Source

This essay first appeared in the journal Literature of Liberty: A Review of Contemporary Liberal Thought, vol. V, no. 2, Summer 1982, published by the Cato Institute (1978-1979) and the Institute for Humane Studies (1980-1982) under the editorial direction of Leonard P. Liggio. Although the editorials were unsigned, they were probably written by the Editor Leonard P. Liggio or the Managing Editor John V. Cody. It is republished with thanks to the original copyright holders.

"Invisible Hand" Explanations of Society

"Wherever we see a well ordered arrangement of things or men we instinctively assume that someone has intentionally placed them in that way." - Michael Polanyi, The Logic of Liberty.

"The effectiveness with which knowledge is transmitted and coordinated through social processes depends upon the actual characteristics of those specific processes. ... Emphasis on the characteristics of social processes implies a systemic analysis of social causation, in contrast to individual or intentional analysis of why things happen as they do .... the (systemic) outcome does not depend on the individual agent's subjectively pursuing the end result of the system." - Thomas Sowell, Knowledge and Decisions.

"By pursuing his own interest he frequently promotes that of society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good." - Adam Smith, The Wealth of Nations.

Since the dawn of history intellectuals, with varying degrees of success, have been trying to explain the nature and meaning of society and suggesting ways to improve the social order. For the most part until the Scottish Enlightenment of the Eighteenth Century, the thrust of these investigations was intentionalist. That is, social order was seen to be the result of some being's conscious design, whether man's or God's. There were exceptions, but as Hayek points out, "Neither the Greeks of the fifth century B.C. nor their successors for the next two thousand years developed a systematic social theory which explicitly dealt with these unintended consequences of human action or accounted for the manner in which an order or regularity could form itself among those actions which none of the acting persons had intended."

During the Age of Enlightenment, modern social theory was born. This non-intentionalist or systemic theory flourished mainly among the Scottish intellectuals such as Adam Ferguson, David Hume, Josiah Tucker, and, most famously, Adam Smith. For the first time there was a thorough investigation of the unintended consequences of human action. These consequences were seen to be not only often benign but also absolutely necessary for mankind to attain any semblance of civilized social order.

Institutions and institutional processes were rendered intelligible not by attributing them to human or divine purpose but by what were later to be called by Robert Nozick "invisible hand" explanations.

Although not usually thought of as such, a price is such an "invisible hand" institution. No one enters an exchange to produce a price, but nevertheless an exchange ratio or a price emerges from the transaction. Not being the result of anyone's intention a price can be rendered meaningful only by an invisible hand explanation. Prices are both unintended and benign. They lead in turn to the spontaneous evolution of money which encourages a further division of labor, both of which, like prices, are unintended and undesigned social institutions. These along with other undesigned institutions, such as the Common Law, mesh together to produce a spontaneous social order or what Hayek has called a "catallaxy." The rules that emerge from institutions such as markets and from the Common Law can then be discovered, studied, and implemented by man to establish the Rule of Law. But as can be seen, the rules are not imposed from without to create order, but rather are immanent in the emergent social processes that, as if led by an invisible hand, themselves lead to orderly social institutions which in turn lead to an even wider social interdependence and coordination.

The emergence of money and (when left alone to do so) a free banking system, such as existed in Scotland, constitute one of the clearest object lessons in spontaneous order theory. The recent work of Lawrence H. White in rediscovering and presenting the work of nineteenth-century British monetary theorists Samuel Bailey, Lord King, Henry Parnell, and Thomas Hodgskin should serve as a model to those wishing to learn how spontaneous orders both emerge and maintain themselves. ¹

At first glance one might possibly get the idea that spontaneous order theorists believe that no deliberate planning takes place in the course of achieving social order. Clearly this is not the case. The best theoretical explanations of the need for both constructed and unintended institutions is to be found in the following: (1) Ronald Coase's classic article, "The Nature of the Firm," shows how pockets of planning (firms) permeate the price system. He quotes the master of luminous prose and distinguished economist, Sir Dennis Robertson, to underscore his own point about intentional planning at times superseding yet also fitting together with the price system. Robertson likens firms to "islands of conscious power in this ocean of unconscious cooperation like lumps of butter coagulating in a pail of buttermilk." (2) Michael Polanyi's Logic of Liberty demonstrates the tension yet at the same time the complementarity between what he calls corporate or hierarchical orders and spontaneous orders. (3) Israel M. Kirzner shows in his Competition and Entrepreneurship that spontaneous is not the same thing as automatic if by automatic one means instantaneous and mechanical adjustment. On the contrary, the entrepreneur must perceive changes and adjust the use of resources not only to the new present conditions but also to what he sees as likely conditions in the future. Here again the conscious deliberate plans of entrepreneurs interact with the unintended effects of others' expectations, plans, and actions. (4) Location theory tells us that we can expect people to be led to arrange themselves in relation to one another according to certain functions they will perform for others through the division of labor. As Jane Jacobs demonstrates in her The Economy of Cities, the unintended effects of such self-arrangements are the emergence and development of what we know as cities. (5) The capital theory developed by the Austrians from Carl Menger through Mises, Richard von Strigl, and Hayek is yet another example of the interaction of deliberation and spontaneity. Just as no one sets out to produce a price, neither does one attempt to create a macroeconomic structure of production, yet in building his own plant he unwittingly contributes a new element in what Ludwig Lachmann in his Capital and Its Structure calls a lattice-work structure of heterogeneous yet interconnected and complementary capital goods.

