Invisible hand

Invisible hand

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In economics, invisible hand or invisible hand of the market is the term economist
Economist
An economist is a professional in the social science discipline of economics. The individual may also study, develop, and apply theories and concepts from economics and write about economic policy...

s use to describe the self-regulating nature of the marketplace. This is a metaphor
Metaphor
A metaphor is a literary figure of speech that uses an image, story or tangible thing to represent a less tangible thing or some intangible quality or idea; e.g., "Her eyes were glistening jewels." Metaphor may also be used for any rhetorical figures of speech that achieve their effects via...

 first coined by the economist Adam Smith
Adam Smith
Adam Smith was a Scottish social philosopher and a pioneer of political economy. One of the key figures of the Scottish Enlightenment, Smith is the author of The Theory of Moral Sentiments and An Inquiry into the Nature and Causes of the Wealth of Nations...

. The exact phrase is used just three times in his writings, but has come to capture his important claim that by trying to maximise their own gains in a free market, individual ambition benefits society, even if the ambitious have no benevolent intentions.

Chronologically, he first introduced the concept in The Theory of Moral Sentiments
The Theory of Moral Sentiments
The Theory of Moral Sentiments was written by Adam Smith in 1759. It provided the ethical, philosophical, psychological, and methodological underpinnings to Smith's later works, including The Wealth of Nations , A Treatise on Public Opulence , Essays on Philosophical Subjects , and Lectures on...

, written in 1759. In this work, however, the idea of the market is not discussed. By the time he wrote The Wealth of Nations
The Wealth of Nations
An Inquiry into the Nature and Causes of the Wealth of Nations, generally referred to by its shortened title The Wealth of Nations, is the magnum opus of the Scottish economist and moral philosopher Adam Smith...

 in 1776, Smith had studied the economic models of the French Physiocrats
Physiocrats
Physiocracy is an economic theory developed by the Physiocrats, a group of economists who believed that the wealth of nations was derived solely from the value of "land agriculture" or "land development." Their theories originated in France and were most popular during the second half of the 18th...

 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
Neoclassical economics
Neoclassical economics is a term variously used for approaches to economics focusing on the determination of prices, outputs, and income distributions in markets through supply and demand, often mediated through a hypothesized maximization of utility by income-constrained individuals and of profits...

 . 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 nacent during Smith's life, such as large-scale industry, finance
Finance
"Finance" is often defined simply as the management of money or “funds” management Modern finance, however, is a family of business activity that includes the origination, marketing, and management of cash and money surrogates through a variety of capital accounts, instruments, and markets created...

, and advertising reduce its effectiveness. . Economists who emphasise the distorting effects of these forces include Marx and Keynes and Stiglitz
Joseph E. Stiglitz
Joseph Eugene Stiglitz, ForMemRS, FBA, is an American economist and a professor at Columbia University. He is a recipient of the Nobel Memorial Prize in Economic Sciences and the John Bates Clark Medal . He is also the former Senior Vice President and Chief Economist of the World Bank...

.

"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.
Smith may have borrowed the expression from Shakespeare's Macbeth
Macbeth
The Tragedy of Macbeth is a play by William Shakespeare about a regicide and its aftermath. It is Shakespeare's shortest tragedy and is believed to have been written sometime between 1603 and 1607...

. The expression is used in a dialogue in which Macbeth informs Lady Macbeth of his fears for their safety. Macbeth asks the night to destroy his enemy "with thy bloody and invisible hand" (Act 3, Scene 2).

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. Smith himself participated in such generalization, as is already evident in his allusion to "many other cases" quoted above.

Milton Friedman
Milton Friedman
Milton Friedman was an American economist, statistician, academic, and author who taught at the University of Chicago for more than three decades...

, a Nobel Prize
Nobel Prize
The Nobel Prizes are annual international awards bestowed by Scandinavian committees in recognition of cultural and scientific advances. The will of the Swedish chemist Alfred Nobel, the inventor of dynamite, established the prizes in 1895...

 winner in economics, called Smith's Invisible Hand "the possibility of cooperation without coercion
Coercion
Coercion is the practice of forcing another party to behave in an involuntary manner by use of threats or intimidation or some other form of pressure or force. In law, coercion is codified as the duress crime. Such actions are used as leverage, to force the victim to act in the desired way...

