hand” is often associated with positive externalities, leading to different interpretations of the concept.
A breakdown of the “invisible hand”
The “invisible hand” encapsulates three separate but interconnected ideas:
1. private actions can have surprising social consequences
(eg. someone might start a bakery to earn money, but he also feeds his community by selling bread);
2. these actions done for personal gain often align with what is good for the whole society
(eg. the baker is not just making a living but also meeting the basic need of the community); and
3. there is a seeming order that guides these self-interested actions into a pattern that is good for all
(eg. imagine lots of bakeries, each working for their own gain, together, they ended up creating a robust food industry that provides job opportunities, supports the economy, and ensures everyone has access to daily bread (Blaug, 2007).
While these ideas form the backbone of the spontaneous order doctrine — “the collective sum of myriad individual actions leading to the emergence of social institutions, languages, markets, etc”, it is important to remember that Adam Smith himself did not explicitly describe the “invisible hand” as being the driving force of these phenomena (Luban, 2020).
The transition of the “invisible hand” as a poetic comment on human nature to a serious economic theory did not occur until the 19th century. Adam Smith’s original purpose of the metaphor may have been to merely explain why merchants would still buy domestic products even if tariffs were removed, rather than the grander perception we attribute to it today (Blaug, 2007).
Conclusion
The “invisible hand” is indeed a beautiful rhetorical device that has been reverberated by many politicians and economists to support their own views. While Adam Smith’s “invisible hand” elegantly captures certain aspects of market behaviour, its modern interpretation often strays away from his original intention. Rather than being a simple endorsement of laissez-faire capitalism, the “invisible hand” was his way of illustrating the complex interplay of individual actions, market dynamics and societal outcomes.
Although Adam Smith was called the Father of Modern Economics, he was a moral philosopher, and he typically used “invisible” to describe things that are either believed in due to superstition or aspects of scientific theories that are not yet fully understood (Rothschild, 1994). Therefore, there is no right or wrong definition of the “invisible hand” (you can get different of them just by Googling it), but only different interpretations due to different and evolving socioeconomic backgrounds and knowledge.
Prepared by Francis Lau
References and further readings:
Bamford, C., & Grant, S. (2015). Cambridge International AS and A Level Economics Coursebook. 3rd Edition. Cambridge: Cambridge University Press.
Blaug, M. (2007). The fundamental theorems of modern welfare economics, historically contemplated. History of political economy, 39(2), pp. 185-207.
LUBAN, D. (2020). What Is Spontaneous Order? American Political Science Review, 114(1), 68-80. doi:10.1017/S0003055419000625
Rothschild, E. (1994). Adam Smith and the invisible hand. The American Economic Review, 84(2), 319-322.
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