Overview

Why is there bread in the store? Is it because the baker loves you? No. It’s because he wants to make money. Adam Smith pointed out a miracle: By acting selfishly, the baker accidentally helps society. He is led by an “Invisible Hand” to do good.

Core Idea

The core idea is Self-Interest serves the Public Good. You don’t need a King to order people to grow food. The price mechanism does it automatically.

Formal Definition

A metaphor used by Adam Smith to describe the unintended social benefits of an individual’s self-interested actions.

Intuition

  • The Line: In the Soviet Union, people waited in line for bread because the government planned the bakeries.
  • The Market: In the US, bakeries compete to sell you bread. If they make bad bread, they go out of business. If they charge too much, you go to the other guy. The result: Good bread at a fair price, without any government planning.

Examples

  • The Pencil: Milton Friedman’s famous example. No single person knows how to make a pencil. The wood is from Oregon, the graphite from Sri Lanka, the rubber from Malaysia. Thousands of people who hate each other cooperated to make this pencil for $0.10. The Invisible Hand coordinated them.

Common Misconceptions

  • Greed is Good: Smith didn’t say greed is good. He said self-interest is useful. He also wrote a whole book (The Theory of Moral Sentiments) about how we need empathy and morality to keep society together.
  • Markets are perfect: The Invisible Hand fails when there are Monopolies or Externalities (Pollution).
  • Laissez-Faire: “Let it be.” The philosophy that the government should leave the market alone.
  • Spontaneous Order: Order that emerges without a designer. (Like a flock of birds).

Applications

  • Capitalism: The entire Western economic system is built on faith in the Invisible Hand.

Criticism / Limitations

  • Inequality: The Invisible Hand doesn’t care if people starve. It only cares about efficiency.
  • Public Goods: The market won’t build a lighthouse (because you can’t charge ships for seeing the light). The government has to do it.

Further Reading

  • Smith, Adam. The Wealth of Nations.
  • Friedman, Milton. Free to Choose.