Adam Smith is considered, today, to be the father of modern economics. He was a crucial figure during the enlightenment period and his two major works, “The Theory of Moral Sentiments” and “The Wealth of Nations” are still vastly influential in the fields of economics, philosophy, political theory, and sociology. A term often used today in defense of free markets and neoliberal policies is “the invisible hand.” It is said this short phrase, popularized by Adam Smith, explains why markets work so well. But what does it mean?
Well for such a prominent phrase in modern economics it was only used three times in all of Smith’s work. This is worth noting because even though this fact is sometimes used by capitalism’s opponents against the term and it’s theoretical worth I think it is a positive aspect of it. The fact that Smith didn’t treat the hand, or the market, as dogma and instead resolutely defended capitalism from a logical, in-depth, but unassuming position shows there was more to his contributions than just a short phrase. Even though I am going to focus on this one phrase here because of all it says about markets and how they relate to human interaction, I urge you to dig deeper and read more of Smith’s brilliant work. He isn’t the father of modern economics for nothing.
To my audience reading this on their computer, which is all of you, through what process did you obtain your computer? What about the shirt you are wearing on your back? The cell phone in your pocket? These are luxuries we in the developed world enjoy but does anyone take a second to really think about why we are so lucky to have them? Well there are hundreds of different reasons I could cite right now but in regards to the actual exchange that occurred when you acquired your computer, shirt and phone, the invisible hand explains what is responsible for our enjoyment of first-world luxuries. In short what is responsible is those human characteristics that you are told are bad, evil, maybe sinful, and should always reject. Those awful and harmful feelings of greed, selfishness and self-interest are actually the reason I have the ability to type this article on my computer right now. They are responsible for making the exchange that took place when I bought my computer possible.
Do you think it was by the benevolence and selflessness that the clerk at Best Buy assisted me in finding my computer? Was it by the care and generosity of Bill Gates that he created the technology for my computer to exist? If so why didn’t he just give away the technology once he invented it? Why did he charge people money for it? The truth is self-interest is why Bill Gates charged for his new product, and why he invented it in the first place. Without greed he wouldn’t have bothered to create something. By acting in a self-interested manner Bill Gates incidentally created something that made all of society much better off. In “The Theory of Moral Sentiments” Smith puts it like this, “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…”
Rather than by the compassion and kindness of the shirt maker or the phone maker, it was by their greed that they created those things and sold them to you. In the same way it wasn’t by my love for shirt makers that I bought the shirt. It was my want, or greed for a t-shirt. In this way both the shirt maker and I cooperated and helped each other, while also helping society. Milton Friedman called the invisible hand “the possibility of cooperation without coercion.”
You might be saying ok, people are made better off through the greedy actions of the members of society in a market situation, but why does that make it preferable to government action? Wouldn’t government still be better, or at least equally good at, running the economy? I think you know my answer. What the invisible hand has to say about the free market and human interaction is that markets channel humanity’s natural tendencies of selfishness into a productive engine that makes life better for everyone. Regardless of the doer’s intentions, they are promoting human happiness by engaging in market activities. This is one of the key selling points of capitalism. It doesn’t require some massive shift in man’s nature to work. It doesn’t rely on people to suddenly become inherently selfless creatures to function.
On the other hand government does require those things. If officials have greedy intentions, it’s easy as pie for them to abuse the system in their favor. If they have good, honest intentions they might be able to use their power for good. But looking at the history of human civilization, which is more likely to be the case? Looking at the past weeks’ news stories which do you think is the case? Getting government officials in power that have virtuous motives is a utopian pipe dream. The same is the case for influential CEOs, but capitalism doesn’t require that to work well and government does.
Next week I tackle Mises’ calculation problem!
Follow me on twitter @corymassimino or you can email me at [email protected]