Adam Smith´s Invisible hands

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Adam Smith´s Invisible hands
Helge Peukert
University of Erfurt
The article discusses A. Smith´s five invisible hands. Taking into consideration his philosophical background, the skeptical Scottish enlightenment, it is argued that Smith had a very sophisticated understanding of market mechanisms and did not support a simplified liberalism.
Keywords: Adam Smith, invisible hand, Scottish enlightenment.
JEL: B0, B1, B3, B4, N, N3, Z1.

1. Introduction

“While economists frequently refer to “the invisible hand” [and other metaphors] ... they are often only dimly aware of the history and context behind these expressions” (Persky 1989, p. 195). Adam Smith´s ”invisible hand” (henceforth IH) is probably the most influential and incessantly mentioned metaphor not only in economics but in the social sciences in general (for recent examples see Sinn 2002, p. 398, Browne 2002, p. 791). “Although he mentioned it only twice [sic], Adam Smith introduced into the language of economists a metaphor as powerful as any used before or since: the invisible hand” (Eatwell et al. 1987, p. VII).
The literature on Smith´s oeuvre is abounding (see e.g. Wood [ed.] 1993ff. and Mizuta [ed.] 2000), but even the most elementary questions of interpretation are not settled: Was Smith the archetype of economic liberalism (Recktenwald 1978), an overvalued eclectic (Schumpeter 1954), the founder of a (ambiguous) labor theory of value (Ricardo 1951/1817, Marx 1974/1862, pp. 40-121), the precursor of neoclassical equilibrium economics (Arrow and Hahn 1971) or marginal value theory (Hollander 1973)? Did he understand economics as social psychics (Mirowski 1999), did he fall even behind the scholastics (Rothbard 1995), or did he present two contradictory approaches in The Theory of Moral Sentiments (1982c/1759) and in The Wealth of Nations (1976/1776) as some representatives of the historical School suspected (Oncken 1897, Schmoller 1913)? It is not surprising that the literature on the IH is not less diverse (see e.g. Ahmad 1990, Cropsey 1979, Defalvard 1990, Flew 1987, Grampp 2000, Hahn 1982, Heath 1992, Khalil 2000a and 2000b, Maître 2000, Martin 1990, Nassehi 1994, Pack and Dimand 1996, Perlman 1999, Priddat and Elsner 1997, Rothchild 2001, chapter five, Schnabel 1996, Streissler 2003).

In contrast to this literature we will focus on the skeptical tradition of the Scottish enlightenment to grasp the meaning and the rhetorical role of the IH in particular and Smith´s approach in general. Before, we will briefly delineate the present meaning and connotations of the metaphor. In the more recent literature, invisible hand-explanations (henceforth IHE) are supposed “... to describe [1] the principle by which [2] a beneficient social order emerged as [3] the unintended consequences of [4] individual human actions ... the invisible hand made theoretical social science itself possible ... the wealth of nations depends [5] not on conscious governmental planning, but on the [6] freedom of individuals to exchange, specialize and extend their markets ... the overall beneficial nature of Smith´s [7] ´simple system of natural liberty´ depends not on the benevolence of individuals, but upon the operation of [8] self-love in [9] a system of free exchange.” (Vaughn 1987, pp. 997-998, emphases and numbers added; see also Ullmann-Margalit 1978, and Koppl 1994). A couple of authors have tried to apply IH-explanations for the understanding of political and economic phenomena (see e.g. Nozick 1974 and 1997, and Selgin and White 1994, Dowd 2000). IH-explanations also demarcated elementary ideological and economic policy cleavages. ”Keynesian economics was a revolution against invisible hand orthodoxy” (Tobin, 1992, p. 117, and Niman 1987).

2. Smith´s philosophical background
Like Hume, Lauderdale, Rae, McCulloch, Hutcheson, and Steuart, Smith was deeply affected by the Scottish enlightenment which prevailed between 1730 and 1870 (for Smith´s intellectual and philosophical roots see the profound study by Griswold 1999). It was influenced by the French enlightenment (Montesquieu, Voltaire), but also by classical stoicism (Cicero, Seneca). The Scots were well at home in empirical facts, they presented them critically, based on a shrewd commonsense. They endeavored to develop a history of society as a general theory of society, including economics, psychology, ethics, law, and politics. The method was explicitly historical and actual events played a major role as a resource for theorizing. Institutional relations and their comparison were central research topics.
