Adam Smith’s two invisible hands Anthony Brewer An inaugural lecture given in the University of Bristol, 25 January 20001

It is traditional to start an inaugural lecture by saying something about one’s predecessors. Since my post in the history of economics is new, I have no direct predecessors, though I would like to mention David Collard, now of the University of Bath, and John Whitaker, now of the University of Virginia. Both used to be at Bristol and both have made distinguished contributions to the history of economics. Since I am a historian of economics, it seems natural to go back to an earlier period and say something about Alfred Marshall, the first professor of political economy at Bristol and thus (I could claim) the first of my predecessors He was a very important figure in the history of the subject – there is even a regular Marshall Studies Bulletin for those who specialize in the study of his work. He was also the first principal of what was then Bristol University College, and thus the first predecessor of the Vice Chancellor – indeed, since the college was pretty small at that time, one could say that he was the predecessor of the Vice Chancellor, the Deputy Vice Chancellor, the Pro Vice Chancellors, and most of Senate House. At one point, I gather, he found himself arranging lodgings for students since there was no-one else to do it, so he was the predecessor of the Accommodations Office as well. I should also mention Mary Paley Marshall, his wife, who was one of the first two women to earn a Cambridge degree, though she did not actually get one – Cambridge did not then award degrees to women. She came here with her husband and taught alongside him, which makes her one of the first women to teach economics, or indeed any subject, in a British university. It is interesting to look back at that time from our modern world of Research Assessment Exercises and the like. Marshall’s great work, the Principles of Economics defined the subject, provided the framework and set the agenda for more than a generation. That should score pretty well, but if there had been an RAE in those days there would have been a problem for Bristol. When Marshall came here, he had published nothing of any significance, and the position was little better when he left – the Principles was a long time in gestation. Fortunately, Bristol appointed on the basis of promise. They got good advice and took it, but it is hard to imagine anyone doing the same today. Unfortunately, Marshall found the load of administration too much and left Bristol for Oxford and then Cambridge, where he remained until his death. Because of his Bristol connections, I was tempted to make Marshall the main subject of this lecture. My own research interests, however, focus on an earlier period, so I will turn to the eighteenth century, to Adam Smith and to his most famous concept, the invisible hand.

The Invisible Hand The basic idea of the invisible hand is simple enough – individual selfishness can lead to socially beneficial outcomes. More generally, a coherent, possibly beneficent, social order may emerge as the unintended consequence of individual actions. A corollary is that the

1 This lecture is what it says it is – a lecture intended for a non-specialist audience. It is not a scholarly paper

(though it may become the basis of one). It does not have the references to the literature and the range of references to primary sources which would be appropriate in a scholarly paper.

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motives of individuals tell us nothing about the merits of the result – a point that all economists take for granted, but that non-economists still often seem to find hard to grasp. A great deal has been said and written about Smith and about the invisible hand, but there has been remarkably little careful examination of exactly what he himself meant by it and of the arguments he used to support it. In particular, there has been little close comparative examination of the invisible hand as it appears in Smith’s two main works, the Theory of Moral Sentiments and the Wealth of Nations, the two invisible hands of my title. I want to ask whether they are really the same or whether, as it seems at first sight, they might be in conflict. It may seem surprising that Smith only used the actual phrase, ‘invisible hand’ three times in all his surviving writings, in three different works, but to Smith the phrase was not a tool of analysis or even a label indicationg a particular line of analysis, as it is now. To him it was simply a metaphor, an image which served to drive home his point. To use it repeatedly would have been a stylistic lapse. I will only deal with two of these three ‘invisible hands’ because the third, which appears in an early, unpublished work on the History of Astronomy, has nothing to do with the invisible hand of economics. 2

