The invisible hand is an economic concept that describes the unintended greater social benefits and public good brought about by individuals acting in their own self-interests. The concept was first introduced by Adam Smith in The Theory of Moral Sentiments, written in 1759. According to Smith, it is literally divine providence, that is the hand of God, that works to make this happen.
The invisible hand is a metaphor for the unseen forces that move the free market economy. Through individual self-interest and freedom of production and consumption, the best interest of society, as a whole, are fulfilled. The constant interplay of individual pressures on market supply and demand causes the natural movement of prices and the flow of trade.
By the time he wrote The Wealth of Nations in 1776, Smith had studied the economic models of the French Physiocrats for many years, and in this work, the invisible hand is more directly linked to production, to the employment of capital in support of domestic industry. The only use of “invisible hand” found in The Wealth of Nations is in Book IV, Chapter II, “Of Restraints upon the Importation from Foreign Countries of such Goods as can be produced at Home.” The exact phrase is used just three times in Smith’s writings.
Smith may have come up with the two meanings of the phrase from Richard Cantillon who developed both economic applications in his model of the isolated estate.
The idea of trade and market exchange automatically channeling self-interest toward socially desirable ends is a central justification for the laissez-faire economic philosophy, which lies behind neoclassical economics. In this sense, the central disagreement between economic ideologies can be viewed as a disagreement about how powerful the “invisible hand” is. In alternative models, forces that were nascent during Smith’s lifetime, such as large-scale industry, finance, and advertising, reduce its effectiveness.
Interpretations of the term have been generalized beyond the usage by Smith.
The invisible hand concept is based on the idea of free markets and is said to benefit consumers by creating market equilibrium by people pursuing their own self-interest.
In theory, people acting based on their own interests creates supply and demand and market efficiency, creating a positive outcome for the whole of the economy. Without government intervention, the markets work on their own based on consumer preferences and actions.
However, the invisible hand theory assumes that consumers are rational when making economic decisions. But that’s not always the case. As humans, we don’t always behave logically but based on emotions or need. Consider any time you have gone to the grocery store and overspent because you’re hungry or sleep-deprived.
Additionally, some critics note the possibility of greed and exploitative practices that could be justified due to “self-interest” and the invisible hand.
The invisible hand theory is an important economic concept that is still relevant today. It can offer an explanation into free markets and consumer behavior. While the concept is important, it’s also often used out of context or in a way that’s out of alignment with Smith’s original text.
“Smith’s theory has been misinterpreted by some modern lay economists and even some professional economists to mean that the unfettered pursuit of self-interest will always produce an optimal result, without any attention whatsoever to communal interests or to altruism, and that government intervention is always bad,” says Edesess. “This aberrant strain of economics has been recently dubbed ‘market fundamentalism.'”
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