Physical or Invisible Hands?


Early American economic theory as supported by Thomas  Jefferson, etc.,. was apparently based based on the views of independent, self-sufficient farmers.

Global Industrialization is based on the production of marketable goods. Urbanisation, moneterisation and the interdependence of markets.

Are these two opposing systems: Hopelessly confusing modern Americans .......
................(and perhaps destroying the rest of the world)?




Pierre Samuel du Pont de Nemours: A prominent Physiocrat, emigrated to the US and his son founded DuPont, the world's second largest chemicals company. In his book la Physiocratie, du Pont advocated low tariffs and free trade.

Physiocracy (from the Greek for "Government of Nature") 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 century. Physiocracy is perhaps the first well-developed theory of economics.

The movement was particularly dominated by François Quesnay (1694–1774) and Anne-Robert-Jacques Turgot (1727–1781).[1] It immediately preceded the first modern school, classical economics, which began with the publication of Adam Smith's The Wealth of Nations in 1776.

The most significant contribution of the Physiocrats was their emphasis on productive work as the source of national wealth. This is in contrast to earlier schools, in particular mercantilism, which often focused on the ruler's wealth, accumulation of gold, or the balance of trade. At the time the Physiocrats were formulating their ideas, economies were almost entirely agrarian. That is presumably why the theory considered only agricultural labor to be valuable. Physiocrats viewed the production of goods and services as consumption of the agricultural surplus, since the main source of power was from human or animal muscle and all energy was derived from the surplus from agricultural production.

The perceptiveness of the Physiocrats' recognition of the key significance of land was reinforced in the following half-century, when fossil fuels had been harnessed through the use of steam power. Productivity increased manyfold. Railways, and steam-powered water supply and sanitation systems, made possible cities of several millions, with land values many times greater than agricultural land. Thus, whilst modern economists also recognise manufacturing as productive and wealth-creating, the underlying principles laid down by the Physiocrats remain valid. Physiocracy also has an important contemporary relevance in that all life remains dependent on the productivity of the raw soil and the ability of the natural environment to renew itself.

Historian David B. Danbom explains, "The Physiocrats damned cities for their artificiality and praised more natural styles of living. They celebrated farmers."[2] They called themselves économistes, but are generally referred to as physiocrats to distinguish them from the many schools of economic thought that followed them.


Physiocracy is an agrarianist philosophy. In the late Roman Republic, the dominant senatorial class was not allowed to engage in banking or commerce[3] but relied on their latifundia, large plantations, for income. They circumvented this rule through freedmen proxies who sold surplus agricultural goods.

After the decline of the Roman Empire, de-urbanization led to commerce ceasing and trade declining throughout most of western Europe. Economies became centered around agricultural manors where warrior-landlords, the medieval nobility, collected rent from their serfs in the form of produce. This was the dominant economic system until trade began to revive in the Late Middle Ages, fostering the rise of the merchant class.

Another inspiration came from China's economic system, then the largest in the world. Chinese society broadly distinguished four occupations, with scholar-bureaucrats, who were also agrarian landlords, at the top and merchants at the bottom (because they did not produce but only distributed goods made by others). Leading physiocrats like François Quesnay were avid Confucianists who advocated China's agrarian policies.[4] Some scholars have advocated connections with the school of Agriculturalism, which promoted utopian communalism.[5]


Pierre Le Pesant, sieur de Boisguilbert served as a member of Louis XIV's local administration of Paris, and wrote pamphlets and booklets on subjects related to his work: taxation, grain trade, and money. Le Pesant asserted that wealth came from self-interest and markets are connected by money flows (i.e. an expense for the buyer is revenue for the producer). Thus he realized that lowering prices in times of shortage – common at the time – is dangerous economically as it acted as a disincentive to production. Generally, Le Pesant advocated less government interference in the grain market, as any such interference would generate "anticipations" which would prevent the policy from working. For instance, if the government bought corn abroad, some people would speculate that there is likely to be a shortage and would buy more corn, leading to higher prices and more of a shortage. This was an early example of advocacy of free trade. In anonymously published tracts, Vauban proposed a system known as La dîme royale: this involved major simplification of the French tax code by switching to a relatively flat tax on property and trade. Vauban's use of statistics contrasted with earlier empirical methods in economics.[6]

Around the time of the Seven Years' War between France and England (1756-63), the physiocracy movement grew. Several journals appeared, signaling an increasing audience in France for new economic ideas. Among the most important were the Journal Œconomique (1721–72), which promoted agronomy and rational husbandry and the Journal du commerce (1759–62), which was heavily influenced by the Irishman Richard Cantillon (1680–1734), both dominated by physiocrats; the Journal de l'agriculture, du commerce et des finances (1765–74) and the Ephémérides du citoyen (1767–72 and 1774–76). Also, de Gournay (1712–59), the Intendant du commerce, brought together a group of young researchers including François Véron Duverger de Forbonnais (1722–1800) and one of the two most famous physiocrats, Anne-Robert-Jacques Turgot (1727–81). The other, François Quesnay (1694–1774), was among those writing prolifically in contemporary journals.[1]

In the 19th century Henry George in the United States advocated the collection of land rent as the primary if not the sole source of public revenue.

Tableau économique

The Tableau économique or Economic Table is an economic model first described by François Quesnay in 1759, which laid the foundation of the Physiocrats’ economic theories.[7]

The model Quesnay created consisted of three economic agents: the "proprietary" class consisted only of landowners; the "productive" class consisted of agricultural laborers; the "sterile" class was made up of artisans and merchants. The flow of production and/or cash between the three classes originated with the proprietary class because they owned the land and bought from both of the other classes.


Natural Order

The Physiocrats thought there was a "Natural order" that allowed human beings to live together. Men did not come together via a somewhat arbitrary "social contract". Rather, we have to discover the laws of the natural order that will allow individuals to live in society without losing significant freedoms.[8]

Individualism and laissez-faire

The Physiocrats, especially Turgot, believed that self-interest is the motivation for each segment of the economy to play its role. Each individual is best suited to determine what goods he wants and what work would provide him with what he wants out of life. While a person might labor for the benefit of others, he will work harder for his own benefit; however, each person's needs are being supplied by many other people. The system works best when there is a complementary relationship between one person's needs and another person's desires, and trade restrictions place an unnatural barrier to achieving one's goals.

Private property

None of the theories concerning the value of land could work without strong legal support for the ownership of private property. Combined with the strong sense of individualism, private property becomes a critical component of the Tableau's functioning.

Diminishing returns

Turgot was one of the first to recognize that “successive applications of the variable input will cause the product to grow, first at an increasing rate, later at a diminishing rate until it reaches a maximum.”[9] This was a recognition that the productivity gains required to increase national wealth had an ultimate limit, and, therefore, wealth was not infinite.

