Friday, 3 March 2017

Adam Smith's Destructive Hand

Adam Smith's "invisible hand" is perhaps one of the most misunderstood concepts in economics. It is usually interpreted to mean that when individuals all operate according to their own self-interest, their actions somehow combine to create a well-ordered, well-functioning society "as if guided by an invisible hand".

To be fair, this statement about the "invisible hand" (from the Theory of Moral Sentiments) does seem to mean exactly that:
[The rich] consume little more than the poor, and in spite of their natural selfishness and rapacity…they divide with the poor the produce of all their improvements. 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.
This should have been challenged long ago on the lack of counterfactual evidence. It is an assertion, not a fact. Nonetheless, despite the glaring inequalities in our world today, it could be true. The history of the command economies of the 20th century is not a happy one: attempts to equalise the distribution of resources created poverty for (nearly) all, and the natural human desire to seize resources for oneself at the expense of others was inevitably strongest among those tasked by the rest with ensuring equitable distribution. No socialist revolution in history has succeeded in raising the living standards of all by killing off the rich: but the last 20 years, in which "communist" states have adopted capitalist practices and the number of billionaires in developing countries has risen to an all-time high, has seen the greatest rise in living standards for the world's population in recorded history.

The problem with Smith's statement is that it gives the impression that equitable distribution is not only possible, it is inevitable. The "invisible hand" guides the human species ever closer to complete equality of distribution. Marx would have been proud of him. But I don't think this is what Smith meant. I think he meant that the best distribution of resources we can have as a species is achieved when each individual pursues their own self interest. Unequal distribution of resources is inevitable, but because it is not possible for the rich to hoard everything they have - since ultimately, hoarding is death - the poor benefit from the selfishness of the rich. That is the implication of this paragraph from Smith's better-known work, The Wealth of Nations:
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 necessities but of their advantages.
The poor are fed not in spite of, but because of the selfishness and greed of the rich.

But that is only half the story. This, also from The Wealth of Nations, is the other half:
Every individual... neither intends to promote the public interest, nor knows how much he is promoting it... he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, 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.
For Smith, self-interest is inevitably benevolent in effect, whatever the intention. He does not consider the possibility that self-interest could have malevolent effects. Nor does he consider the possibility that short-sightedness and stupidity may have unexpected consequences. And this is because he is thinking in aggregates. Smith's "invisible hand" applies not to the individual, but to the group. The individual does whatever he wants: but the collective actions of thousands or millions of individuals together bring about a better society.

Here is Adam Smith's "invisible hand" at work:

(YouTube link for this video is here)

Beautiful, isn't it? Millions of individuals all looking for dinner. They are all pursuing their own gain, but they look as if they are organised and directed to create wonderful patterns. They fly as if guided by an "invisible hand". Note that we can see those patterns, but they, individually, cannot.

For Smith, people are like starlings. People pursuing their own self-interest fly as if directed by an "invisible hand", and together, unknowingly, make beautiful patterns. Individually, we cannot see the pattern of which we are part: but when we look back through history, we can see how patterns form and shape themselves from the actions of our forbears. Smith's observation is positive, optimistic, and for a swarming species like humans, accurate. So long as the majority of people are peacefully pursuing their own gain, the outcome for society must be beneficial.

But this is also the "invisible hand" at work:

(YouTube link for this video is here)

Millions of individuals, all looking for dinner - but this time, they make not a benign, beautiful pattern, but a terrifying, destructive one. Locusts are not the only species that can ruin an entire economy when they swarm. Some birds do, too. A small bird known as the "quelea" is feared all over Africa because it arrives without warning in huge flocks and eats everything in sight. The now-extinct "passenger pigeon" was a swarming bird that was feared by farmers in the American Mid-West for the same reason.

