Beyond GDP: Get Ready For A New Way To Measure The Economy

“A balanced Input-Output framework…provides a more accurate and consistent picture of the U. S. economy.”

– Survey of Current Business

Starting in spring 2014, the Bureau of Economic Analysis will release a breakthrough new economic statistic on a quarterly basis.  It’s called Gross Output, a measure of total sales volume at all stages of production. GO is almost twice the size of GDP, the standard yardstick for measuring final goods and services produced in a year.

This is the first new economic aggregate since Gross Domestic Product (GDP) was introduced over fifty years ago.

It’s about time. Starting with my work The Structure of Production in 1990 andEconomics on Trial in 1991, I have made the case that we needed a new statistic beyond GDP that measures spending throughout the entire production process, not just final output.  GO is a move in that direction – a personal triumph 25 years in the making.

GO attempts to measure total sales from the production of raw materials through intermediate producers to final retail.  Based on my research, GO is a better indicator of the business cycle, and most consistent with economic growth theory.

GO is a measure of the “make” economy, while GDP represents the “use” economy.  Both are essential to understanding how the economy works.

While GDP is a good measure of national economic performance, it has a major flaw:  In limiting itself to final output, GDP largely ignores or downplays the “make” economy, that is, the supply chain and intermediate stages of production needed to produce all those finished goods and services.  This narrow focus of GDP has created much mischief in the media, government policy, and boardroom decision-making. For example, journalists are constantly overemphasizing consumer and government spending as the driving force behind the economy, rather than saving, business investment, and technological advances.  Since consumer spending represents 70% or more of GDP, followed by 20% by government, the media naively concludes that any slowdown in retail sales or government stimulus is necessarily bad for the economy.  (Private investment comes in a poor third at 13%.)

For instance, the New York Times recently reported, “Consumer spending makes up more than 70% of the economy, and it usually drives growth during economic recoveries.” (“Consumers Give Boost to Economy,” New York Times, May 1, 2010, p. B1)  Or as the Wall Street Journal stated a few years ago, “The housing bust has chilled consumer spending — the largest single driver of the U. S. economy…” (“Home Forecast Calls for Pain,” Wall Street Journal, September 21, 2011, p. A1.)

Or take this report during the economic recovery:

“Friday’s estimates of second-quarter gross domestic product [1.3%, well below consensus forecasts] provided a sobering look at how a decline in public spending and investment can restrain growth….The astonishingly slow growth rate from April through June was due in large part to sluggish consumer spending and an increase in imports, which subtract from growth numbers. But dwindling government spending also held back growth.”  (“The Role of Government Spending,” New York Times, July 29, 2011.)

In short, by focusing only on final output, GDP underestimates the money spent and economic activity generated at earlier stages in the production process. It’s as though the manufacturers and shippers and designers aren’t fully acknowledged in their contribution to overall growth or decline.

Gross Output exposes these misconceptions.  In my own research, I’ve discovered many benefits of GO statistics.  First, Gross Output provides a more accurate picture of what drives the economy.  Using GO as a more comprehensive measure of economic activity, spending by consumers turns out to represent around 40% of total yearly sales, not 70% as commonly reported. Spending by business (private investment plus intermediate inputs) is substantially bigger, representing over 50% of economic activity.  That’s more consistent with economic growth theory, which emphasizes productive saving and investment in technology on the producer side as the drivers of economic growth.  Consumer spending is largely the effect, not the cause, of prosperity.

Second, GO is significantly more sensitive to the business cycle.  During the 2008-09 Great Recession, nominal GDP fell only 2% (due largely to countercyclical increases in government), but GO collapsed by over 7%, and intermediate inputs by 10%.  Since 2009, nominal GDP has increased 3-4% a year, but GO has climbed more than 5% a year.   GO acts like the end of a waving fan.  (See chart below.)

Screen Shot 2013-11-26 at 8.49.25 PM

I believe that Gross Output fills in a big piece of the macroeconomic puzzle.  It establishes the proper balance between production and consumption, between the “make” and the “use” economy, and it is more consistent with growth theory.   As Steve Landefeld, director of the BEA, and co-editors Dale Jorgenson and William Nordhaus state in their work, A New Architecture for the U. S. National Accounts (University of Chicago Press, 2006),  “Gross output [GO] is the natural measure of the production sector, while net output [GDP] is appropriate as a measure of welfare.  Both are required in a complete system of accounts.”

Historical Background

The history of these two economic statistics goes back to several pioneers.  Two economists in particular had much in common — they were both Russian Americans who taught at Harvard University, and both won the Nobel Prize.  Simon Kuznets did breakthrough work on GDP statistics in the 1930s.  Following the Bretton Woods Agreement in 1946, GDP became the standard measure of economic growth.  A few years later, Wassily Leontief developed the first input-output tables, which he regarded as a better measure of the whole economy.  I-O accounts require examining the “intervening steps” between inputs and outputs in the production process, “a complex series of transactions…among real people.”