The invisible hand in the Theory of Moral Sentiments Smith’s first main work, the Theory of Moral Sentiments (TMS) is a study of moral philosophy. The passage which deals with the invisible hand is a digression from the main line of argument, so there is no need here to discuss the book as a whole. The fact that it is a digression, even a digression within a digression, is interesting because it suggests that Smith went out of his way to find a place for it, to the extent of forcing it rather artificially into a book that was really concerned with quite different issues. It must have been something that he really wanted to say. The context was a discussion of beauty. Things may seem beautiful because they are useful, a point Hume had made. To give an example (mine, not Smith’s) a roaring fire may seem beautiful because we enjoy, or remember enjoying, the pleasures of sitting by a fire when we are cold. Smith extended the argument, claiming that things may seem beautiful (admirable, desirable) because they serve their purpose well, even if the purpose they serve is trivial. He claimed originality for this extension (which ‘has not, so far as I know, been yet taken notice of by any body’: TMS 180). His example was watches – people who are notoriously unpunctual may still pride themselves on having a very accurate and expensive watch.3 A modern example might be someone who buys a powerful four-wheel drive vehicle for the school run and the supermarket car park. Smith took the argument a step further, generalizing it to cover the whole of what he called the ‘oeconomy of greatness’. The reference is to the life of the great eighteenth century magnates, with their country houses, armies of liveried servants, elaborate clothes, wigs, coaches, and all the rest of it. To Smith these were no more than ‘baubles and trinkets’, and guaranteed no real happiness. To drive the point home, he made up a little story about a poor but ambitious boy who struggles throughout his life to achieve real wealth, but who looks back in old age and sees that it was pointless. Smith knew that few would see it like that. We are seduced by the attractions of wealth, 2 For the record, Smith wrote:‘In all polytheistic religions … it is the irregular events of nature only that are

ascribed to the agency and power of their gods. Fire burns and water refreshes … by the necessity of their own nature, nor was the invisible hand of Jupiter ever apprehended to be employed in those matters’ (1980, 49). 3 As Dava Sobel’s Longitude (1996) has reminded us, accurate time-keeping was at the cutting edge of technology in the eighteenth century.

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however illusory, and a good thing too. The pleasures of wealth and greatness … strike the imagination as something grand and beautiful and noble. … And it is well that nature imposes upon us in this manner. It is this deception which rouses and keeps in continual motion the industry of mankind. It is this which first prompted them to cultivate the ground, to build houses, to found cities and commonwealths, and to invent and improve all the sciences and arts, which ennoble and embellish human life. (TMS 183) This is clearly an invisible hand argument (though the phrase has yet to come). Note too that although Smith attached little value to individual wealth he clearly did not despise the results of development at the level of the system as a whole – the sciences and arts ‘ennoble and embellish human life’. Smith then digressed further to consider the availability of food (and other necessities) to the majority of the population. I shall quote at some length to convey the flavour as well as the substance of his arguments. It is to no purpose, that the proud and unfeeling landlord views his extensive fields. … 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 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. The produce of the soil maintains at all times nearly that number of inhabitants which it is capable of maintaining. The rich … consume little more than the poor, and in spite of their natural selfishness and rapacity, though they mean only their own conveniency, though the sole end which they propose from the labours of all the thousands whom they employ, be the gratification of their own vain and insatiable desires, they divide with the poor the produce of all their improvements. (184) This is not the Hello magazine view of the rich – Smith was no flatterer, but the merits of the outcome have nothing to do with the intentions of the landowners. 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. When Providence divided the earth among a few lordly masters, it neither forgot nor abandoned those who seemed to have been left out in the partition. These last too enjoy their share of all that it produces. In what constitutes the real happiness of human life, they are in no respect inferior to those who would seem so much above them. In ease of body and peace of mind, all the different ranks of life are nearly upon a level, and the beggar, who suns himself by the side of the highway, possesses that security which kings are fighting for. (184–5) Here, at last, is the invisible hand, coupled with the surprising claim that rich and poor are equally happy. Inequality, it seems, is not a problem because all classes are equal in the things that matter. Necessities and luxuries play quite different roles. Luxuries are trivial in themselves but act as a key part of the economic mechanism, both in the redistribution of necessities to those who need them and as an incentive to expand production and (unintentionally) provide for a growing population. Let me pause here to deal with two possible objections. First, how seriously can we take the claim that rich and poor are equally happy? There is no doubt that Smith meant it seriously – it is discussed carefully at various points in the Theory of Moral Sentiments. It is not an unreasonable claim, since there are many modern studies of happiness which