This is the part of the story that Smith omits. Humans are a swarming species. Swarms can be benign - or they can be destructive. And importantly, people do not know when they are swarming. Even if they are part of a very large movement of people that is feared by those in its path, they are still pursuing what they perceive to be their own self-interest. It's worth remembering, too, that when people swarm, an individual's own self-interest is to stay with - or join - the crowd. It is a brave person indeed who defies a crowd. And when people are caught up in a swarm, they behave in uncharacteristic and sometimes destructive ways. The "madness of crowds" drives berserker behaviour.

Malign swarms are deliberately whipped up by powerful individuals in pursuit of their own self-interest: the most destructive form of malign swarm is imperialist expansion (think of the Golden Horde, for example). But some swarms are destructive without being malign. The transatlantic credit bubble was a case in point: it was not deliberately whipped up to bring down the financial system, but it very nearly did so anyway. Everyone was pursuing their own interest, but collectively, their own interest, far from being benign as Smith assumes, was highly destructive. We do not see the patterns of which we are part.....

We do not yet know what triggers human swarming behaviour, though research is continuing in this area. But whether a human swarm is benign or destructive is a matter of perception. We don't see the starling swarm as destructive, because we are not being eaten. But the insects that the starlings are eating might (correctly) see the murmuration as a terrifying destructive force that aims to wipe them out. Similarly, people in China don't fear their annual migration home for New Year, which is the largest movement of people on the planet: but people in the West fear the influx of migrants from war-torn Middle Eastern countries.

The swarms we fear are those we believe could destroy our means of survival or wipe us out. And we have reason for our fear. Humans are a swarming species, and swarms can be destructive. Even though individually we may only be looking for a better life, the "invisible hand" is capable of guiding us to destruction.

Related reading:

Here is why economics is built on a monumental mistake - Evonomics
The Invisible Hand is dead! - Evonomics
The Wealth of Nations - Adam Smith
The Theory of Moral Sentiments - Adam Smith
Twitter storms and the madness of crowds - FT

Thanks to Matt and AFP for the videos, and Evonomics for the header image. 

I have corrected the mistaken attribution of the quotations in an earlier version of this post. 


  1. It is a small thing, and I may have misread what you wrote, but my Kindle edition of Wealth of Nations shows that Adam Smith mentioned "the invisible hand" only once and here is the key passage:"By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, 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."

    Is it possible that your quote comes from Smith's "The Theory of Moral Sentiments?"

  2. Samuel Fleischacker, a scholar who specializes in Adam Smith as well as the history of moral philosophy, published "On Adam Smith’s ‘Wealth of Nations,’ A Philosophical Companion," in 2004. He discussed Smith’s “invisible hand” paragraph in detail, and here is part of what he said:

    "So Smith is by no means pronouncing a universal rule [in this paragraph]. It would be odd, moreover, if such a rule appeared in this context. Smith is in the midst of making a relatively small point (that merchants will tend to base even their “carrying trade” in their home ports), and has adduced a few plausible but weak generalizations about merchant behavior in support of that point. If he wanted to proclaim that an invisible hand always guides individual economic decisions toward the good of society, we would expect that proclamation at the opening of the book, as part of his grounding theory of economic activity. The theory Smith gives us there does support the claim that individuals generally promote the social good in their economic behavior without intending to do so, but there is no hint that this holds in all cases, much less that it is guaranteed to hold by either empirical or metaphysical laws."

    Thomas Jefferson gave the phrase “all men are created equal” the most prominent position in the Declaration of independence. After a single-sentence opening, he introduced self-evident truths and made “all men are created equal” the foremost of them. On the other hand, Smith introduced “invisible hand” on page 192 of the copy of Wealth of Nations in my bookcase—that is very far from pride of place. Smith by no means intended for the phrase, “invisible hand,” to be the primary operating principle for one of the largest economies the world has ever known—in fact, he did not think it was an operating principle of any kind.

