In the same year that Adam Smith wrote about the invisible hand in economics, Benjamin Franklin expressed a similar idea in politics to some reluctant signers of the Declaration of Independence: "We must all hang together, or assuredly we shall all hang separately."
One reason for today's economic difficulties is that the invisible hand no longer motivates men and women to hang together in buildig a productive economy.
The invisible hand is one of the oldest and best ideas in economics. the businessman who builds a railroad may think only of his own profits, but the nation's transportation system is beter for his efforts. The farmer who thinks only of the money he will receive for his crops still benefits the city dwellers who consume them. Self-interest is the dynamic force that motivates individuals, and the invisible hand channels their efforts in directions that are good for society as a whole.
The invisible hand worked well in an economy with stable prices and low taxes, which is what Smith took for granted. In today's economy, with high inflation and high marginal tax rates, however, the invisible hand no longer motivates individuals in directions that are good for the economy as a whole.
Inflation diverts individual self-interest from production to speculation, In an economy with stable prices, the best way to get ahead is to produce more goods and services. Founding new enterprises and being on the leading edge of real economic growth is the path to riches.
When real growth declines and inflation takes off, the path to riches changes toward speculation. The Puritan ethic of hard work, frugal saving and productive investment is as unprofitable as it is uncomfortable in a society where new millionaires arise from the ranks of leveraged speculators in gold, commodities and existing real estate.
Today's stagnant economy is like a giant poker game that creates no new wealth but transfers it to players clever enough to anticipate where the next price increases will take place.
A whole new generation is growing up with the idea that getting ahead in life involves speculating on inflation rather than producing more goods and services. Much of today's inflation is due to excessive fiscal and monetary stimulus by Keynesian economists, but it was Keynes himself who warned, "Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes a bubble on a whirlpool of speculation. When the capital development of a country becomes the by-product of the activities of a casino, the job is likely to be ill done."
Inflation is only one force that diverts self-interest away from social interest. Everyone from welfare recipient to well-paid executive faces a progressive tax system that penalizes additional productive activity rather than rewarding it. A century ago the American economist Henry George observed:
"The present method of taxation . . . oeprates upon energy, and industry, and skill, and thrift like a fine on those qualities . . . If I have saved while you have wasted, I am mulct while you are exempt. If a man builds a ship we make him pay for his temerity as though he had done injury tto the state . . . We say we want capital, but if anyone accumulates it we charge him as though we were giving him a privilege."
The gap between self-interest and social interest widens to a chasm when taxpayers have the incentive to become tax evaders, a problem found in most other highly taxed nations. Swedish economist Gunnar Myrdal recently complained that his countrymen, once paragons of taxpaying virtue, have become a "nation of hustlers" in response to high tax rates there. The British, who once viewed tax evasion as an amusing depravity unique to the French and Italians, now regard "the fiddle" as a national pasttime and a financial necessity.
The emergence of tax-evading underground economies here and abroad is a rational though antisocial response of individual self-interest to high tax rates.
The current popularity of supplyside economics can be viewed as an attempt to restore the invisible hand that unites self interest with social interest. Ronald Reagan's proposed 30 percent cut in federal income taxes assumes that a torrent of new productive activity will spring forth to revive the economy and to offset lost tax revenues.
If the administration proposes tax cuts to cure the recession, they are likely to favor investment over consumption as a way to motivate individuals and corporations to become more productive.
Even in its heyday the invisible hand was never perfect in aligning self-interest with social interest. A diligent pickpocket promotes his own self interest at the expense of men with newly empty pockets and of society which must pay for a system of justice to deal with the pickpocket problem.
Years before Ralph Nadar, many questioned Charles Wilson's assertion that, "What is good for General Motors is good for the country."
There are two basic ways to get rich -- produce wealth or take it from someone else. When talented and ambitious men and women see that the path to riches lies through production, then the invisible hand works and the economy is likely to thrive.
When the path to riches lies through speculation and tax evasion, both of which take wealth from someone else, then the invisible hand is inoperative as a force to promote the general welfare.
One reason that today's economy does not work very well is that the invisible hand does not work very well either.