Adam Smith’s idea of the Invisible Hand is one of the most influential theories for any modern day economist. The simplicity of the argument that competition channels self-interest for the common good seems to be a convincing proposition at first. It is also one of the most widely cited theories used to support free markets and deregulation. In this article, I would like to argue against the invisible hand theory derived from the work of Charles Darwin. Economist Robert H. Frank has also made similar arguments in his book The Darwin Economy: Liberty, Competition, and the Common Good.
Adam Smith’s book “An Inquiry into the Nature and Causes of the Wealth of Nations” (1776) briefly introduced the idea of the Invisible Hand. Its most influential paragraph read “every individual endeavors to employ his capital so that its produce may be of the greatest value. He generally neither intends to promote the public interest, nor knows how much he is promoting it...he is led in this as if by an invisible hand to promote an end that 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."
He argued that every individual acts in self-interest and tries to maximize personal gain but in the process the economy attains equilibrium where prosperity of the entire economy is advanced. These arguments laid the foundation for what was later called laissez-faire capitalism.
Upon looking closer, it would appear that this argument completely ignores the process through which the economy travels to attain such equilibrium. Although self-acting individuals might be capable of eventually attaining equilibrium, the period of transition between equilibria might lead to chaos in the economy.
As per standard economic rationale, when the demand for a certain commodity goes up and there is constant supply, prices are bound to go up. In such a scenario, more suppliers are to enter the market and restore the supply deficit and bring back price equilibrium. But this idea completely ignores the dynamics of the economy where there might be market forces that create a barrier to entry in the economy. It also ignores the transitory effects it will have on the labor and other resource markets.
Contrary to Smith’s rationale, Darwin’s observations from the animal kingdom can give us pivotal insights into how an economy with no oversight can lead to wasteful expenses.
Darwin was a naturalist. He observed that if a species is left alone it might evolve with traits that would collectively benefit the group, but at the same time some species would evolve with traits that would put them at a relative disadvantage. His observations have most prominently been used to explain the arms race. Take for instance the case where every country cuts its military spending by half – it would not affect the world order significantly, but at the same time leave additional resources for governments to be invested in other avenues.
Darwin observed wasteful expenses from the animal kingdom like the peacocks with long tail feathers that leave the bird at a considerable disadvantage against any predator. Another animal that is relevant in this comparison is the elephant seal. During the mating season, these animals can grow up to as heavy as 6000 pounds, spending significant metabolic capacity to maintain this size. But this also puts these animals at a significant disadvantage against their predators.
In Darwin’s theory of sexual selection, genes that are favorable for survival of the entire species are chosen. But such a mechanism can also lead to development of traits, which lead to wasteful investments due to the Red Queens Race. In either case, the dominant gene is still transferred and the species survives. But in the human world The Red Queen hypothesis has lead to an equilibrium where survival of the entire species is at risk.
This idea, on which extensive work has been done by Robert H. Frank, states that when individual performance is measured in relation to the relative performance of every other individual then in such scenarios unregulated market equilibrium might not always be the most optimal outcome. This line of thought can provide us with insight into the labor market or demand for education, where the relative performance of the candidate is critical for individual being selected.
Hence we can think of Adam Smith’s invisible hand as only a part of the story about what happens when economies are left to function on their own.
It is certain that Smith was one of the most influential economic philosophers of the 18th century. But his understanding of the economy was insufficient to clearly capture modern day economic problems like information asymmetry and tragedy of commons. These complexities create a need for centralized control mechanism to set in when it senses a market failure. For example, a mediation authority like UN helps streamline global incentives to avoid costly arms races.
It is also important to note that this line of argument does not validate the need for government intervention in all scenarios, but only argues for a need in case of market failure.