Investment capital

Both Quesnay and Anne Robert Jacques Turgot, Baron de Laune recognized that capital was needed by farmers to start the production process, and both were proponents of using some of each year’s profits to increase productivity. Capital was also needed to sustain the laborers while they produced their product. Turgot recognizes that there is opportunity cost and risk involved in using capital for something other than land ownership, and he promotes interest as serving a “strategic function in the economy.”[10]

See also



Adam Smith


Adam Smith (5 June 1723 OS – 17 July 1790) was a Scottish moral philosopher and a pioneer of political economy. One of the key figures of the Scottish Enlightenment,[1] Adam Smith is best known for two classic works: The Theory of Moral Sentiments (1759), and An Inquiry into the Nature and Causes of the Wealth of Nations (1776). The latter, usually abbreviated as The Wealth of Nations, is considered his magnum opus and the first modern work of economics. Smith is cited as the father of modern economics and is still among the most influential thinkers in the field of economics today.[2] In 2009, Smith was named among the "Greatest Scots" of all time, in a vote run by Scottish television channel STV.[3]

Smith studied social philosophy at the University of Glasgow and at Balliol College in the University of Oxford, where he was one of the first students to benefit from scholarships set up by his fellow Glaswegian John Snell. After graduating, he delivered a successful series of public lectures at Edinburgh, leading him to collaborate with David Hume during the Scottish Enlightenment. Smith obtained a professorship at Glasgow teaching moral philosophy, and during this time he wrote and published The Theory of Moral Sentiments. In his later life, he took a tutoring position that allowed him to travel throughout Europe, where he met other intellectual leaders of his day. Smith then returned home and spent the next ten years writing The Wealth of Nations, publishing it in 1776. He died in 1790 at the age of 67.


Early life

Smith was born in Kirkcaldy, fife, Scotland. His father, also named Adam Smith, was a lawyer, civil servant, and widower who married Margaret Douglas in 1720 and died two months after Smith was born.[4] Although the exact date of Smith's birth is unknown, his baptism was recorded on 5 June 1723 at Kirkcaldy.[5] Though few events in Smith's early childhood are known, Scottish journalist and Smith's biographer John Rae recorded that Smith was abducted by gypsies at the age of four and released when others went to rescue him.[N 1] Smith was close to his mother, who likely encouraged him to pursue his scholarly ambitions.[7] He attended the Burgh School of Kirkcaldy—characterised by Rae as "one of the best secondary schools of Scotland at that period"—from 1729 to 1737.[6] While there, Smith studied Latin, mathematics, history, and writing.[7]

Formal education

Smith entered the University of Glasgow when he was fourteen and studied moral philosophy under Francis Hutcheson.[7] Here, Smith developed his passion for liberty, reason, and free speech. In 1740, Smith was awarded the Snell exhibition and left to attend Balliol College, Oxford.[8]

Smith considered the teaching at Glasgow far superior to that at Oxford, which he found intellectually stifling.[9] In Book V, Chapter II of The Wealth of Nations, Smith wrote: "In the University of Oxford, the greater part of the public professors have, for these many years, given up altogether even the pretence of teaching." Smith is also reported to have complained to friends that Oxford officials once discovered him reading a copy of David Hume's Treatise on Human Nature, and they subsequently confiscated his book and punished him severely for reading it.[6][10][11] According to William Robert Scott, "The Oxford of [Smith's] time gave little if any help towards what was to be his lifework."[12] Nevertheless, Smith took the opportunity while at Oxford to teach himself several subjects by reading many books from the shelves of the large Oxford library.[13] When Smith was not studying on his own, his time at Oxford was not a happy one, according to his letters.[14] Near the end of his time at Oxford, Smith began suffering from shaking fits, probably the symptoms of a nervous breakdown.[15] He left Oxford University in 1746, before his scholarship ended.[15][16]

In Book V of The Wealth of Nations, Smith comments on the low quality of instruction and the meager intellectual activity at English universities, when compared to their Scottish counterparts. He attributes this both to the rich endowments of the colleges at Oxford and Cambridge, which made the income of professors independent of their ability to attract students, and to the fact that distinguished men of letters could make an even more comfortable living as ministers of the Church of England.[11]

Smith's discontent at Oxford might be in part due to the absence of his beloved teacher in Glasgow, Francis Hutcheson. Hutcheson was well regarded as one of the most prominent lecturers at the University of Glasgow in his day and earned the approbation of students, colleagues, and even ordinary residents with the fervor and earnestness of his orations (which he sometimes opened to the public). His lectures endeavored not merely to teach philosophy but to make his students embody that philosophy in their lives, appropriately acquiring the epithet, the preacher of philosophy. Unlike Smith, Hutcheson was not a system builder; rather it was his magnetic personality and method of lecturing that so influenced his students and caused the greatest of those to reverentially refer to him as "the never to be forgotten Hutcheson"––a title that Smith in all his correspondence used to describe only two people, his good friend David Hume and influential mentor Francis Hutcheson.[17]

Teaching career

Smith began delivering public lectures in 1748 in University of Edinburgh, sponsored by the Philosophical Society of Edinburgh under the patronage of Lord Kames.[18] His lecture topics included rhetoric and belles-lettres,[19] and later the subject of "the progress of opulence". On this latter topic he first expounded his economic philosophy of "the obvious and simple system of natural liberty". While Smith was not adept at public speaking, his lectures met with success.[20]

In 1750, he met the philosopher David Hume, who was his senior by more than a decade. In their writings covering history, politics, philosophy, economics, and religion, Smith and Hume shared closer intellectual and personal bonds than with other important figures of the Scottish Enlightenment.[21]

In 1751, Smith earned a professorship at Glasgow University teaching logic courses, and in 1752 Smith was elected a member of the Philosophical Society of Edinburgh, having been introduced to the society by Lord Kames. When the head of Moral Philosophy died the next year, Smith took over the position.[20] He worked as an academic for the next thirteen years, which he characterized as "by far the most useful and therefore by far the happiest and most honorable period [of his life]".[22]

Smith published The Theory of Moral Sentiments in 1759, embodying some of his Glasgow lectures. This work was concerned with how human morality depends on sympathy between agent and spectator, or the individual and other members of society. Smith defined "mutual sympathy" as the basis of moral sentiments. He bases his explanation, not on a special "moral sense" as the Third Lord Shaftesbury and Hutcheson had done, nor on utility as Hume did, but on mutual sympathy, a term best captured in modern parlance by the twentieth-century concept of empathy, the capacity to recognize feelings that are being experienced by another being.

