Adam Smith’s Theory of ‘The Invisible Hand’
This essay tries to absolve Adam Smith from left-wing criticism that he has established the mode of greed in Western societies. It lays stress on the fact that Smith’s theory concerning the “invisible hand” was a scientific observation, and that it expressed natural law, something that is beyond the capacity of humans to control. To this end it considers various issues raised in The Wealth of Nations, discusses how they were relevant to Britain and the world at the time of publication, and also how they continue to be relevant to this day.
It points out that left-wing criticism derives from a misreading of Smith, and is due to a conflation of Smith’s theories and capitalism. It argues that capitalism existed well before the time of Smith, and its course has nothing to do with Smith’s discoveries. The underlying theme is that Smith’s theory expresses freedom in economic life.
The first thing to keep in mind when discussing the concept of Adam Smith’s theory of the “invisible hand” is that he was foremost a moral philosopher and a social scientist, and by no means an economist in the modern sense. The modern economist usually functions in the capacity of a social policy advisor who is politically motivated. It is true that Smith offers advice to governments towards achieving prosperity, but this is only in the capacity of a moral philosopher.
The substance of his findings is that economic life is governed by a simple principle, and his advocacy derives from the understanding that is it unwise to intercede in the path of natural law. This is the principle of laissez faire, that governments should not impose their designs of the economy of a country, and that even the cleverest idea is bound to be detrimental to prosperity, compared to that which comes naturally. In the modern context we find the World Bank criticized by the left for ‘imposing’ free market ideology on poorer nations, an ideology supposedly derived from Smith. If it is an imposition, then it must surely be contrary to the workings of the invisible hand, and therefore detrimental to prosperity. But it is questionable whether the World Bank really imposes itself at all, a point that will be taken up further on.
Smith’s thesis is a mere elaboration of Bernard Mandeville’s motto “private vices, public benefits”, though Smith is careful not to conflate vice with self-interest. In Smith’s version of the teaching, we act in our own interest in the sphere of economic activity, but in doing so we bring about benefit to society as a whole. Smith imagines an invisible hand arranging things in economic life, so that even though we do not intend to serve the public good, we end up doing so. He describes the mechanism of price determinism to put the thesis into focus. The price of a commodity is determined by two factors – supply and demand.
If there is a sudden glut in the market, the price of corn falls. This means that there is more supplied than that which is demanded, and so consumers are not willing to buy corn at the previous price, and so the seller is forced to lower it. On the other hand a bad harvest suddenly makes corn less available, in which circumstance the price rises. Consumers still demand the same amount of corn, so the seller is able to extract a larger price for his corn. This describes the fluctuation of supply, and the situation mirrors itself when the demand fluctuates. This analysis actually describes two opposing tendencies in the market. The seller wants a high price for his goods, while the consumer would pay the least. Matters settle at the equilibrium price, which is the point that balances the two tendencies. The mechanism of price determination is as close as we come to see the workings of the invisible hand, which works for the general benefit by balancing contraries.
Smith is describing a natural law of human interaction, so he cannot make suggestions as to how the theory should be utilized. Governor Pownall of Massachusetts has fittingly described the thesis as “an institute of the Principia of those laws of motion, by which the operations of the community are directed and regulated, and by which they should be examined.” Smith is observing as a scientist would, and in his reasoning we discover a strong imprint of Hume’s “science of man”. David Hume was a crucial philosopher for the age, who emphasized that reason must be applied to the sphere of man, against the Rationalists who harked for metaphysical certainty in knowledge. Most of the substance of The Wealth of Nations is anticipated by Hume, especially the benefits to be gained from competition and free trade. The special contribution of Smith was to put the matter on a solid scientific footing.
Another significant influence is of the physiocratic school in France, led by Francois Quesnay. This school also believed in a natural law determining economic life, but based the law on land, and therefore on agriculture. Because agriculture is the support of all other activities, the agricultural community was thought to be the sacred heart of society and in this context the advocacy was “laissez faire” – to let things be. Smith instead identified the source in labour, and in free competition regards the exchange of it products. This is the heart of economic activity that must be left inviolate, and he carried on the same slogan of the Physiocrats in this new context.
The opponents of Smith accuse him of promoting greed, but this is certainly not the way Smith meant his thesis to come across. As a true scientist, his sole regard was for natural law. He does not pretend that economic activity can be changed at the atomic level. His only advocacy was for free trade at the macroscopic level. He felt passionately in this regard because the conventional policy of European governments at the time was hardly conducive to free trade. This policy is described as mercantilism, which in the modern context may be described as protectionism. Governments believed that they should always aim for a favourable balance of trade.
The reasoning was that, if net exports exceed net imports, there is an accumulation of specie (gold or silver currency) within the domestic economy. The extra wealth may then be utilised towards further self-sufficiency, by cultivating or mining the colonies. It also helps in the emergency of war, because troops may be quickly assembled to the task of protecting the national interests. At the time all major European powers were colonial, and effectively at war with each other in their expansionary drives. International trade was carried out in this atmosphere of suspicion and rivalry, and Smith did not see this as a situation favourable to prosperity. His reasoning was simply that it obstructed natural law.