They tried to detect the conditions of the natural growth of institutions in unique environments which made the formulation of general hypotheses difficult. Their analysis of the social division of labor, embedded in ethical, political, and legal arguments is an example of this research orientation. Not historical or sociological “musts,” but positive valuations and norms of people were considered to be basic driving forces of society. According to Smith, humans and their tools of understanding, especially language, permit only bounded rational thinking and acting (see also Cosmides and Tooby 1994). Skepticism vis-à-vis human knowledge and social institution building, epistemological constructivism and the insight into the importance of rhetoric for argumentative statements was on the Scottish enlightenment agenda (see Smith 1982a and 1982b). Man is by nature a social animal and the Scots held an optimistic, and tolerant general viewpoint. Man is eager for social benefits between and within nations. They supported individualism and personal freedom but at the same time always had a close look for the promotion of the common good which can be grasped by the good will and common sense of the inquirer.
“The Scottish method was more concerned with giving a broad well balanced comprehensive picture seen from different points of view than with logical rigour ... It is part of wisdom to recognize, accept and be able to carry such inconsistencies. While we should of course try to reduce them, we should not insist on avoiding them in our critical descriptions” (Macfie 1967, p. 22). In his profound analysis of Smith and the Scots, Macfie highlights important and often overlooked special traits which are of prime importance for an understanding of Smith´s entire work. “They are typically curious about people, men at work, about comparative institutions ... They are not concerned with logical processes or sequences, or the framing of abstract hypotheses and their analysis to their utmost limits. They wish to build a truly balanced picture of social life as they found it and the forces which controlled it” (1967, p. 29).
From this philosophical background it seems questionable if Smith purported a clear-cut IHE in the sense of Vaughns description given above because the Scots underlined the inconsistencies and trade-offs of institutional arrangements and did not present simple and overall solutions like an unhampered system of liberty, i.e. a market exchange system. Further, we can observe that IHE contradict to a certain degree the optimist-individualist idea of enlightenment that human actors are able to broadly perceive the consequences of their actions whereas in IHE the beneficial order is the result of the unintended consequences of individual actions. In addition, a certain mastermind problem creeps up: there are some elucidated scientists who know the unintended beneficial results and there is the bulk of those who do not.
This contradicts the common knowledge perspective of the Scots which excluded the assumption of distinguished superior knowledge. Another point is that after the publication of The Wealth of Nations with the alleged IHE the former IH becomes transparent and is no longer invisible because Smith explained the mechanism and made it known. Finally, Smith purported a fine humanism which included the rejection of the oppression of the colonies, and Smith castigates all pillow fights for reasons to sustain the dependency situation. But with IHE almost all evils in the world can be justified, e.g. that without the holocaust the Israeli state would never have emerged. Can´t those who claim to know the hidden logic of history legitimately try to manipulate the narrow minded majority; don´t IHE provoke authoritarian manipulation (Hahn 1982)? So at first sight some reasons to assume a broken or subtle hand instead of a simple IHE can be identified. In the following, we will follow the principle of hermeneutical charity: we will take the metaphor serious and do not regard it as an ´ironic trinket´ (Rothschild 1994).We will initially assume that the IH has an underlying consistent meaning in Smith´s writings (contra Grampp 2000).
3. Smith´s five invisible hands
Smith first mentioned the metaphor in The History of Astronomy (1982a, pp. 33-105), written between 1751 and 1758. It is a commonplace in the Anglo-Saxon literature that Macfie (1971, p. 595) discovered the passage (Ahmad, 1990, p. 137). But it was known e.g. in the German literature on Smith (see e.g. Rüstow 2001/1945, p. 51). “Hence the origin of Polytheism, and of that vulgar superstition which ascribes all the irregular events of nature to the favour or displeasure of intelligent, though invisible beings – to gods, demons ... it is the irregular events of nature only that are ascribed to the agency and power of their gods. Fire burns, and water refreshes ... by the necessity of their own natures; nor was the invisible hand of Jupiter ever apprehended to be employed in those matters. But thunder and lightning, storms and sunshine, those more irregular events, were ascribed to his favour, or his anger ... (S)uperstition supplied the place of philosophy ... But when law has established order and security, and subsistence ceases to be precarious, the curiosity of mankind is increased ... ” (1982a, pp. 49-50, emphasis added).
