Adam Smith and the not so invisible hand: A revision for the undergraduate classroom

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Abstract

Students in introductory economics rarely get much exposure to historical ideas, but they often hear about at least one historical concept: “the invisible hand.” Unfortunately, what they learn about the invisible hand – at least as far as is evident in the leading undergraduate textbooks – is flawed, largely because it is removed from its historical context. In this paper, we describe recent research on Smith’s metaphor and suggest some simple ways for instructors to use it – informed by the context in which it was written and Smith’s original intent. We also describe some simple classroom experiments that aid in these discussions.

Introduction

Nearly all of the leading textbooks in economics reference the invisible hand concept, but these references do not accurately reflect the essence of Adam Smith’s original thinking. As historians of economics have explained, the discipline has, at least since Paul Samuelson, interpreted Smith’s metaphor to mean something quite different from what he intended. We argue in this paper that using Adam Smith is an effective way to engage student interest in economics but that it is important to accurately present his ideas; moreover, doing so opens up some avenues for classroom instruction on important topics like the nature of competition and the role of institutions that have proven to be engaging for students. Using Adam Smith, along with complementary classroom experiments, provides a valuable way to make these concepts more relevant and interesting to students.1

More often than not, modern economists interpret the invisible hand as a descriptor of the efficiency results achieved from perfect competition or at least some vague notion that free markets work well.2 That is how we often present this idea to students, who may adopt an unrealistic perspective on markets as a result. But the historical reality is that the “invisible hand” went unnoticed for at least a century after Smith wrote the words, and Gavin Kennedy (2005, 2009) has persuasively argued that it held no particular significance for Smith. According to Kennedy (2009, p. 240), it was a well-known literary metaphor of the 18th century and “contrary to the assertions of the modern consensus, he gave the invisible hand no role in his theory of competitive markets…” Yet the metaphor “slipped into the mainstream almost unnoticed and unquestioned; it only became synonymous with his name from the mid-20th century onwards” (Kennedy, 2009, p. 243). Samuels (2011, pp. 21–29) also documented many of the early uses of the phrase, pointing out that it appears in very few writings before 1938 (Minowitz, 2004).

In discussing the effects of investing at home rather than abroad on aggregate employment, Smith wrote that each person was “led by an invisible hand to promote an end which is no part of his intention.” However, it is clear that the particular “end” he had in mind was not an equilibrium outcome in perfectly competitive markets nor did he mean to refer to allocative efficiency as implied by the link to the welfare theorems of Arrow and Debreu.3 A number of scholars have expanded on these points including Mark Blaug (1997, p. 60) who wrote, “Smith’s faith in the benefits of ‘the invisible hand’ had absolutely nothing whatever to do with allocative efficiency in circumstances where competition is perfect à la Walras and Pareto; the effort in modern textbooks to enlist Adam Smith in support of what is now known as the ‘fundamental theorems of welfare economics’ is a historical travesty of major proportions.” Other scholars have made similar points (Khalil, 2000; Wight, 2011; Rothschild, 2001; Liu, 2019).4

The contemporary use of the invisible hand metaphor has also contributed to a view that economic theory is not applicable to the “real world,” as the invisible hand is often seen as some magical force bringing markets into equilibrium. In our experience, students often enter even upper-division classes with this general perspective. Many economists have contributed to this misconception over the years, often relying on an erroneous version of the invisible hand. Consider, for example, that Samuel Bowles (2016, p. 15), who is otherwise not particularly enamored with mainstream Samuelsonian economics, indicates that “competitive markets and secure, well-defined property rights, Smith explained, would order a society so that the invisible hand could do its magic.” In their highly influential textbook, Paul Samuelson and William Nordhaus claim that the invisible hand is an “almost miraculous coincidence of economic life.” John Komlos’(Komlos, 2019) textbook describes the conventional view of markets as “practically flawless, acquiring an almost divine aura…” These perspectives, especially when misattributed to Adam Smith, are counterproductive, particularly in the classroom.5

Experimental economists have repeatedly observed that competitive markets in the laboratory do not equilibrate due to the miraculous workings of an “invisible hand” but rather due to a process that is remarkably similar to the process of competition that Smith actually does describe in the Wealth of Nations. Blaug (1997, p.42) explains that, “For Smith, competition is not a state or a situation but a behavioural activity; it is a race between two or more persons to dispose of excess supplies or to obtain goods available in limited quantities; it is a regulatory mechanism which forces prices and profits to their lowest sustainable levels.…..In short, competition denoted that pattern of business behaviour which we conjure up by the verb ‘to compete’: to invade profitable industries, to expand one’s share in the market by price cutting, in short, to jockey for advantage by any and all possible means.” This approach to competition as a process is quite different from the “perfect competition as market structure” approach that is typically presented to students, and fairly accurately describes the actual process that is frequently observed in competitive laboratory markets. This makes classroom experiments a particularly useful way to put the invisible hand into context for students.