."

Notice that the Invisible Hand is here considered a "natural inclination", not yet a social mechanism as it was later classified by Leon Walras
Léon Walras
Marie-Esprit-Léon Walras was a French mathematical economist associated with the creation of the general equilibrium theory.-Life and career:...

 and Vilfredo Pareto
Vilfredo Pareto
Vilfredo Federico Damaso Pareto , born Wilfried Fritz Pareto, was an Italian engineer, sociologist, economist, political scientist and philosopher. He made several important contributions to economics, particularly in the study of income distribution and in the analysis of individuals' choices....

.

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 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. 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.

It also works as a balancing mechanism. For example, the inhabitants of a poor country will be willing to work very cheaply, so entrepreneurs can make great profits by building factories in poor countries. Because they increase the demand for labor, they will increase its price; further, because the new producers also become consumers, local businesses must hire more people to provide the things they want to consume. As this process continues, the labor prices eventually rise to the point where there is no advantage for the foreign countries doing business in the formerly poor country. Overall, this mechanism causes the local economy to function on its own.

In The Wealth of Nations, Smith provides an example that illustrates the principle:
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, Professor 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.

Understood as a metaphor


Smith uses the metaphor
Metaphor
A metaphor is a literary figure of speech that uses an image, story or tangible thing to represent a less tangible thing or some intangible quality or idea; e.g., "Her eyes were glistening jewels." Metaphor may also be used for any rhetorical figures of speech that achieve their effects via...

 in the context of an argument against protectionism
Protectionism
Protectionism is the economic policy of restraining trade between states through methods such as tariffs on imported goods, restrictive quotas, and a variety of other government regulations designed to allow "fair competition" between imports and goods and services produced domestically.This...

 and government regulation of markets, but it is based on very broad principles developed by Bernard Mandeville, Bishop Butler
Bishop Butler
Bishop Butler may refer to:*Joseph Butler , Anglican Bishop of Bristol and Durham*John Butler, 12th Baron Dunboyne , Roman Catholic Bishop of Cork...

, Lord Shaftesbury, and Francis Hutcheson
Francis Hutcheson (philosopher)
Francis Hutcheson was a philosopher born in Ireland to a family of Scottish Presbyterians who became one of the founding fathers of the Scottish Enlightenment....

. 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
The Fable of the Bees
The Fable of The Bees: or, Private Vices, Public Benefits is a book by Bernard Mandeville, consisting of the poem The Grumbling Hive: or, Knaves turn’d Honest and prose discussion of it. The poem was published in 1705 and the book first appeared in 1714...

 (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
The Theory of Moral Sentiments
The Theory of Moral Sentiments was written by Adam Smith in 1759. It provided the ethical, philosophical, psychological, and methodological underpinnings to Smith's later works, including The Wealth of Nations , A Treatise on Public Opulence , Essays on Philosophical Subjects , and Lectures on...

, 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
Tragedy of the commons
The tragedy of the commons is a dilemma arising from the situation in which multiple individuals, acting independently and rationally consulting their own self-interest, will ultimately deplete a shared limited resource, even when it is clear that it is not in anyone's long-term interest for this...

 is an example where self-interest tends to bring an unwanted result.

Moreover, a free market arguably provides numerous opportunities for maximizing one’s own profit at the expense (rather than for the benefit) of others. The tobacco industry
Tobacco industry
The tobacco industry comprises those persons and companies engaged in the growth, preparation for sale, shipment, advertisement, and distribution of tobacco and tobacco-related products. It is a global industry; tobacco can grow in any warm, moist environment, which means it can be farmed on all...