In this first passage the IH plays in Greek antiquity and demarcates a set of superstitious beliefs by people who ascribe irregular events in nature to a god due to a lack of real knowledge on natural processes. We can call this IH Smith´s Jupiter hand. It is just the opposite of an IHE in so far as here the detection of an IH is not an expansion of real knowledge of phenomena but the opposite, i.e. superstition and human projections of quasi-intentional activities in nature which have no real basis; they are expressions of fear and ignorance.
The question arises, if Smith could not also have introduced an IHE in a market economy context in the same vein: Human beings do not understand the working of market mechanisms, they often fear their consequences (like unemployment) and therefore they project a benevolent intentionality into the market mechanisms. In this case too, we would not have to do with a real process out there but with a mere projection of the human mind and the IH metaphor would again not be a descriptive, but a critical category.
The second passage on the IH can be found in Smith´s The Theory of Moral Sentiments (1982c/1759). The historical context is medieval Europe with landlords, servants, peasants and structures of mainly feudal political dependency. “The capacity of his [the proud and unfeeling landlord´s] stomach bears no proportion to the immensity of his desires, and will receive no more than that of the meanest peasant ... 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 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” (1982c, pp. 184-185, emphasis added).
It makes sense to divide this IH into two aspects: the physical limitation of the stomach of the landlord on the one hand (the Physis hand, but the landlord could also simply destroy the agricultural surplus) and his psychological desire for distinctions on the other hand. This last aspect can be called the Mandeville IH with the elements of selfishness, luxury, and the desire for an ´economy of greatness´ with mainly employment effects. Greatness is measured here by the number of inferiors.
Did Smith take the thesis of a more or less equal distribution of the necessaries of live serious and did the historical facts of the time he discussed correspond to his equality argument? Smith could also have severely and ironically criticized the unequal distribution of necessities in Medieval Europe until the 18th century. The present-day reader´s first impression may tend to interpret the passage as irony and criticism. But the more recent research in the economic history of his time, especially the biological standard of living research and the empirical anthropometric data inform that Smith´s assumption of a more or less equal biological standard of living corresponds to the facts, irrespective of the psychological reasons Smith advances in the above quote (see Komlos 1993, and 1996).
But with the emergence of early industrialization the situation changed dramatically: the average biological standard decreased and a gap between the rich and the poor set in (for the reasons see Komlos 2000). In England, ”bad seasons, rising prices, the demands of growing industries and population and the threat of starvation during the wars from 1793 to 1815 would have driven any kind of British government to foster enclosure after 1760” (Heaton 1944/1931, p. 525). Therefore, shortly after the publication of The Theory of Moral Sentiments (first published in 1759) Smith could witness marked social changes: the rationalization of agriculture, including the enclosures, the massive expulsion of little peasants from their plots granted by customary law, the displacement of the staff in the economy of greatness, the emergence of cities as centers of commerce, (long-)distance trade, etc.
Smith described these transformations in the often overlooked book III of The Wealth of Nations, written in a new economic history manner (1976, Vol. 1, pp. 399-445; compare North 1990). Smith is well aware of the above mentioned transformation in agriculture and he consequently renounces the permanence of his Mandeville IH. ”As soon ... as they [the landlords] could find a method of consuming the whole value of their rents themselves, they had no disposition to share them with any other persons” (1976, Vol. I, p. 437). Long-distance trade made luxury consumption goods available for the landlords who now reinforced the agricultural revolution and the intensification of production to extract as much revenue as possible for the purchase of these commodities. The ´economy of greatness´ was substituted by the ´economy of distinction´ and commodity display (like diamond buckles, see 1976, Vol. 1, p. 437).
For Smith, this led to the disappearance of the Mandeville IH which made room for a new IH mechanism with a high benevolence potential in view of the increase of the population and the lagging behind of agricultural production. Smith did not explicitly mention the IH metaphor in this context and therefore it was hardly recognized in the IH secondary literature. He states: ”A revolution of the greatest importance to the public happiness, was in this manner brought about by two different orders of people, who had not the least intention to serve the public. To gratify the most childish vanity was the sole motive of the great proprietors. The merchants and artificers, much less ridiculous, acted merely from a view to their own interest ... Neither of them had either knowledge or foresight of that great revolution which the folly of the one, and the industry of the other, was gradually bringing about” (1976, Vol. 1, p. 440). Here Smith used the IH rhetoric in its purest form. We may call this the cold IH because it was accompanied by a lot of suffering by the agriculturally displaced and the new underclass in the cities.
