What Is the Invisible Hand?

There are few concepts in the history of economics that have been misunderstood, and misused, more often than the "invisible hand." For this, we can mostly thank the person who coined this phrase: the 18th-century Scottish e conomist Adam Smith, in his influential books The Theory of Moral Sentiments and (much more importantly) The Wealth of Nations.

By the time he wrote The Wealth of Nations, published in 1776, Smith had vastly generalized his conception of the "invisible hand": 

People who pursue their own selfish ends in the market (charging top prices for their goods, for example, or paying as little as possible to their workers) actually and unknowingly contribute to a larger economic pattern in which everybody benefits, poor as well as rich.“

You can probably see where we're going with this. Taken naively, at face value, the "invisible hand" is an all-purpose argument against the regulation of free markets. 

Is a factory owner underpaying his employees, making them work long hours, and compelling them to live in substandard housing? The "invisible hand" will eventually redress this injustice, as the market corrects itself and the employer has no choice but to provide better wages and benefits, or go out of business. 

And not only will the invisible hand come to the rescue, but it will do so much more rationally, fairly and efficiently than any "top-down" regulations imposed by government (say, a law mandating time-and-a-half pay for overtime work).

Does the "Invisible Hand" Really Work?

To answer this question, we have to look at the era in which Adam Smith came up with it.

At the time Adam Smith wrote The Wealth of Nations, England was on the brink of the greatest economic expansion in the history of the world, the "industrial revolution" that resulted in  widespread wealth.

In the 18th and 19th centuries England had some natural advantages not enjoyed by other countries, which also contributed to its economic success. An island nation with a powerful navy, fueled by a Protestant work ethic, with a constitutional monarchy gradually yielding ground to a parliamentary democracy, England existed in a unique set of circumstances, none of which are easily accounted for by "invisible hand" economics. Taken uncharitably, then, Smith's "invisible hand" often seems more like a rationalization for the successes (and failures) of capitalism than a genuine explanation.

The "Invisible Hand" in the Modern Era

Today, there is only one country in the world that has taken the concept of the "invisible hand" and run with it, and that's the United States. 

As Mitt Romney said during his 2012 campaign, "the invisible hand of the market always moves faster and better than the heavy hand of government," and that is one of the basic tenets of the Republican party. 

For the most extreme conservatives (and some libertarians), any form of regulation is unnatural, since any inequalities in the market can be counted on to sort themselves out, sooner or later. (England, meanwhile, even though it has separated from the European Union, still maintains fairly high levels of regulation.)

But does the "invisible hand" really work in a modern economy? For a telling example, you need look no further than the health-care system. There are many healthy young people in the U.S. who, acting out of sheer self-interest, choose not to purchase health insurance—thus saving themselves hundreds, and possibly thousands, of dollars per month. This results in a higher standard of living for them, but also higher premiums for comparably healthy people who choose to protect themselves with health insurance, and extremely high (and often unaffordable) premiums for elderly and unwell people for whom insurance is literally a matter of life and death.