Must-read: Adam Smith (1776): “As if by an Invisible Hand…”

Must-Read: Adam Smith’s “Invisible Hand” argument. It’s not “markets are good”. It is, instead, two moves:

1. Complicated processes involving the interactions of large numbers of humans have emergent properties and produce outcomes that often are not and cannot be understand as intended by any one of the humans whose actions led to the outcome.

2. Sometimes (often?) the emergent properties are those that we want to nurture and develop: as Bernard Mandeville first noted, one of the tasks of the clever statesman is to structure things so that the satisfaction of private vices does in fact yield public benefits.

Note that in this particular example, it is the (a) psychological home bias of merchants combined with (b) increasing returns in the agglomeration of economic activity that leads to the good outcome–and it is a good outcome for Amsterdam, not for Lisbon or Königsberg…

Adam Smith (1776): Wealth of Nations, Book IV, Chapter 2: “The capital which an Amsterdam merchant employs in carrying corn from Konigsberg to Lisbon…

…and fruit and wine from Lisbon to Königsberg, must generally be the one half of it at Königsberg and the other half at Lisbon. No part of it need ever come to Amsterdam. The natural residence of such a merchant should either be at Konigsberg or Lisbon, and it can only be some very particular circumstances which can make him prefer the residence of Amsterdam. The uneasiness… which he feels at being separated so far from his capital generally determines him to bring part… of the… goods… to Amsterdam… though this necessarily subjects him to a double charge of loading and unloading, as well as to the payment of some duties and customs, yet for the sake of having some part of his capital always under his own view and command, he willingly submits…. In this manner that every country which has any considerable share of the carrying trade becomes always the emporium, or general market, for the goods of all the different countries whose trade it carries on….

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…. Upon equal, or only nearly equal profits, therefore, every individual naturally inclines to employ his capital in the manner in which it is likely to afford the greatest support to domestic industry, and to give revenue and employment to the greatest number of people of his own country….

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. Nor is it always the worse for the society that it was no 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…