 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


Since Smith’s time, the principle of the invisible hand has been further incorporated into economic theory. Leon Walras
Léon Walras
Marie-Esprit-Léon Walras was a French mathematical economist associated with the creation of the general equilibrium theory.-Life and career:...

 developed a four-equation general equilibrium
General equilibrium
General equilibrium theory is a branch of theoretical economics. It seeks to explain the behavior of supply, demand and prices in a whole economy with several or many interacting markets, by seeking to prove that a set of prices exists that will result in an overall equilibrium, hence general...

 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
Vilfredo Pareto
Vilfredo Federico Damaso Pareto , born Wilfried Fritz Pareto, was an Italian engineer, sociologist, economist, political scientist and philosopher. He made several important contributions to economics, particularly in the study of income distribution and in the analysis of individuals' choices....

 used an edgeworth box
Edgeworth box
In economics, an Edgeworth box, named after Francis Ysidro Edgeworth, is a way of representing various distributions of resources. Edgeworth made his presentation in his book Mathematical Psychics: An Essay on the Application of Mathematics to the Moral Sciences, 1881...

 contact line to illustrate a similar social optimality.

Ludwig von Mises
Ludwig von Mises
Ludwig Heinrich Edler von Mises was an Austrian economist, philosopher, and classical liberal who had a significant influence on the modern Libertarian movement and the "Austrian School" of economic thought.-Biography:-Early life:...

, in Human Action
Human Action
Human Action: A Treatise on Economics is the magnum opus of the Austrian economist Ludwig von Mises. It presents a case for laissez-faire capitalism based on Mises' praxeology, or rational investigation of human decision-making. It rejects positivism within economics...

 (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
Robert Nozick
Robert Nozick was an American political philosopher, most prominent in the 1970s and 1980s. He was a professor at Harvard University. He is best known for his book Anarchy, State, and Utopia , a right-libertarian answer to John Rawls's A Theory of Justice...

 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
Natural selection
Natural selection is the nonrandom process by which biologic traits become either more or less common in a population as a function of differential reproduction of their bearers. It is a key mechanism of evolution....

. In turn, Daniel Dennett
Daniel Dennett
Daniel Clement Dennett is an American philosopher, writer and cognitive scientist whose research centers on the philosophy of mind, philosophy of science and philosophy of biology, particularly as those fields relate to evolutionary biology and cognitive science. He is currently the Co-director of...

 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). See also Social Darwinism
Social Darwinism
Social Darwinism is a term commonly used for theories of society that emerged in England and the United States in the 1870s, seeking to apply the principles of Darwinian evolution to sociology and politics...

.

Tawney's interpretation


Christian socialist
Christian socialism
Christian socialism generally refers to those on the Christian left whose politics are both Christian and socialist and who see these two philosophies as being interrelated. This category can include Liberation theology and the doctrine of the social gospel...

 R. H. Tawney
R. H. Tawney
Richard Henry Tawney was an English economic historian, social critic, Christian socialist, and an important proponent of adult education....

 saw Smith as putting a name on an older idea:

Home bias interpretation



Noam Chomsky
Noam Chomsky
Avram Noam Chomsky is an American linguist, philosopher, cognitive scientist, and activist. He is an Institute Professor and Professor in the Department of Linguistics & Philosophy at MIT, where he has worked for over 50 years. Chomsky has been described as the "father of modern linguistics" and...

 argues that Smith (and more specifically David Ricardo
David Ricardo
David Ricardo was an English political economist, often credited with systematising economics, and was one of the most influential of the classical economists, along with Thomas Malthus, Adam Smith, and John Stuart Mill. He was also a member of Parliament, businessman, financier and speculator,...

) used the phrase to mean a "home bias" for investing domestically in opposition to outsourcing
Offshore outsourcing
Offshore outsourcing is the practice of hiring an external organization to perform some business functions in a country other than the one where the products or services are actually developed or manufactured. It can be contrasted with offshoring, in which the functions are performed in a foreign...

 production and neoliberalism
Neoliberalism
Neoliberalism is a market-driven approach to economic and social policy based on neoclassical theories of economics that emphasizes the efficiency of private enterprise, liberalized trade and relatively open markets, and therefore seeks to maximize the role of the private sector in determining the...

