What does the “invisible hand” refer to in the economy?
The concept of the “invisible hand” was explained by Adam Smith in his classic 1776 seminal work, “An Inquiry into the Nature and Causes of the Wealth of Nations”. He was referring to the indirect or unintended benefits to society that result from the operations of a free market economy.
Adam Smith: the father of economics
Smith, considered to have founded modern economic theory in the late 18th century, was not a supporter of widespread government regulation of the economy. He even went so far as to defend smuggling as a natural and legitimate part of the economy.
His laissez-faire, or free market, theories are mainly adopted by the Milton Friedman school of economic thought on the supply side. These theories contrast with 19th century Keynesian demand-side economic theories that have become increasingly prominent in the economic policy-making of Western governments since the 1930s and the Great Depression.
Smith’s invisible hand theory forms the basis of his belief that large-scale government intervention and regulation of the economy are neither necessary nor beneficial. Smith advanced the notion of the invisible hand by asserting that free individuals operating in a free economy, making decisions that are primarily focused on their self-interest, logically take actions that benefit society as a whole, even if these results beneficial were not the object or intention of these actions.
Smith went on to say that the intentional intervention of government regulation, although it is specifically intended to protect or benefit society as a whole, is generally less effective in achieving this goal than a free-functioning market economy. . In many cases, this hurts the population as a whole by denying them the benefits of a free market.
According to Smith, the collective desires of all individual buyers and sellers in a free economy function naturally to accomplish:
- Producing the most desired and beneficial goods in the most efficient way possible, since the most successful seller gets the most market share and revenue.
- Make goods and services available at the functionally lowest possible prices, because free competition between sellers does not allow price gouging.
- Automatically channel most of the investment capital to finance the production of the most needed, beneficial and sought after goods and services, as companies producing the goods or services for which the highest demand is highest are able to obtain the highest prices and the resulting profits.
The existence or effectiveness of the invisible hand of free market “goodwill” is hotly debated. It’s hard to deny, however, that Smith’s market philosophy helped create the most successful economy in history.