Russ Roberts

Smith Lessons: What I've learned from Adam and Vernon

EconTalk Extra
by Russ Roberts
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This week's EconTalk episode with Vernon Smith helped me understand something that has been bothering me for a long time.

Economics students are taught that human beings are maximizers--we want more rather than less of the things that give us pleasure. But we are constrained by our income. That means making choices. And that means facing tradeoffs.

Deirdre McCloskey has called this vision of human behavior Max U. Humans are thought to maximize utility subject to the constraint of income. Adam Smith in The Theory of Moral Sentiments seems to take a different approach. He argues that material well-being is nice but not what brings true satisfaction. "Man naturally desires, not only to be loved, but to be lovely." We care about what others think of us and we want the reputation that we earn to be earned honestly.

What does this perspective on humanity have to do with Max U and how does it fit in with Smith's view in The Wealth of Nations? On the surface, they don't conflict at all and it's only a methodological difference. All we have to do is make the utility function richer to include the non-material satisfactions we enjoy. We don't just care about stuff, we also care about our reputation and whether people admire us or respect us or honor us. So someone is willing to lose respect by doing something unethical if the gains in material well-being outweigh the losses from a poorer reputation. One can argue that Gary Becker's whole approach to price theory is an attempt to take the richer Smithian model of human behavior and embed it in utility maximization approach.

Vernon Smith is arguing in this week's episode that that's wrong. You can't just wedge the Smithian concerns about reputation into the Max U framework. Here is how I understand Vernon's point (and I am also drawing here on the last chapter of my Adam Smith book). The Wealth of Nations is about trade among strangers. When I'm on the web buying something or choosing where to shop for groceries or buying a house, it's all about what's in it for me. I'm self-interested and trying to get the best deal possible. That doesn't mean I'll cheat and lie but I'm trying to maximize my net benefit from these kinds of transactions.

Of course I'm self-interested in more intimate settings--my emotional and social interactions with my friends, neighbors, and colleagues. But here, I constrain my self-interest. As Adam Smith writes in The Theory of Moral Sentiments:

Though it may be true, therefore, that every individual, in his own breast, naturally prefers himself to all mankind, yet he dares not look mankind in the face, and avow that he acts according to this principle. He feels that in this preference they can never go along with him, and that how natural soever it may be to him, it must always appear excessive and extravagant to them.

I want to put myself first. But I don't act that way. It's dishonorable. In the social interactions that are intimate and face-to-face, I'm trying to conform to the expectations of those around me. Vernon says it's all about conduct. How do I best conduct myself when you have experienced a tragedy, or I have just experienced a success. Or you need a favor from me. Or I've let you down. In these situations, I try to put my natural self-interest and self-centeredness to the side and instead focus on what is the appropriate thing to do. You can still think of it as a maximization exercise--how do I get people to respect and like me. But I don't think that's the point. The point I'm trying to fit in and match the emotions and meet the expectations of those around me.

The difference between how I behave in small, intimate social settings vs. commercial interactions with relative strangers is the difference between dancing with a partner on a crowded dance floor and playing football. When I dance on a crowded dance floor, I'm not trying to maximize anything. I'm trying to make sure I don't step on my partner's toe or the toes of the other dancers. I don't want to bang into anyone. My goal is grace. My goal is playing by the rules and expectations of the other dancers, especially my partner. When I play football, I'm trying to win. There are rules to meet in football, of course. But the exercise I'm engaged in is about triumph. There's no personal triumph on a crowded dance floor. It might be nice to be the best dancer or the best dancing couple. But the real triumph on the dance floor is complying with the desire to be elegant or beautiful or graceful without hurting anyone else.

When you're out on a crowded dance floor, you're still self-interested. But if you're focused on what's in it for you, you're a lousy dancer and people won't welcome you to the dance. It's not about maximizing anything. It's about complying with the rules of how to dance when the dance floor is crowded to make sure everyone can fit in and enjoy the music and the dance. Those rules are all implicit. They're cultural norms that emerge from our approval and disapproval. That's all in The Theory of Moral Sentiments, too.

Hayek said we have to be of two minds in the modern world--the microcosm of our smaller social settings and the macrocosm of trade across distance with strangers. Vernon's view of Adam Smith is another way to see Hayek's point. In the macrocosm--it's all about what's in it for me. In the microcosm, it's all about knowing the rules and trying to comply with them. It's about conducting myself with sensitivity to those around me in ways that are honorable and admirable.

The real punchline of The Theory of Moral Sentiments and Adam Smith's overall perspective is that the microcosm--my world of friends, family, and colleagues, is where the deepest and most rewarding satisfaction is found. As economists, maybe we ought to be thinking more about how we earn respect from those around us and what is considered respectable, and less time on the demand for potatoes or iPhones.

UPDATE: My talk at the World Bank deals with some of these issues as does this piece on religion at Econ Journal Watch.