Following the publication of The Theory of Moral Sentiments, Smith became so popular that many wealthy students left their schools in other countries to enroll at Glasgow to learn under Smith.[23] After the publication of The Theory of Moral Sentiments, Smith began to give more attention to jurisprudence and economics in his lectures and less to his theories of morals.[24] For example, Smith lectured that the cause of increase in national wealth is labor, rather than the nation's quantity of gold or silver, which is the basis for mercantilism, the economic theory that dominated Western European economic policies at the time.[23]

In 1762, the University of Glasgow conferred on Smith the title of Doctor of Laws (LL.D.). At the end of 1763, he obtained an offer from Charles Townshend—who had been introduced to Smith by David Hume—to tutor his stepson, Henry Scott, the young Duke of Buccleuch. Smith then resigned from his professorship to take the tutoring position, and he subsequently attempted to return the fees he had collected from his students because he resigned in the middle of the term, but his students refused.[25]

Tutoring and travels

Smith's tutoring job entailed touring Europe with Scott, during which time he educated Scott on a variety of subjects – such as proper Polish.[25] He was paid £300 per year (plus expenses) along with a £300 per year pension; roughly twice his former income as a teacher.[25] Smith first travelled as a tutor to Toulouse, France, where he stayed for one and a half years.[25] According to his own account, he found Toulouse to be somewhat boring, having written to Hume that he "had begun to write a book to pass away the time".[25] After touring the south of France, the group moved to Geneva, where Smith met with the philosopher Voltaire.[26]

From Geneva, the party moved to Paris. Here Smith came to know several great intellectual leaders of the time; invariably having an effect on his future works. This list included: Benjamin Franklin,[27] Turgot, Jean D'Alembert, André Morellet, Helvétius and, notably, François Quesnay; head of the Physiocratic school.[28] So impressed with his ideas[29] Smith considered dedicating The Wealth of Nations to him – had Quesnay not died beforehand.[30] Physiocrats were opposed to mercantilism, the dominating economic theory of the time. Illustrated in their motto Laissez faire et laissez passer, le monde va de lui même! (Let do and let pass, the world goes on by itself!). They were also known to have declared that only agricultural activity produced real wealth; merchants and industrialists (manufacturers) did not.[27] This however, did not represent their true school of thought, but was a mere 'smoke screen' manufactured to hide their actual criticisms of the nobility and church; arguing that they made up the only real clients of merchants and manufacturers.[31] The wealth of France was virtually destroyed by Louis XIV and Louis XV to ruinous wars,[32] by aiding the American insurgents against the British, and perhaps most destructive (in terms of public perceptions) was what was seen as the excessive consumption of goods and services deemed to have no economic contribution – unproductive labour. Assuming that nobility and church are essentially detractors from economic growth, the feudal system of agriculture in France was the only sector important to maintain the wealth of the nation. Given that the English economy of the day yielded an income distribution that stood in contrast to that which existed in France, Smith concluded that the teachings and beliefs of Physiocrats were, "with all [their] imperfections [perhaps], the nearest approximation to the truth that has yet been published upon the subject of political economy".[33] The distinction between productive versus unproductive labour – the physiocratic classe steril – was a predominant issue in the development and understanding of what would become classical economic theory.

Later years

In 1766, Henry Scott's younger brother died in Paris, and Smith's tour as a tutor ended shortly thereafter.[27] Smith returned home that year to Kirkcaldy, and he devoted much of the next ten years to his magnum opus.[34] There he befriended Henry Moyes, a young blind man who showed precocious aptitude. As well as teaching Moyes, Smith secured the patronage of David Hume and Thomas Reid in the young man's education.[35] In May 1773, Smith was elected fellow of the Royal Society of London,[36] and was elected a member of the Literary Club in 1775.[37] The Wealth of Nations was published in 1776 and was an instant success, selling out its first edition in only six months.[38]

In 1778, Smith was appointed to a post as commissioner of customs in Scotland and went to live with his mother in Panmure House in Edinburgh's Canongate.[39] Five years later, as a member of the Philosophical Society of Edinburgh when it received its royal charter, he automatically became one of the founding members of the Royal Society of Edinburgh,[40] and from 1787 to 1789 he occupied the honorary position of Lord Rector of the University of Glasgow.[41] He died in the northern wing of Panmure House in Edinburgh on 17 July 1790 after a painful illness and was buried in the Canongate Kirkyard.[42] On his death bed, Smith expressed disappointment that he had not achieved more.[43]

Smith's literary executors were two friends from the Scottish academic world: the physicist and chemist Joseph Black, and the pioneering geologist James Hutton.[44] Smith left behind many notes and some unpublished material, but gave instructions to destroy anything that was not fit for publication.[45] He mentioned an early unpublished History of Astronomy as probably suitable, and it duly appeared in 1795, along with other material such as Essays on Philosophical Subjects.[44]

Smith's library went by his will to David Douglas, Lord Reston (son of his cousin Colonel Robert Douglas of Strathendry, Fife), who lived with Smith. It was eventually divided between his two surviving children, Cecilia Margaret (Mrs. Cunningham) and David Anne (Mrs. Bannerman). On the death of her husband, the Rev. W. B. Cunningham of Prestonpans in 1878, Mrs. Cunningham sold some of the books. The remainder passed to her son, Professor Robert Oliver Cunningham of Queen's College, Belfast, who presented a part to the library of Queen's College. After his death the remaining books were sold. On the death of Mrs. Bannerman in 1879 her portion of the library went intact to the New College (of the Free Church), Edinburgh.

Personality and beliefs


Not much is known about Smith's personal views beyond what can be deduced from his published articles. His personal papers were destroyed after his death at his request.[45] He never married,[47] and seems to have maintained a close relationship with his mother, with whom he lived after his return from France and who died six years before his own death.[48]

Smith was described by several of his contemporaries and biographers as comically absent-minded, with peculiar habits of speech and gait, and a smile of "inexpressible benignity".[49] He was known to talk to himself,[43] a habit that began during his childhood when he would smile in rapt conversation with invisible companions.[50] He also had occasional spells of imaginary illness,[43] and he is reported to have had books and papers placed in tall stacks in his study.[50] According to one story, Smith took Charles Townshend on a tour of a tanning factory, and while discussing free trade, Smith walked into a huge tanning pit from which he needed help to escape.[51] He is also said to have put bread and butter into a teapot, drunk the concoction, and declared it to be the worst cup of tea he ever had. According to another account, Smith distractedly went out walking in his nightgown and ended up 15 miles (24 km) outside of town, before nearby church bells brought him back to reality.[50][51]

James Boswell who was a student of Smith's at Glasgow University, and later knew him at the Literary Club, says that Smith thought that speaking about his ideas in conversation might reduce the sale of his books, and so his conversation was unimpressive. According to Boswell, he once told Sir Joshua Reynolds that 'he made it a rule when in company never to talk of what he understood'.[52]

Smith, who is reported to have been an odd-looking fellow, has been described as someone who "had a large nose, bulging eyes, a protruding lower lip, a nervous twitch, and a speech impediment".[11] Smith is said to have acknowledged his looks at one point, saying, "I am a beau in nothing but my books."[11] Smith rarely sat for portraits,[53] so almost all depictions of him created during his lifetime were drawn from memory. The best-known portraits of Smith are the profile by James Tassie and two etchings by John Kay.[54] The line engravings produced for the covers of 19th century reprints of The Wealth of Nations were based largely on Tassie's medallion.[55]

Religious views

There has been considerable scholarly debate about the nature of Smith's religious views. Smith's father had shown a strong interest in Christianity and belonged to the moderate wing of the Church of Scotland.[56] The fact that Adam Smith received the Snell Exhibition suggests that he may have gone to Oxford with the intention of pursuing a career in the Church of England. It is generally believed that at Oxford Smith rejected Christianity, returning to Scotland a deist.[57]

