Invisible hand of Adam Smith

November 16, 2016
Adam Smith Invisible Hand
with permission from: The Warren J. Samuels Portrait Collection at Duke University ..every individual necessarily labours to render the annual revenue of the society as great as he can. He generally, indeed, 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. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good.

In this passage, taken from his 1776 book "An Inquiry into the Nature and Causes of the Wealth of Nations" Adam Smith set out the mechanism by which he felt economic society operated. Each individual strives to become wealthy "intending only his own gain" but to this end he must exchange what he owns or produces with others who sufficiently value what he has to offer; in this way, by division of labour and a free market, public interest is advanced.

Smith is often regarded as the father of economics, and his writings have been enormously influential. Nowadays, "invisible hand" explanations are invoked to explain all sorts of phenomena, from scientific progress to environmental degradation. In the modern context, mathematicians study "invisible hand" processes as part of Game Theory, the branch of mathematics that deals with payoffs and strategies (see Game Theory and the Cuban Missile Crisis) in Issue 13 of Plus.

Smith was profoundly religious, and saw the "invisible hand" as the mechanism by which a benevolent God administered a universe in which human happiness was maximised. He made it clear in his writings that quite considerable structure was required in society before the invisible hand mechanism could work efficiently. For example, property rights must be strong, and there must be widespread adherence to moral norms, such as prohibitions against theft and misrepresentation. Theft was, to Smith, the worst crime of all, even though a poor man stealing from a rich man may increase overall happiness. He even went so far as to say that the purpose of government is to defend the rich from the poor.

Here is a description of the way Smith imagined the universe operates:

  • There is a benevolent deity who administers the world in such a way as to maximise human happiness.
  • In order to do this he has created humans with a nature that leads them to act in a certain way.
  • The world as we know it is pretty much perfect, and everyone is about equally happy. In particular, the rich are no happier than the poor.
  • Although this means we should all be happy with our lot in life, our nature (which, remember, was created by God for the purpose of maximising happiness) leads us to think that we would be happier if we were wealthier.
  • This is a good thing, because it leads us to struggle to become wealthier, thus increasing the sum total of human happiness via the mechanisms of exchange and division of labour.

It is clear why Smith says that moral norms are necessary for such a system to work - in order for exchange to proceed, contracts must be enforceable, people must have good access to information about the products and services available, and the rule of law must hold.

The modern "Invisible Hand"

Nowadays, something much more general is meant by the expression "invisible hand". An invisible hand process is one in which the outcome to be explained is produced in a decentralised way, with no explicit agreements between the acting agents. The second essential component is that the process is not intentional. The agents' aims are not coordinated nor identical with the actual outcome, which is a byproduct of those aims. The process should work even without the agents having any knowledge of it. This is why the process is called invisible.

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