What is the invisible hand? Definition and meaning
The definition and meaning of the invisible hand is a term that Scottish moral philosopher and political economist Adam Smith (1723-1790) used to describe the unintended social benefits of individual actions. The term refers to the free market’s ability to allocate factors of production, products and services to their most valuable use. If we all act from self-interest, motivated by profit, then the economy will function more efficiently and productively, than it would if economic activity were directed by some kind of central planner.
In other words, Mr. Smith’s ‘invisible hand’ described how individuals making selfish decisions could collectively and unwittingly contribute to an effective economic system that was in the public interest.
Mr. Smith, who is known today as the ‘father of modern economics’, used ‘the invisible hand’ with respect to income distribution in 1759 and production in 1776 in his papers The Theory of Moral Sentiments and An Inquiry into the Nature and Causes of the Wealth of Nations respectively.
BusinessDictionary.com makes the following comment regarding the invisible hand: “Its positive aspect is that if everyone in a society seeks economic self interest (in an environment of free and open competition) then, as if prodded by an invisible hand, he or she (unknowingly and unintentionally) will also be serving the larger interest of the society as a whole.”
Mr. Smith only used the term three times in his writings. However, the ‘invisible hand’ has come to capture his fundamental belief that society benefits more by individual people’s self-interested actions than actions that are intended to directly benefit society.
Mr. Smith explained that it was as if an invisible hand guided the actions of individual people to combine for the common good. He also recognized that this invisible hand was not flawless, and that sometimes government action was required. Examples he included of government action were laws to protect consumers from monopolistic behaviors, i.e. antitrust legislation, the enforcement of property rights, and to provide national defense and policing.
Smith did not believe there was a real invisible hand. He used the term as a metaphor for how, in a market that is allowed to function freely, basically selfish people operate through a system of mutual interdependence, which overall benefits society.
Smith’s interpretation of the invisible hand
In Mr. Smith’s interpretation, if each consumer is allowed to choose freely what to purchase, and each supplier or producer is allowed to choose freely what to sell and how to make it, the market will settle on the best possible balance of product distribution and prices, which benefits society as a whole.
According to Adam Smith, by definition the invisible hand is an observable market force that helps the demand and supply of goods and services in a free market economy reach a balance automatically.
Self-interest drives the players to beneficial behavior in a case of serendipity (fortunate coincidence). Producers’ desire to maximize profits leads to efficient methods of production.
Producers’ desire to gain market share are achieved by offering the lowest prices possible. Investors invest in those businesses that provide the best returns, and remove their capital from those that are less efficient in creating value.
All these effects – efficient production, low prices, growth of successful businesses that make lots of things we want – occur dynamically and automatically.
Mr. Smith used the metaphor in context of an argument criticizing government regulation of markets and protectionism. Protectionism is a policy some governments adopt to reduce imports by imposing tariffs, quotas and other barriers.
In general, the ‘invisible hand’ can apply to any individual action that has unintended and/or unplanned consequences, particularly those that arise from actions not organized or orchestrated by a central command, and that have an evident, patterned effect on society.
Adam Smith (172301790), a key figure in the Scottish Enlightenment, was a Scottish moral philosopher and pioneer of political economy. He studied Social philosophy at the University of Glasgow, and then at Balliol College, Oxford. After graduating, he delivered a series of public lectures at Edinburgh, where he collaborated with David Hume during the Scottish Enlightenment. Mr. Smith laid the foundations of classical free market economic theory. (Image: adamsmith.org)
How economists interpreted the invisible hand
Economists have nearly always generalized the concept of the invisible hand beyond Mr. Smith’s original uses.
The phrase was unpopular among economists before the 20th century. In his textbook Principles of Economics, influential British economist Alfred Marshall (1842-1924) never used the term. William Stanley Jevons (1835-1882), a British economist and logician, did not use it in his Theory of Political Economy either.
American economist Paul Samuelson (1915-2009), the first US citizen to win the Nobel Memorial Prize in Economic Sciences, cited it in his textbook in 1948:
“Even Adam Smith, the canny Scot whose monumental book – ‘The Wealth of Nations’ (1776) – represents the beginning of modern economics or political economy – even he was so thrilled by the recognition of an order in the economic system that he proclaimed the mystical principle of the “invisible hand”: that each individual in pursuing his own selfish good was led, as if by an invisible hand, to achieve the best good of all, so that any interference with free competition by government was almost certain to be injurious.”
Margaret Hilda Thatcher (1925-2012) was the Prime Minister of the United Kingdom from 1979 to 1990 – the longest-serving British Prime Minister of the twentieth century. A journalist in the Soviet Union dubbed her The Iron Lady, a nickname that became associated with her leadership style and uncompromising politics. She was an ardent supporter of democratically-elected government and the free market economy. She was Britain’s first female Prime Minister. (Image: Wikipedia)
Mr. Samuelson went on to say that Mr. Smith’s ‘unguarded’ conclusion regarding the invisible hand had done almost as much harm as good during the past 150 years.
Many economists today say that the current use of the invisible hand in economic thinking as a symbol of free market capitalism stretches the use and meaning of the term far beyond Mr. Smith’s intentions.
Gavin Kennedy, Professor Emeritus at Heriot-Watt University, Edinburgh, is one of several economists to criticize modern interpretations of the term in this way.
Video – The Invisible Hand – Definition and Meaning
In this BBC Radio 4 video, narrator Aidan Turner explains what Adam Smith meant by the term ‘The Invisible Hand’, and how people today interpret it.