Invisible hand facts for kids

The invisible hand is a cool idea from a Scottish thinker named Adam Smith. It's like a metaphor (a way of describing something by calling it something else) that explains how people, by trying to help themselves, can accidentally help society too.

Imagine a baker who wants to make money. They bake delicious bread. They aren't thinking, "I want to feed my town!" They're thinking, "I want to sell bread and earn cash." But by making bread for themselves, they end up feeding many people in their community. That's the "invisible hand" at work!

Adam Smith first talked about this idea in his book Theory of Moral Sentiments in 1759. But it became really famous from his other big book, The Wealth of Nations. In The Wealth of Nations, he only mentioned the exact phrase once, when talking about rules on imports.

Other thinkers before Smith, like Anders Chydenius, had similar ideas. They wanted to show that society could work well even without strict old rules from the past.

What is the Invisible Hand?

The "invisible hand" suggests that when people act in their own self-interest (meaning they do what's best for themselves), it can lead to good things for everyone, even if that wasn't their plan. It's like an unseen force guiding the market.

This idea is a big reason why some people believe in laissez-faire economics. This means letting the economy run freely with very little government involvement. The main debate in economics often comes down to how powerful this "invisible hand" really is. Some think it works perfectly, while others believe that things like big businesses or advertising can make it less effective.

It's important to know that Adam Smith himself had some concerns. He didn't always think that unchecked self-interest was a good thing. Some experts even say that the modern understanding of the "invisible hand" was made popular much later by someone named Paul Samuelson.

Ideas Before Adam Smith

In the Islamic World

Some people believe that an early idea similar to the "invisible hand" appeared in the 600s. The Islamic prophet Muhammad was asked to set prices for goods that had become very expensive. He replied that it is God who makes prices go up and down. This has been seen as an early example of believing in a free market where even leaders shouldn't interfere with prices.

Anders Chydenius's Thoughts

Anders Chydenius was a scientist and politician from Finland (which was part of Sweden back then). In 1765, he wrote a book called The National Gain. In it, he explained ideas about free markets, like free trade and industry. He also described something very similar to what Adam Smith later called the "invisible hand." For example, Chydenius argued that government help for exports could actually harm the local economy.

Adam Smith's Ideas

The Theory of Moral Sentiments

Adam Smith first wrote about the "invisible hand" in his book The Theory of Moral Sentiments (1759). He used it to describe a rich landlord. This landlord was selfish and only thought about himself and his huge fields. He imagined eating all the food himself.

However, Smith explained that the landlord's stomach couldn't possibly hold all the food he desired. So, he had to give the rest to the people who worked for him. These workers prepared his food, built his palace, and provided his fancy items. Even though the landlord only cared about his own comfort and desires, his actions ended up sharing the necessities of life with many poor people.

Smith wrote that the rich are "led by an invisible hand to make nearly the same distribution of the necessities of life, which would have been made, had the earth been divided into equal portions among all its inhabitants." This means that without even planning it, the rich helped society and allowed more people to live.

It's interesting that in this book, Smith wasn't just praising the "invisible hand." He also questioned how wealth was shared. He pointed out that the poor only got what they needed after the rich had satisfied their own desires.

The Wealth of Nations

The famous phrase "invisible hand" appears only once in Smith's other major book, The Wealth of Nations. This happens in a section about rules on importing goods from other countries.

Smith started by saying that everyone tries to find the best way to use their money or resources. They are looking out for their own benefit, not society's. But he believed that looking out for oneself naturally leads to choices that are also good for society.

He explained that people usually prefer to invest their money close to home. This is because it feels less risky and costs less. So, a merchant would rather trade within their own country than with foreign countries, if the profits are similar.

Smith argued that when money is used in local businesses, it helps the country's industries. It creates more jobs and income for people in that country. This also means there are more resources for things like national defense, which helps everyone. So, what's best for an individual (investing locally) also turns out to be best for their country.

Smith then said that people will naturally invest in industries that create the most value. Business owners want to make the most profit, so they will put their money where it will produce the most valuable goods or services.

Finally, Smith brought it all together. He said that because everyone tries to use their money in the best way for themselves, they also make the country's total wealth as great as possible. He wrote, "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."

In simple terms, the "invisible hand" means that when people act selfishly, it can accidentally lead to good things for everyone. Smith also believed that government officials shouldn't try to tell people how to use their money. He thought individuals knew best how to invest their own capital.

Other Times Smith Used the Phrase

Adam Smith used the phrase "invisible hand" a few times in his writings, but not always in the same way.

In an earlier work called The History of Astronomy, he talked about "the invisible hand" (with "the") to describe how people used to explain natural events they didn't understand, like why fire burns or water refreshes. They would say it was the work of a god like Jupiter.