I-O data created the first estimates of Gross Output.  However, GO was not emphasized as an important macroeconomic tool until my own work, The Structure of Production,was published in 1990 by New York University Press.  In chapters 6 and 9, I created a universal four stage model of the economy (see the diagram below) demonstrating the relationship between total spending in the economy and final output.

Screen Shot 2013-11-26 at 8.49.13 PM

In chapter 6, I made the point that GDP was not a complete picture of economic activity, and compared it to GO for the first time, contending that GO was more comprehensive and more accurately revealed that business investment was far bigger than consumption in the economy.

Since writing Structure, I discovered that the BEA’s Gross Output does not include all sales at the wholesale and retail level.  The BEA only includes value-added data for commodities after they become finished products.  Gross sales are ignored at the final two stages of production.  David Wasshausen, a BEA staff researcher, offers this rationale:  since “there is no further transformation of these goods…to the production process, they are excluded from wholesale/retail trade output.”

Therefore, in the 2nd edition of Structure, published in 2007, I created my own aggregate statistic, Gross Domestic Expenditures (GDE), which includes gross sales at the wholesale and retail level and is therefore significantly larger (more than double GDP).  For a comparison between GDE, GO and GDP, see my working paper.

The BEA has been compiling GO statistics from input-output data for years, but the media have largely ignored these figures because they came out only every five years (known as benchmark I-O tables).  Since the early 1990s, the BEA has been estimating industry accounts annually.  Even so, the data was never up-to-date like GDP.  (The latest input-output industry accounts are for 2011).

That has gradually changed. Under the leadership of BEA director Steve Landefeld, the BEA now has the budget to report the input-output data, including Gross Output, on a quarterly basis, and has already begun publishing quarterly data prior to 2012.  This is a major breakthrough involving the cooperation of the Bureau of the Census, Bureau of Labor Statistics, the Federal Reserve Board, and other government agencies.

Controversies Over This New Statistic

Several objections have been made over the years to the use of GO and GDE. Economists are especially fixated over the perceived problem of “double counting” with GO and GDE.  I am the first to note that GO and GDE involve double counting.  A commodity is often sold repeatedly as it goes through the resource, production, wholesale and retail stages.  Why not just measure the value added at each stage rather than double or triple count? they ask.  GDP eliminates double counting and measures only the value added at each stage.

There are several reasons why double counting should not be ignored and is actually a necessary feature to understanding the overall economy.  As accountants and financiers know, double counting is essential in business.  No company can operate or expand on the basis of value added or profits only. They must raise the capital necessary to cover the gross expenses of the company — wages and salaries, rents, interest, capital tools and equipment, supplies and goods-in-process.  GO and GDE reflect this vital business decision making at each stage of production.  Can publicly-traded firms ignore sales/revenues and only focus on earnings when they release their quarterly reports?  Wall Street would object.  Aggregate sales/revenues are important to measure on an individual firm and national basis.

In my own research, I find it interesting that GO and GDE are far more volatile than GDP during the business cycle.  As noted in the chart above, sales/revenues rise faster than GDP during an expansion, and collapse during a contraction (wholesale trade fell 20% in 2009; retail trade dropped over 7%).

Economists need to explore the meaning of this cyclical behavior in order to make accurate forecasts and policy recommendations.  Double counting counts.

Another objection involves outsourcing and merger/acquisitions.  Companies that start outsourcing their products will cause an increase in GO or GDE, while companies that merge with another company will show a sudden decrease, even though there is essentially no change in final output (GDP).

That’s a legitimate concern.  Similar problems occur with GDP.  When a homeowner marries the maid, the maid may no longer be paid and therefore her services may no longer be included in GDP.  Black market activities often fail to show up in GDP data as well.  Certainly if a significant trend develops in outsourcing or merger & acquisition activity, it will be reflected in GO or GDE statistics, but not necessarly in GDP.  It bears further investigation to see how serious this issue is.  No aggregate statistic is perfect, but GO and GDE offer forecasters an improved macro picture of the economy.

In conclusion, GO or GDE should be the starting point for measuring aggregate spending in the economy, as it measures both the “make” economy (intermediate production), and the “use” economy (final output).  It complements GDP and can easily be incorporated in standard
national income accounting and macroeconomic analysis.  To see how, take a look at the 4th edition of my textbook, Economic Logic (Capital Press, 2014), available in paperback and Kindle.


FreedomFest 2013, Las Vegas

Cobden Centre readers based in the US, along with those who fancy a visit, are invited to …

FreedomFest, July 10-13, 2013:  Just think 7-11 in Las Vegas.

This year we expect over 3,000 libertarians coming from around the world, as we move to bigger headquarters, Caesars Palace.  Our theme:  “Are We Rome?”  Be sure to watch our 2 1/2 min video preview at

Big News:  John Stossel and Fox News are coming to FreedomFest, taping his award-winning show STOSSEL on 7-11 in Vegas.  You’re invited.

