Adam Smith Invisible Hand
In economics, the invisible hand of the market is a metaphor conceived by Adam Smith to describe the self-regulating behavior of the marketplace.[1] The exact phrase is used just three times in Smith 's writings, but has come to capture his important claim that individuals ' efforts to maximize their own gains in a free market benefits society, even if the ambitious have no benevolent intentions. Smith came up with the two meanings of the phrase from Richard Cantillon who developed both economic applications in his model of the isolated estate.[2]
He first introduced the concept in The Theory of Moral Sentiments, written in 1759. In this work, however, the idea of the market is not discussed, and the word "capitalism" is never used.[3] By …show more content…
the time he wrote The Wealth of Nations in 1776, Smith had studied the economic models of the French Physiocrats for many years, and in this work the invisible hand is more directly linked to the concept of the market: specifically that it is competition between buyers and sellers that channels the profit motive of individuals on both sides of the transaction such that improved products are produced and at lower costs. This process whereby competition channels ambition toward socially desirable ends comes out most clearly in The Wealth of Nations, Book I, Chapter 7.
The idea of markets automatically channeling self-interest toward socially desirable ends is a central justification for the laissez-faire economic philosophy, which lies behind neoclassical economics.[4] In this sense, the central disagreement between economic ideologies can be viewed as a disagreement about how powerful the "invisible hand" is. In alternative models, forces which were nascent during Smith 's life, such as large-scale industry, finance, and advertising, reduce its effectiveness.[5]
Contents
1 The Theory of Moral Sentiments 2 The Wealth of Nations 3 Economists ' interpretation of the "invisible hand" quotation 4 Understood as a metaphor 5 Examples and arguments 6 Tawney 's interpretation 7 Home bias interpretation 8 Other uses of the phrase by Smith 9 Criticisms 9.1 Joseph E. Stiglitz 9.2 Noam Chomsky 9.3 Stephen LeRoy 10 See also 11 References 12 Bibliography 13 External links
The Theory of Moral Sentiments
The first appearance of the invisible hand in Smith occurs in The Theory of Moral Sentiments (1759) in Part IV, Chapter 1, where he describes a selfish landlord as being led by an invisible hand to distribute his harvest to those who work for him:
“ The proud and unfeeling landlord views his extensive fields, and without a thought for the wants of his brethren, in imagination consumes himself the whole harvest ... [Yet] the capacity of his stomach bears no proportion to the immensity of his desires ... the rest he will be obliged to distribute among those, who prepare, in the nicest manner, that little which he himself makes use of, among those who fit up the palace in which this little is to be consumed, among those who provide and keep in order all the different baubles and trinkets which are employed in the economy of greatness; all of whom thus derive from his luxury and caprice, that share of the necessaries of life, which they would in vain have expected from his humanity or his justice...The rich...are led by an invisible hand to make nearly the same distribution of the necessaries of life, which would have been made, had the earth been divided into equal portions among all its inhabitants, and thus without intending it, without knowing it, advance the interest of the society... ”
Elsewhere in The Theory of Moral Sentiments, Smith has described the desire of men to be respected by the members of the community in which they live, and the desire of men to feel that they are honorable beings.
While Smith does not mention these social pressures in the above-cited discussion of the invisible hand, one might infer that the selfish and proud landlord hires servants in order to feel himself respected, and displays his wealth in a fine palace in order to gain the respect of others. In this sense, the invisible hand is in its first stage, a sort of system of social pressure that persuades the wealthy to do, of their own volition, what the society around them requires.
The Wealth of Nations
The part of The Wealth of Nations (1776) which describes what future generations would consider to be Smith 's invisible hand, ironically, does not use the term. The process by which market competition channels individual greed is most clearly described in Book I, Chapter 7.
Adam Smith uses the metaphor in Book IV, chapter II, paragraph IX of The Wealth of Nations. In the often misquoted and poorly understood paragraph quoted below Smith argues that a preference for the use of "domestic" industry over "foreign" industry to gain individual profit constitutes an "invisible" and benevolent hand which promotes the interests of the nation and society at large while at the same time enriching the individual. The individual may have a selfish motive but the use of domestic industry and labor enriches and promotes the interests of society as a
whole.
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 not 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. It is an affectation, indeed, not very common among merchants, and very few words need be employed in dissuading them from it.