  3. Frances gets Smith reference to 'an invisible hand' mixed up between his two books, and quotes one as a simile ('as if' etc), not as a metaphor.
    Smith also wrote a great deal on the misconduct of merchants and manufacturers in lobbying for tariffs on imports and their outright prohibition, in order to reduce competition and raise prices.
    Moreover, Smith died in 1790 and therefore had no views on socialism or global capitalism - word first used in English in 1874, thereby unknown to Smith.

    1. If the quotes are mixed up between the two books I will correct, of course.

      Simile and metaphor perform similar functions in English. I have not materially changed the sense of what Smith wrote.

      The fact that Smith wrote other things is not relevant here. I am interested solelyl in the concept of the "invisible hand". I am not writing a general critique of Smith's work.

      It does not matter whether the concepts of "socialism" and "global capitalism" were known in his time. As I pointed out in the very first paragraph of this piece, a great deal has been built upon the concept of the "invisible hand" since Smith's time. The words are therefore relevant to my analysis even if they were not known to him.

      Do you have anything useful to say about my analysis, or is your criticism limited to semantics?

    2. Wikipedia's quite handy for that....

      an example itself of the hidden hand perhaps? ...

      Similarly were the Capitalists of the 1700 really that good for humanity? All that self interest in monopolies and slave trading... ??? Make's you wonder why the empire ultimately collapsed....

  4. "The problem with Smith's statement is that it gives the impression that equitable distribution is not only possible, it is inevitable."

    And with the correct framework of property rights he is right.

    By the consumption of produced factors, one person does not harm the ability of another to either produce or consume goods or services themselves. As Smith noted, it is actually mutually beneficial as it gives rise to possibly of economies of scale ie agglomeration effects.

    However the consumption of non-produced factors does harm others, as when they become scarce there can be no supply response. That is a mechanism for rent extraction, either real or imputed.

    The uncompensated right to exclude others from natural resources or ideas represent State granted monopoly rights. It is these monopoly rights which are based on the aberration of the property rights of others that are the root of all injustice.

    From which we get symptoms like wars, violence, economic dysfunction (like the 2007 crash) and excessive individual, inter-generational and regional inequality.

    This isn't rocket science, and I'm sure that Smith would be amazed that so many intelligent people have failed to see the elephant in the room.

    The debate of higher/lower taxes on produced factors has been the perfect smokescreen for the wealthiest to hide behind for over one hundred years. There has been the perfect symbiosis between Socialism and Neo-Liberalism that's crowed out the ability to think or debate fundamental issues like property rights

  5. Smith’s lone use of the term, “invisible hand” in "Wealth" has been deliberately pulled out of context and repeatedly used to the great detriment of the people. His clear message was to be wary of capitalists.

    Tyranno-capitalists favor the “invisible hand” for several reasons. The one that has the greatest adverse impact on society is that there is no need to worry about the common good—it will “theoretically” emerge from the independent and self-serving actions of individuals who are participating in the economy as producers and as consumers. To tyranno-capitalists, this means also that there is no need for central planning, or for government intervention in the economy—self-interest will suffice. Another important reason that tyranno-capitalists embrace the “invisible hand,” is that it gives permission for the worship of the concept of the “free market.” This concept says that all is fair in love, war, and the economy. To tyranno-capitalists the term “free” indicates that the market is free from government regulation, but it really is more accurate to say that “free” stems from the term “free-for-all,” which is a schoolyard game in which there are no rules against roughing up the other players—such a game is better described as a brawl, or a scam, or a bubble, or as worthless derivatives—or as Wall Street. Because there are no rules in a free-for-all, there is no such thing as fair play.

    The terms “Adam Smith, the invisible hand, and the free market,” are all used by tyranno-capitalists, perhaps unconsciously, as aliases for evolution by natural selection, the eternal Darwinian struggle. In such an economy it is clear that there are far more losers than winners, and it is also clear that the net outcome today, next year, or decade after decade, is not good for society as a whole. Adam Smith realized that the economy of a society is best served when it is organized around rules of fair conduct, and this understanding would cause him to reject the distorted application of his views as support for the theories of tyranno-capitalism.