Over 100 speakers, 100 exhibitors (“The Trade Show for Liberty”), and hundreds of panels, debates, and events.  All the major think tanks will be there — Cato, Reason, Heritage, FEE, Adam Smith Institute, ISIL, Ayn Rand Institute, etc.

It’s also the 100th anniversary of the Federal Reserve and the Federal income tax, so we are having major panels/debates on central banking and the income tax.  End the Fed, Now What?  What is the Ideal Tax — Flat Tax, Fair Tax, No Tax?  Plus Billionaire Libertarian Hedge Fund Panel with Jim Rogers (former partner with George Soros).  Democracy and Liberty, Friends or Foes?

FreedomFest is an OPEN FORUM:  If you would like to speak, or exhibit, contact us immediately:  Mark Skousen, producer, or Tami Holland, conference coordinator: www.freedomfest.com1-866-266-5101.  Email:

Come join us — the intellectual feast in the entertainment capital of the world.  Steve Forbes said it best:  “So good I changed my schedule to attend all 3 days.”


Will the real Adam Smith please stand up

“Adam Smith had one overwhelmingly important triumph: he put into the center of economics the systematic analysis of the behavior of individuals pursuing their self-interest under conditions of competition.”– George Stigler [1]

A major debate has flared up recently about Adam Smith. Was he the father of free-market economics and libertarian thought, or some kind of radical egalitarian and social democrat?

Adam Smith as a Free-Market Hero

The traditional view, held by Milton Friedman, is that the Scottish philosopher was “a radical and a revolutionary in his time–just as those of us who preach laissez faire are in our time.” [2] He lauded Smith’s metaphor of the “invisible hand,” the famous Smithian idea that “by pursuing his own self interest, [every individual] frequently promotes that of the society.” [3] According to Friedman, “Adam Smith’s flash of genius was his recognition that the prices that emerged from voluntary transactions between buyers and seller — for short, in a free market — could coordinate the activity of millions of people, each seeking his own interest, in such a way as to make everyone better off.” [4] Other defenders of free-enterprise capitalism describe the invisible hand as “gentle,” “wise,” “far reaching,” and one that “improves the lives of others.” [5]

George Stigler, Friedman’s colleague at the University of Chicago, identified the invisible hand doctrine as “the crown jewel” and first principle of welfare economics, “the most important substantive proposition in all of economics.” [6] He waxed eloquently about the “grandparent” of modern economics, his “bold explorations, his resourceful detective work…, his duels and triumphs and defeats…. [his] superior mind…a clear-eyed and tough-minded observer…The Wealth of Nations has joined the great literature of all time; it was the most powerful assault ever launched against the mercantile philosophy that dominated Western Europe from 1500 to 1800.” [7] Adam Smith was Stigler’s favorite economist, and a portrait of the Chicago economist holding a copy of The Wealth of Nations hangs in the hall way of the business school at Chicago.

This is one area where the Austrians Ludwig von Mises and Friedrich Hayek concurred with the Chicago school. Like Stigler, Mises wrote an introduction to The Wealth of Nations, calling it a “great book.” According to Mises, Smith’s works are “the consummation, summarization, and perfection…of a marvelous system of ideas…presented with admirable logical clarity and an impeccable literary form…. [representing] the essence of the ideology of freedom, individualism, and prosperity.” Furthermore, “Its publication date — 1776 — marks the dawn of freedom both political and economic….It paved the way for the unprecedented achievements of laissez-faire capitalism.” He concluded,

There can hardly be found another book that could initiate a man better into the study of the history of modern ideas and the prosperity created by industrialization. [8]

In like manner, Hayek wrote a laudatory article on the 200th anniversary of the publication date of The Wealth of Nations. After praising earlier economists and warning of defects in Smith’s value and distribution theories, he went on to extol Smith as “the greatest of them all” because the Scottish economist, more than any of his contemporaries or ancestors, recognized that “a man’s efforts will benefit more people, and on the whole satisfy greater needs, when he lets himself be guided by the abstract signals of prices rather than perceived needs,” and thus Smith helped to create a “great society.” [9]

Social Democrats Contest the Free-Marketeers

Critics of laissez faire — from Cambridge economist Emma Rothschild to British Labor Party leader Gordon Brown — have recently become quite unhappy by what they consider a conspiracy by free-marketeers to claim Adam Smith as their hero and symbol of laissez faire. They seem to be especially annoyed that the Adam Smith Institute, a London-based free-market think tank, raised a popular statue of the grand old man on Mile High Street in Edinburgh on July 4, 2008.

