Adam Smith as Behavioral Economist?

self-interest happiness adam smith division of labor altruism behavioral economics trust income distribution

Alejandra Salinas for AdamSmithWorks

March 1, 2023

Some behavioral economists invoke Adam Smith’s ideas to support their understanding of economic decisions in the market. In his address given at the American Economic Association, Richard Thaler traces back to Smith the cognitive biases behind individual decisions that do not lead to the satisfaction of the interest they pursue. Thaler found inspiration in a paper entitled “Adam Smith, Behavioral Economist,” (Ashraf et al) which will be the focus of the analysis here. The purpose is to call into question the connection between Smith’s theory and their behavioral economics approach. To this end, the text addresses three topics: the nature of market interactions, the notion of happiness, and the question of sympathy for the rich.

The nature of market interactions

Ashraf and his co-authors argue that “for Adam Smith, a mixture of concern about fairness (enforced by the fear of negative appraisal by the impartial spectator) and altruism played an essential role in market interactions, allowing trust, repeated transactions and material gains to occur” (136). To support their claim they cite Smith’s Lectures on Jurisprudence:

“In a nation of hunters, if anyone has a talent for making bows and arrows better than his neighbours he will at first make presents of them, and in return get presents of their game. By continuing this practice he will live better than before and will have no occasion to provide for himself, as the surplus of his own labor does it more effectually” (LJ 493, in Ashraf et al. 136).

However, they omit to cite the beginning of the paragraph, which reads: “By this disposition to barter and exchange the surplus of one’s labour for that of other people, in a nation of hunters (...).” This introductory sentence shows that Smith aims at explaining the nature of market interactions based on the division of labor. Nowhere in this passage is there a reference to altruism and fairness, or to their role in markets.

In any case, it is strange that the authors quote from Lectures on Jurisprudence since the natural place to look for an economic analysis is The Wealth of Nations. Altruism does not play any economic role in that book, where Smith is explicit about the self-interested motivation that drives economic exchanges, as attested in the famous observation: “It is not from the benevolence of the butcher, the brewer or the baker that we wait for our dinner, but the attention that they put in their own interest. We are not addressing their humanity but their own love, and we never talk to them about our needs but about their advantages” (WN 26-27).

It should also be noted that the division of labor and self-interest are connected to the employment of the “faculties of reason and speech” (WN I 25). More generally, although Smith finds that human beings are “weak and imperfect,” he acknowledges the rational capacity to discern “the remote consequences of all our actions” and to foresee “the advantage or detriment, which is likely to result from them” (TMS 77, 189).

Far from decrying self-interest for its chrematistic tone, Smith also praises the moral qualities derived from the pursuit of rational self-interest:

“The habits of oeconomy, industry, discretion, attention, and application of thought, are generally supposed to be cultivated from self-interested motives, and at the same time are apprehended to be very praise-worthy qualities (…) The condition of human nature were peculiarly hard, if those affections, which, by the very nature of our being, ought frequently to influence our conduct, could upon no occasion appear virtuous, or deserve esteem and commendation from any body” (304-305).

Thus, self-interest is an essential concept that serves both a descriptive and evaluative purpose in explaining and justifying individual motivations behind market interactions. In their reading of Smith, behavioral economists wrongly displace the centrality of self-interest in favor of altruism and the sense of fairness.

Behavioral economists also seem to be confused about the logical relation of causality between altruistic behavior and trust. For Smith, trust plays a crucial role in sustaining profitable and enduring economic relations in the system of natural liberty. Along these lines, he writes, some wages vary according to trust (WN I 122); we trust that free markets will provide the goods people need, “without any attention of government” (435); merchants seek trustworthy exchanges and laws that protect them (454), and people are entrusted with “the care of their own interest, as in their local situations they must generally be able to judge better of it than the legislator can do” (531). In sum, we could say that trust is a praise-worthy quality and necessary for successful reiterated exchanges in a market economy.

