Adam Smith’s Invisible Hand

You’ve probably heard of the term ‘invisible hand’. But what does it really mean? Have you been misled?

Economist Adam Smith (1723 – 1790) used the term ‘invisible hand’ in The Theory of Moral Sentiments (1759) and The Wealth of Nations (1776). In both cases, Smith refers to a situation where those acting in their own self-interest, end up promoting the interest of society in general, even though that was not their intention. Articles found in search results that define the invisible hand as the law of supply and demand miss the mark.

The Theory of Moral Sentiments (1759)

In part 4 of chapter 1 in The Theory of Moral Sentiments (1759), Smith writes that man’s desire for great wealth drives him to great industry, which increases the carrying capacity of the earth. While the landlord surveys his fields with thoughts only for himself, he is obliged to distribute proceeds to those who keep him in his ‘economy of greatness’. These proceeds could not have been obtained by relying on his humanity or justice. Therefore, the landlord’s selfish desires are led by an invisible hand to provide many with the necessities of life, and increase the human population.

Let us read what Adam Smith wrote himself:

“The pleasures of wealth and greatness, … strike the imagination as something grand and beautiful and noble” … and “rouses and keeps in continual motion the industry of mankind. … The earth by these labours of mankind has been obliged to redouble her natural fertility, and to maintain a greater multitude of inhabitants. It is to no purpose, that 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 that grows upon them. … The capacity of his stomach bears no proportion to the immensity of his desires, and will receive no more than that of the meanest peasant. The rest he is 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 oeconomy 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. … 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.”[1]

The Wealth of Nations (1776)

In chapter 2 of book 4 in The Wealth of Nations (1776), Smith writes that individuals seek the greatest advantage in employing the capital at their command. The product of an industry is the value that it adds to the materials upon which capital is employed, and this can be measured by profit. Seeking his own advantage leads him to employ his capital where it is most advantageous to society. Therefore, the capitalist’s selfish desires for profit are led by an invisible hand to support industries that supply produce of greatest value to society. Indeed, the pursuit of his own advantage does a better job of promoting the interests of society than if he had aimed for the public good directly.

Again, let us read the words of Adam Smith:

“Every individual is continually exerting himself to find out the most advantageous employment for whatever capital he can command. It is his own advantage, indeed, and not that of the society, which he has in view. But the study of his own advantage naturally, or rather necessarily, leads him to prefer that employment which is most advantageous to the society. … The produce of industry is what it adds to the subject or materials upon which it is employed. In proportion as the value of this produce is great or small, so will likewise be the profits of the employer. But it is only for the sake of profit that any man employs a capital in the support of industry; and he will always, therefore, endeavour to employ it in the support of that industry of which the produce is likely to be of the greatest value, or to exchange for the greatest quantity either of money or of other goods. … He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. 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. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good. It is an affectation, indeed, not very common among merchants, and very few words need be employed in dissuading them from it.”[2]

[1] Adam Smith, The Theory of Moral Sentiments, 1759, Part 4, Chapter 1,

[2] Adam Smith, The Wealth of Nations, 1776, Book 4, Chapter 2,

Milton Friedman on Four Ways to Spend Money

In chapter 4 of his book Free to Choose, Milton Friedman uses a simple table to outline four ways to spend money based on whose money is spent, and upon whom it is spent. Combining these two factors give four possibilities shown in the following table:[1]

Four Ways to Spend Money

Category 1: You spend your money on yourself. For example, you buy food in the supermarket; you buy a hamburger for lunch. You have a strong incentive to economise and get full value for every dollar.

Category 2: You spend your money on someone else. For example, you buy gifts for someone’s birthday or wedding. As in category 1, you have a strong incentive to economise but less incentive to get full value, as judged by the person receiving the gift. If the objective were to allow the recipient to gain maximum value, you would give them cash. This converts category 2 spending into category 1 spending.

Category 3: You spend someone else’s money on yourself. You buy lunch on an expense account. You have a strong incentive to get full value but little incentive to economise.

Category 4: You spend someone else’s money on someone else. You buy someone else’s lunch on an expense account. You are on the committee of a community organisation spending your contributors’ money on your organisation’s programs; you are a politician or bureaucrat, spending taxpayers’ money on government programs. You have little incentive either to economise or get full value. In this last category of spending, we are likely to see higher costs and lower quality.

[1] Ideas paraphrased from Milton Friedman, Free to Choose, 1980, pp. 115-119