What does ‘Invisible Hand’ mean
The term “invisible hand” is a metaphor for how, in a free market economy, self-interested individuals operate through a system of mutual interdependence to promote the general benefit of society at large. It was introduced by Scottish enlightenment thinker Adam Smith in his book “An Inquiry into the Nature and Causes of the Wealth of Nations” (1776).
BREAKING DOWN ‘Invisible Hand’
There are two critical ideas behind the invisible hand. First, voluntary trades in a free market produce unintentional and widespread benefits. Second, these benefits are greater than those of a regulated, planned economy.
Each free exchange creates signals about which goods and services are valuable and how difficult they are to bring to market. These signals, captured in the price system, spontaneously direct competing consumers, producers, distributors and intermediaries — each pursuing their individual plans — to fulfill the needs and desires of others.
In “The Wealth of Nations,” Adam Smith wrote:
“Every individual necessarily labors to render the annual revenue of the society as great as he can … 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 … By pursuing his own interests, 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.”
Smith only mentioned the invisible hand three times and just once in “The Wealth of Nations,” leaving a rather nebulous concept. Later economists better explained Smith’s invisible hand, especially F.A. Hayek’s “spontaneous order” and Joseph Schumpeter’s “creative destruction.”
Invisible Hands Guide Business Productivity
Business productivity and profitability are improved when profits and losses accurately reflect what investors and consumers want. This is well-demonstrated through a famous example in Richard Cantillon’s “An Essay on Economic Theory” (1755), the book from which Smith developed his invisible hand concept.
Cantillon described an isolated estate that divided into competing leased farms. Independent entrepreneurs ran each farm to maximize their own production and returns. The successful farmers introduced better equipment and techniques, and brought to market only those goods for which consumers were willing to pay. He showed that returns were far higher when the estate was run by competing self-interests rather than the previous landlord’s command economy.
Invisible Hand, Economics and Regulation
“The Wealth of Nations” was published during the first Industrial Revolution and the same year as the American Declaration of Independence. Smith’s invisible hand became one of the primary justifications for an economic system of free market capitalism.
As a result, the business climate of the United States developed with a general understanding that voluntary private markets are more productive than government-run economies. Even government rules sometimes try to incorporate the invisible hand. Former Fed Chairman Ben Bernanke explained the “market-based approach is regulation by the invisible hand” which “aims to align the incentives of market participants with the objectives of the regulator.”