Does The Invisible Hand Have Arthritis?

Excerpt from The Butterfly Generation, 30 October 2009

'Listen to enough economists and you’ll eventually brush up against an odd-sounding concept that’s known in the industry as “The Invisible Hand.” As legend goes, the first guy to use the term was Adam Smith - the economist who was really a political philosopher - who mentions it in his 1776 book, The Wealth of Nations:

“[An individual is] 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 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 Invisible Hand refers to market forces and the positive social outcomes that result — forces we all experience as we move through life. Our likelihood of consuming something is directed, in large part, by price: if the price is low we more readily consume, if it’s high, we’ll probably hold off. The same goes for the production of things: if we feel there’s enough personal gain to be made by baking and selling a loaf of bread, we’ll do it. If not, we probably won’t. These forces are a bit like the weather: if it’s hot out, we’re more likely to go to the beach. But if it’s cold, we’ll probably choose to stay indoors. The social outcomes piece lies in looking at the sum of all of these daily microdecisions and interactions: we might not have the time or knowledge to bake our own bread, so the baker provides bread in response to our willingness to pay for it. Socially, we’re all better off: we have bread, the baker makes a living.

That’s the The Invisible Hand in action — guiding each of us, via the “weather” of the market, to do things that wind up benefiting everyone. It’s the magic of markets: figuring out, by virtue of billions of individual decisions, the optimal allocation of scare resources.

But how much trust should we put in this Hand We Can’t See to guide us toward “positive social outcomes” when the following is happening:

• a fast-breaking global economic recession
• towering unemployment
• a bubble & bust housing market
• climate change
• epic biodiversity loss
• 15 of 24 major ecosystem services in decline, globally

Did I forget my x-ray glasses? What happened to the Invisible Hand? Is all this “optimal resource allocation” giving the Hand a bad case of arthritis?

No, of course I wouldn’t leave the house without my x-ray glasses. The bad situations listed above are all results, in one way or another, of “externalities”, or blind spots that derail the Hand’s ability to allocate properly. More interestingly, they represent a comprehensive case for our culture to start questioning the ability of the Invisible Hand to make good on its claim of positive social outcome. That’s starting to happen, I think, in the aftermath of the banking sector’s gross miscalculations leading up to today’s economic crisis. And it’s a good thing: it sheds light on the existence of externalities, and suggests that we’ll have to figure out a way to deal with them proactively...'