The invisible hand is a metaphor inspired by the Scottish economist and moral philosopher Adam Smith that describes the incentives which free markets sometimes create for self-interested people to accidentally act in the public interest, even when this is not something they intended.
Going far beyond the original intent of Smith's metaphor, twentieth century economists, especially Paul Samuelson, popularized the use of the term to refer to a more general and abstract conclusion that truly free markets are self-regulating systems that always tend to create economically optimal outcomes, which in turn can't be improved upon by government intervention.
[1] Adam Smith was a proponent of less government intervention in his own time, and of the possible benefits of a future with more free trade both domestically and internationally.
For example, it is argued that tendencies that were nascent during Smith's lifetime, such as large-scale industry, finance, and advertising, have reduced the effectiveness of the supposed invisible hand.
In his early unpublished essay on The History of Astronomy (written before 1758) he specifically described this type of explanation as a common and unscientific way of thinking.
For this reason the philosophical or scientific study of nature can only begin when there is social order and security, so that people are not living in fear, and can be attentive.
It has been influenced by arguments for free markets found not only in Smith's works, but also by earlier writers such as especially Bernard Mandeville, and later more mathematical approaches by economists such as Pareto and Marshall.
The statesman, who should attempt to direct private people in what manner they ought to employ their capitals, would not only load himself with a most unnecessary attention, but assume an authority which could safely be trusted, not only to no single person, but to no council or senate whatever, and which would nowhere be so dangerous as in the hands of a man who had folly and presumption enough to fancy himself fit to exercise it.
This passage concerns the distribution of wealth: the poor receive the "necessities of life" after the rich have gratified "their own vain and insatiable desires".
[17] The proud and unfeeling landlord views his extensive fields, and without a thought for the wants of his brethren, in imagination consumes himself the whole harvest ... [Yet] the capacity of his stomach bears no proportion to the immensity of his desires... the rest he will be obliged to distribute among those, who prepare, in the nicest manner, that little which he himself makes use of, among those who fit up the palace in which this little is to be consumed, among those who provide and keep in order all the different baubles and trinkets which are employed in the economy of greatness; all of whom thus derive from his luxury and caprice, that share of the necessaries of life, which they would in vain have expected from his humanity or his justice...The rich only select from the heap what is most precious and agreeable.
They are led by an invisible hand to make nearly the same distribution of the necessaries of life, which would have been made, had the earth been divided into equal portions among all its inhabitants, and thus without intending it, without knowing it, advance the interest of the society, and afford means to the multiplication of the species.
There is no repeat of this argumentation in Smith's comprehensive work on economics in his later Wealth of Nations, and income distribution is not a central concern of modern neoclassical market theory.
[19] In contrast to Smith's own usage, the "invisible hand" today is often seen as being specifically about the benefits of voluntary transactions in a free market, and is treated as a generalizable rule.
[21] Samuelson's remark was as follows: Even Adam Smith, the canny Scot whose monumental book, The Wealth of Nations (1776), represents the beginning of modern economics or political economy-even he was so thrilled by the recognition of an order in the economic system that he proclaimed the mystical principle of the "invisible hand": that each individual in pursuing his own selfish good was led, as if by an invisible hand, to achieve the best good of all, so that any interference with free competition by government was almost certain to be injurious.
Léon Walras developed a four-equation general equilibrium model that concludes that individual self-interest operating in a competitive market place produces the unique conditions under which a society's total utility is maximized.
Ludwig von Mises, in Human Action uses the expression "the invisible hand of Providence", referring to Marx's period, to mean evolutionary meliorism.
Milton Friedman, a Nobel Memorial Prize winner in economics, called Smith's Invisible Hand "the possibility of cooperation without coercion.
Gavin Kennedy, Professor Emeritus at Heriot-Watt University in Edinburgh, Scotland, argues that its current use in modern economic thinking as a symbol of free market capitalism is not reconcilable with the rather modest and indeterminate manner in which it was employed by Smith.
[29]Harvard economist Stephen Marglin argues that while the "invisible hand" is the "most enduring phrase in Smith's entire work", it is "also the most misunderstood."
[31] Warren Samuels described it as "a means of relating modern high theory to Adam Smith and, as such, an interesting example in the development of language.
[33] Smith uses the metaphor in the context of an argument against protectionism and government regulation of markets, but it is based on very broad principles developed by Bernard Mandeville, Bishop Butler, Lord Shaftesbury, and Francis Hutcheson.
Lord Shaftesbury turned the convergence of public and private good around, claiming that acting in accordance with one's self-interest produces socially beneficial results.
Francis Hutcheson also accepted this convergence between public and private interest, but he attributed the mechanism, not to rational self-interest, but to personal intuition, which he called a "moral sense".
II, page 316, he says, "By acting according to the dictates of our moral faculties, we necessarily pursue the most effective means for promoting the happiness of mankind."
Christian socialist R. H. Tawney saw Smith as putting a name on an older idea: If preachers have not yet overtly identified themselves with the view of the natural man, expressed by an eighteenth-century writer in the words, trade is one thing and religion is another, they imply a not very different conclusion by their silence as to the possibility of collisions between them.
Naturally, again, such an attitude precluded a critical examination of institutions, and left as the sphere of Christian charity only those parts of life that could be reserved for philanthropy, precisely because they fell outside that larger area of normal human relations, in which the promptings of self-interest provided an all-sufficient motive and rule of conduct.
If there is a set of taxes, subsidies, and lump sum transfers that leaves household utilities unchanged and increase government revenues, then the above equilibrium is not Pareto optimal.
Noam Chomsky suggests that Smith (and more specifically David Ricardo) sometimes used the phrase to refer to a "home bias" for investing domestically in opposition to offshore outsourcing production and neoliberalism.
[38]Stephen LeRoy, professor emeritus at the University of California, Santa Barbara, and a visiting scholar at the Federal Reserve Bank of San Francisco, offered a critique of the Invisible Hand, writing that "The single most important proposition in economic theory, first stated by Adam Smith, is that competitive markets do a good job allocating resources.
(...) The financial crisis has spurred a debate about the proper balance between markets and government and prompted some scholars to question whether the conditions assumed by Smith...are accurate for modern economies.