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report that wealth and (self-reported) happiness are uncorrelated, just as Smith claimed. It is true that recent work by Andrew Oswald at Warwick suggests a positive relation between wealth and happiness, but even he finds the effect of wealth to be rather small compared with that of other variables. It should perhaps be added that Smith thought that sudden changes in the wealth of an individual would indeed affect their happiness, even though long established differences in wealth between different people did not. Second, one might think that Smith was being appallingly complacent about the living standards of ordinary people in his time. It is indeed true that most people in the eighteenth century were very poor by our modern standards but they were not poor by the standards of their own time. Ordinary people in eighteenth century Britain were possibly better off than any substantial population had ever been. English cartoonists habitually represented the Englishman as well fed and healthy, in contrast to the thin and sickly Frenchman.4 They did not consider themselves to be poor, and that is what matters.

The invisible hand in the Wealth of Nations I now turn to the better known invisible hand of the Wealth of Nations (WN). Some definitions are needed to understand Smith’s case, but fortunately he provided them in the very passage which deals with the ‘invisible hand’. [T]he annual revenue of every society is always precisely equal to the exchangeable value of the whole annual produce of its industry, or rather is precisely the same thing with that exchangeable value. As every individual, therefore, endeavours as much as he can … to employ his capital [so] that its produce may be of the greatest value; every individual necessarily labours to render the annual revenue of the society as great as he can. (WN 455–6) In Smith’s terminology, revenue means (net) income. The ‘annual revenue’ of the society is the sum of the incomes earned by all members of society. It is, essentially, what would now be called Net National Income.5 The exchangeable value of the annual produce is essentially what would now be called Net National Product. The two are equal because the sale of output is the source of the incomes of those who have produced it, or provided resources used in production. Smith’s argument, then, is that each individual uses his capital so as to add as much value as possible to the cost of the resources used, and that the total value added (total revenue) is maximized as a result. By modern standards, this can hardly be called a proof. It is barely a sketch of an argument, but Smith’s intuition was good – on appropriate assumptions his result can be derived with as much rigour as you like. Smith continued: He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. … 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. (456) Here is the invisible hand. Selfish actions serve the ‘public interest’, identified with the wealth of nation, that is, with total revenue (National Income) or the value of the annual 4 The French view, of course, was different. 5 Transfer incomes are excluded – Smith treated as transfers various incomes from services which would now be

considered as part of national income, but that can be neglected here.

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produce (National Product).

Two invisible hands or one? The problem should be clear. The invisible hand of the Theory of Moral Sentiments deals in necessities, and treats luxuries with contempt. Wealth does not lead to happiness, so it is hard to see why it should be valued. The invisible hand of the Wealth of Nations, by contrast, seems to treat necessities and luxuries alike. The wealth of the nation is the sum of all incomes, high or low, equal to the total value of all produced goods, however frivolous. The two invisible hands seem to embody quite different and conflicting visions. 6 To understand the invisible hand of the Wealth of Nations, it will help to say something about the general character of the book. It has two main themes. In the first place, it is exactly what its full title says it is, An Inquiry into the Nature and Causes of the Wealth of Nations. In that context, the invisible hand is unproblematic – the causes of the wealth of nations are under discussion, and the invisible hand tells us something about how selfish individual behaviour affects the wealth of the nation. But, in addition, the Wealth of Nations makes a case for what Smith called ‘natural liberty’. Rather oddly, many modern (anglophone) commentators translate this into laissez faire, or something else, perhaps because modern economists are embarrassed by such obviously loaded words as ‘natural’ and ‘liberty’. I will argue that the phrase, with all its connotations, may have been important to Smith. Here is his definition. All systems either of preference or of restraint, therefore, being thus completely taken away, the obvious and simple system of natural liberty establishes itself of its own accord. Every man, as long as he does not violate the laws of justice, is left perfectly free to pursue his own interest his own way, and to bring both his industry and capital into competition with those of any other man, or order of men. (WN 687) Smith presented a number of quite different but mutually supporting arguments for natural liberty. What may have been the most important in Smith’s mind is not economic at all. He thought that it was simply wrong to restrict people’s liberty. For example, the Poor Law as it then existed put the burden of supporting the poor on the parish, but parishes could, and did, refuse to allow potentially poor people to settle in the parish. Smith thought this was obviously wrong. ‘To remove a man who has committed no misdemeanour from the parish where he chooses to reside is an evident violation of natural liberty and justice.’ It is worth recalling that the Wealth of Nations was published in the same year as the Declaration of Independence, which also dealt in ‘self-evident’ truths, and in liberty. ‘We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty, and the pursuit of Happiness.’ In addition, Smith stressed the incompetence of governments, not merely in the sense that governments are in fact observed to be incompetent, but in the sense that they are always bound to be. We each know our own business much better than any outside authority can ever do, so it is impertinent of them to tell us what we should do. In addition, he thought that the state is almost always over-influenced by special interests and that state intervention normally amounts to the creation of unjustified privileges for particular pressure groups. There is a pretty clear link here with the ethical case for liberty – natural liberty was the antithesis of privilege. 6 One’s first thought might be that Smith simply changed his mind but the puzzle is not so easily solved. He

