The Real Meaning of Adam Smith’s Invisible Hand

Modern economists would attribute pretty much any market function to the mystical “invisible hand” that Adam Smith wrote about. In fact it’s been argued that the core message of Smith’s “The Wealth of Nations” was the argument about the invisible hand of the free market. Being the bad business student that I am, I decided to actually read Adam Smith instead of just worship him.

The term “invisible hand” only appears once in the entire “Wealth of Nations” and only three times in all of Smith’s writing. The next use we’ll look at it comes in his “Theory of Moral Sentiments” and the third time, curiously enough, in an essay about the history of astronomy. I’ll analyze all three uses to find some coherent meaning to the phrase. 

In “Wealth of Nations” the phrase appears in book IV chapter II. The chapter discusses the relationship between importing foreign goods vs. producing the same goods domestically. Smith argues that the merchant will naturally employ his capital domestically rather than in a foreign market, the reason being that employing it domestically is more beneficial to the merchant and coincidentally the society as a whole. The entire passage appears as follows:

But the annual revenue of every society is always precisely equal to the exchangeable value of the whole annual produce of its industry, or rather is precisely the same thing with that exchangeable value. As every individual, therefore, endeavors 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 may be 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 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 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. 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 be employed in dissuading them from it.

This idea relies heavily on the proposition that it is more beneficial to employ his capital in a domestic market. To prove this idea he imagines a scenario in which a merchant employs goods in a foreign market with equal, or nearly equal, profits generated compared to the domestic market. Smith’s objections to this are fairly straightforward, saying “In the home-trade his capital is never so long out of his sight as it frequently is in the foreign trade of consumption. He can know better the character and situation of the persons whom he trusts, and if he should happen to be deceived, he knows better the laws of the country from which he must seek redress.” This is very much true for any business when Smith was writing, but we can’t put him at fault for not envisioning the modern international corporations that we see today.

adam-smith
Adam Smith was born in Scotland in 1723, and died in 1790 at the age of 67. He is celebrated as the father of modern economics, although saw his most important work to be in moral philosophy.

But Smith doesn’t stop there with the scenario. He writes that “In the carrying trade, the capital of the merchant is, as it were, divided between two foreign countries, and no part of it is every necessarily brought home, or placed under his own immediate view and command.” For this uneasiness at having his capital not under his own control Smith argues that the merchant will actually invest to have his capital brought home, despite the obvious costs of moving it back. He gives an example of an Amsterdam merchant that has stock moving from Lisbon to Konigsberg and vice versa. Eventually the uneasiness in the merchant will build up until he moves the stock back to Amsterdam at a great cost to him, writing that “this necessarily subjects him to a double charge of loading and unloading, as well as to the payment of some duties and customs, yet for the sake of having some part of his capital always under his own view and command, he willingly submits to this extraordinary charge.”

I don’t think I need to go to great lengths to disprove this theory. Advancements in technology alone have rendered this idea obsolete, but the modern corporation puts it to rest. I wouldn’t be surprised if most CEO’s and large business owners never step foot in the stores that their company runs. And there is no need to have a watchful eye over all goods since communication can be instant at any moment. Given this conception, it would certainly seem if the “invisible hand” of the market didn’t exist at all.

The use of the phrase in “Theory of Moral Sentiments” doesn’t differ too much from the previous use. Smith argues that the rich don’t actually consume more than the poor, and thus have more to give the poor. The passage goes:

The rich only select from the heap what is most precious and agreeable. They 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.

There is some ambiguity in this passage, specifically when the rich “divide” with the poor the produce of their improvements. I have seen it argued that this passage indicates that the rich will naturally give charity to the poor, that charity coming from the improvements of land which the poor helped produce anyway. But there is some evidence that Smith is talking literally about fresh produce plucked from the field, and the landlords desire to feed his workers. In the same passage he writes:

It is to no purpose, that 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 that grows upon them. The homely and vulgar proverb, that the eye is larger than the belly, never was more fully verified than with regard to him. The capacity of his stomach bears no proportion to the immensity of his desires, and will receive no more than that of the meanest peasant. The rest he is 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 produce of the soil maintains at all times nearly that number of inhabitants which it is capable of maintaining.