Economists ' interpretation of the "invisible hand" quotation
The concept of the "invisible hand" is nearly always generalized beyond Smith 's original discussion of domestic versus foreign trade. Milton Friedman, a Nobel Prize winner in economics, called Smith 's Invisible Hand "the possibility of cooperation without coercion."[6] Kaushik Basu has called the First Welfare Theorem the Invisible Hand Theorem.[7]
The theory for 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.[citation needed]
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.[8] 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.[9] 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.[10]
The former Drummond Professor of Political Economy at Oxford, D. H. MacGregor, argued that:
The one case in which he referred to the ‘invisible hand’ was that in which private persons preferred the home trade to the foreign trade, and he held that such preference was in the national interest, since it replaced two domestic capitals while the foreign trade replaced only one. The argument of the two capitals was a bad one, since it is the amount of capital that matters, not its subdivision; but the invisible sanction was given to a Protectionist idea, not for defence but for employment. It is not surprising that Smith was often quoted in Parliament in support of Protection. His background, like ours today, was private enterprise; but any dogma of non-intervention by government has to make heavy weather in The Wealth of Nations.[11]
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."
Economists have taken this passage to be the first step in the cumulative effort of mainstream economics to prove that a competitive economy provides the largest possible economic pie (the so-called first welfare theorem, which demonstrates the Pareto optimality of a competitive regime). But Smith, it is evident from the context, was making a much narrower argument, namely, that the interests of businessmen in the security of their capital would lead them to invest in the domestic economy even at the sacrifice of somewhat higher returns that might be obtainable from foreign investment. . . .
David Ricardo . . . echoed Smith . . . [but] Smith 's argument is at best incomplete, for it leaves out the role of foreigners ' investment in the domestic economy. It would have to be shown that the gain to the British capital stock from the preference of British investors for Britain is greater than the loss to Britain from the preference of Dutch investors for the Netherlands and French investors for France."[12]
According to Professor Emeritus William Grampp of the University of Chicago,
The invisible hand is not a power that makes the good of one the good of all, and it is not any of a number of other things it is said to be. It is simply the inducement a merchant has to keep his capital at home, thereby increasing the domestic capital stock and enhancing military power, both of which are in the public interest and neither of which he intended. Smith 's exposition discloses how his rhetorical sallies could disfigure his economics, confuse his argument for free trade, and make him play fast and loose with facts and the ideas of others. . . . [T]here is little or no support in what Smith wrote that can substantiate the interpretations it has been given, thus offering another example of how the words of a great man can mean different things to his readers and can be made into something that he himself would not recognize.[13]
According to Emma Rothschild, Smith was actually being ironic in his use of the term.[14] Warren Samuels described it as "a means of relating
He first introduced the concept in The Theory of Moral Sentiments, written in 1759. In this work, however, the idea of the market is not discussed, and the word "capitalism" is never used.[3] By …show more content…
the time he wrote The Wealth of Nations in 1776, Smith had studied the economic models of the French Physiocrats for many years, and in this work the invisible hand is more directly linked to the concept of the market: specifically that it is competition between buyers and sellers that channels the profit motive of individuals on both sides of the transaction such that improved products are produced and at lower costs. This process whereby competition channels ambition toward socially desirable ends comes out most clearly in The Wealth of Nations, Book I, Chapter 7.
The idea of markets automatically channeling self-interest toward socially desirable ends is a central justification for the laissez-faire economic philosophy, which lies behind neoclassical economics.[4] In this sense, the central disagreement between economic ideologies can be viewed as a disagreement about how powerful the "invisible hand" is. In alternative models, forces which were nascent during Smith 's life, such as large-scale industry, finance, and advertising, reduce its effectiveness.[5]
Contents
1 The Theory of Moral Sentiments 2 The Wealth of Nations 3 Economists ' interpretation of the "invisible hand" quotation 4 Understood as a metaphor 5 Examples and arguments 6 Tawney 's interpretation 7 Home bias interpretation 8 Other uses of the phrase by Smith 9 Criticisms 9.1 Joseph E. Stiglitz 9.2 Noam Chomsky 9.3 Stephen LeRoy 10 See also 11 References 12 Bibliography 13 External links
The Theory of Moral Sentiments
The first appearance of the invisible hand in Smith occurs in The Theory of Moral Sentiments (1759) in Part IV, Chapter 1, where he describes a selfish landlord as being led by an invisible hand to distribute his harvest to those who work for him:
“ The proud and unfeeling landlord views his extensive fields, and without a thought for the wants of his brethren, in imagination consumes himself the whole harvest ... [Yet] the capacity of his stomach bears no proportion to the immensity of his desires ... the rest he will be obliged to distribute among those, who prepare, in the nicest manner, that little which he himself makes use of, among those who fit up the palace in which this little is to be consumed, among those who provide and keep in order all the different baubles and trinkets which are employed in the economy of greatness; all of whom thus derive from his luxury and caprice, that share of the necessaries of life, which they would in vain have expected from his humanity or his justice...The rich...are led by an invisible hand to make nearly the same distribution of the necessaries of life, which would have been made, had the earth been divided into equal portions among all its inhabitants, and thus without intending it, without knowing it, advance the interest of the society... ”
Elsewhere in The Theory of Moral Sentiments, Smith has described the desire of men to be respected by the members of the community in which they live, and the desire of men to feel that they are honorable beings.