Adam Smith's explanation of the division of labor is by most accounts cited as the first significant step in modern social theory. Perhaps Carl Menger's evolutionary explanation of money deserves to be ranked beside Smith's, although in many ways Menger was rediscovering and rearticulating for a new generation a set of theoretical insights that for several decades had languished or had been superseded and pushed aside by intentionalist social explanations of one sort or another.

Surely it must follow that the second great step in modern social theory after Smith's explanation of the division of labor was Hayek's contention that the central problem in social and economic theory is that knowledge is fragmented and dispersed unevenly among the members of society, i.e. the division of knowledge. How, then, can this knowledge of time and circumstance - including their expectations about the future - which by definition can be known only by the individual members of society - how can this knowledge be utilized in such a way so as to lead to a coherent and viable social order?

Hayek is not alone in addressing this question over the decades since he first encountered the problem during the debate in the 1930s concerning the impossibility of economic calculation under a regime of socialism, and when he succinctly articulated the problem in his classic 1945 article "The Use of Knowledge in Society." The same question has also captured the attention of some of the leading contemporary economists and social theorists, such as Michael Polanyi, Ronald Coase, Karl Popper, G. L. S. Shackle, James Buchanan, Alan Coddington, George Stigler, Harold Demsetz, Axel Leijonhufvud, Armen Alchien, Robert Nozick, Israel Kirzner, Ludwig Lachmann, Brian Loasby, and most recently Thomas Sowell in his remarkable 1980 work, Knowledge and Decisions.

With the publication of Sowell's book, Hayek's trilogy Law, Legislation and Liberty, Norman Barry's Hayek's Social and Economic Philosophy, George Shackle's Epistemics and Economics, and Brian Loasby's Choice, Complexity, and Ignorance, the reissuance of Michael Polanyi's The Logic of Liberty, the spontaneous order tradition has again been thrust into the midst of the academic debate. This time the economics and sociology of knowledge are at the cutting edge of the tradition's return. There is much work yet to be done in this field of research, but as the work of Hayek, Sowell, and others demonstrates, there are many aspects of society (most of the interesting aspects) that can be understood and explained only through the use of invisible hand explanations.

Endotes

[1] See Lawrence H. White, Free Banking in Britain: Theory, Experience, and Debate, 1800-1845 (Cambridge University Press, 1984).

Bibliography

Norman Barry's Hayek's Social and Economic Philosophy (London: Macmillan, 1979).

Ronald Coase, "The Nature of the Firm," originally published in Economica (November 1937) and reprinted in R.H. Coase, The Firm, the Market, and the Law (University of Chicago Press, 1990), pp. 33-55.

Friedrich Hayek's trilogy Law, Legislation and Liberty (London: Routledge & Kegan Pau, 1973-79), vol. I, Rules and Order, 1973; vol. II, The Mirage of Social Justice, 1976; vol. III, The Political Order of a Free People, 1979.

Jane Jacobs, The Economy of Cities (New York: Random House, 1969).

Israel M. Kirzner, Competition and Entrepreneurship (University of Chicago Press, 1973).

Ludwig Lachmann, Capital and Its Structure (1956) (Kansas City: Sheed, Andrews and McMeel, 1978).

Brian Loasby, Choice, Complexity, and Ignorance: An Enquiry into Economic Theory and Practice of Decision-making (New York: Cambridge University Press, 1976).

Michael Polanyi, The Logic of Liberty: Reflections and Rejoinders (1951) (Indianapolis: Liberty Fund, 1998). Available from Liberty Fund's Online Book catalog.

Sir Dennis Robertson, The Control of Industry (London: Nisbet, 1928).

George Shackle, Epistemics and Economics ( Cambridge University Press, 1972).

Thomas Sowell, Knowledge and Decisions (New York: Basic Books, 1980).

Lawrence H. White, Free Banking in Britain: Theory, Experience, and Debate, 1800-1845 (Cambridge University Press, 1984).