Therefore, we infer that altruism does not allow for trust –as the authors claim- but rather the inverse case is true: insofar as economic trust is conducive to more stable and prosperous societies it allows for altruistic actions to take place (as is the case, for example, with philanthropic donations sent from more affluent to poorer countries).

The notion of happiness

In The Theory of Moral Sentiments happiness is understood in a double meaning, as the individual tranquility and enjoyment, and as the emotion arising from “the consciousness of being beloved” (37, 41;166). Thus, a happy state of mind is unrelated to wealth or income: “In ease of body and peace of mind, all the different ranks of life are nearly upon a level, and the beggar, who suns himself by the side of the highway, possesses that security which kings are fighting for” (185). In Smith’s other texts, happiness is related to securing material conditions for subsistence, since there can be no happy society if a majority of the people are “poor and miserable” (WN I 96); when it comes to basic economic goods “society lives less happy when only the few can possess them” (LJ 497).

Smith assigns the political system the function of securing liberty, peace, and prosperity, the basic conditions for individuals to pursue both mental and material happiness. If the system works well, he anticipates, “the game of human society will go on easily and harmoniously, and is very likely to be happy and successful” (TMS 233).

Smith offers a multidimensional consideration about happiness. However, under the somehow misleading title of “Consumption and its discontents,” the authors relate Smith’s notion of happiness to the distribution of material resources only. For Smith, they write, “the distribution of things that actually bring happiness to people is far more equitable than the distribution of tweezer-cases and other ‘trinkets of frivolous utility” (Ashraf et al 140). From this, they infer that such equitable distribution explains “why cross-sectional differences in income seem to bring such small increments in happiness” (Ibid.).

Two comments are in order concerning their interpretation. First, they are right to observe that it takes little to be materially happy in Smith’s world. However, recall that this can be true only in a society where the majority is not “poor and miserable” (let’s assume, for the argument’s consistency, that the beggar resting by the highway meets his basic needs thanks to charitable donations).

Secondly, in regard to the “weak connections between happiness and wealth or income” (139), Ashraf et al. mention a paper by B. Frey and A. Stutzer among the empirical studies to back that claim. Among the findings of the paper, we read:

“The empirical research on happiness has clearly established that at a given point in time, and within a particular country, persons with higher income are happier. Over time, however, happiness in western countries and Japan does not systematically increase, despite considerable growth in real per capita income. This can be attributed to the rise in aspiration levels going with increases in income. Between countries, and at per capita income levels much below the United States, higher average income goes with higher average happiness, but the improvements in reported subjective well-being seem to be rather small” (Frey and Stutzer 428).

The conclusion we draw is that people with higher incomes feel happier in all countries. To reach a peak in the feeling of happiness or to include other variables that lessen the overall sense of well-being does not refute the fact of a strong correlation between income and happiness.

Moreover, if we adjust the finding to the present-day situation, there is recent literature that confirms this is still true. According to a relatively recent study conducted in the U.S., higher incomes are associated with better life evaluations. The same holds if we compare perceptions of happiness among several countries; in those with a higher GDP per capita, people tend to have more positive life evaluations, as informed in the 2022 World Happiness Report. Therefore, despite the title that links consumption to discontent, consumption is not the most relevant concept related to happiness, income is. And several studies show that there is a positive correlation between income and happiness understood as life evaluation.

The World Happiness Report also shows that there is a positive correlation between happiness, personal liberty, and low levels of governmental corruption: “Income, health, having someone to count on, having a sense of freedom to make key life decisions, generosity, and the absence of corruption all play strong roles in supporting life evaluations. Confidence in public institutions also plays an important role” (36). Not surprisingly, Smith correctly anticipates this when he writes about the public conditions for success in the “game of human society.” His readers should not find it difficult to conclude that, if we value happiness, we need to strive not only for economic systems conducive to higher incomes but also for the strengthening of personal liberty and for smaller and less corrupt governments.