This last and most well-known passage refers to what may be called the neoclassical IH. It argues from the supply-side, is merely based on rational self-interest (and e.g. not the landlord´s vanity) and it should lead at first sight to the optimization of the production process. But we will see that the neoclassical IH is not without caveats. A first hint may be seen in the fact that it is hidden in chapter two of book four on systems of political economy, headed: ”Of restraints upon the importation from foreign countries of such goods as can be produced at home.” As a rhetorical masterpiece, Smith starts the chapter by temporarily adopting some prejudices of the mercantilists to demolish them step by step.
Interestingly, Smith posits the IH at the beginning where he accepts for a moment the preponderance of domestic over foreign trade. “As every individual, therefore, endeavours as much as he can both to employ his capital in the support of domestic industry, and so to direct that industry that its produce may be of the greatest value; every individual necessarily labours to render the annual revenue of the society as great as he can. He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. 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 ... By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it” (1976, Vol. 1, pp. 477-478, all emphases added).
If Smith would have presented this IH in an unambiguous way he had introduced the IH at the wrong place, i.e. in the context of trade restrictions or barriers where domestic trade is better than foreign trade not only for reasons of personal security but even from the general vantage point. ”But a capital employed in the home-trade ... necessarily puts into motion a greater quantity of domestic industry, and gives revenue and employment to a greater number of the inhabitants of the country” (1976, Vol. 1, pp. 476-477). So, the IH passage is presented in a distorted context where Smith affirms the mercantilist position.
Some paragraphs after the IH passage Smiths begins the demolishing of the mercantilist position by asking simple questions to people with usual common sense. ”If the produce of domestic can be brought there as cheap as that of foreign industry, the regulation is evidently useless ... It is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than to buy ... What is prudence in the conduct of every private family, can scarcely be folly in that of a great kingdom” (1976, Vol. 1, p. 478). For a pure and simple version of the IH (see again Vaughn 1987) Smith presented it too early in the chapter, and maybe in the wrong chapter.
But we can also interpret this placement as a conscious decision, as a warning against simple formula and to give a balanced picture in the skeptical tradition of the Scottish enlightenment. In this sense the IH metaphor is not an economic policy blanket clause but a sophisticated possibility whose realization depends on the specific historical situations. Seen this way, the interplay of the five IHs (the Jupiter, the Physis, the Mandeville, the cold and the neoclassical hand) offer a very profound and well-balanced viewpoint (see the summary) compared with the alleged simple message of the IH as an unconditional plead for e.g. (neo)liberalism. It may be noted in passing that in the history of economic thought very often Gresham´s law applies, i.e. that easy arguments drive out deeper and more complex arguments.
There may also exist a certain misperception what Smith´s motivational background of the neoclassical IH is concerned. In usual explanations it is argued that he was deeply influenced by I. Newton´s worldview (Pack 1995) or that he held a deistic religious vision of the world and its harmonious functioning, including the economic sphere (Schmoller 1913, Rüstow 2001). These explanations are contradicted by Smith´s critical epistemology: He interpret all systems of knowledge as inventions of the human imagination (1982a, pp. 45-46). “And even we, while we have been endeavouring to represent all all philosophical systems as mere inventions of the imagination ... have insensibly been drawn in, to make use of language expressing the connecting principles of this one, as if they were the real chains which Nature makes use of to bind together her several operations” (1982a, p. 105, emphasis added). His explicit atheist and merely functional view of religion has convincingly been pointed out (Anderson 1998; compare Oswald 1995, and Hill 2001). “As ignorance begot superstitition, science gave birth to the first theism” (Smith 1982a, p. 9).
A less deep-digging pragmatic explanation was given by Smith himself in the sentence which follows the neoclassical IH. He gave a simple reason why a beneficient order may result from self-interested individual actions, at best without governmental planning. “What is the species of ... industry which his capital can employ, and of which the produce is likely to be of greatest value, every individual, it is evident, can, in his local situation, judge much better than any statesman or lawgiver can do for him” (1976, Vol. 1, p. 478). The reason Smith gives is what later has been made capital out off by Hayek (1945) who called it the problem of knowledge.
Smith gives numerous examples: “[A little grocer, his trade and] the qualifications which it requires. ... (H)e must be able to read, write, and account, and must be a tolerable judge too of, perhaps, fifty or sixty different sorts of goods, their prices, qualities, and the markets where they are to be had cheapest. He must have all the knowledge” (1976, Vol. 1, p. 125, see also Vol. 2, p. 38).
