1.1 The Invisible Hand

That ordinary scene in downtown Halifax would not have looked at all ordinary several centuries ago—say, to the people who General Cornwallis brought to the area in 1749 to establish a British community. Halifax has the second largest natural harbour in the world, but at that time the area was mostly unoccupied, and known mainly to the Mi’kmaq First Nations people.

Imagine that you could transport a Nova Scotian from 1749, or even from the time of the Halifax Explosion of 1917, forward in time to our own era. (Isn’t that the plot of a movie? Several, actually.) What would this time traveller find amazing?

Surely the most amazing thing would be the sheer prosperity of modern Canada—the range of goods and services that ordinary families can afford. Looking at all that wealth, our transplanted traveller would wonder, “How can I get some of that?” Or perhaps she would ask herself, “How can my society get some of that?”

An economy is a system for coordinating society’s productive activities.

The answer is that to get this kind of prosperity, you need a well-functioning system for coordinating productive activities—the activities that create the goods and services people want and a means to get them to the people who want them. That kind of system is what we mean when we talk about the economy. And economics is the social science that studies the production, distribution, and consumption of goods and services.

Economics is the social science that studies the production, distribution, and consumption of goods and services.

An economy succeeds to the extent that it, literally, delivers the goods. A time traveller from the eighteenth century—or even from 1950—would be amazed at how many goods and services the modern Canadian economy delivers and at how many people can afford them. Compared with any past economy and with all but a few other countries today, Canada has an incredibly high standard of living.

A market economy is an economy in which decisions about production and consumption are made by individual producers and consumers.

So our economy must be doing something right, and the time traveller might want to compliment the person in charge. But guess what? There isn’t anyone in charge. Canada has a market economy, in which production and consumption are the result of decentralized decisions by many firms and individuals. There is no central authority telling people what to produce or where to ship it. Each individual producer makes what he or she thinks will be most profitable; each consumer buys what he or she chooses.

The alternative to a market economy is a command economy, in which there is a central authority making decisions about production and consumption. Command economies have been tried, most notably in the Soviet Union between 1917 and 1991. But they didn’t work very well. Producers in the Soviet Union routinely found themselves unable to produce because they did not have crucial raw materials, or they succeeded in producing but then found that nobody wanted their products. Consumers were often unable to find necessary items—command economies are famous for long lines at shops.

Market economies, however, are able to coordinate even highly complex activities and to reliably provide consumers with the goods and services they want. Indeed, people quite casually trust their lives to the market system: residents of any major city would starve in days if the unplanned yet somehow orderly actions of thousands of businesses did not deliver a steady supply of food. Surprisingly, the unplanned “chaos” of a market economy turns out to be far more orderly than the “planning” of a command economy.

The invisible hand refers to the way in which the individual pursuit of self-interest can lead to good results for society as a whole.

In 1776, in a famous passage in his book The Wealth of Nations, the pioneering Scottish economist Adam Smith wrote about how individuals, in pursuing their own interests, often end up serving the interests of society as a whole. Of a businessman whose pursuit of profit makes the nation wealthier, Smith wrote: “[H]e 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.” Ever since, economists have used the term invisible hand to refer to the way a market economy manages to harness the power of self-interest for the good of society.

Microeconomics is the branch of economics that studies how people make decisions and how these decisions interact.

The study of how individuals make decisions and how these decisions interact is called microeconomics. One of the key themes in microeconomics is the validity of Adam Smith’s insight: individuals pursuing their own interests often do promote the interests of society as a whole.

So part of the answer to our time traveller’s question—”How can my society achieve the kind of prosperity you take for granted?”—is that her society should learn to appreciate the virtues of a market economy and the power of the invisible hand.

But the invisible hand isn’t always our friend. It’s also important to understand when and why the individual pursuit of self-interest can lead to counterproductive behaviour.