Anglo-American economist Ronald Coase has challenged the view that Smith was a deist, based on the fact that Smith's writings never explicitly invoke God as an explanation of the harmonies of the natural or the human worlds.[58] According to Coase, though Smith does sometimes refer to the "Great Architect of the Universe", later scholars such as Jacob Viner have "very much exaggerated the extent to which Adam Smith was committed to a belief in a personal God",[59] a belief for which Coase finds little evidence in passages such as the one in the Wealth of Nations in which Smith writes that the curiosity of mankind about the "great phenomena of nature", such as "the generation, the life, growth and dissolution of plants and animals", has led men to "enquire into their causes", and that "superstition first attempted to satisfy this curiosity, by referring all those wonderful appearances to the immediate agency of the gods. Philosophy afterwards endeavoured to account for them, from more familiar causes, or from such as mankind were better acquainted with than the agency of the gods".[59]

Smith was also a close friend and later the executor of David Hume, who was commonly characterized in his own time as an "atheist".[60] The publication in 1777 of Smith's letter to William Strahan, in which he described Hume's courage in the face of death in spite his irreligiosity, attracted considerable controversy.[61]

Published works

The Theory of Moral Sentiments

In 1759, Smith published his first work, The Theory of Moral Sentiments. He continued making extensive revisions to the book, up until his death.[N 2] Although The Wealth of Nations is widely regarded as Smith's most influential work, it is believed that Smith himself considered The Theory of Moral Sentiments to be a superior work.[63]

In the work, Smith critically examines the moral thinking of his time, and suggests that conscience arises from social relationships.[64] His goal in writing the work was to explain the source of mankind's ability to form moral judgements, in spite of man's natural inclinations towards self-interest. Smith proposes a theory of sympathy, in which the act of observing others makes people aware of themselves and the morality of their own behavior.[65]

Scholars have traditionally perceived a conflict between The Theory of Moral Sentiments and The Wealth of Nations; the former emphasizes sympathy for others, while the latter focuses on the role of self-interest.[66] In recent years, however, some scholars[67][68][69] of Smith's work have argued that no contradiction exists.[70] They claim that in The Theory of Moral Sentiments, Smith develops a theory of psychology in which individuals seek the approval of the "impartial spectator" as a result of a natural desire to have outside observers sympathize with them. Rather than viewing The Wealth of Nations and The Theory of Moral Sentiments as presenting incompatible views of human nature, some Smith scholars regard the works as emphasizing different aspects of human nature that vary depending on the situation.

These views ignore that Smith's visit to France (1764–66) changed radically his former views and that The Wealth of Nations is an inhomogeneous convolute of his former lectures and of what Quesnay taught him.[71] Before his voyage to France in The Theory of Moral Sentiments, Adam Smith refers to an "invisible hand" ("By preferring the support of domestic to that of foreign industry, [an individual] 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 eases, led by an invisible hand to promote an end which was no part of his intention.") [72] which ensures that the gluttony of the rich helps the poor, as the stomachs of rich are so limited that they have to spend their fortune on servants. After his visit to France, Smith considers in the Wealth of Nations (1776) the gluttony of the rich as unproductive labour. The micro-economical/psychological view in the tradition of Aristotle, Puffendorf and Hutcheson,[73] Smith's teacher, – elements compatible with a neoclassical theory – changed to the macro-economical view of the classical theory Smith learned in France.[clarification needed]

The Wealth of Nations

There is a fundamental disagreement between classical and neoclassical economists about the central message of Smith's most influential work: An Inquiry into the Nature and Causes of the Wealth of Nations. Neoclassical economists emphasise Smith's invisible hand,[74] a concept mentioned in the middle of his work – book IV, chapter II – and classical economists believe that Smith stated his programme for promoting the "wealth of nations" in the first sentences.

Smith used the term "the invisible hand" in "History of Astronomy"[75] referring to "the invisible hand of Jupiter" and twice – each time with a different meaning – the term "an invisible hand": in The Theory of Moral Sentiments[76] (1759) and in The Wealth of Nations[77] (1776). This last statement about "an invisible hand" has been interpreted as "the invisible hand" in numerous ways. It is therefore important to read the original:

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 may be 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 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 eases, 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 need be employed in dissuading them from it.

Those who regard that statement as Smith's central message also quote frequently Smith's dictum:[78]

It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages.

Smith's statement about the benefits of "an invisible hand" is certainly meant to answer[citation needed] Mandeville's contention that "Private Vices ... may be turned into Public Benefits".[79] It shows Smith's belief that when an individual pursues his self-interest, he indirectly promotes the good of society. Self-interested competition in the free market, he argued, would tend to benefit society as a whole by keeping prices low, while still building in an incentive for a wide variety of goods and services. Nevertheless, he was wary of businessmen and warned of their "conspiracy against the public or in some other contrivance to raise prices."[80] Again and again, Smith warned of the collusive nature of business interests, which may form cabals or monopolies, fixing the highest price "which can be squeezed out of the buyers".[81] Smith also warned that a business-dominated political system would allow a conspiracy of businesses and industry against consumers, with the former scheming to influence politics and legislation. Smith states that the interest of manufacturers and merchants " any particular branch of trade or manufactures, is always in some respects different from, and even opposite to, that of the public...The proposal of any new law or regulation of commerce which comes from this order, ought always to be listened to with great precaution, and ought never be adopted till after having been long and carefully examined, not only with the most scrupulous, but with the most suspicious attention."[82]

The neoclassical interest in Smith's statement about "an invisible hand" originates in the possibility to see it as a precursor of neoclassical economics and its General Equilibrium concept. Samuelson's "Economics" refers 6 times to Smith's "invisible hand". To emphasize this relation, Samuelson[83] quotes Smith's "invisible hand" statement putting "general interest" where Smith wrote "publick interest". Samuelson[84] concluded: "Smith was unable to prove the essence of his invisible-hand doctrine. Indeed, until the 1940s no one knew how to prove, even to state properly, the kernel of truth in this proposition about perfectly competitive market."

Very differently, classical economists see in Smith's first sentences his programme to promote "The Wealth of Nations". Taking up the physiocratical concept of the economy as a circular process means that to have growth the inputs of period2 must excel the inputs of period1. Therefore the outputs of period1 not used or usable as input of period2 are regarded as unproductive labour as they do not contribute to growth. This is what Smith had learned in France with Quesnay. To this French insight that unproductive labour should be pushed back to use more labour productively, Smith added his own proposal, that productive labour should be made even more productive by deepening the division of labour. Deepening the division of labour means under competition lower prices and thereby extended markets. Extended markets and increased production lead to a new step of reorganising production and inventing new ways of producing which again lower prices, etc., etc.. Smith's central message is therefore that under dynamic competition a growth machine secures "The Wealth of Nations". It predicted England's evolution as the workshop of the World, underselling all its competitors. The opening sentences of the "Wealth of Nations" summarize this policy:

The annual labour of every nation is the fund which originally supplies it with all the necessaries and conveniences of life which it annually consumes ... . [T]his produce ... bears a greater or smaller proportion to the number of those who are to consume it ... .[B]ut this proportion must in every nation be regulated by two different circumstances;