4. Smith´s balanced view
Above it was pointed out that Smith was strongly influenced by the Scottish tradition which foreclosed simple solutions and hypotheses like Vaughn´s IHE. Here it was argued that the Scottish attitude could also be found in the strategic and substantial presentation of his IHs. In the following this balanced view will be briefly exemplified and it will be asked further in how far the general spirit of Smith´s major writings is in favor or against simple IHEs.
In The Theory of Moral Sentiments (1982c) Smith tried to find a middle ground between egotism and private interests (Epicur´s prudence), propriety (Zeno) and altruistic solidarity (Shaftesbury´s benevolence). Often, sympathy and the impartial spectator are stressed as the main topics of Smith´s moral and anthropological system. “(T)here are evidently some principles in his [man´s] nature, which interest him in the fortune of others, and render their happiness necessary to him, though he derives nothing from it except the pleasure of seeing it” (1982c). But it must also be taken into account that Smith essentially qualified this principle by introducing other relevant social, anti-social, self-interested, emulative, cognitive and other passions like generosity, kindness, hatred, resentment, grief, joy, love of distinction, vanity, bettering our condition (pleasure), customs, harmony and tranquility. Some basic passions of his homo complex have dysfunctional consequences, e.g. his opinion that the disposition to admire the rich and great corrupts the moral sentiments. Sympathy can be combined ”with any passion whatever” (1982c, p. 10), they can ”fall short” (1982c, p. 21) in the case of suffering of strangers.
Sympathy further depends on social ranking: the rich are easily felt sorry for but the sorrow for the really suffering poor is limited, for Smith a ”universal case of moral corruption” which leads to flattery and falsehood (1982c, p. 61).
There is no IH mechanism in the fabric of human passions that probably directs society to a beneficial order. Not even scientific research provides a certain guarantee. Men are fascinated by wonder (the new) and surprise (the unexpected). They admire (the great) and exhibit curiosity to detect hidden chains: “Wonder is the first principle which prompts mankind to the study of philosophy ... they pursue this study for its own sake, as an original pleasure or good in itself” (1982a, p. 51). The evaluative criteria are beauty, simplicity, and novelty. Smith holds a civilization theorem on the one hand: social and economic security lead to curiosity which leads to knowledge. But on the other hand humans do not like to do violence to their usual habits. Therefore, the ultimate aim of all inquiries in normal science is “repose and tranquility of the imagination” (1982a, p. 61).

Smith´s complex understanding of human passions does not coincide with a homo oeconomicus, a utilitarian, an opportunism model of new institutionalism, recent research on fairness, the irrational model of behavioral finance, the homo duplex model of Durkheim or Etzioni, the vista of Hobbes, the implicit rationality of passions in R. Frank or the ethical view of the German historical school. The message of The Theory of Moral Sentiments is that, formerly, in small communities, “love, affection, esteem, gratitude” prevailed and guaranteed a certain stability. But in large societies with a certain degree of the division of labor “a sense of its utility, without any mutual love or affection [prevails] ... Society cannot subsist unless the laws of justice are tolerably observed ... the enforcement of the laws of justice by the punishment of those who violated them” (1982c, pp. 86-87). The enforcement of law must substitute earlier feelings of sympathy, reciprocity and benevolence.

For this reason a brief investigation in his Lectures on Jurisprudence (1985) will be undertaken. “Jurisprudence is the theory of the rules by which civil governments ought to be directed” (1985, p. 5). Smith discussed five origins of property and an economic stage theory which included the opinion that the state was established to protect the rich against the infringements of the poor; Smith supported the superimposition theory against the contract theory with regard to the emergence of the state (1985, p. 207). He described some evident natural defense rights, e.g. against the assault of murder or injury. For Smith, one interesting exception existed: “The only case where the origin of natural rights is not altogether plain, is in that of property. It does not ... appear evident that, e.g. any thing which may suit another as well or perhaps better than it does me, should belong to me exclusively of all others barely because I have got it under my power” (1985, p. 13).
This contradicts a natural rights theory of property and Smith stressed that the more society evolves the more regulations and laws are necessary. He argued against the theory of a minimal state. “The more improved any society is and the greater length the severall [sic] means of supporting the inhabitants are carried, the greater will be number of their laws and regulations necessary to maintain justice, and prevent infringements of the right of property” (1985, p. 16).