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COMMENTS (8 to date)
Per Kurowski writes:

The Swedish author Hjalmar Söderberg, in 1905 said it this way:

"You want to be loved, failing that admired, failing that feared, failing that hated and despised. One wants to instill the people some kind of emotion. The soul shudders of emptiness and wants contact at any price." from Doktor Glas, 1905

MG writes:

Fascinating quote from Söderberg. But those sentiments seem more appropriate of extroverts and naricistic extroverts at that. For me, I can see settling for "being left alone", and even "being ignored" way ahead of hated/despised, feared, and often, admired...

Greg Silverman writes:

I found one thing about the episode with Vernon Smith to be puzzling. In the second half of the hour the asymmetrical attitudes of people towards loss and gain is discussed, e.g., that people, generally, find the possibility of losing $10 they have to be much worse than not succeeding in acquiring $5 from taking a risk.
But, earlier Vernon Smith discussed his Trust Game where about 50% of first actor participants risked losing $10, and, having nothing, for the chance to get an extra $5. Should they not have been averse to this asymmetry, according to Adam Smith? Should they not have been even more averse to benefiting a stranger with the risk of losing everything? And, if the first actors had chosen to exit the game with both parties having $10 that would have been a fair, equitable, reasonable way to conduct themselves. These two Adam Smith-ian concepts, the asymmetry of attitudes to loss and gain, and, the desire to conduct themselves in a proper manner seem to be in contradiction.

Seth writes:

"In the microcosm, it's all about knowing the rules and trying to comply with them. It's about conducting myself with sensitivity to those around me in ways that are honorable and admirable."

For why? I think for the same reason as the macrocosm. What's in it for me? We learn it's in our own best interest to do so.

I thought that was one of Hayek's points. We are self-interested, but we trade in different currencies when dealing with those in our close-knit groups (respect, favors, etc.) than we do when dealing with the extended order (money and prices, more so).

I also think that's why another rule has emerged -- why it's not a good idea to do business with those in your close-knit groups. When you cross the currencies, bad things happen.

william writes:

"Humans are thought to maximize utility subject to the constraint of income."

I think that is such a quaint sentence for anyone that is not an Economist.

It is interesting that Economists are so fascinated that human are not interested in money as much as they are interested in social status.

If you look at the subject from Evolutionary Biology point of view, of course human are more interested in Social Status. It is a 100,000 years old survival requirement to be Homo Sapiens.

Money on the other hand, is a very recent human invention. Money only matters where there is Market, and Market only matters when there are trust (either in the market participants, or in the property law and civil court).

Given that human evolve in the era where if you cheat, at best you can eat more in one day, and then die to starvation as your group abandon you (no fridge back then); isn't it to be expected that Social Acceptance and Herd Mentality be the driving force of human instinct?

it is not that human desire "to be lovely" , catchy as the phrase is. Human desire not to be ostracized from their group. Any human without inborn instinct to seek acceptance would be dead long time ago without children carrying their "non herd mentality" genes.

William writes:

@Greg Silverman

To answer your query, most human does not think opportunity cost as a loss.

There is a well observed phenomenon when an object becomes more valuable to you once your mind accept that you "OWN" the object.

I am guessing the result of the experiment will be a lot different if the first person is given $10 in his hand and told, if you want to pass the $40, you have to give that $10 back to me.

That would trigger the loss aversion. But the idea that "you may win $10, or you may win $0-$15" won't trigger it because in their mind, the worst that can happen is break even ($0).

mark e writes:

What the world needs now is not a Theory of Moral Sentiment but a Theory of Social Capital.

mike davis writes:

This is the 50th Anniversary of the Charlie Brown Christmas Special and the 10th Anniversary of Steven Landsburg’s clever little essay in Slate “What I Love About Scrooge” The two make interesting bookends to this Season and the discourse on Theory of Moral Sentiments helps understand why.

Landsburg points out that the miser Scrooge left a lot of stuff for others to enjoy since he produced a lot and consumed very little. He didn’t do this to garner status or even to make himself happy—Dickens describes him as a “Squeezing, Wrenching, Grasping, Scraping, Clutching, Covetous, Old Sinner”. He just did it. And because of this, Landsburg claims, Scrooge was actually the most generous of all the characters.

Charlie Brown’s view is, of course, entirely different. He is not obsessed with consumption and is frustrated by those who are—“OH NO! My own dog has GONE COMMERCIAL!” He is seeking that moment when individuals join community. But he’s a kid and doesn’t quite understand that longing or even if it is attainable. When Linus recites from the Gospel of Luke, we’re told that there may be hope. (Schulz was a Christian and so he used the Gospel to make the point. But it's not an ad for Christianity, it's a claim about human nature.) When the kids rally around and redeem the Charlie Brown Christmas tree, we see it happening.

Landsburg and Schulz are both on to something but after reading this blog--and, more importantly, Russ’s piece “Sympathy for Homo Religiosus”--I’m convinced that the Charles (Dickens, Shultz and Brown) have the much more interesting story to tell. Russ put it about as well as it can be put, “my world of friends, family, and colleagues, is where the deepest and most rewarding satisfaction is found. As economists, maybe we ought to be thinking more about how we earn respect from those around us and what is considered respectable, and less time on the demand for potatoes or iPhones.”

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