Criticism and dissent

Prominent interpretation, as well as criticism, of Smith's views on the societal merits of unregulated labor management by the ruling class is expressed by Noam Chomsky as follows: "He's pre-capitalist, a figure of the Enlightenment. What we would call capitalism he despised. People read snippets of Adam Smith, the few phrases they teach in school. Everybody reads the first paragraph of The Wealth of Nations where he talks about how wonderful the division of labor is. But not many people get to the point hundreds of pages later, where he says that division of labor will destroy human beings and turn people into creatures as stupid and ignorant as it is possible for a human being to be. And therefore in any civilized society the government is going to have to take some measures to prevent division of labor from proceeding to its limits."[86]

Other works

Shortly before his death, Smith had nearly all his manuscripts destroyed. In his last years, he seemed to have been planning two major treatises, one on the theory and history of law and one on the sciences and arts. The posthumously published Essays on Philosophical Subjects, a history of astronomy down to Smith's own era, plus some thoughts on ancient physics and metaphysics, probably contain parts of what would have been the latter treatise. Lectures on Jurisprudence were notes taken from Smith's early lectures, plus an early draft of The Wealth of Nations, published as part of the 1976 Glasgow Edition of the works and correspondence of Smith. Other works, including some published posthumously, include Lectures on Justice, Police, Revenue, and Arms (1763) (first published in 1896); and Essays on Philosophical Subjects (1795).[87]


In economics and moral philosophy

The Wealth of Nations was a precursor to the modern academic discipline of economics. In this and other works, Smith expounded how rational self-interest and competition can lead to economic prosperity. Smith was controversial in his own day and his general approach and writing style were often satirized by Tory writers in the moralizing tradition of Hogarth and Swift, as a discussion at the University of Winchester suggests.[88] In 2005, The Wealth of Nations was named among the 100 Best Scottish Books of all time.[89] Former British Prime Minister Margaret Thatcher, it is said, used to carry a copy of the book in her handbag.[90]

In light of the arguments put forward by Smith and other economic theorists in Britain, academic belief in mercantalism began to decline in England in the late 18th century. During the Industrial Revolution, Britain embraced free trade and Smith's laissez-faire economics, and via the British Empire, used its power to spread a broadly liberal economic model around the world, characterized by open markets, and relatively barrier free domestic and international trade.[91]

George Stigler attributes to Smith "the most important substantive proposition in all of economics." It is that, under competition, owners of resources (for example labor, land, and capital) will use them most profitably, resulting in an equal rate of return in equilibrium for all uses, adjusted for apparent differences arising from such factors as training, trust, hardship, and unemployment.[92]

Paul Samuelson finds in Smith's pluralist use of supply and demand as applied to wages, rents, profit a valid and valuable anticipation of the general equilibrium modeling of Walras a century later. Smith's allowance for wage increases in the short and intermediate term from capital accumulation and invention added a realism missed later by Malthus, Ricardo, and Marx in their propounding a rigid subsistence-wage theory of labour supply.[93]

On the other hand, Joseph Schumpeter dismissed Smith's contributions as unoriginal, saying "His very limitation made for success. Had he been more brilliant, he would not have been taken so seriously. Had he dug more deeply, had he unearthed more recondite truth, had he used more difficult and ingenious methods, he would not have been understood. But he had no such ambitions; in fact he disliked whatever went beyond plain common sense. He never moved above the heads of even the dullest readers. He led them on gently, encouraging them by trivialities and homely observations, making them feel comfortable all along."[94]

Classical economists presented competing theories of those of Smith, termed the "labour theory of value". Later Marxian economics descending from classical economics also use Smith's labour theories, in part. The first volume of Karl Marx's major work, Capital, was published in German in 1867. In it, Marx focused on the labour theory of value and what he considered to be the exploitation of labour by capital.[95][96] The labour theory of value held that the value of a thing was determined by the labor that went into its production. This contrasts with the modern understanding of mainstream economics, that the value of a thing is determined by what one is willing to give up to obtain the thing.

The body of theory later termed "neoclassical economics" or "marginalism" formed from about 1870 to 1910. The term "economics" was popularized by such neoclassical economists as Alfred Marshall as a concise synonym for "economic science" and a substitute for the earlier, broader term "political economy" used by Smith.[97][98] This corresponded to the influence on the subject of mathematical methods used in the natural sciences.[99] Neoclassical economics systematized supply and demand as joint determinants of price and quantity in market equilibrium, affecting both the allocation of output and the distribution of income. It dispensed with the labour theory of value of which Smith was most famously identified with in classical economics, in favour of a marginal utility theory of value on the demand side and a more general theory of costs on the supply side.[100]

The bicentennial anniversary of the publication of The Wealth of Nations was celebrated in 1976, resulting in increased interest for The Theory of Moral Sentiments and his other works throughout academia. After 1976, Smith was more likely to be represented as the author of both The Wealth of Nations and The Theory of Moral Sentiments, and thereby as the founder of a moral philosophy and the science of economics. His homo economicus or "economic man" was also more often represented as a moral person. Additionally, economists David Levy and Sandra Peart in "The Secret History of the Dismal Science" point to his opposition to hierarchy and beliefs in inequality, including racial inequality, and provide additional support for those who point to Smith's opposition to slavery, colonialism, and empire.[101] They show the caricatures of Smith drawn by the opponents of views on hierarchy and inequality in this online article. Emphasized also are Smith's statements of the need for high wages for the poor, and the efforts to keep wages low. In The “Vanity of the Philosopher”: From Equality to Hierarchy in Postclassical Economics Peart and Levy also cite Smith's view that a common street porter was not intellectually inferior to a philosopher,[102] and point to the need for greater appreciation of the public views in discussions of science and other subjects now considered to be technical. They also cite Smith's opposition to the often expressed view that science is superior to common sense.[103]

Smith also explained the relationship between growth of private property and civil government:

"Men may live together in society with some tolerable degree of security, though there is no civil magistrate to protect them from the injustice of those passions. But avarice and ambition in the rich, in the poor the hatred of labour and the love of present ease and enjoyment, are the passions which prompt to invade property, passions much more steady in their operation, and much more universal in their influence. Wherever there is great property there is great inequality. For one very rich man there must be at least five hundred poor, and the affluence of the few supposes the indigence of the many. The affluence of the rich excites the indignation of the poor, who are often both driven by want, and prompted by envy, to invade his possessions. It is only under the shelter of the civil magistrate that the owner of that valuable property, which is acquired by the labour of many years, or perhaps of many successive generations, can sleep a single night in security. He is at all times surrounded by unknown enemies, whom, though he never provoked, he can never appease, and from whose injustice he can be protected only by the powerful arm of the civil magistrate continually held up to chastise it. The acquisition of valuable and extensive property, therefore, necessarily requires the establishment of civil government. Where there is no property, or at least none that exceeds the value of two or three days' labour, civil government is not so necessary. Civil government supposes a certain subordination. But as the necessity of civil government gradually grows up with the acquisition of valuable property, so the principal causes which naturally introduce subordination gradually grow up with the growth of that valuable property. (...) Men of inferior wealth combine to defend those of superior wealth in the possession of their property, in order that men of superior wealth may combine to defend them in the possession of theirs. All the inferior shepherds and herdsmen feel that the security of their own herds and flocks depends upon the security of those of the great shepherd or herdsman; that the maintenance of their lesser authority depends upon that of his greater authority, and that upon their subordination to him depends his power of keeping their inferiors in subordination to them. They constitute a sort of little nobility, who feel themselves interested to defend the property and to support the authority of their own little sovereign in order that he may be able to defend their property and to support their authority. Civil government, so far as it is instituted for the security of property, is in reality instituted for the defence of the rich against the poor, or of those who have some property against those who have none at all." (Source: The Wealth of Nations, Book 5, Chapter 1, Part 2)


Adam Smith resided at Panmure house from 1778-90. This residence has now been purchased by the Edinburgh Business School at Heriot Watt University and fundraising has begun to restore it.[112][113] Part of the Northern end of the original building appears to have been demolished in the 19th century to make way for an iron foundry.

