What is Left of the Invisible Hand?

On the Legacy of the Scottish Enlightenment

My wife and I are back from a short trip to Scotland. We arrived at Edinburgh and then went to the North in the region of Glencoe, had a boat ride on the Loch Ness, and ended up at the seaside at Nairn. We finished our journey back to Edinburgh, not without stopping in a whisky distillery on the way. It was a somehow “adventurous” trip – we got a screw in one of the tires of our rented car after 20 minutes of driving! It was our first time in Scotland and we definitely plan to return, if only for the absolutely beautiful landscapes. Edinburgh is a nice medium-sized city, especially the old town. It has some great bookstores, especially – for academic books – Blackwell and – for the general feeling and the free tea – Topping & Company. I was searching for Matt Zwolinsky and John Tomasi’s book The Individualists which nobody had, but Blackwell was able to order and receive it before the end of our stay. As you can judge from the photo below, this is not the only book I ended up buying! On the food & drink side, we’ve eaten fairly well, but I’m ashamed to confess that my highlight will remain the Scottish national drink – no, not whisky (though I enjoyed it, too), but the Irn Bru!

Many of my readers probably know that Edinburgh (Edimbra as the Scots call it) is where Adam Smith and David Hume (who was also born here) are buried. So, I thought that would be a great opportunity to say a few words about a concept that continues to be tightly associated with (mainstream) economics, the so-called invisible hand. It is probably not even worth recalling that the concept is to be found (exactly three times) in Adam Smith’s writings. However, though Hume and other Scottish philosophers do not use it, the underlying idea that Hayek would capture two hundred years later in his account of spontaneous orders was largely pervasive in the Scottish Enlightenment.[1]

From the popular view, the invisible hand concept evokes free-market economics and the idea that markets are self-regulating. There is now a large literature that shows how this association has been literally made up by some neoclassical economists, more particularly those belonging to the Chicago School – the name of George Stigler comes again and again as the main person responsible for this revisionist account. It is now well acknowledged (at least among historians of economics and economists with a sensitivity to the history of their discipline) that the way Smith used the concept and its free-market interpretation are completely unrelated. This is important to have in mind because it is not exaggerating to say that free-market views are not very trendy in the Western world and elsewhere. This fact doesn’t say anything however about the contemporary relevance of the invisible hand concept in economics and other social sciences.

Adam Smith’s grave

With this in mind, let’s quote two of the three occurrences of the concept in Smith’s writings – I leave the first occurrence in Smith’s treaty of astronomy aside. I don’t intend here to do exegesis or comment on Smith’s text, but it’s still useful to know how Smith was using the concept. The second occurrence of the concept is to be found in The Theory of Moral Sentiments:

“The rich only select from the heap what is most precious and agreeable. They 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 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. 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.”

The third and last occurrence – famously – appears in The Wealth of Nations:

“By preferring the support of domestic to that of foreign industry, he intends only how 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 is no part of his intention. Nor is it always the worse for the society that it was not 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.”

The common idea in these two paragraphs is that of unintended social consequences. In both cases, Smith is describing a situation where individual behaviors, while intentionally pursuing particular ends, end up producing collective consequences that were not foreseen or, at least, not intended. These collective or social consequences are not only unintended, but they are also somehow “beneficial.” In both cases, individual behaviors unintentionally promote the interest of society or the species. This is of course this kind of socially beneficial unintended consequence that free-market economists wanted to emphasize when they revisited the invisible hand concept.

Now, beyond the fact that it is pretty clear that in neither case Smith is using the invisible hand concept in relation to any kind of claim that markets are self-regulating, what is at play here is a particular type of social theoretical explanation that we could call “invisible hand explanations” (IHE). The best systematic philosophical study of invisible hand explanations I know of has been provided by my colleague at the Journal of Economic Methodology Emrah Aydinonat in his book The Invisible Hand in Economics.[2] Emrah shows that the true legacy of the invisible hand concept has nothing to do with self-regulating markets but rather with a particular type of social theoretical account. This type of accounts was already identified by Robert Nozick among others:[3]

“They show how some overall pattern or design, which one would have thought had to be produced by an individual’s or group’s successful attempt to realize the pattern, instead was produced and maintained by a process that in no way had the overall pattern or design ‘in mind.’ After Adam Smith, we shall call such explanations invisible hand explanations.”

In his book, Emrah thoroughly explores the nature of IHE, how they materialize in contemporary social sciences, as well as their explanatory power and limitations. IHE are concerned with accounting for unintended consequences at the social level, which implies in particular that (i) they were not intended by a particular individual, (ii) they result from the aggregation of the actions of a collection of individuals, (iii) the actions of individuals are intentionally directed toward individual ends that are minimally diverse, and (iv) neither one single individual’s action nor intention can fully produce the social outcome. In this respect, Emrah contends that a good (i.e., successful) IHE has the following properties:

(a)   It must display one or a collection of mechanisms that produce the social outcome that is the target of the explanation.

(b)   The initial conditions and the mechanisms, while they need not perfectly match with what is at play in the real world, should nonetheless be credible and sound familiar.

(c)   The characterization of the unintended social consequences should match with the social outcome that is the target of the explanation.

(d)  The explanation should offer a new mechanism that accounts for the social outcome or strengthens previous IHE.  

