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

Russ Roberts reflects on an engaging EconTalk conversation about Adam Smith with friend and Nobel laureate Vernon Smith.

This 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:

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.




Originally published at EconTalk, November 21, 2014.