As a symbol of free market economics

Smith has been celebrated by advocates of free market policies as the founder of free market economics, a view reflected in the naming of bodies such as the Adam Smith Institute in London, the Adam Smith Society[114] and the Australian Adam Smith Club,[115] and in terms such as the Adam Smith necktie.[116]

Alan Greenspan argues that, while Smith did not coin the term laissez-faire, "it was left to Adam Smith to identify the more-general set of principles that brought conceptual clarity to the seeming chaos of market transactions". Greenspan continues that The Wealth of Nations was "one of the great achievements in human intellectual history".[117] P. J. O'Rourke describes Smith as the "founder of free market economics".[118]

However, other writers have argued that Smith's support for laissez-faire (which in French means leave alone) has been overstated. Herbert Stein wrote that the people who "wear an Adam Smith necktie" do it to "make a statement of their devotion to the idea of free markets and limited government", and that this misrepresents Smith's ideas. Stein writes that Smith "was not pure or doctrinaire about this idea. He viewed government intervention in the market with great skepticism ... yet he was prepared to accept or propose qualifications to that policy in the specific cases where he judged that their net effect would be beneficial and would not undermine the basically free character of the system. He did not wear the Adam Smith necktie." In Stein's reading, The Wealth of Nations could justify the Food and Drug Administration, the Consumer Product Safety Commission, mandatory employer health benefits, environmentalism, and "discriminatory taxation to deter improper or luxurious behavior".[119]

Similarly, Vivienne Brown stated in The Economic Journal that in the 20th century United States, Reaganomics supporters, The Wall Street Journal, and other similar sources have spread among the general public a partial and misleading vision of Smith, portraying him as an "extreme dogmatic defender of laissez-faire capitalism and supply-side economics".[120] In fact, The Wealth of Nations includes the following statement on the payment of taxes:

"The subjects of every state ought to contribute towards the support of the government, as nearly as possible, in proportion to their respective abilities; that is, in proportion to the revenue which they respectively enjoy under the protection of the state."[121]

Moreover, in this passage Smith goes on to specify that progressive, not flat, taxation would be tolerable:

"It is not very unreasonable that the rich should contribute to the public expense, not only in proportion to their revenue, but something more than in that proportion."[122]

Smith even specifically named taxes that he thought should be required by the state among them luxury goods taxes and tax on rent. He believed that tax laws should be as transparent as possible and that each individual should pay a "certain amount, and not arbitrary," in addition to paying this tax at the time "most likely to be convenient for the contributor to pay it".[121] Smith goes on to state that:

"Every tax, however, is, to the person who pays it, a badge, not of slavery, but of liberty."[123]

Additionally, Smith outlined the proper expenses of the government in The Wealth of Nations, Book V, Ch. I. Included in his requirements of a government is to enforce contracts and provide justice system, grant patents and copy rights, provide public goods such as infrastructure, provide national defense and regulate banking. It was the role of the government to provide goods "of such a nature that the profit could never repay the expense to any individual" such as roads, bridges, canals, and harbours. He also encouraged invention and new ideas through his patent enforcement and support of infant industry monopolies. he supported public education and religious institutions as providing general benefit to the society. Finally he outlined how the government should support the dignity of the monarch or chief magistrate, such that they are equal or above the public in fashion. He even states that monarchs should be provided for in a greater fashion than magistrates of a republic because "we naturally expect more splendor in the court of a king than in the mansion-house of a doge."[124] In addition, he was in favor of retaliatory tariffs and believed that they would eventually bring down the price of goods. He even stated in Wealth of Nations:

"The recovery of a great foreign market will generally more than compensate the transitory inconvenience of paying dearer during a short time for some sorts of goods."[125]

Noam Chomsky has argued[N 3] that several aspects of Smith's thought have been misrepresented and falsified by contemporary ideology, including Smith's reasons for supporting markets and Smith's views on corporations. Chomsky argues that Smith supported markets in the belief that they would lead to equality, and that Smith opposed wage labor and corporations.[126] Economic historians such as Jacob Viner regard Smith as a strong advocate of free markets and limited government (what Smith called "natural liberty") but not as a dogmatic supporter of laissez-faire.[127]

Economist Daniel Klein believes using the term "free market economics" or "free market economist" to identify the ideas of Smith is too general and slightly misleading. Klein offers six characteristics central to the identity of Smith's economic thought and argues that a new name is needed to give a more accurate depiction of the "Smithian" identity.[128][129] Economist David Ricardo set straight some of the misunderstandings about Smith's thoughts on free market. Most people still fall victim to the thinking that Smith was a free market economist without exception, though he was not. Ricardo pointed out that Smith was in support of helping infant industries. Smith believed that the government should subsidise newly formed industry, but he did fear that when the infant industry grew into adulthood it would be unwilling to surrender the government help.[130] Smith also supported tariffs on imported goods to counteract an internal tax on the same good. Smith also fell to pressure in supporting some tariffs in support for national defense.[130] Some have also claimed, Emma Rothschild among them, that Smith supported a minimum wage.[131]

Though, Smith had written in his book The Wealth of Nations:

"The price of labour, it must be observed, cannot be ascertained very accurately anywhere, different prices being often paid at the same place and for the same sort of labour, not only according to the different abilities of the workmen, but according to the easiness or hardness of the masters. Where wages are not regulated by law, all that we can pretend to determine is what are the most usual; and experience seems to show that law can never regulate them properly, though it has often pretended to do so." (Source: The Wealth of Nations, Book 1, Chapter 8)

See also


Adam Smith and the invisible hand


by Helen Joyce

Submitted by plusadmin on March 1, 2001

...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 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. I have never known much good done by those who affected to trade for the public good.

In this passage, taken from his 1776 book "An Inquiry into the Nature and Causes of the Wealth of Nations" Adam Smith set out the mechanism by which he felt economic society operated. Each individual strives to become wealthy "intending only his own gain" but to this end he must exchange what he owns or produces with others who sufficiently value what he has to offer; in this way, by division of labour and a free market, public interest is advanced.