. In this interpretation, Smith meant that merchants in the act of "preferring the support of domestic to that of foreign industry" as if "led by an invisible hand," benefited society.

The implications are that Smith saw outsourcing and neoliberalism as damaging to society and "the invisible hand" helped steer society away from these things.However, even in this view Smith's objection is on practical grounds and outsourcing would still be allowed in a market system.

Other uses of the phrase by Smith


Only in The History of Astronomy (written before 1758) Smith speaks of the invisible hand, to which ignorants refer to explain natural phenomena otherwise unexplainable:

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.

In The Theory of Moral Sentiments
The Theory of Moral Sentiments
The Theory of Moral Sentiments was written by Adam Smith in 1759. It provided the ethical, philosophical, psychological, and methodological underpinnings to Smith's later works, including The Wealth of Nations , A Treatise on Public Opulence , Essays on Philosophical Subjects , and Lectures on...

 (1759) and in The Wealth of Nations
The Wealth of Nations
An Inquiry into the Nature and Causes of the Wealth of Nations, generally referred to by its shortened title The Wealth of Nations, is the magnum opus of the Scottish economist and moral philosopher Adam Smith...

 (1776) Adam Smith speaks of an invisible hand, never of the invisible hand. In The Theory of Moral Sentiments Smith uses the concept to sustain a “trickling down” theory, a concept also used in neoclassical development theory: The gluttony of the rich serves to feed the poor.

The rich … consume little more than the poor, and in spite of their natural selfishness and rapacity, though they mean only their own conveniency, though the sole end which they propose from the labours of all the thousands whom they employ, be the gratification of their own vain and insatiable desires, they divide with the poor the produce of all their improvements. They 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, and afford means to the multiplication of the species. When Providence divided the earth among a few lordly masters, it neither forgot nor abandoned those who seemed to have been left out in the partition. These last too enjoy their share of all that it produces. In what constitutes the real happiness of human life, they are in no respect inferior to those who would seem so much above them. In ease of body and peace of mind, all the different ranks of life are nearly upon a level, and the beggar, who suns himself by the side of the highway, possesses that security which kings are fighting for (emphasis added).

Smith’s visit to France and his acquaintance to the French Économistes (known as Physiocrats) changed his views from micro-economic optimisation to macro-economic growth as the end of Political Economy
Political economy
Political economy originally was the term for studying production, buying, and selling, and their relations with law, custom, and government, as well as with the distribution of national income and wealth, including through the budget process. Political economy originated in moral philosophy...

. So the invisible hand in The Theory of Morals Sentiments is denounced in the Wealth of Nations as unproductive labour
Unproductive labour in economic theory
Unproductive labour is labour which does not further the end of the system. Therefore this concept has sense only with reference to a determined system. In classical economics the end is growth and development, in Marxian economics the end is capitalistic profit and in business the end is to place...

. Walker
Amasa Walker
Amasa Walker was an American economist and United States Representative, and was the father of Francis Amasa Walker.-Biography:...

, the first president (1885 to 92) of the American Economic Association
American Economic Association
The American Economic Association, or AEA, is a learned society in the field of economics, headquartered in Nashville, Tennessee. It publishes one of the most prestigious academic journals in economics: the American Economic Review...

, concurred:

The domestic servant … is not employed as a means to his master's profit. His master's income is not due in any part to his employment; on the contrary, that income is first acquired … and in the amount of the income is determined whether the servant shall be employed or not, while to the full extent of that employment the income is diminished. As Adam Smith expresses it "a man grows rich by employing a multitude of manufacturers; he grows poor by maintaining a multitude of menial servants."

Smith’s theoretical U-turn from a micro-economical to a macro-economical view is not reflected in The Wealth of Nations. Large parts of this book are retaken from Smith’s lectures before his visit to France. So one must distinguish in The Wealth of Nations
The Wealth of Nations
An Inquiry into the Nature and Causes of the Wealth of Nations, generally referred to by its shortened title The Wealth of Nations, is the magnum opus of the Scottish economist and moral philosopher Adam Smith...

 a micro-economical and a macro-economical Adam Smith. Whether Smith’s quotation of an invisible hand in the middle of his work is a micro-economical statement or a macro-economical statement condemning monopolies and government interferences as in the case of tariffs and patents is debatable.