In a series of books and articles, they have attempted to wrestle Adam Smith out of the hands of the free-market arena and into the camp of the social democrats. According to Oxford Professor Iain McLean and Illinois Professor Samuel Fleschaker, the Scottish philosopher was a “radical egalitarian” who, while endorsing economic liberalism, had a lively appreciation of market failure and ultimately rejected “ruthless laissez-faire capitalism” in favor of “human equality” and “distributive justice.” [10] These revisionists are quick to claim that Smith was no friend of rent-seeking landlords, monopolistic merchants and conspiring businessmen, and that he advocated an active state authority in support of free education, large-scale public works, usury laws, progressive taxation, and even some limits on free trade. They contend that Smith had more in common with Karl Marx than Thomas Jefferson. [11]

The critics of laissez faire offer a mixed review of Smith’s invisible hand. In their Keynesian textbook, William Baumol and Alan Blinder admit that “the invisible hand has an astonishing capacity to handle a coordination problem of truly enormous proportions.” [12] Despite expecting anarchic chaos, Frank Hahn discovers spontaneous order in Adam Smith’s market place. He honors the invisible hand theory as “astonishing,” noting

whatever criticisms I shall level at the theory later, I should like to record that it is a major intellectual achievement….The invisible hand works in harmony [that] leads to the growth in the output of goods which people desire. [13]

And yet despite these words of praise, Smith’s wonderful world is full of inefficiencies, waste, and imperfections. Accordingly, the public must beware of the “backhand,” “the trembling hand,” the “bloody hand,” the “iron fist of competition,” a hand “getting stuck,” and perhaps even a hand that may need to be “amputated.” [14]

To emphasize the imperfections of the market place, mainstream publishers have mostly assigned big-government advocates to write the introductions to the popular editions of The Wealth of Nations, including Marx Lerner and Robert Reich for the Modern Library editions, and Alan B. Krueger for the Bantam paperback edition, where he labels Adam Smith as a follower not of Milton Friedman but of John Rawls; his invisible hand is seen as “all thumbs.” [15]

Murray Rothbard’s Dissent

The political waters have been muddied a bit since libertarian Murray Rothbard and his followers have joined the critics in their attack on Adam Smith (one of a few examples where Rothbard departs company from Mises and Hayek). Rothbard took exception to the celebrated Adam Smith in his two volume history of economic thought, published at the time of Rothbard’s death in 1995. He lambasted the classical economists, arguing that Smith apostatized from the sound doctrines and theories previously developed by pre-Adamites such as Richard Cantillion, Anne Robert Turgot, and the Spanish scholastics. He asserted that Adam Smith’s contributions were “dubious” at best, that “he originated nothing that was true, and that whatever he originated was wrong,” and that The Wealth of Nations was “rife with vagueness, ambiguity and deep inner contradictions.” Specifically, his doctrine of value was an “unmitigated disaster”; his theory of distribution was “disastrous”; his emphasis on the long run was a “tragic detour”; and Smith’s putative “sins” include support for progressive taxation, fractional reserve banking, and a crude labor theory of value that Marxists later borrowed from Adam Smith and David Ricardo. [16]

Adam Smith Reveals the Invisible Hand

What about the metaphor of the “invisible hand,” the famous Smithian idea that “by pursuing his own self interest, [every individual] frequently promotes that of the society” [17]? Free-market economists from Ludwig von Mises to Milton Friedman have regarded it as a powerful symbol of unfettered market forces, what Adam Smith called his “system of natural liberty.” In rebuttal, the new critics belittle Adam Smith’s metaphor as a “passing, satirical” reference and suggest that he favored more of a “helping hand.” [18] They emphasize the fact that Smith used the phrase “invisible hand” only once in each of his two major works, The Theory of Moral Sentiments (1759) and The Wealth of Nations (1776). The references are so sparse that commentators seldom mentioned the expression by name in the 19th century. No notice was made of it during the celebrations of the centenary of The Wealth of Nations in 1876. In the 18th and 19th century, no subject index, including the well-known volume edited by Edwin Cannan, published in 1904, lists “invisible hand” as a separate entry. It was finally added to the subject index in 1937 by Max Lerner for the Modern Library edition. Clearly, it wasn’t until the 20th century that the invisible hand became a popular symbol of laissez faire.

Invisible Hand: Marginal or Central Concept?

Could the detractors be correct in their assessment of Adam Smith’s sentiments? Is the invisible hand metaphor central or marginal to Adam Smith’s “system of natural liberty”?

Milton Friedman refers to Adam Smith’s symbol as a “key insight” into the cooperative, self-regulating “power of the market to produce our food, our clothing, our housing…without central direction.” [19] George Stigler calls it the “crown jewel” of The Wealth of Nations and “the most important substantive proposition in all of economics.” [20] The idea that laissez faire leads to the common good is called “the first fundamental theorem of welfare economics” by Kenneth Arrow, Paul Samuelson, and Ronald Coase. [21]

On the other hand, Gavin Kennedy contended in earlier writings that the invisible hand is nothing more than an after-thought, a “casual metaphor” with limited value. [22] Emma Rothschild even goes so far as to declare, “What I will suggest is that Smith did not especially esteem the invisible hand…It is un-Smithian and unimportant to his theory” and was nothing more than a “mildly ironic joke.” [23]

Who’s right?

