From the 1500s to the 1800s Mercantilism was the only economic philosophy in the major European countries. This ideology says that wealth is defined by what a nation has, or really what the king has dominion over. As such, colonies were an important way to gain wealth and heavily regulating trade was a good way to prevent other nations from gaining wealth.
Adam Smith was among the first to question mercantilism. His inquiry into the form of wealth came as quite a shock. He asserted that wealth did not come from possessions of a nation, but instead from the living standard of the people. (Dr. H said that today this idea would be called the “per capita income.”)
Along with Smith’s philosophy on wealth was he introduced some radical ideas to gain wealth. He argued that because mercantilism depended on “ins” with government officials, it was not the best way to go. Instead, Smith believed the government should encourage production and consumption by whoever wanted to produce and consume.
Instead of government regulation Smith called for a market economy in which the demands of the market determine what should be produced. The market players who produce better quality products will be able to continue producing while those who produce poor quality products or products with little demand will loose out and be unable to continue producing.
This is where the invisible hand comes in. It should replace government regulation because the market should be able to operate essentially by itself. Because people would be acting in their own self interest consumable goods would continue to be produced. The invisible hand means that a player in the market will “promote an end which was no part of his intention. By pursuing his own interest he frequently promotes that of the society more effectually than…” Over all, the invisible hand results in a win-win situation. The players in the market win by acting in their own self interest and the marked over all wins because the most useful goods will be produced.
It is interesting to notice that Adam Smith’s Market System/ Invisible Hand philosophy came into play as the United States was being creative. While the founding fathers were working to expand political freedom and prosperity, Smith’s philosophy was developing to expand economic freedom and prosperity.