In The Theory of Moral Sentiments and The Wealth of Nations, he used "an invisible hand" (with "an"). In The Theory of Moral Sentiments, he used it to explain how the rich, even in their greed, end up sharing wealth. He said the rich "consume little more than the poor" and, despite their selfishness, they "divide with the poor the produce of all their improvements." They are "led by an invisible hand" to share resources, almost as if the earth had been divided equally.

Later, after visiting France, Smith's ideas shifted more towards how a country's economy grows as a whole. He started to see the rich landlord's excessive spending, which he mentioned in The Theory of Moral Sentiments, as "unproductive labor" in The Wealth of Nations. This means it didn't help the economy grow.

Understood as a Metaphor

The "invisible hand" is a metaphor that Adam Smith used to argue against too much government control over markets. It's based on ideas from other thinkers like Bernard Mandeville and Francis Hutcheson.

Generally, the "invisible hand" can describe any individual action that has unexpected, good results for the community, especially when no one planned it.

• Bernard Mandeville thought that even private "vices" (bad habits) could lead to public benefits. For example, people wanting fancy things might create jobs for others.
• Lord Shaftesbury believed that acting in your own rational self-interest would naturally lead to good results for society. He thought there was a "Will of Nature" that kept things balanced.
• Francis Hutcheson agreed that public and private interests could align, but he thought it was due to a "moral sense" or intuition, not just self-interest.

Smith developed his own version, where different human motivations combine to create good for everyone.

It's important to remember that Smith didn't say all selfish actions always benefit society. He just suggested that in a free market, people usually make things that others want. Sometimes, self-interest can lead to bad results, like the tragedy of the commons, where everyone acts selfishly and a shared resource gets ruined.

Some thinkers, like Robert Nozick, compare the "invisible hand" to other ideas, such as natural selection in biology. They see it as a general principle where unplanned actions lead to organized outcomes.

Criticisms of the Invisible Hand

Joseph E. Stiglitz's View

Joseph E. Stiglitz, a Nobel Prize-winning economist, famously said: "the reason that the invisible hand often seems invisible is that it is often not there."

He explains that Adam Smith believed businesses trying to make money would be guided by an "invisible hand" to do what's best for the world. But Stiglitz argues that Smith himself knew there were limits to free markets. Modern research has shown even more reasons why free markets alone don't always lead to the best outcomes.

Stiglitz points out "externalities"—situations where one person's actions affect others, but they don't pay for the impact (like pollution) or get paid for the good (like basic research). For example, markets on their own create too much pollution and not enough basic research. Governments often fund important scientific discoveries, like the internet.

He says that these problems are common, especially when people don't have perfect information or perfect ways to manage risks. So, government plays a key role in regulating banks, ensuring contracts, and protecting property rights. The real challenge, Stiglitz believes, is finding the right balance between the market and government. Both are needed and can help each other.

Noam Chomsky's Perspective

Noam Chomsky, a well-known thinker, suggests that Adam Smith (and David Ricardo) sometimes used the "invisible hand" to talk about a preference for investing money at home instead of sending jobs overseas.

Chomsky says that Smith worried about what would happen if British businesses invested all their money abroad. Smith thought they might make more profit, but Britain itself would suffer. However, Smith believed this wouldn't happen because business owners would prefer to invest at home, as if guided by an "invisible hand." Chomsky points out that this is the only time the famous phrase appears in The Wealth of Nations, and it's in a section that criticizes what we now call neoliberalism (a focus on free markets and less government).

Stephen LeRoy's Critique

Stephen LeRoy, an economics professor, also questioned the "invisible hand." He said that the most important idea in economics, first from Adam Smith, is that competitive markets do a good job of sharing resources.

However, after the 2008 financial crisis, many people started debating the right balance between markets and government. Some scholars wondered if the conditions Smith assumed were true for today's economies. LeRoy's critique suggests that modern economies might be too complex for the "invisible hand" to work as perfectly as Smith imagined.

John D. Bishop's Argument

John D. Bishop, a professor, suggested that the "invisible hand" might apply differently to business people than to society as a whole. In his 1995 article, he argued that Smith might have contradicted himself.

Bishop pointed out that the interests of business people can clash with the interests of society. He said that business people often pursue their own goals, sometimes at the expense of the public good. He also noted that Smith's The Wealth of Nations contains ideas that "the interest of merchants and manufacturers were fundamentally opposed of society in general." Bishop believes the "invisible hand" argument only applies to investing money in one's own country for profit, not to all self-interested actions outside of business.

Thomas Piketty's View

French economist Thomas Piketty agrees that the "invisible hand" exists and that economic problems can fix themselves over time. However, he notes that these problems can cause long periods of hardship. He believes that non-market solutions, like government help, could solve these issues faster.

For example, Piketty mentions how imbalances in real estate can last for decades. He also brings up the Great Famine of Ireland. He argues that this disaster could have been avoided if food had been sent from Great Britain to the affected areas, instead of waiting for market forces to fix the problem.

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