According to this view there does not exist a system of natural and unrestricted liberty with IH properties. But on the other hand Smith shared Locke´s view that in an acquisitive commercial society private property is necessary and only legitimate if it is based on productive work. “A person who can acquire no property, can have no other interest but to eat as much, and to labour as little as possible.” (1976, Vol. 1, p. 411). Therefore and in full accordance with an IH view Smith argues in The Wealth of Nations: ”The property which every man has in his own labour, as it is the original foundation of all other property, so it is the most sacred and inviolable ... All systems either of preference or of restraint, therefore, being thus completely taken away, the obvious and simple system of natural liberty establishes itself of its own accord” (1976, Vol. 1, p. 136, and Vol. 2, p. 208).
It is regrettable that Smith never discussed these opposing views of a social-legal theory of law and society and the natural right of labor approach. At least we find again his balanced view and Smith deliberately admits contradictions and tensions between the two vistas in fully accordance with the Scottish tradition. He obviously put forward the natural system of liberty so forcefully in The Wealth of Nations because his critical target was the distorted British mercantilism of his time.
Smith also developed an ambiguous Scottish theory of value in which labor was not an exact measure but a skeptical and pragmatic rule of thumb. “(T)he proportion betwen the quantities of labour necessary for acquiring different objects seems to be the only circumstance which can afford any rule for exchanging them ... In exchanging indeed the different productions of different sorts of labour for one another, some allowance is commonly made for both [hardship and ingenuity]. It is adjusted ... not by any accurate measure, but by the higgling and bargaining of the market, according to that sort of rough equality which though not exact, is sufficient for carrying on the business of common life” (1976, Vol. 1, pp. 53, and 35-36; emphases added).
Smith deliberately formulated agonizing theses on value theory: “[Labor is] the only ... measure of value” (1976, p. Vol. 1, p. 41). But at the same time he stated: “Wages, profit and rent, are the three original sources of all revenue as well as of all exchangeable value” (1976, Vol. 1, p. 59). Smith gave leeway to this contradiction because for pragmatic reasons profits and rents are necessary, otherwise land and capital would not be offered for the production process. But they are not fundamentally justified because they are not due to productive work. Profits for example “bear no proportion to the quantity, the hardship, or the ingenuity of this supposed labour of inspection and direction” (1976, Vol. 1, p. 54). Rent is not less questionable. “As soon as the land of any country has all become private property, the landlords ... love to reap where they never sowed, and demand a rent” (1976, Vol. 1, p. 56). These sentences do not suggest Smith´s belief in an IH mechanism in the realm of distribution.
The prices of the factors of production were determined by Humean “customs,” the wage is set upon the minimum of existence and rules of common humanity (1976, Vol. 1, p. 77). “(D)oubtless Smith had in mind a customary norm” (Hollander 1973, p. 115). The same holds for profits as a customary average return, “the ordinary rate of profit” (1976, Vol. 1, pp. 62-63).
Smith did not have an equilibrium approach of markets in mind. He surely talks about self-interest (1976, Vol. 1, p. 18) the higgling and bargaining in the market (1976, Vol. 1, p. 36), supply and demand relations and natural prices. But he held no simple model of the market process and emphasized the importance of varying historical and empirical circumstances. Smith´s firms and entrepreneurs are not only price taker, they are also price maker and often have a margin for pricing (see the coal example 1976, Vol. 1, p. 184). They exploit the power to withhold (1976, Vol. 1, p. 74), conceal inventions from the public (1976, Vol. 1, pp. 67-68), they collude (1976, Vol. 1, p. 69), and speculate into the more or less unknown future (1976, Vol. 1, p. 128).This may lead to bankruptcy (see the example of the corn dealer, 1976, Vol. 2, pp. 30-31). Often the economic actors are motivated by irrational avarice (1976, Vol. 1, pp. 30-31). In real time, firms may have problems to serve quickly changing demand (the case of the national mourning, see 1976, Vol. 1, p. 67). Firms may also destroy or artificially limit the supply of goods to increase prices (1976, Vol. 2, p. 150), and Smith highlights the importance of differential degrees of organizability between labor and capital (1976, Vol. 1, pp. 140-141).