Abusing Smith’s statement of an invisible hand


That part of Smith’s The Wealth of Nations that belongs to his views prior to his acquaintance to the French Économistes (Physiocrats) can rightly be claimed by neo-classical economists as their forerunner. The earlier Smith and his teacher Hutcheson
Francis Hutcheson (philosopher)
Francis Hutcheson was a philosopher born in Ireland to a family of Scottish Presbyterians who became one of the founding fathers of the Scottish Enlightenment....

 belong to a micro-economic strain in line with Aristotle
Aristotle
Aristotle was a Greek philosopher and polymath, a student of Plato and teacher of Alexander the Great. His writings cover many subjects, including physics, metaphysics, poetry, theater, music, logic, rhetoric, linguistics, politics, government, ethics, biology, and zoology...

 and Puffendorf
Samuel von Pufendorf
Baron Samuel von Pufendorf was a German jurist, political philosopher, economist, statesman, and historian. His name was just Samuel Pufendorf until he was ennobled in 1684; he was made a Freiherr a few months before his death in 1694...

. An agonising neoclassical theory had been reanimated in the 30th [?] in Chicago against dominant Institutional economics
Institutional economics
Institutional economics focuses on understanding the role of the evolutionary process and the role of institutions in shaping economic behaviour. Its original focus lay in Thorstein Veblen's instinct-oriented dichotomy between technology on the one side and the "ceremonial" sphere of society on the...

, so claims to be the heirs of Adam Smith are partially justified. In this line of reading Smith, already Samuelson indicates that Smith should be an American citizen:

And at the bicentennial celebration of The Wealth of Nations 1976 at Glasgow University, Stigler
George Stigler
George Joseph Stigler was a U.S. economist. He won the Nobel Memorial Prize in Economic Sciences in 1982, and was a key leader of the Chicago School of Economics, along with his close friend Milton Friedman....

 (from Chicago) was happy to declare: "I bring you greetings from Adam Smith who is alive and well and living in Chicago".

But this equation of Smith’s invisible hand statement and the American-led neoclassical General equilibrium theory is obtained only by curtailing Smith. An example is Paul Samuelson
Paul Samuelson
Paul Anthony Samuelson was an American economist, and the first American to win the Nobel Memorial Prize in Economic Sciences. The Swedish Royal Academies stated, when awarding the prize, that he "has done more than any other contemporary economist to raise the level of scientific analysis in...

’s Economics
Economics (textbook)
Economics is an influential introductory textbook by American economists Paul Samuelson and William Nordhaus. It was first published in 1948, and has appeared in nineteen different editions, the most recent in 2010. It was the best selling economics textbook for many decades and still remains...

 – published since 1948 with over 4 million copies. It mentions Smith’s invisible hand seven times. But the use Samuelson makes of Smith’s invisible hand is stated best by comparing Smith’s text with how it is cited in excerpts by Samuelson (Smith’s text, with Samuelson’s selections in bold):

“As every individual … therefore, endeavours as much as he can, both to employ his capital in the support of domestic industry, and so to direct that industry that its produce maybe of the greatest value; 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 general [Smith said “public” not general] 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.

Smith nowhere wrote about "the invisible hand of the market" as is commonly assumed. He just used the phrase "invisible hand". Furthermore, the qualifier, "By preferring the support of domestic to that of a foreign industry," is not quoted when referring to the "invisible hand" sentence.

Joseph E. Stiglitz


The Nobel Prize-winning economist Joseph E. Stiglitz
Joseph E. Stiglitz
Joseph Eugene Stiglitz, ForMemRS, FBA, is an American economist and a professor at Columbia University. He is a recipient of the Nobel Memorial Prize in Economic Sciences and the John Bates Clark Medal . He is also the former Senior Vice President and Chief Economist of the World Bank...