Smith is often regarded as the father of economics, and his writings have been enormously influential. Nowadays, "invisible hand" explanations are invoked to explain all sorts of phenomena, from scientific progress to environmental degradation. In the modern context, mathematicians study "invisible hand" processes as part of Game Theory, the branch of mathematics that deals with payoffs and strategies (see Game Theory and the Cuban Missile Crisis) in Issue 13 of Plus.

Smith was profoundly religious, and saw the "invisible hand" as the mechanism by which a benevolent God administered a universe in which human happiness was maximised. He made it clear in his writings that quite considerable structure was required in society before the invisible hand mechanism could work efficiently. For example, property rights must be strong, and there must be widespread adherence to moral norms, such as prohibitions against theft and misrepresentation. Theft was, to Smith, the worst crime of all, even though a poor man stealing from a rich man may increase overall happiness. He even went so far as to say that the purpose of government is to defend the rich from the poor.

Here is a description of the way Smith imagined the universe operates:

It is clear why Smith says that moral norms are necessary for such a system to work - in order for exchange to proceed, contracts must be enforceable, people must have good access to information about the products and services available, and the rule of law must hold.

The modern "Invisible Hand"

Nowadays, something much more general is meant by the expression "invisible hand". An invisible hand process is one in which the outcome to be explained is produced in a decentralised way, with no explicit agreements between the acting agents. The second essential component is that the process is not intentional. The agents' aims are not coordinated nor identical with the actual outcome, which is a byproduct of those aims. The process should work even without the agents having any knowledge of it. This is why the process is called invisible.

The system in which the invisible hand is most often assumed to work is the free market. Adam Smith assumed that consumers choose for the lowest price, and that entrepreneurs choose for the highest rate of profit. He asserted that by thus making their excess or insufficient demand known through market prices, consumers "directed" entrepreneurs' investment money to the most profitable industry. Remember that this is the industry producing the goods most highly valued by consumers, so in general economic well-being is increased.

One extremely positive aspect of a market-based economy is that it forces people to think about what other people want. Smith saw this as a large part of what was good about the invisible hand mechanism. He identified two ways to obtain the help and co-operation of other people, upon which we all depend constantly. The first way is to appeal to the benevolence and goodwill of others. To do this a person must often act in a servile and fawning way, which Smith found repulsive, and he claimed it generally meets with very limited success. The second way is to appeal instead to other people's self-interest. In one of his most famous quotes:

Man has almost constant occasion for the help of his brethren, and it is in vain for him to expect it from their benevolence only. He will be more likely to prevail if he can interest their self-love in his favour, and show them that it is for their own advantage to do for him what he requires of them. Whoever offers to another a bargain of any kind, proposes to do this. Give me what I want, and you shall have this which you want, is the meaning of every such offer; and it is the manner that we obtain from one another the far greater part of those good offices which we stand in need of. It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love.

For Smith, to propose an exchange is to attempt to show another that what you can do, or what you have, can be of use to the other. When you carry out the exchange, it means the other person recognises that what you can do or that what you have is of value. This is why so much of a person's self-esteem is bound up in their job - a well-paid job is supposed to be a sign that others value your contribution and find it worth exchanging their own resources for.

How wise is the Invisible Hand?

with permission from: The Warren J. Samuels Portrait Collection at Duke University

The theory of the invisible hand is certainly persuasive, and its simplicity is also very attractive. No doubt every reader can see that it describes the way that things really work on many occasions, and, whether we find it palatable or not, we probably all recognise the truth of Smith's assertion that paying for your dinner is a more reliable way to get it than appealing to the benevolence of others.

But, even assuming all the correct conditions, does the invisible hand theory really lead to the maximisation of human economic wellbeing in some sense, as Smith asserts? This is where mathematics, in the form of Game Theory, can provide us with some insights.

The Prisoner's Dilemma

The "Prisoner's Dilemma" is a very famous "paradox" in Game Theory. It describes two people in a simple situation, acting in an informed manner, both attempting to maximise their wellbeing, and yet making choices that lead to an unnecessarily poor outcome for both.

Two people, who are suspected of being accomplices in a crime, are held prisoner in separate, non-communicating cells. The police visit each prisoner, and tell both that if neither confesses, each will be sentenced to two years in jail. However, if exactly one prisoner confesses, implicating each other, the one who confesses will get off scot-free as a reward, and the other, who didn't confess, will receive a punitive sentence of five years. If each confesses and implicates the other, both will be sentenced to three years.

What should a prisoner in this situation do? Suppose that the other prisoner doesn't confess. Then the best course of action is to confess, and go free. Even if the other prisoner does confess, it will be better to have done likewise - at least the sentence will be lower. Both prisoners will reason thus, so both will confess and end up serving sentences of three years - even though, if both had remained silent, both would have served sentences of only two years.

It may not be immediately clear what the relevance of the Prisoner's Dilemma is to Smith's theory of the Invisible Hand. In fact, it has a number of implications for economic behaviour.

The temptation to default

We can think of the prisoners as being asked to decide whether to keep a contract they have made with each other (remain silent) or to default (confess and betray the other). Similar choices have to be made all the time in economic society. When two people freely agree to exchange goods or services to their mutual benefit, each must decide whether to try to cheat the other by defaulting, or handing over counterfeit goods, or whether to act in good faith and risk the other party defaulting. Obviously, both parties are better off if neither default than if both default - after all, we suppose they willingly contracted with each other - but each would like to get something for nothing, and each is afraid the other will feel the same. The result may well be that the parties are unable to carry out the exchange as arranged, and both lose out.

The reason we don't see this behaviour too often is because we live in a society where courts can enforce contracts. This reduces the fear of the other party defaulting, and makes it easier to hand over goods ahead of receiving whatever is to be exchanged for them. In illegal exchanges, for example, receiving stolen goods, default is more common, and rather difficult for criminals to guard against.

Enforcing laws of contract requires cooperation and resources from someone else - in democratic societies, the courts on behalf of the government and the people. But courts and prisons and police cost money and most of the costs fall on people who were not party to the contract in the first place - who are therefore paying for a service that doesn't directly benefit themselves. Such courts fall into the category of "public good" - we are all better off in a society where the rule of law is upheld - but are not created and maintained by any invisible hand mechanism. Courts are set up deliberately to carry out a public good; and, although they may not always work the way they are intended to, there is nothing unintended about their use to enforce contracts.


In a democratic society, there is a strong temptation for "special-interest" groups to form and lobby the government to provide tax-payers' money to the group in the form of subsidies. Politicians find the prospect of buying the loyalty of the group attractive, and the group sees the prospect of getting other people's money for nothing. Clearly, everyone would be better off if no one sought subsidies - by definition, subsidies are only needed for unprofitable activities, that is, activities that other people do not value sufficiently to pay their own money for. However, if other people seek and gain subsidies, anyone who doesn't bother trying to do the same for themselves will end up subsidising others while receiving no subsidies themselves. This fear may force large numbers of people to spend their time lobbying the government for subsidies, rather than simply engaging in more profitable activities - a classic example of the Prisoner's Dilemma, and one over which no court has jurisdiction.