Adam Smith Reveals His Invisible Hand

A fascinating discovery uncovered by Daniel Klein, professor of economics at George Mason University, may shed light on this debate. Based on a brief remark by Peter Minowitz that the “invisible hand” phrase lies roughly in the middle of both The Wealth of Nations and The Theory of Moral Sentiments [24], Klein made preliminary investigations that led him to suggest deliberate centrality. [25] Klein then recruited Brandon Lucas, then a doctoral student at George Mason, to investigate further. Klein and Lucas found considerable evidence that Smith “deliberately placed ‘led by an invisible hand’ at the centre of his tomes” and that the concept “holds special and positive significance in Smith’s thought.” [26]

Klein and Lucas base their conjecture on two major points. First, the physical location of the metaphor: The single expression “led by an invisible hand” occurs almost dead center in the first and second editions of The Wealth of Nations. (It moves slightly away from the middle after an index and additions were added to later editions.)

Moreover, it appears again “well-nigh dead centre” in the final edition of The Theory of Moral Sentiments. Klein and Lucas admit that it was not in the middle of the first edition in 1759, speculating that “physical centrality was not initially a part of his intentions…[but that] by 1776, Smith had become intent on centrality.” Indeed, Smith moved the phrase “invisible hand” closer to the center of the book, first by appending an important essay on the origin of language and finally by making substantial revisions in the final edition. [27]

Second, Klein and Lucas note that as an historian and moral philosopher, Adam Smith commented frequently on the importance of middleness in architecture, literature, science, and philosophy. For example:

  • Smith wrote sympathetically about the Aristotelian golden mean, the idea that virtue exists “between two opposite vices.” For instance, between the two extremes of cowardice and recklessness lies the central virtue of courage.
  • In Smith’s essays on astronomy and ancient physics, Smith was captivated by Newtonian central forces and periodical revolutions.
  • Klein discovered that Smith, in his lectures on rhetoric, admired the poetry of the Greek poet Thycydides, who “often expresses all that he labours so much in a word or two, sometimes placed in the middle of the narration.” [28]

Midpoint analysis and centralized themes existed long before Adam Smith’s time. For example, the Talmud offers considerable commentary about midpoints in the Torah, especially in a poetic form called Chiasmus. Chiasmus is characterized by introverted parallelism, and found in Greek, Latin, Hebrew and Christian literature. A Chiasmus is a pattern of words or ideas stated once and then stated again but in reverse order. Classic examples are found in the Bible: “Who sheds the blood of a man, by a man shall his blood be shed…” (Genesis 9:6), or “The first shall be last and the last shall be first…” (Matthew 19:30).

Most Chiasmi have a “climactic centrality,” that is, the structure of the poem points to a central theme in the middle. For instance, the Psalmist writes, “Our soul is escaped as a bird out of the snare of the fowlers; the snare is broken, and we are escaped.” (Psalms 124:7) Here the Psalmist is urging us (the soul) to escape the clutches of Satan, even as a bird escapes the snare of the fowler or the hunter (the central word).

The standard pattern of a centralized Chiamus is:

  • A
  • B
  • C (central theme or focal point)
  • B
  • A

In sum, according to Klein and Lucas, the invisible hand represents the climatic centrality of Smith’s “system of natural liberty,” and is appropriately found in the middle of his works. By this discovery, if true, one goes from one extreme to the other — from seeing the invisible hand as a marginal concept to accepting it as the touchstone of his philosophy.

Klein and Lucas’s list of evidence is what a lawyer might call circumstantial, or “impressionistic,” to use Klein and Lucas’s own adjective. Taken as a whole, the documentation is either an ingenious breakthrough or a “remarkable coincidence,” to quote Gavin Kennedy. [29]

A few Smithian experts have warmed up to Klein and Lucas’s claim. Gavin Kennedy, who previously considered the invisible hand a “casual” metaphor, now sees a “high probability” in their thesis of deliberate centrality. [30] Others are more skeptical. “We have no direct evidence for the conjecture,” states Craig Smith, an expert on Adam Smith at the University of St. Andrews. The idea that Adam Smith deliberately hid his favorite symbol of his philosophy “strikes me…as very un-Smithian,” he states, and runs contrary to his policy of expressing thoughts in a “neat, plain and clever manner.” [31] Placing the shorthand phrase “invisible hand” in the middle of his works may not be plain, but is it not neat and clever?

We may never know the truth, since we have no record of Smith commenting on the matter. Fortunately, one does not need to depend on the physical centrality of the “invisible hand” to recognize the doctrinal centrality of his philosophy. As Craig Smith states, “I’m not convinced that Smith deliberately placed the invisible hand at the centre of his books, but I am certain that it lies at the heart of his thinking.” [32]

The Significance of the Invisible Hand Doctrine

There are many passages from the Wealth of Nations and the Theory of Moral Sentiments that elucidate the theme of “invisible hand,” the idea that individuals acting in their own self-interest unwittingly benefit the public weal, or that eliminating restrictions on individuals’ behaviors “better their own condition” and make society better off. Smith repeatedly advocates removal of trade barriers, state-granted privileges, and employment regulations so that entrepreneurs and enterprises can flourish. [33]

The invisible hand metaphor is an example of Smith’s law of unintended consequences.

