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September 26, 2014

Demystifying the Invisible Hand

The phrase “invisible hand” can easily evoke fanciful imagery of invisible hands magically manipulating the world. So it’s no surprise that many critics of laissez-faire, particularly on the left, misconstrue the concept as a form of magical thinking or religious fundamentalism. For example, Neil Douglas and Terry Wykowski allege that “market fundamentalists imagine that the market magically transforms market participants into moral agents who mitigate self interest through the ‘invisible hand’ as described by Adam Smith.”1

But economists don’t argue that markets produce moral outcomes as a result of “magic.” Rather, they argue that the institutions associated with markets produce incentives and those incentives guide self-interested individuals towards socially beneficial actions. As Peter Boettke explains, Adam Smith did not argue “that the pursuit of self-interest will automatically translate into public benefits.”2  To the contrary, Boettke points out:

The Wealth of Nations actually has plenty of examples in which the pursuit of self-interest can lead to socially undesirable options. His discussion of the vocation of teaching in Oxford (bad) and in Glasgow (good) provides a classic example. In Glasgow, the teacher had a strong incentive to provide valuable instruction because salary was a function of fees paid by the students, whereas in Oxford, because an endowment guaranteed a teacher’s salary, the professors had long ago given up even the pretense of teaching. Smith’s work is full of such comparative institutional analysis. The pursuit of self-interest in one case leads to a socially desirable outcome, whereas in the other it leads to an undesirable one. The key point: Smith’s analysis does not turn on the behavioral postulate of self-interest but instead on the institutional specifications that are in operation.3

Boettke uses this emphasis on institutions to rephrase Smith’s invisible hand proposition as follows: “Individuals pursuing their own self-interest within an institutional setting of property, contract, and consent will produce an overall order that, although not of their intention, enhances the public good.”4 Under these conditions, social cooperation emerges that is a result of human action but not of human design.

Under libertarian institutions, the easiest way to gain wealth is through production and exchange. Thus, individuals fulfill their self-interest by producing goods and services that others want. While they may have no altruistic intentions as they enter the marketplace, their selfish actions produce a better world for all who reap the benefits of exchange, whether producers or consumers. As Adam Smith put it, “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages.”5

Philosopher Robert Nozick explored invisible hand explanations beyond simply their application in economics. According to Nozick, “An invisible-hand explanation explains what looks to  be the product of someone’s intentional design, as not brought about by intentional design.”6 Given this definition, it’s particularly bizarre to treat invisible hand explanations as a form of religious fundamentalism. For as Nozick notes, evolutionary explanations of how species develop through natural selection, genetic drift, and mutations rather than intelligent design fall in the general category of invisible hand explanations.7 Invisible hand explanations are useful throughout the sciences.

Nozick explains that “Invisible hand explanations minimize the use of notions constituting the phenomena to be explained…they don’t explain complicated patterns by including the full-blown pattern-notions as objects of people’s desires or beliefs. Invisible hand explanations of phenomena thus yield greater understanding than do explanations of them as brought about by the design of people’s intentions.”8 Mocking these explanations as religious or magical is precisely backwards. Where conspiracy theorists and creationists assume that powerful planners have designed complex orders from above, they are engaging in magical and religious thinking. In contrast, invisible hand explanations involve carefully studying the natural processes that underpin the intricate orders we observe.

Invisible hand explanations apply throughout everyday life. For example, whenever we use language we benefit from a spontaneous order. No planners designed our languages from the top down. Instead, individuals work to communicate their ideas to each other, employing a massive body of existing language and coining new words and phrases where necessary. Language, like the market, is a result of human action and not of human design.

Rather than mocking and deriding invisible hand explanations, seek to understand them. These explanations do not rely on blind faith or magical thinking.  Instead, they help us study the way that institutions and incentives can shape social cooperation without appealing to top-down plans and designs. They are not a form of fundamentalism, but a vital tool of social science.

1. Neil Douglass and Terry Wykowski. From Belief to Knowledge: Achieving and Sustaining an Adaptive Culture in Organizations. Boca Raton: CRC, 2011. Page: 9.

2. Boettke, Peter. Living Economics: Yesterday, Today, and Tomorrow. Oakland: Independent Institute and Universidad Francisco Marroquin, 2012. Page: 7.

3. Ibid.

4. Ibid, 8.

5. Smith, Adam. An Inquiry into the Nature and Causes of the Wealth of Nations. Edwin Cannan, ed. 1904. Library of Economics and Liberty. 13 September 2014. <http://www.econlib.org/library/Smith/smWN1.html>.

6. Nozick, Robert. Anarchy, State, and Utopia. Oxford: Blackwell Publishing, 1974. Page: 19.

7. Ibid, 20.

8. Ibid, 19.

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