    The folly of letting the Wall Street banks run free in the design, marketing, rating, and insuring of dubious financial instruments resulted in the crash that occurred at the end of the George W. Bush administration. One can say that the government did a rotten job of regulating the banks, but one cannot say that the crash was the result of government planning. In fact, the crash is a perfect example of just how the invisible hand works. If it is not regulated and if it is not subjected to any planning, then it produces disasters on a vast scale. Such is the problem with extreme weather due to global warming. The lack of government regulation and planning has enabled the “invisible hand” of tyranno-capitalism to run free thereby polluting our air and water and placing the future of our civilization and our species in grave danger.

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  7. Capitalista don't like Invisible Hand. They prefer to be friends of power, to protect theyself from competence. That's is the exact message of Smith! Freedom versus power...
    democracy is not posible without liberty & capitalism. Capitalism can be corrected of excess, but to confuse the message of Smith - directed against mercantilism - is missing the true. Sorry, this post is tendentious.

  8. The passenger pigeon is a very telling example. The newly arrived Midwestern farmers resorted to their own swarming behaviour and all took to shooting them whenever they saw them, and within an astonishingly short space of time, they had killed literally each and every bird.

    1. Exactly, Alex. And when one swarm of humans battles another swarm of humans, that is war.

    2. And poor seamanship.

    3. Destruction of habitat was probably the main reason for the demise of the passenger pigeon.

  9. "It is an assertion, not a fact. " Well, that a very accurate representation of economics that have been presented to me.

    I must give Blanchard his due, in his book he often said, these are the assumptions... That is a proper way to start if there are assumptions made. To an engineer used to juggling facts, figures, data, graphs, equations and very rare guesses, I knew exactly what he meant and what it was worth. I hope every one else did. But, I did not meet them when I fled macroeconomics class for the library searching for some thing more realistic.

    Nice to meet you all here.

  10. Myth.

    So the self referencing group makes a myth. Eventually so many point out the failings and there is employment for making new myths.

    But, Soros knows better.

  11. The birds in your photo at the top of this page are acting independently as they "swarm." But humans don't swarm in that way. They form hierarchical groups who delegate the power of the masses to a few group members. Human "swarms" devise systems whereby their chosen leaders apply that power. These systems are given many names, but essentially there are only two: democracies and everything else. Unfortunately, there has been only one democracy in human history and that form of government was in action for the last time over two millennia ago. The American system is based on the Roman republic--it is not a democracy.

    So human "swarms" are all about the natures of their leaders. Some leaders act for the common good, while most, by a wide margin, act against it. This fact, and it is a fact, put into action over years, hurls the "swarm" to its ultimate demise.

    We humans must swap our current forms of government for a democracy that adapts the seven superior ideas of Athenian democracy: Power Management, liturgies and public works, government of, by, and for the people, the oath of the ephebes, evolution by intellection, the silver mines of Laurium, and investing in the people . Only in this way will we be able to apply our combined power to define and implement the common good. The essential ingredient of all seven of these Athenian ideas is that they employ rationality as their basis for decision-making.

  12. what is interesting is this belief in the 'hidden hand' of self interest is at the core of the blockchain ethereum movement... thre is a strong belief in that movement that data systems which serve self interest can similarly be equitable... however the cost of such a system in terms of it's security is crippling as it tries to prevent everyone picking everyone else's pockets....

    one could argue that as with Smith the concept is scale dependent.. In a small group, self interest works to the extent that it is the interests of the better off to maintain the less in order to protect the group... However as that group grows in number so the importance of the bottom end diminishes relative to the top... The Indian bakshesh system is a good example of this .. at village level it ensures that wealth is distributed but once you get to the metropolis of Delhi then it becomes something quite else...