Very early in The Theory of Moral Sentiments, Smith makes his first statement of this doctrine:

The ancient stoics were of the opinion, that as the world was governed by the all-ruling providence of a wise, powerful, and good God, every single event ought to be regarded, as making a necessary part of the plan of the universe, and as tending to promote the general order and happiness of the whole: that the vices and follies of mankind, therefore, made as necessary part of this plan as their wisdom and their virtue; and by that eternal art which educes good from ill, were made to tend equally to the prosperity and perfection of the great system of nature. [34]

Or this statement:

The man of system, on the contrary, is apt to be very wise in his own conceit; and is often so enamoured with the supposed beauty of his own ideal plan of government, that he cannot suffer the smallest deviation from any part of it. He goes on to establish it completely and in all its parts, without any regard either to the great interests, or to the strong prejudices which may oppose it. He seems to imagine that he can arrange the different members of a great society with as much ease as the hand arranges the different pieces upon a chess-board. He does not consider that the pieces upon the chess-board have no other principle of motion besides that which the hand impresses upon them; but that, in the great chess-board of human society, every single piece has a principle of motion of its own, altogether different from that which the legislature might chuse to impress upon it. If those two principles coincide and act in the same direction, the game of human society will go on easily and harmoniously, and is very likely to be happy and successful. If they are opposite or different, the game will go on miserably, and the society must be at all times in the highest degree of disorder. [35]

Thus, we see how Smith’s argument is comparative. To quote Klein:

Hewing to the liberty principle generally works out better than not doing so—in this respect, Arrow, Stiglitz, and Hahn do disfigure Smith when they identify the invisible hand with some rarified perfection. We need not rehearse Smith on the ignorance, folly, and presumption of political power, on the corruption and pathology of political ecology….Smith sees the liberty principle as a moral, cultural, and political focal point, a worthy and workable principle in the otherwise dreadful fog of interventionism. [36]

To think that Adam Smith, the renowned absent minded professor, hid a little “invisible” secret in his tomes is indeed the ultimate irony. As Klein concludes, “That the phrase appears close to the center, and but once, in TMS and in WN might be taken as evidence that Smith did intend for us to take up the phrase.” [37]

I find Professor Klein’s story compelling, and have enjoyed showing copies of Smith’s works with a bookmark in the key passages, to students, faculty and interested friends. It has, in the words of Robert Nozick, “a certain lovely quality.” [38]

Will the Real Adam Smith Please Stand Up: My Own Odyssey

In this paper, I’ve discussed the controversies surrounding Adam Smith and the meaning and significance of his invisible hand. As an economist sympathetic with the Austrian school, I myself have gone through an odyssey in my attitude toward Adam Smith. When I first started writing my history, The Making of Modern Economics in the late 1990s, I was still quite infatuated with everything Rothbardian, including his critique of Adam Smith. In fact, I was the one who commissioned Murray Rothbard to write his history of thought in 1980, and like everyone else, was surprised by his attack on Adam Smith. It was a shocking indictment of the Scottish philosopher celebrated by almost all free-market economists, including Rothbard’s teacher Ludwig von Mises.

At that time, I had to decide, who was right, Rothbard or Mises? There was only one way to find out. I decided to read the entire 1,000-page Wealth of Nations, page by page and cover to cover, and come to my own conclusion. Two months later, I put the book down and said to myself: “Murray Rothbard is wrong and Mises is right.” Adam Smith has written a grand defense of the invisible hand and economic liberalism. I followed up by reading Smith’s other great work, The Theory of Moral Sentiments (1759), which reinforced my positive view of Smith.

My change of heart completely transformed my history. Suddenly, The Making of Modern Economics had a plot, an heroic figure, and a bold storyline. Adam Smith and his “system of natural liberty” became the focal point from which all economists could be judged, either adding to or distracting from his system of natural liberty. After coming under attack by socialists, Marxists and Keynesians, the invisible-hand model of Adam Smith was often left for dead but inevitably was revived, revised and improved upon by the French, Austrian, British, and Chicago schools, and ultimately triumphed with the collapse of the socialist central planning model in the early 1990s (although it is again being tested by the ongoing financial crisis).

Granted, Smith made numerous mistakes in his classic work, such as his crude labor theory of value, his attack on landlords, and his failure to recognize marginal subjective values, but French, British, Austrian and Chicago economists have done a great job improving upon the House that Adam Smith Built without destroying his fundamental system of natural liberty, and his policy prescriptions, which were largely libertarian (the classical model of limited government, free trade, balanced budgets, and sound money).

