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The invisible hand and the magic of the market

January 11, 2021

reading time: 4 minutes

by Florian Semle, guest author

Steam engine production by Soho Engineering Works at the time of Adam Smith, the

Robert Burns wrote of man’s inhumanity to man. But the Scottish economist and moral theorist Adam Smith’s thoughts on the “invisible hand” provide a more uplifting outlook.

Let’s start with the visible, the economic and social environment in which Adam Smith developed his ideas: during the late 18th century, England was a pioneer in industrialization. Trade was thriving, factories were growing and groundbreaking inventions were giving rise to prosperity, but also poverty. These contrasts shaped Adam Smith, who at the time was teaching logic, economics and moral philosophy at the University of Glasgow.

Cover of the classic book by Adam Smith: Wealth of Nations.

In his most important work on economics, The Wealth of Nations, Adam Smith developed an intellectual way out of the increasingly pointed social dilemma between the economic egoism of the individual and the common good of all. According to Smith, if sensible egoists continuously increase their profits, they act in the interests of society because they create growth, raise standards, trigger progress and thus also give rise to new opportunities for others. Adam Smith even saw a certain superiority in this healthy egoism, as he believed it benefits society more than altruism, which he felt inhibits the individual’s ability to be productive. The rational egoist is, in Smith’s words, “led by an invisible hand to promote an end which was no part of his intention.” The invisible hand thus indirectly creates prosperity for all, although not to the same degree for all.

The concept of the invisible hand gave rise to the notion of the market as a system that settles almost automatically into a healthy internal equilibrium and ultimately benefits everyone. The idea of the invisible hand made the free market an effective instrument of the common good – and ultimately made its architect the founder of modern economics.

Statue of Adam Smith at the University of Glasgow.
Adam Smith is commemorated with a statue at the University of Glasgow.

However, there is an “if” that casts a shadow on Smith’s theory: it only works if people behave rationally. Otherwise, the market also fails. Adam Smith himself provided a glaring example of the irrationality humankind: as a professor of economics, he promoted the free market as the general principle behind economic reason. A few years later, after being appointed Scottish customs commissioner, he became a rigorous advocate of protective tariffs. So sometimes, economic reason is simply what you make of it.

This article was first published on LGT's financial blog, which will be discontinued in Q1 2021.

Visual in header © Keystone / the Granger Collection. 

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