So it seems Smith means literally that the landlord will divide his food with the poor that are working for him, and that by the poor being associated with him they derive from his luxury. If we are to take this quite literally then the concept is outdated, seeing how the proportion of agricultural jobs have shrunk quite dramatically since Smith’s time. But we can extend the concept to analyze further in the modern day, that is, the workers benefiting from the luxury of the owner.

If we look at it in this view, the existence of this invisible hand has at least some validity. Working for a rich company may have some benefits, for instance they will have more resources to supply their offices with the fastest computers and the newest software, something that small independent offices may not have. But there is nothing for certain to say that they will do this. It’s no doubt that there are good corporate jobs and bad corporate jobs, and a huge international corporation cannot possibly care for the well-being of every single employee. In this respect, a small independent office may be more inclined to provide their staff with the newest technology (if it is within their means) simply because they have a more personal relationship with them.

Given what we’ve seen so far it doesn’t seem that an invisible hand exists at all. The main reason being that in the examples given by Smith, the entire concept is rendered obsolete from technological advances.It is only when we extend the metaphor into modern times that it requires disproving. In the example given above, sure the rich may at times give part of the wealth back to the workers but it seems highly variable and inconsistent. And I see no point in calling it an invisible hand if it is not universal. It is also worth noting that Smith never refers to “the” invisible hand, instead he calls it “an” invisible hand. This, I suppose, lends support to the idea that Smith only intended the metaphor to be a descriptor for why men decide their actions.

The third use of the phrase is in the essay “History of Astronomy” published after Smith’s death. However, it’s been suggested that the essay was written before “Theory of Moral Sentiments” meaning that it would actually be the first time the term “invisible hand” was used in Smith’s writing.

Smith writes about Jupiter that “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 this use, it is presented as “the” invisible hand this time, differing from the other two uses. Smith uses the phrase to mean the actions or characteristics of Jupiter in this usage, not applying it at all to man or his affairs.

After looking at all three uses of Smith’s “invisible hand” phrase it seems just to be a metaphor for the causes of actions, and not the hand of God controlling the free market, as would be suspected from the way economists use it. But since Smith uses it in three different ways, it’s quite possible that it’s just a phrase that Smith liked the sound of and contrived no deeper meaning from at all. Perhaps economists were worshiping a poetic phrase Smith used to describe actions for all this time.

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13 thoughts on “The Real Meaning of Adam Smith’s Invisible Hand

  1. Ooh, good for you for reading it. I admit economics and I don’t get along, and I really have to slow down and make sure I get it right because like you said, some statements can have many meanings if the context is lost or not clarified. The domestic trade being beneficial made me think of my first economics class in college (basic, naturally), about the “multiplier effect” and how money spent locally multiplies there, and money elsewhere never comes back…or at least, not without a lot of time and expense, or investments. Good analysis.

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  2. In “A Summary View of the Rights of British America,” two years before “The Wealth of Nations,” Thomas Jefferson already refers to the “unseen hand.” Perhaps Adam Smith had read a copy before proposing his “invisible hand”?

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  3. Interesting analysis. I believe that in “Wealth of Nations” Smith also asserted the domestic trade was preferable to international trade, but that the king and governments generally believed otherwise. This is the basis for what we now call the “trade deficit.” At that time, governments profited greatly from tariffs and duties, and Smith himself was appointed Customs Commissioner of Edinburgh after “Wealth” became such a success.

    Smith also made a good point about currency, that a penny buys a penny’s worth every time it changes hands. Thus, in a domestic economy, that same penny could buy many hundreds of pounds’ worth of goods over time, if it’s exchanged frequently, and directly improve the local economy.. Under this scenario, the money supply is not as important as the number of transactions. Hoarded wealth has no value in itself.

    It’s important to remember that Smith was writing from a tax collector’s point of view, and “Wealth of Nations” was essentially a survey of taxing possibilities to help the UK get out of debt after the “late war,” which I presumed to mean the Seven Years’ War. It was published in 1776, which makes me wonder if its ideas helped inspire the Declaration of Independence.