Most of today’s textbooks seem to adopt one of many different versions of the invisible hand – that it reflects in some abstract way the price system itself, or at least the coordination that emerges from a price system.6 Others take a slightly different emphasis on the spontaneous creation of overall “well-being” (rarely, if ever, being specific about what that means) from the individual’s pursuit of his or her own interests.

Table 1 summarizes the passages from a number of widely used undergraduate microeconomics textbooks. While obviously not an exhaustive list, it shows the extent to which and the ways in which the “invisible hand” is referenced in a number of popular introductory textbooks.

While each book takes a slightly different approach, some emphasizing the invisible hand to a much greater degree than others, the patterns are clear.7 Overall, these textbooks characterize the invisible hand as either the price system itself (or the coordination function that emerges from that system) or a first welfare theorem-type claim that perfect competition generates an optimal outcome (not always specifying what that means, although some books are clearly referring to efficient allocations of goods under conditions of perfect competition). None of these broad interpretations properly characterizes Smith’s metaphor, nor do they provide the context in which Smith used it.

Does it really matter that contemporary textbooks get Smith’s metaphor wrong in a fundamental way? We believe it does. For instance, upper-division economics students typically associate Adam Smith with “the invisible hand,” but they almost always think it had something to do with the price system, the efficiency of markets or the inherent properties of the market system. Given Smith’s stature in the discipline, this misattribution may well deeply affect their conception of markets – and this is a key reason why it is important to correct in the classroom. As Grampp (2000, p. 442) noted, “If what [Smith] meant by the invisible hand is misunderstood, then what it is mistakenly said to mean may be misunderstood also. For example, to interpret the invisible hand as the price mechanism, which it is not, is likely to make one overlook the numerous reservations Smith had about the price mechanism or what he called the simple system of natural liberty, which…is seen to be neither simple nor systematic and is by no means meant for all markets.” And Samuels (2011) points out that the common (mis)interpretation of the invisible hand has created a misleading view of what Smith believed to be the proper role of government.

Adopting a narrow misconception of the invisible hand also tends to lead us away from the richness of Smith’s actual ideas. His work was in fact broad enough that moving beyond the narrowness imposed on it by modern textbooks opens up a number of important topics in the classroom. While both the invisible hand concept and the other ideas we describe later in this paper could be taught without any reference to Smith, we have found that orienting the discussion around Smith is a valuable way to frame the issues. Students learn early on that Smith was the “father of economics,” so their interest in his contributions is natural. Moreover, given the limited exposure many students have to the history of the discipline, framing these issues in the context of Smith’s scholarship at least helps remedy this problem. These are key concepts for economics students and while using Smith is not the only way to present them to students, grounding them in historical context is one of the best ways to tie them all together and motivate student interest.8 In addition to getting Smith’s ideas right, which we think has value in itself, students are regularly surprised and interested to learn that what they think Smith wrote about the invisible hand is not quite accurate.

Section snippets

Exploring the “invisible hand” in the classroom

Smith used the metaphor of the invisible hand only once in the Wealth of Nations, and his original words provide instructors with a nice starting point. If they are so inclined, instructors can begin with a brief overview of Smith’s primary works and the context of the Enlightenment in which they were written. It is also worth explaining to students that Smith did not use the phrase in the first two books of the Wealth of Nations where he outlines his theory of markets, but instead made it part

Conclusion

The invisible hand has been a powerful metaphor in economics classrooms for generations of students despite the fact that Smith himself used it only once in the Wealth of Nations. Unfortunately, students are too often left with the impression that there is some mystical force that guides markets to equilibrium even though Smith’s use of the phrase implied nothing of the sort. Perhaps the most damaging aspect to this narrow and historically inaccurate presentation of Smith’s idea is that it

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