I noticed that Murray Rothbard largely ignored the strong libertarian language found in The Wealth of Nations and overemphasized marginal statements by Smith that were pro-government or anti-market. His attack on Smith reminds me of free-market critics who take the same parenthetical statements in Smith’s writings and make him into some kind of social democrat. Both are wrong.

Here are just a few samples of Smith’s strong libertarian voice in The Wealth of Nations (Modern Edition, 1965 [1776]):

Every man, as long as he does not violate the laws of justice, is left perfectly free to pursue his own interest in his own way, and to bring both his industry and capital into competition with those of any other man, or order of men. (p. 651, emphasis added).

To prohibit a great people…from making all that they can of every part of their own produce, or from employing their stock and industry in the way that they judge most advantageous to themselves, is a manifest violation of the most sacred rights of mankind. (p. 549)

And elsewhere:

Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism but peace, easy taxes, and a tolerable administration of justice; all the rest being brought about by the natural course of things. All governments which thwart the natural course are unnatural, and to support themselves, are obliged to be oppressive and tyrannical. [39]

In sum, Mises, Hayek, Friedman and Stigler all had the right attitude when it came to Adam Smith. He established the “keystone” of the market economy.


[1] George Stigler, “The Successes and Failures of Professor Smith,” Journal of Political Economy 84:6 (December, 1976), p. 1201. Emphasis added.

[2] Milton Friedman, quoted in Fred R. Glahe, ed., Adam Smith and the Wealth of Nations: 1776-1976 Bicentennial Essays (Colorado Associated University Press, 1978), p. 7.

[3] Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (Liberty Fund, 1981 [1776]), p. 456.

[4] Milton and Rose Friedman, Free to Choose (Harcourt Brace Jovanovich, 1980), pp. 13-14.

[5] See chapter 9, “Faith and Reason in Capitalism,” by Mark Skousen, Vienna and Chicago, Friends or Foes? (Regnery, 2005) for a variety of comments, both positive and negative, about the invisible hand.

[6] George J. Stigler, “The Successes and Failures of Professor Smith,” Journal of Political Economy 84:6 (December, 1976), p. 1201. See Stigler’s quotation at the beginning of this paper.

[7] George J. Stigler, “Introduction,” Selections from the Wealth of Nations(Appleton-Century-Crofts, 1957), pp. vii-viii.

[8] Ludwig von Mises, “Why Read Adam Smith Today,” in Adam Smith, The Wealth of Nations (Regnery, 1998), pp. xi-xiii.

[9] Friedrich Hayek, The Trend of Economic Thinking: Essays on Political Economists and Economic History, The Collected Works of F. A. Hayek (University of Chicago Press, 1991), pp. 119, 121.

[10] Iain McLean, Adam Smith: Radical and Egalitarian (Edinburgh University Press, 2006), pp. 91, 120, passim, and Samuel Fleischaker, On Adam Smith’s Wealth of Nations: A Philosophical Companion (Princeton University Press, 2005).

[11] See especially Spencer J. Pack, Capitalism as a Moral System: Adam Smith’s Critique of Free Market Economy (Edward Elgar, 1991).

[12] William J. Baumol and Alan S. Blinder, Economics: Principles and Policies, 8th ed. (Harcourt College Publishers, 2001), p. 214.

[13] Frank Hahn, “Reflections on the Invisible Hand,” Lloyds Bank Review (April, 1982), pp. 1, 4, 8.

[14] See Emma Rothschild, Economic Sentiments: Adam Smith, Condorcet, and the Enlightenment (Harvard University Press, 2001), p. 119; John Roemer, Free to Lose (Harvard University Press, 1988), p. 2-3; and Frank Hahn, “Reflections on the Invisible Hand,” Lloyds Bank Review (April, 1982).

[15] Alan B. Krueger, “Introduction,” The Wealth of Nations (Bantham, 2003), p. xxiii. Krueger’s recommended reading list includes works of Robert Heilbroner and Emma Rothschild, and a brief reference to an article by George Stigler.

[16] Murray N. Rothbard, Economic Thought Before Adam Smith (Edward Elgar, 1995), pp. 435-436, 448, 451, 452, and 458. Even radical economist Spencer Pack considers his attack on Smith “unduly severe” and “one of the harshest attacks every made upon Smith’s work by a non-Marxist (or indeed any) economist.” See “Murray Rothbard’s Adam Smith,” Quarterly Journal of Austrian Economics 1:1 (1998), pp. 73-79.

[17] Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations(Liberty Fund, 1981 [1776]), p. 456.

[18] Iaian McLean, Adam Smith: Radical and Egalitarian, pp. 53, 82.

[19] Milton Friedman, “Adam Smith’s Relevance for 1976,” in Fred R. Glahe, ed., Adam Smith and the Wealth of Nations: 1776-1976 Bicentennial Essays (Colorado Associated University Press, 1978), p. 17.

[20] George Stigler, “Successes and Failures of Professor Smith,” p. 1201.

