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.
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.