While Smith does not mention these social pressures in the above-cited discussion of the invisible hand, one might infer that the selfish and proud landlord hires servants in order to feel himself respected, and displays his wealth in a fine palace in order to gain the respect of others. In this sense, the invisible hand is in its first stage, a sort of system of social pressure that persuades the wealthy to do, of their own volition, what the society around them requires.
The Wealth of Nations
The part of The Wealth of Nations (1776) which describes what future generations would consider to be Smith 's invisible hand, ironically, does not use the term. The process by which market competition channels individual greed is most clearly described in Book I, Chapter 7.
Adam Smith uses the metaphor in Book IV, chapter II, paragraph IX of The Wealth of Nations. In the often misquoted and poorly understood paragraph quoted below Smith argues that a preference for the use of "domestic" industry over "foreign" industry to gain individual profit constitutes an "invisible" and benevolent hand which promotes the interests of the nation and society at large while at the same time enriching the individual. The individual may have a selfish motive but the use of domestic industry and labor enriches and promotes the interests of society as a
whole.
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 not 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. It is an affectation, indeed, not very common among merchants, and very few words need be employed in dissuading them from it.
Economists ' interpretation of the "invisible hand" quotation
The concept of the "invisible hand" is nearly always generalized beyond Smith 's original discussion of domestic versus foreign trade. Milton Friedman, a Nobel Prize winner in economics, called Smith 's Invisible Hand "the possibility of cooperation without coercion."[6] Kaushik Basu has called the First Welfare Theorem the Invisible Hand Theorem.[7]
The theory for 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.[citation needed]
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.[8] 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.[9] 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.[10]
The former Drummond Professor of Political Economy at Oxford, D. H. MacGregor, argued that:
The one case in which he referred to the ‘invisible hand’ was that in which private persons preferred the home trade to the foreign trade, and he held that such preference was in the national interest, since it replaced two domestic capitals while the foreign trade replaced only one. The argument of the two capitals was a bad one, since it is the amount of capital that matters, not its subdivision; but the invisible sanction was given to a Protectionist idea, not for defence but for employment. It is not surprising that Smith was often quoted in Parliament in support of Protection. His background, like ours today, was private enterprise; but any dogma of non-intervention by government has to make heavy weather in The Wealth of Nations.[11]
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."
Economists have taken this passage to be the first step in the cumulative effort of mainstream economics to prove that a competitive economy provides the largest possible economic pie (the so-called first welfare theorem, which demonstrates the Pareto optimality of a competitive regime). But Smith, it is evident from the context, was making a much narrower argument, namely, that the interests of businessmen in the security of their capital would lead them to invest in the domestic economy even at the sacrifice of somewhat higher returns that might be obtainable from foreign investment. . . .
David Ricardo . . . echoed Smith . . . [but] Smith 's argument is at best incomplete, for it leaves out the role of foreigners ' investment in the domestic economy. It would have to be shown that the gain to the British capital stock from the preference of British investors for Britain is greater than the loss to Britain from the preference of Dutch investors for the Netherlands and French investors for France."[12]
According to Professor Emeritus William Grampp of the University of Chicago,
The invisible hand is not a power that makes the good of one the good of all, and it is not any of a number of other things it is said to be. It is simply the inducement a merchant has to keep his capital at home, thereby increasing the domestic capital stock and enhancing military power, both of which are in the public interest and neither of which he intended. Smith 's exposition discloses how his rhetorical sallies could disfigure his economics, confuse his argument for free trade, and make him play fast and loose with facts and the ideas of others. . . . [T]here is little or no support in what Smith wrote that can substantiate the interpretations it has been given, thus offering another example of how the words of a great man can mean different things to his readers and can be made into something that he himself would not recognize.[13]
According to Emma Rothschild, Smith was actually being ironic in his use of the term.[14] Warren Samuels described it as "a means of relating