A very similar situation occurs regarding monopolies. Since pretty much every producer is a consumer, it is probably to everybody's benefit overall if no producers attempt to raise prices by monopolising their market; however, attempting to enforce a monopoly can be very attractive to individual producers. Smith rather sardonically observed that

"People of the same trade seldom meet together even for merriment and diversion, but the conversation ends in a conspiracy against the public or some contrivance to raise prices."

Arrow's Theorem

As explained in the Editorial of Issue 13 of Plus, Arrow's Impossibility Theorem says that, in a certain sense, it is impossible to produce a consistent group preference by aggregating individual preferences. It is normally stated in terms of votes and elections, and, in this format, says that is impossible to use information about individual voters' preferences to decide what is "the will of the people". Every voting system in current use throws up anomalies, such as "flip-flops", which occur when a third candidate enters the race and overturns the group preference between the other two candidates (think of Ralph Nader in California, splitting Al Gore's vote and handing George Bush the election).

The "will of the people"

Again, the relevance to allocation of public goods is not immediately obvious - until you recall that an essential part of the invisible hand process is that producers respond to an single signal that is meant to be an aggregate of all signals by consumers. Arrow's Theorem is often interpreted as saying that there is no consistent way to aggregate the preferences of individuals to give a single preference which can be regarded as the preference of society - or "the will of the people".

An economic version of the flip-flop could occur if a majority of customers would prefer to buy Product X to Product Y, but some of that majority actually like Product Z even better (the equivalent of splitting the vote); the producer may end up producing Product Y even though more people would have liked Product X, and presumably it would have been more profitable to produce it. If this happens, then the invisible hand cannot be said to have worked to maximise economic wellbeing.

In a centralised society a few individuals make decisions on how to spend everyone's money and direct everyone's effort.

How far does the invisible hand reach?

How economic systems work and what can be done to improve them is still very much a live area of research for economists. Mathematicians are currently grappling with the implications of game theory for all sorts of social choice, in particular, what meaning, if any, can be attached to the expressions "the will of the people" and "the public good".

The results of such analyses will not be the only factor in deciding whether societies move towards or away from laissez-faire economics ("laissez-faire" means "let alone" and is shorthand for leaving things to the invisible hand). Political will, whether the world becomes more peaceful or less, and the practicality of any alternatives will also be factors. Alternative systems tend to require much more intervention and more stringent rules. In the real world, such rules automatically introduce more and more opportunities for mistakes and corruption, which might mean that another system, even if better in principle, would be worse in practice.

Perhaps the strongest reason for leaving the allocation of effort and reward to the invisible hand is that when it misappropriates goods, it is likely to be on a small scale. More centralised methods of allocating goods are more prone to corruption and waste. Smith described people given the spending of other people's money thus:

..being the managers of other people's money than of their own, it cannot well be expected that they should watch over it with the same anxious vigilance with which partners in a private copartnery frequently watch over their own. Like the stewards of a rich man, they ... consider attention to small matters as not for their master's honour and very easily give themselves a dispensation from having it.

It is useful to remember the context in which Smith developed his theories - that of a heavily planned and rather dictatorial society, where some individuals were above the law and others were effectively without any rights. In a centralised society a few individuals make decisions on how to spend everyone's money and direct everyone's effort. As Smith said

It is the highest impertinence and presumption, therefore, in kings and ministers to pretend to watch over the economy of private people, and to restrain their expense...They are themselves always, and without exception, the greatest spendthrifts in the society.

Sunday, June 29, 2008

A Tall Sunday Story of an Invisible Hand

Dialektika (‘the working man in the world unit’)

Adam Smith and the invisible hand by Helen Joyce.

Joyce begins by slightly misleading her readers, by cutting into the famous paragraph 9 that mentions the metaphor of the invisible hand (WN IV.ii.9: 455-6).

By cutting out the crucial information that Adam Smith discusses not just the general individual in society but those particular individuals who employ ‘whatever capital [they] command’ (WN IV.ii.4: 454), namely merchant traders. He is dealing with a particular case of owners of capital who contemplate where to invest it and choose between engaging in the ‘foreign trade of consumption’, particularly, though not exclusively, in British colonies in North America or India, or investing it locally.

The decision centres on which destination is ‘most advantageous’, which boils down to which is most profitable and least risky? Both are profitable, but one (foreign trade) is more profitable and more risky than the other.

When he invests locally his ‘capital is never so long out of his sight’ and in the colonial trade it may be away from him for months, and subject to the vagaries of the weather at sea, risks of piracy, seizure during wars, dishonest handling in foreign ports, malfeasance when under the control of distant merchants, of whom he knows less than those close by him, the vagaries of foreign justice, and the fortunes of distant consumers.

Not considering the context of which Smith was addressing is tantamount to drawing in the minds of readers of the stripped down quotation a completely misleading impression that Smith is talking as a general rule of trade. He wasn’t! It isn't even mentioned during his long discussiosn of markets in Books I and II of Wealth Of Nations!

Smith is discussing the risk aversion of merchants to investing in trade abroad and necessarily investing locally. The consequence is for Joyce to downplay those parts of the quotation from paragraph 9 that make it clear of what he speaks.

The individual merchant ‘intends only his own security’ and it is this consideration, plus his desire to make profits, ‘provided he can thereby obtain he ordinary, or not a great deal less than the ordinary profits of stock’ (WN IV.ii.5: 454), which determine inexorably, by the arithmetic rule that the whole is the sum of its parts, that domestic products thereby ‘may be of the greatest value’, and certainly greater than they would be if merchants were risk neutral.

This conclusion is sufficiently explained by Smith and readers who understand its construction would see that truth immediately. His readers were educated and literate, but not necessarily all to the same standard, and to cap his presentation he drew on his knowledge of literature, both contemporary and classical, where the metaphor of ‘an invisible hand’, which was widely used and recognised in the 18th century, of ‘an invisible hand’.

The metaphor represents, as metaphors are supposed to, and as Smith taught in his lectures on Rhetoric (see: Lectures on Rhetoric and Belles Lettres,[1763] 1983), the object under discussion, namely the behaviour of risk averse merchants. It was not a ‘theory’, ‘concept’, or ‘paradigm’, nor the greatest idea of great significance. It was not a reference to God, or some divine intervention, which Joyce thought that Smith discovered because he ‘was profoundly religious, and saw the “invisible hand” as the mechanism by which a benevolent God administered a universe in which human happiness was maximised.’ Her conclusion is an assertion for which she has limited evidence.

Smith’s mother was ‘profoundly religious’ but there is no evidence that he was. Indeed, he had abandoned Oxford University to avoid continuing to become a priest in the Church of England and to preach in the Episcopalian Church in Scotland.

The metaphor of the invisible hand is just a metaphor. Nothing more.

Shakespeare used the invisible hand in Macbeth (the ‘Scottish play’), as did Daniel Defoe in Moll Flanders and Colonel Jack, and a score of other authors in books on the shelves of most educated people in the 18th century.

Helen Joyce makes several other wild assertions in her article (HERE). If I have time I shall return to them, but for now I have a conference to attend.

posted by Gavin Kennedy at 10:59 am


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