What Is the Invisible Hand?
The invisible hand?is a metaphor for the unseen forces that move the free market economy. Through individual self-interest and freedom of production as well as 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.
The invisible hand is part of laissez-faire, meaning "let do/let go," approach to the market. In other words, the approach holds that the market will find its equilibrium without government or other interventions forcing it into unnatural patterns.
Scottish Enlightenment thinker Adam Smith introduced the concept in several of his writings, but it found this economic interpretation in his book An Inquiry into the Nature and Causes of the Wealth of Nations published in 1776 and in The Theory of Moral Sentiments published in 1759. The term found use in an economic sense during the 1900s.
The?invisible hand metaphor distills?two critical ideas.?First, voluntary trades in a free market produce unintentional and widespread benefits. Second, these benefits are greater than those of a regulated, planned economy.
Invisible Hand Explained
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.
- A metaphor for how, in a free market economy, self-interested individuals operate through a system of mutual interdependence.
- Adam Smith introduced the concept in his book An Inquiry into the Nature and Causes of the Wealth of Nations published in 1776.
- Each free exchange creates signals about which goods and services are valuable and how difficult they are to bring to market.
Every individual necessarily labors to render the annual revenue of the society as great as he can ... He intends only his own security, 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.??
Real World Example of Invisible Hand
Business productivity and profitability are improved when profits and losses accurately reflect what investors and consumers want. This concept 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 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 competing self-interests ran the estate rather than the previous landlord's command economy.
An Inquiry into the Nature and Causes of 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."??