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This paper offers a holistic summary of the description, origin, causes and effects of invisible hand of capitalism in the world of business. To begin with, it is imperative to note that the term capitalism has been used for decades to depict an economic system of gaining wealth. The concept and ideology behind capitalism was a brainchild of Adam Smith who came up with the term in the 19th century.
He used this concept to describe the economic system in which the means of production were owned, dominated and operated by private individuals and for the sole purpose of making supernormal profits. In addition, the ideology behind capitalism sought to concentrate wealth among limited number of people. In other words, major economic investments were executed by few in society.
Moreover, it is also worth to note that capitalism is grounded on the freedom of individual enterprises. In this regard, to prevent economic abuses occasioned by market factors such as monopoly, cartels and financial frauds, any other government needs to regulate market operations especially in the case of a capitalistic regime where economic might by the few individuals controls the economy (Kennedy 260).
This has existed from as early as 1930s despite the capitalist ideal of ‘hands off’ government. To date, there are myriad of many countries that have put up measures to control manipulation of the market. For instance, the United States of America government has been employing subsides, tax credits, incentives and other types of exemptions so that the market can be conducive to all players namely producers and consumers.
Moreover, other countries like Japan and German do not advocate the market to fully control the economy. The main rationale behind the latter is to manage the risks that may arise from the very economy. For instance, when Soviet Union and its satellite states collapsed, it resulted into huge losses being incurred. In the case of Adam Smith, the wealth of nations coupled with the free market has persuaded many countries favor the classical capitalism which was initiated during the 19th century.
Following the great depression in the 20st century, most countries ended the laissez-faire economics. By the beginning of the 21st century, capitalism remained unrivaled following demise of state controlled policies in Eastern Europe and former Soviet Union. According to Adam Smith, every individual attempts to maximize wealth through trade or other entrepreneurial activities in a capitalistic economy. This may jeopardize an economy since wealth will not be evenly distributed for the sake of carrying out investments.
In defining the invisible hand, (Sullivan and Sheffrin 32) describe it as the natural phenomenon that guides free market and capitalism through competition of scarce resources. The theory of invisible hand is coined to serve self interests. Therefore, producers have freedom on how to handle the process of production and selling of goods and services. On the other hand, consumers have the liberty to choose on what to purchase hence both players in the market will choose product distribution and the price to be offered.
In addition, invisible hand plays a vital role in revenue creation for those who have invested in the market. Needles to say, competitors must plan well in order to improve their capacity and efficiency of production while simultaneously aiming at maximizing on revenue generation. Nonetheless, they will be compelled to price their products in a way that will increase their market share.
Some economists like Gavin Kennedy and professor Emeritus Atuniversity of Edinburgh, Scotland have questioned the integrity of this indirect form of economic system know as the invisible hand. They conclusively differ that its contemporary use in latest thinking lacks inherent compatibility with the indeterminate manner employed by Adam Smith. Kennedy presents his sentiments to support Smith’s intentions in using the word invisible hand in the current debate.
In line with this, he continues to argue that invisible hand should not be associated with Adam Smith bearing in mind that there is lack of adequate proof that Adam Smith contributed any significance to its meaning today. The personalities who came up with the invisible hand concept thought that capitalism would benefit all traders. Nevertheless Adam Smith did not believe in a magically benevolent market that operates without checks and balances.
Besides creating an environment where there is democracy in the market, there was need for government intervention. This was inevitable when the government needed to protect its civilians from manipulation by traders. As a result some laws such as setting minimum wages for employees as well as ceiling the prices of commodities in the market were made.
Therefore the natural laws of demand and supply were regulated and could not freely control the market. In contrast, the invisible hand concept was not employed in the financial market as some experts in financial modeling and portfolio risk analysis differed with Smith’s theory either partly or in totality.
Moreover, investors would have to pursue individual profits which would yield outcomes that were globally negative. Due to their smart risk management strategy, they would have no significance in the real economy. In other words, were they to reduce their risks in selling their shares in the market, their effect would be far reaching on a global scale. Hence there is a need for investors to account for their actions in the market since their strategies will be a factor in determining the price.
Every person intends to labor for his own gain rather than for the larger society. In so doing, the entire society will benefit. When an individual prefers to trade locally, the economic benefits are two-tier in the sense that the individual entrepreneur will benefit alongside the society where that particular investment is being carried out. A local investment will equally aid in producing the greatest value for the industry concerned.
Therefore such an entrepreneur will be led by the invisible hand to attain certain positive objectives which had not been planned for in advance. In pursuing an individual’s gains as an entrepreneur, a lot of positive economic returns will be ploughed back to society contrary to the original intentions. As a result, more will be achieved in the market as a whole (Kennedy 252).