[21] Mark Skousen, The Making of Modern Economics, 2nd ed. (ME Sharpe, 2009), p. 219.

[22] Gavin Smith, “Adam Smith and the Invisible Hand: From Metaphor to Myth,” Econ Journal Watch 6:2 (2009), p. 240.

[23] Emma Rothschild, Economic Sentiments: Adam Smith, Condorcet, and the Enlightenment (Harvard University Press, 2001), pp. 116, 137.

[24] Peter Minowitz, “Adam Smith’s Invisible Hands,” Econ Journal Watch 1:3 (2004), p. 404.

[25] Daniel B. Klein, “In Adam Smith’s Invisible Hands: Comment on Gavin Kennedy,” Econ Journal Watch 6 (2), (May 2009), pp. 264-279.

[26] Daniel B. Klein and Brandon Lucas, “In a Word or Two, Placed in the Middle: The Invisible Hand in Smith’s Tomes,” Economic Affairs (Institute of Economic Affairs, March 2011), pp. 43, 50.

[27] The modern Glasgow edition published by Oxford University Press and reprinted by Liberty Fund does not include the language essay, so “led by an invisible hand” is not dead-center. However, The Theory of Moral Sentiments published by Richard Griffin & Co. in 1854, and reprinted by Prometheus Books in 2000, does contain the language essay, and “invisible hand” appears on page 264, within five pages of the center (269).

[28] Adam Smith, Lectures on Rhetoric and Belles Lettres (Liberty Fund, 1985), p. 95.

[29] Gavin Kennedy, “Adam Smith and the Role of the Metaphor of an Invisible Hand,” Economic Affairs (March 2011), p. 53. See also Gavin Smith, “Adam Smith and the Invisible Hand: From Metaphor to Myth,” Econ Journal Watch 6:2 (May 2009), pp. 239-263.

[30] Gavin Kennedy, “Adam Smith and the Role of the Metaphor of an Invisible Hand,” op. cit., p. 54.

[31] Craig Smith, “A Comment on the Centrality of the Invisible Hand,” Economic Affairs (March 2011), p. 58.

[32] Craig Smith, op. cit., p. 59. Ryan Hanley (Marquette University) expresses “considerable uneasiness” about Klein’s thesis and is “not yet convinced.” See “Another Comment on the Centrality of the Invisible Hand,” Economic Affairs (March 2011), pp. 60-61.

[33] Adam Smith, The Wealth of Nations, p. 341.

[34] Adam Smith, The Theory of Moral Sentiments (Liberty Fund, 1982 [1759]), p. 36. For a discussion of the invisible hand as a religious symbol of the “invisible God,” and the four levels of faith in capitalism, see chapter 9 in Mark Skousen, Vienna and Chicago, Friends or Foes? (Capital Press, 2005).

[35] Adam Smith, The Theory of Moral Sentiments, p. 234.

[36] Daniel B. Klein, “In Adam Smith’s Invisible Hands: Comment on Gavin Kennedy,” Econ Journal Watch 6:2 (May 2009), p. 275.

[37] Ibid., p. 277.

[38] Robert Nozick, Anarchy, State, and Utopia (Basil Blackwell, 1974), p. 18.

[39] Duguld Stewart, Biographical Memoirs of Adam Smith (1793).


Adam Smith Reveals His (Invisible) Hand!

Today is the anniversary of the publication of Adam Smith’s most famous work,  ”The Wealth of Nations” (March 9, 1776).

To celebrate this important day, I’ve written an article for FEE on Dan Klein’s discovery about the “deliberate centrality” of the invisible hand in Smith’s work, and what it all means.  It will appear in print in the June issue of “The Freeman.”

For some time now, there’s been a controversy brewing about Adam Smith’s famous metaphor of the free market, “the invisible hand.”  Critics point out that it is used only once in each of Smith’s two major works, “The Theory of Moral Sentiments” (1759) and “The Wealth of Nations” (1776).  Therefore, they conclude, this much touted symbol of free-market capitalism was in reality a marginal concept to Smith.

But now Daniel B. Klein (GMU) has made a fascinating discovery: the invisible hand is physically located in the dead center of the middle of both books.  Prof. Klein argues for deliberate centrality by Adam Smith — that the invisible hand doctrine of “the system of natural liberty” was central to his work.  Adam Smith has finally revealed his (invisible) hand!

On a personal note, March 9 is also the pub date of ”The Making of Modern Economics” (March 9, 2001).  It is not a coincidence.  Adam Smith is the heroic figure of the book.   It is now in its 2nd edition.  Last year it won the Choice Book Award for Outstanding Academic Title.  The book is available in hardback, paperback, Kindle, and audio book — and translated into five languages.

I’m happy to announce that Prof. Klein has accepted my invitation to participate in a debate at this year’s FreedomFest (July 14-16, Las Vegas), on the subject:  “Libertarian, Conservative, or Radical Egalitarian:  Will the Real Adam Smith Please Stand Up?” I hope you will join us for this annual event.