ONE of the most often distorted passages in economic literature is surely Adam Smith's aside about the invisible hand of the market. In Economics, which has been the leading college text on the subject since the 1950s, Paul A. Samuelson and William D. Nordhaus concocted a typical variant of Smith's actual remarks. They pulled them from the midst of a paragraph hundreds of pages into The Wealth of Nations, presumed to streamline the prose by chopping and splicing without using ellipses, and elevated the result into the theme of Smith's entire thousand-page book.
Every individual endeavors to employ his capital so that its produce may be of greatest value. He generally neither intends to promote the public interest, nor knows how much he is promoting it. He intends only his own security, only his own gain. And he is in this led by an invisible hand to promote an end which was no part of his intention. By pursuing his own interest he frequently promotes that of society more effectually than when he really intends to promote it. [italics added]
This makes Smith sound as if he thought that the invisible hand always leads individuals who are pursuing their own interests to promote the good of society. He did not. He saw the interests of large capitalists as conflicting with those of the public: capitalists seek high profits, which corrupt and impoverish society. In another example the famous division of labor increases factory output but erodes the intelligence, enterprise, and character of workers. Smith's passage on the invisible hand says only that it operates "in this as in many other cases" -- not always, not even mostly.
The "case" that Samuelson and Nordhaus edited out is about trade, and on this Smith said something indeed strange to modern economists' ears. Before the passage that Samuelson and Nordhaus excerpted, Smith had argued that investment at home produces more "revenue and employment" than investment in foreign trade. In the key sentence about the invisible hand, which Samuelson and Nordhaus reworked into the italicized portion of the quotation, Smith further argued that self-interest does lead the entrepreneur to invest at home rather than in foreign trade.
By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, 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.
The invisible hand promotes the good of society by leading entrepreneurs to invest at home rather than abroad.
Was Adam Smith not a free-trader after all? That is the wrong question. We tend to lump trade policies into either of two categories: free trade or protectionism. Smith was concerned with a third category: mercantilism, a system and ideology, fostered by merchants, that both promotes and manages trade. The Wealth of Nations is an extended polemic against mercantilism.
Smith attacked the way British mercantilism divvied up the world into parcels, granting merchants corporate monopolies to trade with each: the Russia Company, the Hamburgh Company, the African Company, the South Sea Company, and that great bed of waste and corruption the East India Company. Lured by monopolistic profits, "private persons frequently find it more for their advantage to employ their capitals in the most distant carrying trades of Asia and America, than in the improvement and cultivation of the most fertile fields in their own neighbourhood." Smith likewise railed against fighting colonial wars "for the sole purpose of raising up a nation of customers." He raised a point that we might at least consider: is our globalization just a new mercantilism?
Smith held that a nation's wealth lies first in agriculture, to supply its people with ample food; second in domestic industry, to furnish everyday needs; and distinctly third in securing merchandise "of the finer kind" through trade. Unfortunately, Europe emerged from the Middle Ages in an "unnatural and retrograde" manner. Merchants in cities, relatively free from the repressive grip of feudal lords, began trading to secure luxuries from the Muslim empire and Byzantium. Gradually, urban artisans learned to manufacture local goods to replace traded articles. Only last did this commerce erode inefficient feudal estates, so that yeomen farmed their own plots, thereby raising yields and better feeding the populace. Powerful merchants who had led the way from feudalism were able to secure a system that put trade first, domestic manufacturing second, and agriculture last.
Smith's argument is ultimately about values -- not surprising given that before serving as commissioner of customs in Edinburgh, he was a professor of moral philosophy. Modern economists do not admit this sort of argument: if poor people buy traded merchandise "of the finer kind"
rather than agricultural produce, then that is their system of values. Smith made judgments about values, which he saw mercantilism as distorting. The "enormous" sums spent on a reception for a new viceroy in Peru served "to introduce ... the habit of vanity and expense upon all other occasions." Such distorted values in turn distort industry. Spain and Portugal, epitomes of mercantilism, sent galleons chasing after gold and silver while neglecting farming and manufacturing at home: "Have the exorbitant profits of the merchants of Cadiz and Lisbon augmented the capital of Spain and Portugal? Have they alleviated the poverty, have they promoted the industries of those two beggarly countries?"