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Adam Smith's idea of "invisible hand" refers to the self-regulating nature of the

marketplace where even though individuals acted to maximize their self-interest, it eventually

leads to a socially desirable outcome. The paper will discuss the first three chapters of Smith's

The Wealth of Nations. (Ahsan, 2012) The first part of the paper provides a summary of Book 1

of Adam Smith's The Wealth of Nations. The second part of the paper will discuss Book 1 in

relation to the articles by Economic Insights and The World Bank. The third part of the paper

tackles the assumptions, consequences and significance of concepts in Adam Smith's The Wealth

of Nations. This part of the paper will also discuss the application of the concepts advanced by

Smith to modern economics. The last part of the paper presents the conclusion.

Summary of Book 1: Division of Labor and the Market

Chapter 1 of Book 1 is entitled "Of Division of Labor." It begins with, "The greatest

improvement in the productive powers of labor, and the greater part of the skill, dexterity, and

judgment with which it is anywhere directed, or applied, seem to have been the effects of the

division of labor." (Smith, 1776) Smith emphasizes that the improvement of the dexterity of the

workman is directly proportional to the work that he can perform. (Smith, 1776) He further

explains that the advantage gained by saving the time commonly lost in passing from one sort of

work to another is much greater than it is usually imagined to be. (Smith, 1776) Smith also

presented the importance of machinery as it facilitates labor. (Smith, 1776) The examples

provided by Smith are expectedly appropriate to the time period he was writing. It will be noted

later on that the principles are still applicable to the modern concept.

Chapter II talks about "Of the Principle which gives occasion to the Division of Labor."

In this chapter, Smith explains the interdependence between and among economic actors. He

mentions that the difference between the talents of each actor makes interdependence possible.

However, Smith also discusses how the coordination and cooperation is not motivated by the

desire to help and complete others but these emanate out of self-love of each actor. This self-love

of every individual creates the effect of benefiting the society as each self-love motivates one

another to fulfil another's self-love and therefore get what one ultimately desires. (Smith, 1776)

The end of the simultaneous actions by self-interested individuals would still be public welfare.

This is the concept of invisible hand that Smith is famous for.

Chapter 3 is entitled, "That the Division of Labor is limited by the Extent of the Market."

The market is the limitation of the division of labor because it is the power of exchanging that

gives occasion to such division. Smith says that the extent of the market must be in proportion to

the riches of that country. (Smith, 1776) The benefit derived from exchange is what drives

economic actors to specialize and to increase the surplus when exchanging with others. (Butler,

2011) The author discussed specialization in the market which allows for bigger gains.

Comparative Analysis of Smith, Economic Insights and The World Bank

Self-interested Actors and Interaction

Smith has initially used the term "self-love" in Chapter 2 of the Wealth of Nations. This

same concept is delved into by Economic Insights, "Even more radical was Smith's belief that a

society composed of individuals acting in pursuit of their own interests would result in a stable,

free and more prosperous society that one regimented and planned by the state." (Economic

Insights) Because of this insight, the article labelled Smith as the first proponent of capitalism

where economic actors would freely choose to interact and not be governed by strict rules of the

state. This argument is further strengthened by the article of The World Bank. The article by the

World Bank discusses how different countries (as economic actors) interact with each other to

ensure that the natural resources are used to cater the needs of the people. Just as Smith

originally discussed the difference in talents among individuals, the World Bank acknowledge

the difference in natural resources that are available in each state and further suggests that

managing natural resources is a key part of development strategies. (The World Bank, 2006) The

article by World Bank further reiterates the fact that government decisions on investments and

other business projects are self-motivated and aim to make the national products competitive in

the global market.

The Market and Government Intervention

The discussion of the "market" was first seen in Chapter 3 of The Wealth of Nations.

Smith characterizes the market as the extent of exchange among economic actors. For Smith,

economic growth is good and is achieved by the ever-widening application of the division of

labor, which is organized within markets and driven by rational self-interest. (Economic Insights)

Those nations that allow market forces to generate such growth will become wealthier, in Smith's

view, than those that follow the mercantile model of managed trade. (Economic Insights) Smits

has always been in favor of less government intervention to the market. However, this total lack

of intervention by the government should be limited. Smith also recognizes grounds for

legitimate governmental activity in society (Economic Insights): defense against external and

internal security threats, the formation of laws that prevent individuals from oppressing one

another and the provision of public goods that the market would not supply. These specific

grounds are further tackled by the article of World Bank which is applicable to the modern


Where is the Wealth of Nations? provides an overview of the wealth of each nation and

how the decisions by policy makers influence the movement of wealth and generation of more

wealth. (The World Bank, 2006) The production of more wealth can be attributed to an effective

and efficient government intervention because it is dependent on how the natural resources are

managed. Natural resources are special economic goods because they are not produced. As a

consequence, natural resources will yield economic profits - rents - if properly managed. (The