made extensive alterations to the Theory of Moral Sentiments after writing the Wealth of Nations, but did not alter the parts under discussion here.

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And then, of course, there is the economic case, exemplified by the invisible hand. Natural Liberty promotes wealth. This was not Smith’s only, or even perhaps his main, case for natural liberty, but it must at least play a very important supporting role. Smith accepted that natural liberty could be superseded if there were strong enough reasons to do so. Thus he supported restrictions on the issue of small denomination bank notes (for reasons which need not concern us now) even though this was ‘a manifest violation of that natural liberty which it is the proper business of law not to infringe, but to support’ (WN II.ii.94). At the least, Smith must show that natural liberty will not generally lead to economic losses which might justify state intervention. The invisible hand appears in his critique of what he called the ‘Mercantile system’, a set of arguments advanced (typically) by merchants, favouring trade restrictions (usually ones which they stood to gain from) which they said would increase the wealth of the nation. Smith’s invisible hand showed (as he saw it) that these arguments are wrong. The question remains: why would Smith think that increasing national wealth is a good thing, given his contempt for ‘baubles and trinkets’ (a phrase, incidentally that he used more than once in the Wealth of Nations as well as in the Theory of Moral Sentiments)? I will make two points, one negative and one positive. First, a brief digression. Modern welfare economics is built on the assumption that it is good for people to have what they want (to reach higher level in their preference ordering) regardless of what it is that they want. Wealth is good because it allows you to get more of whatever you want. This way of thinking is deeply built into the thinking of modern economists, making it easy to assume implicitly that Smith thought this way. If he had, there would be a real problem of compatibility with the Theory of Moral Sentiments. My negative point is simple. I can find no trace of this modern line of argument in the Wealth of Nations. That is just as well, since modern welfare economics has a major problem. An increase in national wealth means that someone, somewhere can have more of what they want, but that immediately raises the question of the distribution of income. Who is it that benefits? More generally, who should get how much of the things they want? There is no simple answer when each person has an individual set of wants with no way to compare them. The lack of any generally agreed way of dealing with questions of distribution massively weakens modern versions of the invisible hand. But if Smith did not argue in the way we are now accustomed to, we are left with a gap in the argument: why then is national wealth good? My positive point is that the answer (or a major part of the answer) is not hard to find once we set aside the temptation to look for some analogue of modern welfare theorems. The demand for those who live by wages, therefore, necessarily increases with the increase of the revenue and stock of every country, and cannot possibly increase without it. The increase of revenue and stock is the increase of national wealth. The demand for those who live by wages, therefore, naturally increases with the increase of national wealth, and cannot possibly increase without it. (WN 86–7) Those who live by wages are, of course, the majority of the population. Smith linked national wealth directly to jobs. A high demand for labour means high employment and high wages, which are clearly good for the welfare of the majority. There is a further supporting argument. The long-run growth of the economy, and hence of employment, depends on saving and investment, and increased wealth means more opportunity to save and invest, and hence more growth. Smith argued repeatedly that high wages were desirable.7 7 It is true that the passage cited here appears more than three hundred pages before the passage dealing with

the invisible hand, but I do not think that is a problem. The link between wealth and employment is established early in the book, as Smith was setting up his framework. The invisible hand is the end result of a long series of

