The concept of the "invisible hand" was explained by Adam Smith in his 1776 classic foundational work, "An Inquiry into the Nature and Causes of the Wealth of Nations." It referred to the indirect or unintended benefits for society that result from the operations of a free market economy.

Influence

Smith, considered to have founded modern economic theory in the late 18th century, was no fan of widespread government regulation of the economy. He even went so far as to defend smuggling as a natural, legitimate part of the economy.

His "laissez-faire," or free market, theories are primarily embraced by the supply-side Milton Friedman school of economic thought, which stands in contrast to the 19th century demand-side Keynesian economic theories that became increasingly predominant in shaping the economic policies of western governments since the 1930s and the Great Depression.

Basics

Smith's theory of the invisible hand constitutes the basis of his belief that large-scale government intervention and regulation of the economy is neither necessary nor beneficial. Smith put forth the notion of the invisible hand in arguing that free individuals operating in a free economy, making decisions that are primarily focused on their own self-interest logically take actions that benefit society as a whole, even though such beneficial results were not the specific focus or intent of those actions.

Smith went on to argue that the intentional intervention of government regulation, although it is specifically intended to protect or benefit society as a whole, in practice is usually less effective for achieving that end than a freely operating market economy. In many cases, it is actually harmful to the people as a whole by denying them the benefits of an unencumbered marketplace. Entrepreneurs are driven by the desire to create a successful business so they can prosper.

Major Principles

According to Smith, the collective desires of all the individual buyers and sellers in a free economy operate naturally to accomplish:

  • Production of the most desired and beneficial goods in the most efficient manner possible, since the seller who most successfully does this gains the greatest market share and revenues.
  • Making goods and services available at the functionally lowest prices possible, since free competition between sellers does not allow for price gouging.
  • Automatically flowing the bulk of investment capital toward funding the production of the most necessary, most beneficial and most wanted goods and services, since businesses producing goods or services for which there is the highest demand are able to command the highest prices and resulting profits.

Whether the invisible hand of free market "goodwill" exists or is at all effective is hotly debated. It is, however, difficult to deny that Smith's market philosophy helped create the most successful economy in history.