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Concept in economics

The invisible hand is a metaphor inspired by the Scottish moral philosopher Adam Smith that describes the incentives which free markets often create for self interested people to act in the public interest. Smith originally mentioned the term only in specific examples. It is used once in his Theory of Moral Sentiments when discussing the concentration of wealth. More famously, it is also used once in his Wealth of Nations, when arguing that international traders can be trusted if the incentives are right, often making it unnecessary for governments to intervene. Twentieth century economists such as Paul Samuelson popularized the use of the term to refer more generally to unintended greater social impacts brought about by individuals acting in their own self interest. The idea of trade and market exchange perfectly channeling self interest toward socially desirable ends is a central justification for newer versions of the laissez faire economic philosophy which lie behind neoclassical economics. Smith himself described the term "invisible hand" as rhetorical and unscientific, and did not use it to refer to any general principle of economics. His argumentation against government interventions into markets were based on specific cases and were not absolute. While Smith's arguments against government management of the economy were very popular, the ideas were not new. Smith himself cites earlier enlightenment thinkers such as Bernard Mandeville. Because of the modern use of this term to refer to a key neoclassical assumption, a central disagreement between economic ideologies is sometimes viewed as a disagreement about how well the "invisible hand" works. For example, it is argued that tendencies that were nascent during Smith's lifetime, such as large scale industry, finance, and advertising, now reduce its effectiveness.

In The Theory of Moral Sentiments (1759) and in The Wealth of Nations (1776) Adam Smith speaks of an invisible hand, never of the invisible hand. In his early unpublished essay on The History of Astronomy (written before 1758) Smith wrote about the term invisible hand, as a type of appeal to invisible causes, which ignorant people use when trying to explain natural phenomena. "Fire burns, and water refreshes; heavy bodies descend, and lighter substances fly upwards, by the necessity of their own nature; nor was the invisible hand of Jupiter ever apprehended to be employed in those matters."

The first published appearance of the invisible hand metaphor in Smith occurs in The Theory of Moral Sentiments (1759) in Part IV, Chapter 1, where he describes a selfish landlord being led by an invisible hand to distribute his harvest to those who work for him. This passage questions the distribution of wealth and laments the fact that the poor receive the "necessities of life" after the rich have gratified "their own vain and insatiable desires". Smith uses the invisible concept to sustain a "trickle down" tendency, a type of argument against government intervention which is still popular today. The gluttony of the rich serves to feed the poor, because the poor can sell to the rich. It has been noted that in this passage Smith seems to equate the invisible hand to "Providence", implying a divine plan. Although this passage concerns an economic topic in a broad sense, it does not concern "the invisible hand" of the free market as understood by twentieth century economists, but is instead about income distribution. There is no repeat of this argumentation in Smith's comprehensive work on economics in his later Wealth of Nations, and income distribution is not a central concern of modern neoclassical market theory.

The concept of the "invisible hand" is nearly always generalized beyond Smith's original uses. The phrase was not popular among economists before the twentieth century; Alfred Marshall never used it in his Principles of Economics textbook and neither does William Stanley Jevons in his Theory of Political Economy. Paul Samuelson cites it in his Economics textbook in 1948:

In this interpretation, the theory is that 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 all the individual members of a community, and hence to the community as a whole. The reason for this is that self interest drives actors to beneficial behavior in a case of serendipity. Efficient methods of production are adopted to maximize profits. Low prices are charged to maximize revenue through gain in market share by undercutting competitors. Investors invest in those industries most urgently needed to maximize returns, and withdraw capital from those less efficient in creating value. All these effects take place dynamically and automatically. Since Smith's time, this concept has been further incorporated into economic theory. Léon Walras developed a four equation general equilibrium model that 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 uses the expression "the invisible hand of Providence", referring to Marx's period, to mean evolutionary meliorism. He did not mean this as a criticism, since he held that secular reasoning leads to similar conclusions. Milton Friedman, a Nobel Memorial Prize winner in economics, called Smith's Invisible Hand "the possibility of cooperation without coercion." Kaushik Basu has called the First Welfare Theorem the Invisible Hand Theorem. Some economists question the integrity of how the term "invisible hand" is currently used. Gavin Kennedy, Professor Emeritus at Heriot Watt University in Edinburgh, Scotland, argues that its current use in modern economic thinking as a symbol of free market capitalism is not reconcilable with the rather modest and indeterminate manner in which it was employed by Smith. In response to Kennedy, Daniel Klein argues that reconciliation is legitimate. Moreover, even if Smith did not intend the term "invisible hand" to be used in the current manner, its serviceability as such should not be rendered ineffective. In conclusion of their exchange, Kennedy insists that Smith's intentions are of utmost importance to the current debate, which is one of Smith's association with the term "invisible hand". If the term is to be used as a symbol of liberty and economic coordination as it has been in the modern era, Kennedy argues that it should exist as a construct completely separate from Adam Smith since there is little evidence that Smith imputed any significance onto the term, much less the meanings given it at present. The former Drummond Professor of Political Economy at Oxford, D. H. MacGregor, argued that:

