The Visible Effects of the Invisible Hand: Adam Smith Through the Years

Introduction Adam Smith's idea of "invisible hand" refers to the self-regulating nature of the marketplace where even though individuals acted to maximize their self-interest, it eventually leads to a socially desirable outcome. The paper will discuss the first three chapters of Smith's The Wealth of Nations. (Ahsan, 2012) The first part of the paper provides a summary of Book 1 of Adam Smith's The Wealth of Nations. The second part of the paper will discuss Book 1 in relation to the articles by Economic Insights and The World Bank. The third part of the paper tackles the assumptions, consequences and significance of concepts in Adam Smith's The Wealth of Nations. This part of the paper will also discuss the application of the concepts advanced by Smith to modern economics. The last part of the paper presents the conclusion. Summary of Book 1: Division of Labor and the Market Chapter 1 of Book 1 is entitled "Of Division of Labor." It begins with, "The greatest improvement in the productive powers of labor, and the greater part of the skill, dexterity, and judgment with which it is anywhere directed, or applied, seem to have been the effects of the division of labor." (Smith, 1776) Smith emphasizes that the improvement of the dexterity of the workman is directly proportional to the work that he can perform. (Smith, 1776) He further explains that the advantage gained by saving the time commonly lost in passing from one sort of work to another is much greater than it is usually imagined to be. (Smith, 1776) Smith also presented the importance of machinery as it facilitates labor. (Smith, 1776) The examples

provided by Smith are expectedly appropriate to the time period he was writing. It will be noted later on that the principles are still applicable to the modern concept. Chapter II talks about "Of the Principle which gives occasion to the Division of Labor." In this chapter, Smith explains the interdependence between and among economic actors. He mentions that the difference between the talents of each actor makes interdependence possible. However, Smith also discusses how the coordination and cooperation is not motivated by the desire to help and complete others but these emanate out of self-love of each actor. This self-love of every individual creates the effect of benefiting the society as each self-love motivates one another to fulfil another's self-love and therefore get what one ultimately desires. (Smith, 1776) The end of the simultaneous actions by self-interested individuals would still be public welfare. This is the concept of invisible hand that Smith is famous for. Chapter 3 is entitled, "That the Division of Labor is limited by the Extent of the Market." The market is the limitation of the division of labor because it is the power of exchanging that gives occasion to such division. Smith says that the extent of the market must be in proportion to the riches of that country. (Smith, 1776) The benefit derived from exchange is what drives economic actors to specialize and to increase the surplus when exchanging with others. (Butler, 2011) The author discussed specialization in the market which allows for bigger gains. Comparative Analysis of Smith, Economic Insights and The World Bank Self-interested Actors and Interaction Smith has initially used the term "self-love" in Chapter 2 of the Wealth of Nations. This same concept is delved into by Economic Insights, "Even more radical was Smith's belief that a society composed of individuals acting in pursuit of their own interests would result in a stable,
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free and more prosperous society that one regimented and planned by the state." (Economic Insights) Because of this insight, the article labelled Smith as the first proponent of capitalism where economic actors would freely choose to interact and not be governed by strict rules of the state. This argument is further strengthened by the article of The World Bank. The article by the World Bank discusses how different countries (as economic actors) interact with each other to ensure that the natural resources are used to cater the needs of the people. Just as Smith originally discussed the difference in talents among individuals, the World Bank acknowledge the difference in natural resources that are available in each state and further suggests that managing natural resources is a key part of development strategies. (The World Bank, 2006) The article by World Bank further reiterates the fact that government decisions on investments and other business projects are self-motivated and aim to make the national products competitive in the global market. The Market and Government Intervention The discussion of the "market" was first seen in Chapter 3 of The Wealth of Nations. Smith characterizes the market as the extent of exchange among economic actors. For Smith, economic growth is good and is achieved by the ever-widening application of the division of labor, which is organized within markets and driven by rational self-interest. (Economic Insights) Those nations that allow market forces to generate such growth will become wealthier, in Smith's view, than those that follow the mercantile model of managed trade. (Economic Insights) Smits has always been in favor of less government intervention to the market. However, this total lack of intervention by the government should be limited. Smith also recognizes grounds for legitimate governmental activity in society (Economic Insights): defense against external and internal security threats, the formation of laws that prevent individuals from oppressing one
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another and the provision of public goods that the market would not supply. These specific grounds are further tackled by the article of World Bank which is applicable to the modern scenario. Where is the Wealth of Nations? provides an overview of the wealth of each nation and how the decisions by policy makers influence the movement of wealth and generation of more wealth. (The World Bank, 2006) The production of more wealth can be attributed to an effective and efficient government intervention because it is dependent on how the natural resources are managed. Natural resources are special economic goods because they are not produced. As a consequence, natural resources will yield economic profits - rents - if properly managed. (The World Bank, 2006) Although it is encouraged by Smith that the market be allowed to move as freely as possible, legitimate government actions are called for when the market and the selfinterested economic actors are unable to protect the resources on their own. Achieving sustainable development which presents challenge and concerns to the natural resources would be sufficient reason for monitoring by the government. (The World Bank, 2006) Significant Concepts and Application to Modern Economics Capitalism The prevalent economic system amidst globalization and free trade is capitalism. It is based on private ownership of the means of production, in which personal profit can be acquired through investment of capital and employment of labor. Capitalism is grounded in the concept of free enterprise, which argues that government intervention in the economy should be restricted and that a free market, based on supply and demand, will ultimately maximize consumer welfare.