In his view an asymmetry between labor and capital exists on the labor market, and “masters are in always and every where in a sort of tacit, but constant and uniform combination” (1976, Vol. 1, p. 75). In Smith´s realist description external effects (the case of the fire wall, see 1976, Vol. 1, p. 345) and natural monopolies (1976, Vol. 1, pp. 68-69) occur. Laws and their enforcement play a major influence even on the level of interest and the will to save (1976, Vol. 1, pp. 107, and 301). Major trends work against socially benevolent outcomes. “(M)asters are in always and every where in a sort of tacit, but constant and uniform combination ... (T)o narrow the competition, is always the interest of the dealers” (1976, Vol. 1, pp. 75, and 278). Smith´s realist view does not describe a harmonious economic system based on natural liberty. Instead, he warns against the self-abolition of free markets and political institutions. ”... the monopoly which our manufacturers have obtained against us. This monopoly has so much increased the number of some particular tribes of them, that, unlike an outgrown standing army, they have become formidable to the government, and in many cases intimidate the legislature” (1976, Vol. 1, p. 494).
Smith delineates a Scottish realist, causal-genetic approach in a world of the second-best. Markets may, but they may also not lead to good results. Markets may - as a pattern prediction - be superior to planned economies. This was his central message in his critique of mercantilism. But from this insight we cannot deduce that in special markets conscious government planning may not lead to superior results. Smith´s understanding of market processes transcends the one-sided neoclassical view with atomistic individuals, full knowledge, rational optimizing behavior, the simultaneous determination of prices and quantities and the resulting allocative efficiency. Pareto optimality is the probable exception in Smith´s economic world because he considered (as seen above) non-convexities in consumption, not fully competitive and incomplete markets, the power of groups and the emergence of collective strategies, information asymmetries, externalities, real time processes, and uncertainty and instability due to false trading. In so far, Smith was neither the founder of a labor theory of value nor did he foreshadow neoclassical economics.
But we may ask, if his description of markets comes close to a theoretical reasoning or is restricted to a mere description? A closer look reveals that Smith shared what today is described as the Austrian causal-genetic approach with purposive actions, radical ignorance, high information costs (error, regret, surprise), uncertainty, the knowledge problem, real time analysis, entrepreneurship (alertness), multidimensional competition, etc. (Ikeda 1994). But Smith does not share the Austrian ideological commitment, i.e. the thesis, that market processes lead to equilibrium or beneficial results in a system of natural liberty and with the working of IHs.
There are numerous examples where he deviates from a system of free exchange and proposed considerable interventions like monopoly control (1976, Vol. 1, pp. 494-495), the support of the navigation act (1976, Vol. 1, pp. 486-487) and retaliation tariffs (1976, Vol. 1, p. 490). He supported an administrative fixing of relative low interest rates (1976, Vol. 1, pp. 379-380), a taxing of imports if like goods are taxed in the importing country (1976, Vol. 1, p. 487), subsidies to smooth economic change (1976, Vol. 1, p. 491), temporary monopolies in cases of high risk and for invention patents (1976, Vol. 2, p. 278).
He further advocated a policy of high wages at the asymmetric labor market (1976, Vol. 1, pp. 74-75; ”higher wages increase industry,” p. 91) and discussed evolutionary dead ends like joint stock companies which attenuate the principle of full liability (1976, Vol. 2, pp. 264-265). He discussed positive externalities which should be fostered by the state like security, law, and infrastructure (1976, Vol. 2, pp. 213ff.). Negative aspects of the division of labor (1976, Vol. 1, p 142, and Vol. 2, pp. 302-303), the unhappiness of the employed, their dependency and the accompanying criminality (1976, Vol. 1, pp. 74, and 93) were highlighted. Additionally, he proposed some educational remedies against these negative consequences (1976, Vol. 2, p. 306).
But Smith also supported the immediate introduction of a system of free exchange: he urged for a system of freedom of trade, free choice of career, mobility of factor of production, etc. (”perfect liberty”, see 1976, Vol. 1, pp. 70, and 132). He ferociously criticized the guild system (1976, Vol. 1, pp. 70, and 108), and in his historical descriptions he had only negative remarks on economic policy in Europe (1976, Vol. 1, pp. 132ff., and e.g. 406). His target was in fact the mercantile system with its tariffs, legal monopolies, export bounties, restrictions of trade and freedom of establishment, and apprenticeship regulations.