Harvard economist Stephen Marglin argues that while the "invisible hand" is the "most enduring phrase in Smith's entire work", it is "also the most misunderstood." According to Emma Rothschild, Smith was actually being ironic in his use of the term. Warren Samuels described it as "a means of relating modern high theory to Adam Smith and, as such, an interesting example in the development of language." Proponents of liberal economics, for example Deepak Lal, regularly claim that the invisible hand allows for market efficiency through its mechanism of acting as an indicator of what the market considers important, or valuable.

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 that arise from actions not orchestrated by a central command, and that 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 produces socially beneficial results. An underlying unifying force that Shaftesbury called the "Will of Nature" maintains equilibrium, congruency, and harmony. This force, 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. 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 argues in Darwin's Dangerous Idea that this represents a "universal acid" that may be applied to a number of seemingly disparate areas of philosophical inquiry (consciousness and free will in particular), a hypothesis known as Universal Darwinism. Positing an economy guided by this principle as ideal may amount to Social Darwinism, which is also associated with champions of laissez faire capitalism.

Christian socialist R. H. Tawney saw Smith as putting a name on an older idea:

Noam Chomsky suggests that Smith (and more specifically David Ricardo) sometimes used the phrase to refer to a "home bias" for investing domestically in opposition to offshore outsourcing production and neoliberalism.

Stephen LeRoy, professor emeritus at the University of California, Santa Barbara, and a visiting scholar at the Federal Reserve Bank of San Francisco, offered a critique of the Invisible Hand, writing that "The single most important proposition in economic theory, first stated by Adam Smith, is that competitive markets do a good job allocating resources. ( ) The financial crisis has spurred a debate about the proper balance between markets and government and prompted some scholars to question whether the conditions assumed by Smith are accurate for modern economies.

John D. Bishop, a professor who worked at Trent University, Peterborough, indicates that the invisible hand might be applied differently to merchants and manufacturers from how it is applied with society. He wrote an article in 1995 titled "Adam Smith's Invisible Hand Argument", in which he suggests that Smith might be contradicting himself with the "Invisible Hand". He offers various critiques of the "Invisible Hand", and he writes that "the interest of business people are in fundamental conflict with the interest of society as a whole, and that business people pursue their personal goal at the expense of the public good". Thus, Bishop indicates that the "business people" are in conflict with society over the same interests and that Adam Smith might be contradicting himself. According to Bishop, he also gives the impression that in Smith's book 'The Wealth of Nations,' there's a close saying that "the interest of merchants and manufacturers were fundamentally opposed of society in general, and they had an inherent tendency to deceive and oppress society while pursuing their own interests." Bishop also states that the "invisible hand argument applies only to investing capital in one's own country for a maximum profit." In other words, he suggests that the invisible hand applies to only the merchants and manufacturers and that they're not the invisible force that moves the economy. He contends the argument "does not apply to the pursuit of self interest ( ) in any area outside of economic activities".

French economist Thomas Piketty notes that although the Invisible Hand does exist and thus that economic imbalances correct themselves over time, those economic imbalances may lead to an extended unoptimal utility, which could be solved thanks to non commercial processes. He takes for instance the cases of real estate of which imbalances may last decades, and of the Great Famine of Ireland, which could have been avoided by shipments of food from Great Britain to areas in crisis without waiting for new bread producers to come.