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The invisible hand is a Metaphor coined by the Economist Adam Smith to illustrate how those who seek wealth by following their individual self-interest assist society as a whole and build the common good. In '' The Wealth Of Nations '' and other writings, Smith claims that, in Capitalism , an individual pursuing his own good tends to also promote the good of his Community , through a principle that he called “the invisible hand”. Specifically, a free competitive market ensures that those goods and services perceived as most beneficial, efficient, or of highest quality will naturally be those that are most profitable. The mechanism for this, Smith saw as being the Free Price System .Alan Aldridge, The Market, page 15, Blackwell Publishing 2005 Adam Smith originally only mentioned the Invisible hand once in each of his three works. The metaphor has later gained widespread use. ''THE WEALTH OF NATIONS'' Adam Smith mentions the metaphor in Book IV of ''The Wealth of Nations'', arguing that actors in any economy will employ their capital in foreign trading only if the profits available by that method far exceed those available locally, and that in that case it is better for society as a whole that he does so.
(IV.ii.6-9, page 456 of the 1776 Glasgow Edition of Smith’s works; vol. IV, ch. 2, p. 477 of 1776 U. of Chicago Edition.) 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. However Smith's message is in fact very different from the popular understanding of it; namely that greed — including the following of market price signals for the sole purpose of maximising individual profit — is best both for individuals and their communities. Rather, his message is that our social consciences lead us to re-evaluate our self-interest, without our being fully conscious of the process. 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. Capitalists 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:
Criticism As the invisible hand as such is a metaphor of Free Market s, common criticism of free markets also applies to the theory of the invisible hand. 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 claimed 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 claimed 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.”'' A contemporary example of such an effect could be the far-reaching social benefit realized via the proliferation of Computer s and commercial Software ; goods which have been produced almost entirely by people trying to maximize their own economic gain. Presumably those producers didn’t manufacture the computers and develop the software out of a love for humanity or an altruistic desire to promote society’s collective fortune. Any social benefits that have accrued therefore, according to Smith’s doctrine, are simply a by-product of their striving for selfish reward. Contrary to common misconceptions, Smith did not assert that all self-interested labor necessarily benefits society, or that all public goods are produced through self-interested labor. 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, capitalism 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. EXAMPLES AND ARGUMENTS A very simple real world example of how the invisible hand is supposed to work 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 .) However, 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 diabletic 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 (see note 3 at the bottom), 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). See also Social Darwinism . TAWNEY’S INTERPRETATION Christian Socialist R. H. Tawney saw Smith as putting a name on an older idea: If preachers have not yet overtly identified themselves with the view of the natural man, expressed by an eighteenth-century writer in the words, trade is one thing and religion is another, they imply a not very different conclusion by their silence as to the possibility of collisions between them. The characteristic doctrine was one, in fact, which left little room for religious teaching as to economic morality, because it anticipated the theory, later epitomized by Adam Smith in his famous reference to the invisible hand, which saw in economic self-interest the operation of a providential plan... The existing order, except insofar as the short-sighted enactments of Governments interfered with it, was the natural order, and the order established by nature was the order established by God. Most educated men, in the middle of the {Link without Title} century, would have found their philosophy expressed in the lines of Pope : ''OTHER USAGES OF THE PHRASE'' Adam Smith used the phrase two other times in his writings, once published and once unpublished. The unpublished reference simply says that practitioners of Polytheistic religions did not attribute gravity or fire to the invisible hand of Jupiter , and the idea clearly has no relation to the '''invisible hand of the market'''. The other is in his published work, ''Theory of Moral Sentiments'' (1759). Here, Smith uses the ''invisible hand'' to explain the distribution of wealth. The ''invisible hand'' is active in economics because the landlord cannot consume all of the products himself and is thus forced to distribute them in exchange for work and for other goods. CRITICISM Joseph E. Stiglitz The Nobel Prize economist (2001) Joseph E. Stiglitz says: "the reason that the invisible hand often seems invisible is that it is often not there." (''Making Globalization Work'', 2006) ALTMAN, Daniel. ''Managing Globalization.'' In: ''Q & Answers'' with Joseph E. Stiglitz, Columbia University and ''The International Herald Tribune'', Oct 11, 2006 05:03AM. . Stiglitz explains his position: ::Adam Smith, the father of modern economics, is often cited as arguing for the “invisible hand” and free markets: firms, in the pursuit of profits, are led, as if by an invisible hand, to do what is best for the world. But unlike his followers, Adam Smith was aware of some of the limitations of free markets, and research since then has further clarified why free markets, by themselves, often do not lead to what is best. As I put it in my new book, Making Globalization Work, the reason that the invisible hand often seems invisible is that it is often not there. ::Whenever there are “externalities”—where the actions of an individual have impacts on others for which they do not pay or for which they are not compensated—markets will not work well. Some of the important instances have been long understood—environmental externalities. Markets, by themselves, will produce too much pollution. Markets, by themselves, will also produce too little basic research. (Remember, the government was responsible for financing most of the important scientific breakthroughs, including the internet and the first telegraph line, and most of the advances in bio-tech.) ::But recent research has shown that these externalities are pervasive, whenever there is imperfect information or imperfect risk markets—that is always. ::Government plays an important role in banking and securities regulation, and a host of other areas: some regulation is required to make markets work. Government is needed, almost all would agree, at a minimum to enforce contracts and property rights. ::The real debate today is about finding the right balance between the market and government (and the third “sector”—non-governmental non-profit organizations.) Both are needed. They can each complement each other. This balance will differ from time to time and place to place. ALTMAN, Daniel. ''Managing Globalization.'' In: ''Q & Answers'' with Joseph E. Stiglitz, Columbia University and ''The International Herald Tribune'', Oct 11, 2006 05:03AM. Noam Chomsky The American linguist and political analyst Noam Chomsky points out that Smith's metaphor from this book is wildly taken out of context by many of today's mainstream economists. Besides Adam Smith only used this expression once, and it did not have the meaning that is given today: Let's... keep to Adam Smith, a very important figure. He was pre-capitalist in his conceptions, and often quite interesting. For example, his basic argument for his rather nuanced views about markets: Another critique could be that the actual grounds for the invisible hand "Every individual naturally inclines to employ his capital in the manner in which it is likely to afford the greatest support to domestic industry, and to give revenue and employment to the greatest number of people of his own country." is in public reduced to "Every individual naturally inclines to employ his capital in the manner in which it is likely to afford the greatest profit" and has most individuals acting accordingly, which does not include employing the greatest number of people in his own country with shortsighted profit-maximising strategies. SEE ALSO ;Books
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