Element 1.8: The “Invisible Hand” Promotes the General Welfare

“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 society. . . . 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 not part of his intention.”⁽⁸⁾

Self-interest is a powerful motivator. As Adam Smith noted long ago, as if directed by an invisible hand, self-interested individuals have a strong incentive to undertake actions that promote the general prosperity of a community or nation. The “invisible hand” to which Smith refers is the price system. The individual “intends only his own gain” but is directed by the invisible hand of market prices to promote the goals of others, contributing to greater prosperity.

The principle of the “invisible hand” can be difficult to grasp. There is a natural tendency to perceive that orderly outcomes can only be achieved when someone is in charge or through directions from a centralized authority. Yet Adam Smith contended that pursuing one’s own advantage creates an orderly society in which demands are routinely satisfied without centralized planning. This order occurs because when private property and freedom of exchange are present, market prices will direct self-interested individuals toward actions that promote the general welfare. One statistic—the current market price of a particular good or service—provides buyers and sellers with what they need to bring their actions into harmony with the preferences and choices of others. Market prices register the choices of millions of consumers, producers, and resource suppliers. They reflect information about consumer preferences, costs, and matters related to timing, location, and circumstances—information that in any large market is well beyond the comprehension of any individual or central-planning authority.

Have you ever thought about why your local grocery stores have approximately the right amount of milk, bread, vegetables, and other goods—quantities large enough that the goods are nearly always available but not so large that it results in a lot of spoilage and waste? How is it that refrigerators, automobiles, and touch-screen tablets produced at diverse places around the world, are available in your local market in about the quantities that consumers desire? Of course, this is given the costs of their production. We would all “desire” more if they were produced for nothing or someone or somebody (perhaps the government) gave them to us for free! Unfortunately, almost nothing we value can be produced costlessly except perhaps love and laughter, so free lunches are never really free – somebody else always pays. Where is the technical manual for businesses to follow to get this done? Of course, there is no manual. The invisible hand of market prices performs the task. It directs self-interested individuals into cooperative action and brings their choices into line with each other through price signaling, as described in Element 1.6.

The 1974 Nobel laureate F. A. Hayek called the market system a “marvel.” A single indicator, the market price, spontaneously carries so much information that it guides buyers and sellers to make decisions that help both obtain what they want.⁽⁹⁾ The market price of a product reflects thousands, even millions, of decisions made around the world by people who don’t know what the others are doing. For each product or service, the market acts like a cloud-based network grinding out an indicator that gives all participants both the information they need and the incentive to act on it.

Throughout human history, no individual or central-planning authority has been able to obtain or consider all the information needed for millions of consumers and producers to coordinate their actions the way markets do. Moreover, market prices contain this information in a distilled form. They direct producers and resource suppliers toward production of those things that consumers value most (relative to their costs). No one has to force a farmer to raise apples or tell a construction firm to build houses or convince a furniture manufacturer to produce chairs. When the prices of these and other products indicate that consumers value them as much or more than their production costs, producers seeking personal gain will supply them.

Nor is it necessary for anyone to remind producers to search for and use low-cost methods of production. Self-interest directed by market prices provides suppliers with the incentive to seek out the best combination of resources and the most cost-effective production methods. Because lower costs mean higher profits, each producer strives to keep costs down and quality up. In fact, competition virtually forces them to do so. In a modern economy, the cooperation that comes from self-interest directed by the invisible hand of market prices is truly amazing. The next time you prepare a nice dinner, think about all the people who helped you make it possible. It is unlikely that any of them, from the tractor producer, to the farmer, to the truck driver, to the grocer, was motivated by concern that you have an enjoyable meal at the lowest possible cost. Market prices, however, brought their interests into harmony with yours. Farmers who raise the best beef or turkey receive higher prices. Truck drivers and grocers earn more money if their products are delivered fresh and in good condition to the consumer, and so on, while always using the lowest-cost means to do so. Literally tens of thousands of people, most of whom we will never meet, make contributions that help each of us consume a bundle of goods that is far greater than what we could produce for ourselves.

Further, the invisible hand works so quietly and automatically that the order, cooperation, and vast array of goods available are largely taken for granted. Even though underappreciated, the combination of self-interest and the invisible hand is nonetheless a powerful force for economic progress.