Economics abounds with (mathematical and non-mathematical) models that formalize an IHE.[4] Emrah thoroughly discusses Carl Menger’s account of the emergence of money and Thomas Schelling’s famous checkerboard model of residential segregation. But there are plenty of others. Akerlof’s model of adverse selection is for instance a typical IHE. Agents maximize a utility function that unambiguously represents self-interested preferences. Their choices, based on the information available (or lack, thereof), produce a decrease in the number of transactions and of the average quality of goods in the market (the unintended social consequence). The only important difference (which also partially applies to Schelling’s model) is that the social outcome here cannot be considered as beneficial; it is rather socially adverse. But that’s precisely the point: IHE are not committed to showing that actions pursuing individual goals must necessarily produce good social outcomes. Indeed, the whole literature on social dilemmas and market failures is largely based on IHE that emphasize the adverse nature of unintended consequences.  

Enjoying a glass of Aberlour

Let me end this essay with three more considerations about IHE. First, there is a deep connection between the emphasis on invisible hand mechanisms and the rejection of what Karl Popper called the “conspiracy theory of society,” i.e., “the view that an explanation of a social phenomenon consists in the discovery of the men or groups who are interested in the occurrence of this phenomenon (sometimes it is a hidden interest which has first to be revealed), and who have planned and conspired to bring it about.”[5] As I argued in a previous essay, the widespread propensity to view all social phenomena as being the intentional result of the actions of a few individuals is probably embedded in our evolutionary history:

“The genetic and cultural attributes of humans have essentially evolved in the context of small, closed tribal societies where, at least for phenomena that were not due to purely natural forces, it was relatively easy for anyone to observe the agentive causes of whatever was happening. In other words, in “closed” societies, there is a relatively straightforward and non-ambiguous causal relationship between the acts of individuals and their social consequences. This causal relationship becomes far more ambiguous and almost impossible to observe directly as society opens and becomes more complex. With respect to both explanation/prediction and justification/evaluation, we tend to continue to postulate that such a simple causal relationship exists. It is difficult to accept that some collective phenomenon (e.g., the rise of the prices of some category of goods) is not entirely causally due to the intentions and actions of a small and well-identified group of persons. It is difficult to admit that this group is not normatively responsible for the adverse consequences generated by this price increase.”

Obviously, IHE are the antithesis of conspiracy explanatory accounts. That’s why social sciences are so important. By promoting IHE, they go against a deeply entrenched instinctive perception that intentions and consequences are always tied together. It’s not random if the cradle of IHE is to be found in the Scottish Enlightenment. The very ability to produce and accept the relevance of IHE necessitates a rationalistic attitude toward the outer world and a willingness to question one’s beliefs.

At Blackwell

On the other hand, and this is my second point, we should not overestimate the explanatory power of IHE. There is nothing in principle that makes it impossible for conspiracy explanatory accounts to be sometimes correct. Conspiracies may exist, they are just very unlikely. More generally, not every social outcome that is relevant is unintended. In some contexts, outcomes that affect everybody (beneficially or adversely) are the intentional product of intentional actions. IHE are just one type of plausible explanation for social phenomena among others. That we can expect them to be the most relevant when we study complex systems doesn’t mean that we should automatically discard other kind of explanations. This is even more true that, as Emrah discusses in his book, IHE tend to produce “conjectural histories” that are very hard to falsify. On this, IHE and conspiracy explanatory accounts are on the same par. It is virtually always possible to build a model of a social phenomena that provide a IHE for it. We should therefore be very careful in their use and interpretation. That an IHE can be provided doesn’t mean that it is correct or the best explanation available.

David Hume’s statue (yes, I wear a Wittgenstein hoodie!)

Finally, the historical importance of IHE in economics may seem to stand in conflict with the more and more “engineering” nature of many branches of the discipline, i.e., Esther Duflo’s claim that economists are plumbers.[6] At first sight, the engineering conception of economics seems to entail a complete rejection of IHE. After all, an engineer is someone who is intentionally looking to produce an outcome that, in the case of economics, will most of the time be social. Randomized controlled experiments are for instance clearly developed in this perspective. Things are however more complicated. Economists, when they behave as engineers, only intervene at the level of rules and incentives. Ultimately, the social outcomes that the economists are aiming for are still produced by individual actions that, most of the time, are intentionally directed toward individual ends, not the social outcomes. That means that proper economic engineering can hardly do without proper IHE, or at least should not. Acknowledging this helps to clarify what could otherwise be a puzzle regarding the Hayekian origins of mechanism design, the branch of microeconomics that displays the most this engineering approach. More generally, theoreticians of spontaneous orders like Hayek have also emphasized that social orders are rule-based. Because of that, there is no contradiction between the belief that many social phenomena can be appropriately accounted for by an IHE and the belief that it is possible to intentionally (re)organize society by acting on its rules. Individual actions do not take place in a vacuum but respond to rules. If you have an adequate understanding of how rule-following behaviors produce unintended social consequences, then you can somehow purposely change the rules to pursue social goals. IHE are therefore part of the toolkit of the economic engineer.  

The true Scottish national drink!

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[1] See especially Friedrich A. Hayek, Law, Legislation and Liberty, Volume 1: Rules and Order (The University of Chicago Press, 1973 [2011]).

[2] N. Emrah Aydinonat, The Invisible Hand in Economics: How Economists Explain Unintended Social Consequences, First Edition, Second Printing (Routledge, 2009).

[3] Robert Nozick, Anarchy, State, and Utopia, 2e édition (New York: Basic Books, 1974 [2013], p. 18).

[4] Economics is not the only social sciences to produce IHE. Models of invisible hand mechanisms are also common in political science or so-called “analytical sociology.”

[5] Karl Popper, The Open Society and Its Enemies, 7th edition (Routledge, 1944 [2012]), p. 306.

[6] Esther Duflo, “The Economist as Plumber,” American Economic Review 107, no. 5 (May 2017): 1–26.