This is precisely the idea advanced by Adam Smith in The Wealth of Nations. (Columbia Electronic Encyclopedia, 2013) Capitalism does not presuppose a specific form of social or political organization: the democratic socialism of the Scandinavian states, the consensus politics of Japan, and the statesponsored rapid industrial growth of South Korea while under military dictatorship all have coexisted with capitalism. (Columbia Electronic Encyclopedia, 2013) Yet despite the capitalist ideal of "hands-off" government, significant government intervention has existed in most capitalist nations at least since the Great Depression in the 1930s. In the United States, it exists in the form of subsidies, tax credits, incentives, and other types of exemptions. (Columbia Electronic Encyclopedia, 2013) Though private production plays a major role in the economies of Germany and Japan, both nations have had centrally planned industrial policies in which bankers, industrialists, and labor unions meet and seek to agree to wage policies and interest rates; these countries reject the idea of letting the market wholly determine the economy. (Columbia Electronic Encyclopedia, 2013) Although Smith was not the origin of the term capitalism, it is undeniable that his ideas have contributed to this economic system. Economic Growth and Welfare of Society The determinants of wealth of nations have always been an interesting issue for policy makers and economists. In economics, one of the most important subjects is to increase economic growth and welfare of society. As one of the most important political economists, Smith analyzed the dynamics of wealth of nations and welfare of individuals and societies by providing for determinants of economic growth which include division of labor and human capital. (Ayhan, 2013)

Smith discussed that to explain the motivation for economic exchange in the market, one does not have to invoke any objective other than the pursuit of self-interest. (Sen, 2010) Beyond self-love, Smith discussed how the functioning of the economic system in general and of the market in particular, can be helped enormously by other motives. There are two distinct propositions here. The first is one of epistemology, concerning the fact that human beings are not guided only by self-gain or even prudence. The second is one of practical reason, involving the claim that there are good ethical and practical grounds for encouraging motives other than selfinterest, whether in the crude form of self-love or in the refined form of prudence. (Sen, 2010) In moving for a free market system, Smith did not intend to totally eliminate the function of the government. Government is a regulator of the elements of the marketplace. (Ahsan, 2012) It can intervene whenever the market forces do not serve public welfare and when the public interest is already at stake. Conclusion It cannot be denied that Smith will forever be one of the classic economists whose theories are still applicable nowadays. His concept of the invisible hand has led capitalism to its peak. At press time, capitalism is still the prevailing economic system that is accepted by most countries in the world. Furthermore, Smiths theory on market interaction out of self-love is still present in the current era. To give an example, nation states form organizations and economic blocs in order to ensure that economic interdependence will bring economic security to the individual states. Although it is not in the bigger realm, the main foundation of economic interdependence brought by modern concepts of fair trade and free trade, is still the concept of self-love that has been first advanced by Smith. Today, states are self-interested actors that can interact with other states, equally self-interested, to achieve a more efficient and effective
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utilization of resources. Smith was a genius who was able to forecast economic activities using his primitive and medieval examples that fit the economy during the era when he was writing The Wealth of Nations. References Ahsan, A. (2012). Where was the Invisible Hand during the Crash? Vol. LXIV No. 2/2012, Economic Insights - Trends and Challenges. Ayhan, U. (2013). The Sentiments of Adam Smith Relating to Economic Growth as an Inspirer to Modern Growth Theories. Trakya University Journal of Social Science. Jun2013, Vol. 15 Issue 1, p29-48. 20p. "Capitalism." Columbia Electronic Encyclopedia, 6th Edition. Sep2013, p1-1. 1p. Economic Insights. Adam Smith Capitalism's Prophet. Volume 7, Number 1, Federal Reserve Bank of Dallas. Sen, A. (2010). The Economist Manifesto. Accessed on 16 October 2013, from http://www.mcleveland.org/Class_reading/Amartya_SenAdam_Smith_The_Economist_Manifesto.pdf. The World Bank. (2006). Where is the Wealth of Nations?