Adam Smith was somewhat of a paradox a deeply religious
mathematician. In 1776 he wrote "An Inquiry into the Nature and
Causes of the Wealth of Nations" in which he promulgated his
invisible hand theory, which stated that each individual, while
striving for his own gain, of necessity advances the public interest
by the free exchange of goods and services creating division of labor
and a free market economy.
Every individual necessarily labours to render the annual revenue of
the society as great as he can. He generally neither intends to
promote the public interest, nor knows how much he is promoting
it...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. Nor is it always the worse for society that it was no
part of his intention. By pursuing his own interest 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 envisioned the universe as being administered by a benevolent
God and ordered to maximize human happiness. It is our nature to
surmise that we will be happier if we are wealthier, and so we strive
to better our lot through exchange with others in the give and take of
a mutually beneficial free market. To do this, a certain structure is
necessary for the invisible hand to work properly. A free market
society requires strong property rights, a code of law and morals,
enforceable contracts, exchange of information and a means to uphold
the rules of law.
Adam Smith and the Invisible Hand
The invisible hand theory is simple, persuasive, elegant and
attractive; and in many cases, it works. This is its main strength.
Because of this theory, most consider Adam Smith to be the father of
The reason: Adam Smith is the first major figure to articulate in a
profound way what has become known as the first fundamental theorem of
welfare economics: that the invisible hand of competition
automatically transforms self-interest into the common good. George
Stigler rightly labels Smith's model of laissez-faire capitalism
(Smith never used the phrase) the "crown jewel" of The Wealth of
Nations and "the most important substantive proposition in all of
economics." He states, "Smith had one overwhelmingly important
triumph: he put into the center of economics the systematic analysis
of the behavior of individuals pursuing their self-interests under
conditions of competition."
Ideas On Liberty
Economics on Trial, May 2001
It All Started with Adam by Mark Skousen
The invisible hand theory is credited with sustaining the industrial
revolution and its subsequent improvement of the standard of living of
the average man:
In 1776 when The Wealth of Nations was published, the average life
England was probably under thirty. Virtually all of most people's
incomes was needed to provide a subsistence diet, and while it was
considered necessary for both men and women to own a single pair of
shoes, the standards in the rest of Europe were not so lavish. We have
come a long way thanks, in large part, to the industrial revolution
which Smith's theories helped to sustain.
Adam Smith Revisited
Chana B. Cox and Joseph J. Cox
But not everyone believes in the best of all possible worlds
scenario set forth by Smith:
Smith was not sophisticated in the level of economic theory that he
used. He did not understand concepts that are considered basic today,
such as the model of supply and demand. (Alfred Marshall developed the
modern treatment of supply and demand a century after Smith.) In his
comprehensive survey of economic theory, Joseph Schumpeter dismisses
Smith as a theorist, saying, "The fact is that the Wealth of Nations
does not contain a single analytic idea, principle, or method that was
entirely new in 1776."
The Nobel prize for economics was awarded to three Americans who
challenged an assumption that has underpinned economic theory ever
since Adam Smith wrote of the "invisible hand" that guided human
behavior. That theory: Markets operate efficiently.
The three, who will share the nearly $1 million award, have long
argued that markets don't always operate efficiently because buyers
and sellers don't always have access to the information they need to
make optimal choices.
The Wall Street Journal
Jon E. Hilsenrath
The invisible hand works well when supplyof, say, shoescaters to
customers who purchase with their own money product for their own use.
Competing suppliers prosper by best serving demanders. In academia,
however, the demand for academic product comes from journal editors,
referees, and university departments. The demand is the expression of
other suppliers. It is as though shoe demanders were only other shoe
makers, who demand shoes not for how well they wear but for aesthetic
niceties fancied by the guild. Academic economists tend to favor peers
whose crafts exalt their own handiwork. In the social sciences and
humanities, demand and supply are highly interlocking, circular, and
self-legitimating. The industry is more of a craft circle or club.
And the club subsists on tax and tuition dollars. The grounds for
faith in an invisible hand are rather slight.
The Independent Institute
Economists Misplaced Faith in an Invisible Hand
Daniel B. Klein
Biography of Adam Smith (1723-1790)
The Adam Smith Institute
I hope this has answered your question. If you need further
clarification of any of the above points, please do not hesitate to
+Adam Smith +invisible hand theory
Clarification of Answer by
12 Jul 2002 15:24 PDT
Thank you for the nice rating, once again, bren-ga.
I think that the greatest weakness of Adam Smiths theory is that,
with the passage of time, it has become more of a golden ideal than a
workable model. Today, more than ever, information is a valuable
commodity, and not everyone has the same access to that resource. This
means that the playing field is not level, and thus the free exchange
of goods and services is impeded because one of the parties has an
advantage over another.
This is nicely explained at:
Adam Smith's classic economic theory says that markets are efficient
because buyers and sellers have equal access to information and
eventually agree upon a price when both consider the transaction as
making them better off. This is Smith's famous "Invisible Hand"
Challenging this bedrock economic law, Nobel laureates George
Akerlof, Joseph Stiglitz and A. Michael Spence won the Swedish prize
for their work on "asymmetric information.
This theory means either the buyer or the seller has more or superior
information. He or she who has more is at an advantage. This has
implications not only for formal marketplaces, such as the stock
exchanges, but also to markets as seemingly disparate as health care,
automotive, international banking and e-Bay.
Purcue University News Service
October 11, 2001