    Smith was not concerned with the taxpayers’ dilemma. Poor people pay way more in taxes than rich people, because, as you point out, there are more of them, and each eats as much food as a rich person, for instance.

    My take on the “invisible hand” is that we don’t really know how the market operates. It was clear to me, though, that Smith’s sympathies were with the stock holders who profited by squeezing labor to the edge of starvation to maximize profits. I don’t think that has changed with the rise of international corporations, and it may be worse.

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  4. I read The Wealth of Nations as a sort of dare to myself, largely because I was getting tired of hearing people use “invisible hand” as a sort of neoliberal talisman. Smith gets surprisingly… I’ll say “anti-business”… in some bits, especially in the areas of setting national policy and maintaining infrastructure.

    It’s interesting to see that he used the phrase in other contexts. One does wonder if it was a sort of late 18th century literary fad.

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  5. the last phrase if chilling .. it connotes to me that those who do not understand another persons thoughts can carry forward those thoughts misunderstood, swayed by language or grandeur or a person’s speaking skills or that, having been told a lie enough times, a person grows to think it truth.

    It’s chilling to think that those in receipt of knowledge can be swayed by the motion of the words rather than which causes the motion … the reasons behind the rises and falls … what motor or dynamo is driving that which we are trying to understand? in this regard, the invisible hand becomes the winner in the battle between lies and truth … or ignorance and vanity … or sickness and health.

    all polarities and their conflicts are … the invisible hand …. at least by one of the uses …. i think … or … i don’t think … this is the question. k

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  6. OH … ! Sorry … ! i got carried away thinking and forgot to tell you … gosh, for someone who writes as good as you do, it’s pretty cool that you liked my poetry! you know what? there’s plenty more where that came from if you want to …. OH … ! JEEZE .. i did it again … i get so carried away ! anyway, i’m grateful .., thank you .. k

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  7. I think you may be missing the point through a misunderstanding of Smith’s use of “distribute” when he means “sell”. Smith’s point is that the owner of land produces more than he can eat, so he exchanges the excess for the other things (see “baubles and trinkets”) he needs and wants. When multiple land owners do this, the abundance of their excess produce drives the price of the produce down, resulting in lower prices, and therefore a better standard of living to the less wealthy around them. This fits into Smith’s analogy of the invisible hand because like all the operations of the free market it means that people producing things for their own reasons end up benefitting everyone else in order to obtain things they want but don’t produce. This is the reason why even though one farmer can now farm many times more acres than ever before, this has not resulted in farmers being rich and everyone else being poor. Both the farmers and the consumers of their produce have a better standard of living because the farmer sells his excess to buy what he wants. He probably farms for his own profit, but he accidentally also benefits everyone in the market with him, almost as is an invisible hand we’re pushing him to do so.

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  8. Great post. I think you are probably right that it was just a phrase Smith was fond of. But I will say that economists didn’t start believing in Free Markets just because of Smith–there really is sound theory behind it. My guess is that they simply found his phrase to be a useful shorthand (no pun intended) to convey arriving at the optimal solution without consciously planning to do so.

    To get a better sense of the true mechanics of the Free Market, I favor David Ricardo’s writing on comparative advantage over that of Smith. Smith was a fine philosopher, but Ricardo leaned much more on the practical side of things.

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  9. It’s amazing how a phrase, taken out of context and used in ambiguous fashion by later writers can take on a life of its own and gain a currency and meaning that it didn’t have in the original. Many exegeses do this. I enjoyed your article: appropriate for the current times. Thank you.

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  10. Interesting analysis. My sense is that he is just saying if you do “this” than “that” will likely occur. The idea put forth by some that by not intentionally doing anything somehow everything will turn out for the best does seem a trifle naive. Also, regardless of his intention of the word, his world was filled by very visible hands, making very intentional decisions. And it looks like his very analysis itself was intended to produce a result. So there goes your invisible hand.

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