, says: "the reason that the invisible hand often seems invisible is that it is often not there." Stiglitz explains his position:

Adam Smith, the father of modern economics, is often cited as arguing for the "invisible hand" and free market
Free market
A free market is a competitive market where prices are determined by supply and demand. However, the term is also commonly used for markets in which economic intervention and regulation by the state is limited to tax collection, and enforcement of private ownership and contracts...

s: 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 long understood environmental externalities. Markets, by themselves, produce too much pollution. Markets, by themselves, also produce too little basic research. (The government was responsible for financing most of the important scientific breakthroughs, including the internet and the first telegraph line, and many bio-tech advances.) 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 differs from time to time and place to place.

Noam Chomsky


Noam Chomsky
Noam Chomsky
Avram Noam Chomsky is an American linguist, philosopher, cognitive scientist, and activist. He is an Institute Professor and Professor in the Department of Linguistics & Philosophy at MIT, where he has worked for over 50 years. Chomsky has been described as the "father of modern linguistics" and...

, while acknowledging the intelligence of Smith's thesis, criticizes how the term of the "invisible hand" has been used. He also explains:
Throughout history, Adam Smith observed, we find the workings of "the vile maxim of the masters of mankind": "All for ourselves, and nothing for other People." He had few illusions about the consequences. The invisible hand, he wrote, destroys the possibility of a decent human existence "unless government takes pains to prevent" this outcome, as must be assured in "every improved and civilized society." It destroys community, the environment, and human values generally—and even the masters themselves, which is why the business classes have regularly called for state intervention to protect them from market forces. (...)


and

Rather interestingly these issues were foreseen by the great founders of modern economics, Adam Smith for example. He recognized and discussed what would happen to Britain if the masters adhered to the rules of sound economics -- what's now called neoliberalism. He warned that if British manufacturers, merchants, and investors turned abroad, they might profit but England would suffer. However, he felt that this wouldn't happen because the masters would be guided by a home bias. So as if by an invisible hand England would be spared he ravages of economic rationality. That passage is pretty hard to miss. It's the only occurrence of the famous phrase "invisible hand" in Wealth of Nations, namely in a critique of what we call neoliberalism.

Stephen LeRoy


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:
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.


Among the conditions that were assumed, and which have since fallen into question, are that information asymmetries
Information asymmetry
In economics and contract theory, information asymmetry deals with the study of decisions in transactions where one party has more or better information than the other. This creates an imbalance of power in transactions which can sometimes cause the transactions to go awry, a kind of market failure...

, incentive distortions, and the failure of government regulators to serve as a check.

See also


Books
  • Capitalism: The Unknown Ideal
    Capitalism: the Unknown Ideal
    Capitalism: The Unknown Ideal is a collection of essays, mostly by Ayn Rand, with additional essays by her associates Nathaniel Branden, Alan Greenspan and Robert Hessen. The book focuses on the moral nature of laissez-faire capitalism and private property...

     by Ayn Rand
  • Essays on Philosophical Subjects
    Essays on Philosophical Subjects
    Essays on Philosophical Subjects, by the Scottish economist Adam Smith, is a history of astronomy down to Smith's own era, plus some thoughts on ancient physics and metaphysics....

     by Adam Smith
    Adam Smith
    Adam Smith was a Scottish social philosopher and a pioneer of political economy. One of the key figures of the Scottish Enlightenment, Smith is the author of The Theory of Moral Sentiments and An Inquiry into the Nature and Causes of the Wealth of Nations...

  • I, Pencil
    I, Pencil
    "I, Pencil" is an essay by Leonard Read. The full title is "I, Pencil: My Family Tree as Told to Leonard E. Read" and it was first published in the December 1958 issue of The Freeman. It was reprinted in The Freeman in May 1996 and as a pamphlet entitled "I... Pencil" in May 1998. In the reprint,...

     by Leonard Read
    Leonard Read
    Leonard E. Read was an American economist and the founder of the Foundation for Economic Education, which was the first modern free market think tank in the United States....