The alleged contradictions between Smith the interventionist and Smith the liberal economist can be resolved if his Scottish philosophical background is taken into consideration. Smith gave no easy answers but he tried to describe the real world in all its complexity which forbids simple formula. Therefore, Smith does not prohibit interventions and regulations when necessary. The decision depends on the specific conditions and not on general rules or hypotheses on the real world. He could not support an unqualified thesis of the working of an IH in the economic system.
For Smith, in the political sphere no IH was at work but rather a grabbing hand. The interests of the landlords and the workers coincide with the common good. But the first are lethargic and the second have information deficits. The dealers, manufacturers and entrepreneurs are energetic but: “The interest of the dealers, however, in any particular branch of trade or manufacturers, is always in some respects different from, and even opposite to, that of the public ... (T)o narrow the competition, is always the interest of the dealers ... [They] have generally an interest to deceive and even to oppress the public, and who accordingly have, upon many occasions, both deceived and oppressed it” (1976, Vol. 1, p. 278). This is an evident negation of IHE in politics.

But Smith also rejects public choice´s general policy negativism. In his Scottish view, it is the normative task of the scientist and philosopher to defend the common interest against the hate and jealousy of the dealers and the opportunism of the politicians (1976, Vol. 1, pp. 521-522). A major function of The Wealth of Nations is to delineate an ideal political model which has been called the ´invisible-hand-model.´ It fairly describes in a nutshell his political perspective: “(T)he government is well organized, generally uncorrupt, and relatively benevolent. It restricts itself to providing basic public goods, such as contract enforcement, law and order, and some regulations, and it leaves most allocative decisions to the private sector” (Frye und Shleifer, 1997, p. 354). No IH mechanism can establish such a government. What is needed are good will, idealism, objective scientists, called social capital and a civic tradition.

5. Summary: The tentative and groping hand

Smiths major aim was to depict the vision of a tolerant society. Because of the declining biological living standard discussed in the literature as the early industrial growth puzzle (Komlos 1993, and 2000) and the increase of the population he considered a commercial society for some 200 years as a necessary interval (1976, Vol. 1, p. 443; the transitory nature of capitalism in Smith is pointed out by Heilbroner 1975). But this vision did not lead to an unconditional and unsophisticated support of the new system thanks to the Scottish philosophical background and their sense of realism. Smith did not claim the existence of a well-functioning market model. He clearly depicted the disadvantages of the new system. His hypothetical benchmark was in fact the natural system of liberty as a system in which private property is based on achievement and work which legitimizes private property. Additionally, the knowledge problem strongly encourages a decentralized economic system. But as a good social scientist this approach was checked in Smith by his genetical and social-legal insights on the necessities of laws and regulations in advanced societies (see his Lectures on Jurisprudence).
Smith was of the opinion that a pattern prediction comparing basic economic and social systems is possible: A society with a decentralized economy is superior to mercantilism or a communist system. But this comparative advantage did not lead Smith astray to exaggerate its merits. As a first rapprochement to reality he introduced the state (defense, law, infrastructure, education). A second rapprochement consisted in the discussion and acceptance of particular interventions, e.g. due to market failure. But in The Wealth of Nations Smith did not loose out of sight the central enemy of the time: ”mercantilism,” and he castigated policy failures without any reserve.
The IH in Smith corresponds to this balanced view. He did not support IHE as the self-evident and usual case in commercial societies, nor do they play a major role in politics, morals, law and anthropology. Our understanding of the market and social processes in the modern world is in fact limited (Hayek). But the correct conclusion for Smith is not to deny the visible hand as much as possible but to accept the fact that we can only say that both are necessary: the visible and the invisible hand. Their mixture depends on the circumstances (Williamson 1994). The historical lesson and danger of the last century is this: ”(T)he non-fulfillment of the vastly exaggerated claims for the invisible hand will lead to a reaction in which the hand, to our great loss, will be amputated” (Hahn 1982, p. 21).
Smiths IHs finally offer four suggestions: the Jupiter hand reminds us of the danger of superstition, i.e. the belief that in the objective world benevolent and intentional processes are at work. The Mandeville hand reminds us of the possibility that IH mechanisms may exist in reality for some time but may disappear in the stream of historical development. The cold hand reminds us of the possible high costs of IH mechanisms, the displacement of peasants due to the enclosures in the late Middle Ages or the more recent transformation process of former ”communist” countries and the high costs of transformation for major parts of the population. The neoclassical IH reminds us of the boundaries of knowledge and the non-perfection of any (economic) system and policy device.

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