The invisible hand is robust.
In his book Knowledge and the Wealth of Nations, David Warsh claims that there is a conflict between the fact of “selling expenses” (for example, advertising) and Adam Smith‘s Invisible Hand. He writes:
There could be no “selling expenses” of pins if the Invisible Hand was truly at work?
Is Warsh right? In a word, no.
If what he really meant was that there is a conflict between “monopolistic competition” and “perfect competition,” then of course he’s right. Under perfect completion, advertising is not required because everyone in a well-defined industry is selling the same identical good as everyone else in the industry, at an identical price. Under monopolistic competition, sellers differentiate their products and have some market power. They typically don’t sell identical products. They could, unlike in the case of perfect competition, raise their price one percent and not have their sales fall to zero.
But what Warsh is doing is what many modern economists do: interpreting Smith to be saying that the Invisible Hand is his version of perfect competition, even though Smith never said that or even hinted at it. Indeed, the concept of perfect competition came along well over a century after The Wealth of Nations.
Here are the two passages in Smith’s work where he discusses the Invisible Hand:
By preferring the support of domestick 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. (The Wealth of Nations, 1776.)
and:
The rich … 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. (The Theory of Moral Sentiments, 1759.)
Notice that nowhere in either passage does Smith say that producers or “the rich” are charging the same price as everyone else in an industry, the sine qua non of perfect competition.
There is in fact no contradiction between the invisible hand and selling expenses. I gain when Amazon, say, advertises its products, that is, spends money to sell, on its web site. The invisible hand is robust.
READER COMMENTS
Mark Z
Dec 11 2018 at 7:17am
Are you perhaps suggesting that Smith had more of an ‘Austrian’ than ‘classical’ view of competition?
I think the classical view of competition is a bit naive, and people retroactively impute it onto Smith. Arguably most businesses are ‘monopolists’ in that they specialize in selling a very particular kind of good or service which perhaps no one or almost no one else is selling (or selling near them). But their good probably is at least somewhat substitutable with other ones. So if you’re the only company that sells lime green, 4-door, hybrid pickup trucks, you have a monopoly with respect to consumers that want that specifically; you don’t have a monopoly to people who just want a vehicle. And of course, other companies could enter the market, at some cost, producing your particular specialized good if you increased your prices. Likewise, most would agree a cheese monopoly is indeed a monopoly, but it isn’t an absolute monopoly, and may not even be close, since it still has to compete with other foods. “Monopoly” really exists on a spectrum, with goods varying continuously in their substitutability and the cost of entering the market. And how fast the invisible hand moves in response to a price change may depend on where on that spectrum a good lives. It only stops moving at all I think when a good is totally unsubstitutable and the cost of entry is infinite.
David Henderson
Dec 11 2018 at 9:24am
Response to Mark Z:
By definition (according to my understanding of classical economics), Smith had a classical view of competition. The idea of perfect competition came along in the 1920s.
I agree with everything you said except your first 2 sentences.
Fred in PA
Dec 12 2018 at 12:09am
“Selling expenses” (e.g., adverti9sing) are dealt with here as part of differentiation.
I think it interesting that “selling expenses” can, in their own right, create value for society.
I have had the miserable experience of driving across Connecticut in the dead of night having neglected to make a prior hotel reservation. (This was before smartphones.) Connecticut appears to have decided, in its superior wisdom, that advertising is an evil thing and to be discouraged. In any case, hotels in Connecticut do little or no advertising along the highway. We drove for hours in the blackness with no clue which exit might provide accomodations for the weary traveler. (We tried two or three more major exits only to come up empty handed — either nothing there or sold-out.) Eventually, we reached Rhode Island and shelter.
There would have been substantial value in a simple billboard proclaiming “8 miles, Holiday Inn, Exit 32”.
Mark Z
Dec 12 2018 at 1:41am
I don’t know, it sounds like Connecticut is saving you a lot of trouble. Personally, I often find myself making what are supposed to be mere day trips, only to be wooed by the allure of hotel billboards into staying over night at hotels unnecessarily, the desire to do so created ex nihilo by the advertisement. (I’m being facetious if that isn’t clear).
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