The Invisible Hand and Its Scar

If you’ve studied economics or the business pages, you’ve probably heard of the Invisible Hand. Adam Smith introduced the metaphor in The Wealth of Nations two hundred and fifty years ago. It’s been elaborated on and developed into a basic justification of unfettered free market economy.

The Invisible Hand

Invisible guidance in free markets

Invisible guidance in free markets

  • The invisible hand is a metaphor for how, in a free market economy, self-interested individuals operate through a system of mutual interdependence to promote the general benefit of society at large.
  • The invisible hand operates when individuals seeking their economic self-interest actually benefit society more than they would if they tried to benefit society directly.

The first definition justifies following one’s self-interest since it will lead to the general welfare of society. The second underlies the argument that the free market serves society better than the decisions of government.

The invisible hand is understood to work because each fair exchange creates signals about which goods and services are valuable and how difficult they are to bring to market

Conditions

The invisible hand operates when the conditions of fair trade are met. The main condition being that the individuals must be able to make informed choices of which economic activities are in their self-interest. To make informed decisions of one’s self-interest, one must have access to relevant facts—at a minimum, price, quality, and alternatives.

As the business pages routinely reveal, large corporations lie, cover up, misdirect (e.g. Volkswagen, Wells Fargo, cigarette manufacturers for decades, Facebook, etc.) until they are caught.

Asymmetry

Asymmetry exists in an unbalanced relationship. In the economic case, the potential customer and the offering business have considerably different information about the product, its worth and its cost. Of course, the customer knows less about the product than the corporation. Customers only pay attention to the product when they are considering its purchase. Corporations pay attention to their products every day with devoted attention.

That disproportionate attention and information is inevitable and natural. If everyone—customer and corporate—were completely honest then the Invisible Hand would work flawlessly.

Abuse of Asymmetry

Thumb on the Scale of Justice

Thumb on the Scale of Justice

Unfortunately people and the businesses they run are not perfect. When some realize they can profit by hoodwinking others, they do that, disturbing the ideal Invisible Hand.

Because the corporation has the upper hand in economic knowledge about its product and because its reach is across many customers, the most prevalent asymmetric abusers are ethically challenged corporations.

Consequences

In a free market with honorable participants, the invisible hand guides prices down to their natural level, where they equal production cost.

The scar of asymmetric abuse forces the prices of goods higher than their natural level. An additional problem is allocation of production shifts from those that satisfy the societal good, to those that benefit the ethically challenged businesses.

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