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Smith’s very strong claim that the demand for labour ‘increases with the increase of national wealth, and cannot possibly increase without it ‘ is hard to justify on the basis of his own arguments. Wealth is defined here as ‘revenue and stock’. ‘Stock’ means capital. ‘Revenue’ is net income, after maintaining capital stock (and the associated employment) intact. Smith argues, that those whose revenue exceeds what they need to maintain themselves will either save and add to the capital stock or employ servants. Either way, revenue is spent in such a way as to increase employment. But what if revenue is spent on (marketed) ‘baubles and trinkets’? It might be said that this too creates employment. In a sense it does, because there can hardly be bauble-makers without bauble-buyers, but there is a danger of double counting. Suppose rich man A saves and invests in a bauble-making business which sells baubles to rich man B. We cannot credit both with the resulting jobs. There is a further difficulty. Equal amounts of revenue saved and invested in different lines of business will create different amounts of employment, as Smith well knew. In overseas trade, for example, an investor might have to wait five years for the returns, so an investment equal to five man-years of wages will only support one job, while the same investment would support five jobs in a trade which yields its returns in a single year. The question here, however, is not whether Smith could fully support so strong a claim, but why he regarded national wealth as desirable. There seems little doubt that he linked wealth to employment, and hence to the welfare of the majority. The very fact that he overstated his case suggests that the result was important to him. That Smith was in favour of high wages, employment and economic growth is, of course, well known. What has not, I think, been so widely recognized is that his case for natural liberty depends on the desirable consequences which flow from an increase in the wealth of the nation, and not on any respect for, or positive evaluation of, individual wealth in its own right.

Conclusions The argument of the Wealth of Nations is, in outline if not in detail, the same as that of the Theory of Moral Sentiments. It is very different from modern versions of the invisible hand. National wealth generates employment, just as the spending of the selfish landlord does in the Theory of Moral Sentiments. Arithmetically, the wealth (revenue) of the nation is the sum of the wealth (revenue) of individuals, but increasing the wealth of the nation is not good because it represents an increase in the wealth of at least one individual. Beyond a certain point, the wealth of individuals is of no significance in itself. Wealth does not bring greater happiness so there is no need to envy the rich. The baubles and trinkets of the ‘oeconomy of greatness’ are simply part of the mechanism, generating incentives and jobs. In a successful economy the arts and sciences ‘ennoble and embellish human life’ (TMS) and the ordinary labourer enjoys ‘the comfortable hope of bettering his condition, and of ending his days perhaps in ease and plenty’ (WN 99). The wealth of the nation matters because it is an index of the development of civilisation and the welfare of the majority, not because it is the sum of the wealth of individuals. Are there lessons which we can learn from this story? Perhaps. Modern welfare economics is a very feeble tool for investigating the case for (or against) markets, because of its inability to say anything substantial about income distribution and for other reasons (second-best problems, for example). Smith considered a much wider range of issues: wages and living standards, certainly, but also liberty, individual rights, the range of opportunities open to individuals, the scope and incentives for innovation, the growth of the economy, and so on. They still look relevant today. Reading Smith (or other past writers) will not give us simple answers but it can point us towards interesting and fruitful arguments which build on that framework.

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questions.

References Smith, A. (1976a) An Inquiry into the Nature and Causes of the Wealth of Nations, ed. R. Campbell, A. Skinner, and W. Todd, Oxford University Press (referred to as WN). Smith, A. (1976b) The Theory of Moral Sentiments, ed. D. Raphael and A. Macfie, Oxford University Press (referred to as TMS). Smith, A. (1980) Essays on Philosophical Subjects, ed. W.Wightman and J. Bryce, Oxford University Press. Sobel, D. (1996) Longitude, London: Fourth Estate Limited.

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