  • The National Gain
    The National Gain
    The National Gain is the main work of the Finnish scientist, philosopher and politician Anders Chydenius, published in 1765...

     by Anders Chydenius
    Anders Chydenius
    Anders Chydenius was the leading classical liberal of Nordic history. Born in Sotkamo, Ostrobothnia, Sweden and having studied under Pehr Kalm at the Royal Academy of Åbo, Chydenius became a priest, Enlightenment philosopher and member of the Swedish Riksdag of the Estates.The world's first...

  • The Theory of Moral Sentiments
    The Theory of Moral Sentiments
    The Theory of Moral Sentiments was written by Adam Smith in 1759. It provided the ethical, philosophical, psychological, and methodological underpinnings to Smith's later works, including The Wealth of Nations , A Treatise on Public Opulence , Essays on Philosophical Subjects , and Lectures on...

     by Adam Smith
  • The Visible Hand
    The Visible Hand
    The Visible Hand: The Managerial Revolution in American Business is a 1977 business book by Alfred Chandler. The title is a play on Adam Smith's famous notion of the invisible hand....

     by Alfred Chandler
  • The Wealth of Nations
    The Wealth of Nations
    An Inquiry into the Nature and Causes of the Wealth of Nations, generally referred to by its shortened title The Wealth of Nations, is the magnum opus of the Scottish economist and moral philosopher Adam Smith...

     by Adam Smith

Articles
  • Corporation
    Corporation
    A corporation is created under the laws of a state as a separate legal entity that has privileges and liabilities that are distinct from those of its members. There are many different forms of corporations, most of which are used to conduct business. Early corporations were established by charter...

  • Emergence
    Emergence
    In philosophy, systems theory, science, and art, emergence is the way complex systems and patterns arise out of a multiplicity of relatively simple interactions. Emergence is central to the theories of integrative levels and of complex systems....

  • Enlightened self-interest
    Enlightened self-interest
    Enlightened self-interest is a philosophy in ethics which states that persons who act to further the interests of others , ultimately serve their own self-interest....

  • Free price system
    Free price system
    A free price system or free price mechanism is an economic system where prices are set by the interchange of supply and demand, with the resulting prices being understood as signals that are communicated between producers and consumers which serve to guide the production and distribution of...

  • Laissez-faire
    Laissez-faire
    In economics, laissez-faire describes an environment in which transactions between private parties are free from state intervention, including restrictive regulations, taxes, tariffs and enforced monopolies....

  • Market fundamentalism
    Market fundamentalism
    Market fundamentalism is a pejorative term applied to a strong belief in the ability of laissez-faire or free market economic views or policies to solve economic and social problems....

  • Objectivism
    Objectivism (Ayn Rand)
    Objectivism is a philosophy created by the Russian-American philosopher and novelist Ayn Rand . Objectivism holds that reality exists independent of consciousness, that human beings have direct contact with reality through sense perception, that one can attain objective knowledge from perception...

  • Opportunity cost
    Opportunity cost
    Opportunity cost is the cost of any activity measured in terms of the value of the best alternative that is not chosen . It is the sacrifice related to the second best choice available to someone, or group, who has picked among several mutually exclusive choices. The opportunity cost is also the...

  • Partial knowledge
    The Use of Knowledge in Society
    "The Use of Knowledge in Society" is a scholarly article written by economist Friedrich Hayek, first published in the September 1945 issue of The American Economic Review Written as a rebuttal to fellow economist Oskar R...

  • Philosophy of social science
    Philosophy of social science
    The philosophy of social science is the study of the logic and method of the social sciences, such as sociology, anthropology and political science...

  • Rational egoism
    Rational egoism
    In ethical philosophy, rational egoism is the principle that an action is rational if and only if it maximizes one's self-interest. The view is a normative form of egoism. However, it is different from other forms of egoism, such as ethical egoism and psychological egoism...

  • Rational selfishness
  • Spontaneous order
    Spontaneous order
    Spontaneous order, also known as "self-organization", is the spontaneous emergence of order out of seeming chaos. It is a process found in physical, biological, and social networks, as well as economics, though the term "self-organization" is more often used for physical and biological processes,...


External links