In line with the discussion above, it is definite that capitalism will be indirectly responsible (or have an invisible hand) in achieving the stability of the given economy.
This implies that the individual pursuit by entrepreneurs elicits multiple effects to an economy since there will be free exchange of goods and services, comparative advantage will be established, and specialization will take place as well as substantive division of labor. When all of these factors are brought on board, the entire economy will benefit albeit from the unpopular economic system of capitalism (Sullivan and Sheffrin 37).
At this point, it is also necessary to elaborate on the effect of modern hand. At initial stages, process is performed without explicit agreements between the acting agents and its outcome will be produced in a decentralized way. Secondly, the agents will perform the process unintentionally. This means that the process will work out even without the agents’ knowledge hence called invisible. The byproduct of this process is its total outcome but agents’ aims are neither planned nor coordinated.
Adam Smith stated that the invisible hand system would work well in the free market economy. In this regard, the players in the market will be forced to think about the wants of other people. He identified that consumers and entrepreneurs will depend on each other. Hence they will seek help and cooperation from the other so as to fulfill their desires (Kennedy 250). At the free market, consumers will seek the lowest price while producers will pursue the highest rate of profit.
Therefore, producers will invest in projects that the consumers considered to be highly valued. At this point, there will be insatiable demand which will influence the market prices. Moreover, producers will tend to appeal to the consumers proving to them that he cares for their goodwill in using the product he offers.
According to smith, when producers propose an exchange in what they have, it can be of great use to consumers. In addition, this will nurture and build their self esteem since they will be in a position to assess their needs in the free market economy as embraced in capitalism.
Advantages of capitalism
Capitalism is usually characterized with an economy where resources and firms are privately owned in a free market in spite of the fact that there is regulation by the government so as to protect private property. As already mentioned, a capitalistic economy is also capable of triggering major growth in society. The following are some of the merits of capitalism:
1. Successful production- firms in a free market will have incentives in efficient production, minimizing costs and improving productivity as well as enhancing competitiveness. As long as these conditions are maintained, they will be able to operate their business and make meaningful gains.
2. Financial incentives- producers will only invest in the businesses that will yield high returns. If such an opportunity arises, they will be ready to take risks on it.
3. Little interference from the government- in a free market economy, there is plenty of information about the conditions expected hence producers can be able to plan in advance. Due to lack of control of the economy by the government, challenges posed by corruption, lack of incentives and poor information do not arise on a regular basis.
4. Allocation of resources is cost-effective- capitalism being the indirect influence on the market ensures that resources are distributed according to consumers’ choice.
5. Dynamic efficiency- firms need to maintain their efficiency in the market by responding to the consumers’ trends, tastes and preferences (Sullivan and Sheffrin 40).
Disadvantages of capitalism
1. Monopoly behavior- firms will be willing to pay low wages to employees while at the same time charge exorbitant prices to their consumers.
2. Inequality- in capitalism economy, resources are inequitably distributed. Hence, only a small percentage of the population workforce will possess the resources. Due to inequality of wealth and lack of government concern, poverty may arise leading to emergence of slums, diseases, and homelessness. This may compel people to migrate to other parts with more resources.
3. Immobility- it is difficult in a free market economy to transfer resources from unprofitable sector to a more profitable one. This may hinder equitable investments and distribution of resources.
4. Irrational behavior- economic fundamentals are ignored which results into people being caught in hypothetical bubbles leading to irrational behavior.
5. Limited government control- this may result into manipulation of consumers by the producers (Sullivan and Sheffrin 41).
Economic crisis and capitalism
The capitalist system has for many years proved to be a great engine in human prosperity. It has created profit incentives for the industry as well as literally pulling hundreds of millions of people out of poverty across the globe.
The year 2008 was filled with economic crises. First of all, there was the food crisis which was particularly threatening to poor consumers. Secondly, there was a record increase in fuel prices which affected all oil-importing countries around the globe. Towards the end of 2008, global economic downturn was almost at its peak, gathering momentum at unprecedented rate.
The downturn intensified as the year 2009 started. At this point many economists feared a full-scale depression (Kennedy 259). Hence there was a need to look out at the nature of capitalism and whether it needs to be changed.
However, defenders of capitalism are against the idea and believe that capitalism is unnecessarily being targeted for shorter economic problems. They believed that economic scenarios were as a result of bad governance and greed by some individuals. The question that arises is whether there is alternative approach or not since economists are still seeking substantial reforms to counter capitalism.
Works Cited
Kennedy, Gavin. “Adam Smith and the Hand: From Metaphor to Myth”. Econ Journal Watch 6.2(2009): 239-263. Print.
Sullivan, Arthur and Steven Sheffrin. Economics: Principles in action. Upper Saddle River, New Jersey, Pearson Prentice Hall, 2003.Print.
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