Smith singled out the relative prosperity of Britain, and identified the cause in its relative tolerance of free trade. As against Britain he cited the examples of Spain and Portugal, the original European colonists, but now languishing in the race. The demise of the Spanish and Portuguese empires is squarely blamed on mercantilism. Natural love of specie was exacerbated by the discovery of gold and silver mines in South America, and to prevent the acquired treasures from leaking out of their domestic economies, these governments introduced more and more protectionist measures, the net result being merely inflation, because gold and silver lost value in the internal market.
As the domestic economy lost edge, trade also suffered. Because Spain and Portugal held so much gold, the currency elsewhere increased in value, which encouraged industry, so that other nations were able to trade favourably with them. Smith compares this situation to a river being dammed up, so that the dammed up side is at an unusual high level, at the expense of the other side.
“Open the flood-gates,” Smith exhorts, “and there will presently be less water above, and more below, the dam-head, and it will soon come to a level in both places.” Britain too fell into the same trap, when parliament ratified the Corn Laws in 1815, imposing restrictions on the importation of corn, hoping to extract a better price for its corn merchants and producers in international trade. Despite bloody protests, successive administrations failed to repeal the laws, not willing to relinquish a tool by which they could display economic prowess. Peel took steps in 1842 to lessen the severity of the Laws, claiming to have been enlightened by reading Smith. It was only fully repealed by his successor Russell.
Most observers will agree that free trade has been responsible for the miraculous prosperity and technological advance of the modern world. In this way they come to an appreciation of the invisible hand at work, in the same way that Smith appreciated its workings in the favourable position of Britain in the 18th century. But it is unfortunate that capitalism and all its attendant evils have come to be associated with Smith’s ideas. The connection comes through Smith’s elaboration of the concept of “division of labour”.
To illustrate how a free economy comes to assign specialized roles to individuals, Smith described how efficiency is extracted from the factory floor. However, the capitalist who owns the factory can read this description in a different light, and may then try to extract profit through more specialization. Such an attitude gives rise to capitalism, and may be said to come from a misreading of Smith. Marx analyses capitalism entirely from this point of view, and speaks of an unhealthy separation, where “labour power found itself in a state of separation from its means of production,” which has been expropriated by the capitalist. This is supposed to be the beginnings of social alienation. Karl Polanyi identifies an even more drastic consequence.
He describes how “the market becomes ‘disembedded’ from society,” meaning that instead of functioning in the natural context in which Smith observed it, the market is forced to function in the way the capitalist deems necessary. The capitalist is further criticized for imposing enclosures, which bars society towards holistic integration. Some critics lambaste Smith for not once mentioning the controversial “highland clearances”, in which people were barred from access to common land to make way for sheep cultivation, a part of the general policy of ‘enclosure’.
But all such left-wing critiques are merely beside the point. Smith nowhere describes capitalists controlling society, and any such action he describes as merely subversive to the working of the invisible hand. The economic efficiency which he extols is not to the credit of the capitalist, but is rather the outcome of natural law. If capitalism seems to be a reality, then it must be explained otherwise. Braudel offers a more intelligent explanation, in which capitalism is merely a steady commercialization of economic life, and without a specific origin. Smith derides capitalism in the same way as we do. It has nothing to do with the functioning of the invisible hand.
Another way in which Smith is thought to have instigated capitalism is through the influence he wields over the avowed capitalist regimes of the West. He is thought to have played a role in the birth of the American nation, as being an inspiration in the revolutionary war against Britain. But the founding fathers were not followers of Smith, and the later leaders were only so by proxy. They professed to believe in Smith only because his theories had become the norm. In fact Smith’s own predictions concerning America are highly significant. He thought the British treatment of its American colonies as enlightened, and except for trade the colonists were allowed every freedom.
He called for American representation in the British parliament, and predicted that one day British capital would be transplanted to America. In the end Britain had to go to war with its colonies, and eventually granted them independence. If not British capital, then at least British liberality transplanted itself there, and proved to be the foundation to American prosperity. It proves that Smith’s hope for the American colonies was not misplaced, but it was a hope based on liberality, and not on capitalism. This is the sense in which McCloskey describes him as a moral philosopher, and not an economist. The same argument serves to absolve World Bank from the charge of imposing free market reforms, which are said to be imposed as conditions to granting loans to poor countries. Once we accept that the free market is a natural phenomenon, it cannot be conceived how any political body may control it. The left wing seems to mistake moral freedom for conspiracy.
In conclusion, Smith discovered a natural law that guides economic life, and to present it graphically he pictures a pervasive and invisible hand working towards the enrichment of society as a whole despite the fact that the individual members are acting only out of self-interest. The wrong judgement of this theory is to suppose it to be a means for the capitalist to enrich himself. The correct judgement should be that Smith has discovered how freedom exists in the economic life. In the modern world, nations have prospered only to the extent to which they have been infused with the spirit of freedom. If they had tried to conspire to this end they would not have succeeded. This is the basic lesson that we learn from The Wealth of Nations.
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