World Bank, 2006) Although it is encouraged by Smith that the market be allowed to move as

freely as possible, legitimate government actions are called for when the market and the self-

interested economic actors are unable to protect the resources on their own. Achieving

sustainable development which presents challenge and concerns to the natural resources would

be sufficient reason for monitoring by the government. (The World Bank, 2006)

Significant Concepts and Application to Modern Economics


The prevalent economic system amidst globalization and free trade is capitalism. It is

based on private ownership of the means of production, in which personal profit can be acquired

through investment of capital and employment of labor. Capitalism is grounded in the concept of

free enterprise, which argues that government intervention in the economy should be restricted

and that a free market, based on supply and demand, will ultimately maximize consumer welfare.

This is precisely the idea advanced by Adam Smith in The Wealth of Nations. (Columbia

Electronic Encyclopedia, 2013)

Capitalism does not presuppose a specific form of social or political organization: the

democratic socialism of the Scandinavian states, the consensus politics of Japan, and the state-

sponsored rapid industrial growth of South Korea while under military dictatorship all have

coexisted with capitalism. (Columbia Electronic Encyclopedia, 2013) Yet despite the capitalist

ideal of "hands-off" government, significant government intervention has existed in most

capitalist nations at least since the Great Depression in the 1930s. In the United States, it exists in

the form of subsidies, tax credits, incentives, and other types of exemptions. (Columbia

Electronic Encyclopedia, 2013) Though private production plays a major role in the economies

of Germany and Japan, both nations have had centrally planned industrial policies in which

bankers, industrialists, and labor unions meet and seek to agree to wage policies and interest

rates; these countries reject the idea of letting the market wholly determine the economy.

(Columbia Electronic Encyclopedia, 2013) Although Smith was not the origin of the term

capitalism, it is undeniable that his ideas have contributed to this economic system.

Economic Growth and Welfare of Society

The determinants of wealth of nations have always been an interesting issue for policy

makers and economists. In economics, one of the most important subjects is to increase

economic growth and welfare of society. As one of the most important political economists,

Smith analyzed the dynamics of wealth of nations and welfare of individuals and societies by

providing for determinants of economic growth which include division of labor and human

capital. (Ayhan, 2013)

Smith discussed that to explain the motivation for economic exchange in the market, one

does not have to invoke any objective other than the pursuit of self-interest. (Sen, 2010) Beyond

self-love, Smith discussed how the functioning of the economic system in general and of the

market in particular, can be helped enormously by other motives. There are two distinct

propositions here. The first is one of epistemology, concerning the fact that human beings are not

guided only by self-gain or even prudence. The second is one of practical reason, involving the

claim that there are good ethical and practical grounds for encouraging motives other than self-

interest, whether in the crude form of self-love or in the refined form of prudence. (Sen, 2010) In

moving for a free market system, Smith did not intend to totally eliminate the function of the

government. Government is a regulator of the elements of the marketplace. (Ahsan, 2012) It can

intervene whenever the market forces do not serve public welfare and when the public interest is

already at stake.


It cannot be denied that Smith will forever be one of the classic economists whose

theories are still applicable nowadays. His concept of the invisible hand has led capitalism to

its peak. At press time, capitalism is still the prevailing economic system that is accepted by most

countries in the world. Furthermore, Smiths theory on market interaction out of self-love is still

present in the current era. To give an example, nation states form organizations and economic

blocs in order to ensure that economic interdependence will bring economic security to the

individual states. Although it is not in the bigger realm, the main foundation of economic

interdependence brought by modern concepts of fair trade and free trade, is still the concept of

self-love that has been first advanced by Smith. Today, states are self-interested actors that can

interact with other states, equally self-interested, to achieve a more efficient and effective

utilization of resources. Smith was a genius who was able to forecast economic activities using

his primitive and medieval examples that fit the economy during the era when he was writing

The Wealth of Nations.


Ahsan, A. (2012). Where was the Invisible Hand during the Crash? Vol. LXIV No. 2/2012,
Economic Insights - Trends and Challenges.

Ayhan, U. (2013). The Sentiments of Adam Smith Relating to Economic Growth as an Inspirer
to Modern Growth Theories. Trakya University Journal of Social Science. Jun2013, Vol.
15 Issue 1, p29-48. 20p.

"Capitalism." Columbia Electronic Encyclopedia, 6th Edition. Sep2013, p1-1. 1p.

Economic Insights. Adam Smith Capitalism's Prophet. Volume 7, Number 1, Federal Reserve
Bank of Dallas.

Sen, A. (2010). The Economist Manifesto. Accessed on 16 October 2013, from


The World Bank. (2006). Where is the Wealth of Nations?