Sympathy for the rich

Smith describes a general admiration for “the rich and the powerful” who appear to live in a more “perfect and happy state,” which would explain the tendency to imitate or approach them (TMS, 51, 61) and to “admire their happy situation, enter into it with pleasure, and endeavour to promote it” (LJ 401). Based on this idea, Ashraf et al. infer that “people don’t want to tax the rich not because they expect to become rich themselves, as some have suggested, but because average citizens don’t want to “spoil and corrupt” what they perceive as the “agreeable situation” of the rich (141-142).

There are at least two problems with this inference: one is argumentative and the other is empirical. First, it seems a logical leap to assume that because people admire the rich they do not want to tax them. Within an altruistic model such as the one advanced by the authors, it is plausible to assume that people admire the rich and at the same time think that the rich should be more generous towards others. In turn, their gestures of solidarity and benevolent actions would enhance admiration for them. In this regard, Smith even suggests that the rich should be induced to behave in a benevolent fashion, since he allows the government to “command mutual good offices” (TMS 81). He also finds it reasonable to tax the rich “something more than in that proportion” (WN 842). In other words, Smith thinks that the rich could be induced to be more benevolent and also make them pay proportionally higher taxes, a policy that he seems to find consistent with the people’s admiration of the rich.

From the empirical side, the argument against taxing the rich would require some evidence, absent in the paper under analysis. Actually, the reverse situation seems to be true: not only do people want to tax the rich, but admiration for them is also diminishing. According to Gallup polls conducted in the U.S., historically a majority of people have complained that “corporations and upper-income people pay too little” (2018). Another poll showed that 52% of people under 30 say that “most” people got rich “by taking advantage of other people.”

Thus, and independently of any evaluative judgment about the predominating public opinion, the current sentiments towards the rich would support the idea of establishing higher levels of taxation for them.

Conclusion

Ashraf et al correctly assert that “Adam Smith’s world is not inhabited by dispassionate rational purely self-interested agents, but rather by multidimensional and realistic human beings” (142). In effect, the Scottish author regards us as beings with a diversity of interrelated aspects. Of particular interest here is the connection between his moral and economic considerations. In this regard, Smith reinforces the interconnection between the notions of self-interest, trust, and happiness. In societies ordered according to the system of natural liberty, he argues, people are driven by self-interest to engage in economic transactions based on mutual trust, in a dynamic that improves the allocation of resources and increases general well-being and happiness more than under alternative arrangements. Thus, “the game of human society” unfolds better under institutions that respect individual liberty.

In contrast, the behavioral approach here under analysis argues that economic agents are more altruistic, less happy, and less rational than generally assumed. We have contested the uses of Smith’s multidimensional theory to support these claims: altruism does not play any economic role; economic agents do have a strong enough rational capacity, and they tend to feel happier as their income increases. In this regard, Adam Smith should not be considered a behavioral economist.

Last, although Ashraf et al do not engage in policy recommendations, other behavioral economists derive prescriptions in favor of government regulations to steer individual choices in allegedly more rational directions (Thaler 2016). In this sense, it would also be improper to consider Adam Smith a behavioral economist, given his staunch defense of a limited government, and his criticism of the “man of the system” who wants to arrange the lives of people as if the latter were pieces in a chessboard (TMS 233).

Related Links
Alejandra Salinas, Behavioral Economics: Method, Norms, and Policy, at Econlib.
Christopher Martin, Adam Smith on the Rich and the Poor, at AdamSmithWorks.
Richard Thaler on Libertarian Paternalism, an EconTalk podcast.

References

Frey, Bruno and Alois Stutzer, “What Can Economists Learn From Happiness Research?” Journal of Economic Literature, Vol. LX (2) 2002, 402-435.

Nava Ashraf, Colin F. Camerer, and George Loewenstein, “Adam Smith, Behavioral Economist,” Journal of Economic Perspectives 19, no. 3 (Summer 2005): 131-145.

Smith, Adam, An Inquiry into the Nature and Causes of the Wealth of Nations, 2 Vol., R.H. Campbell & A.S. Skinner (eds.), The Glasgow Edition of the Works and Correspondence of Adam Smith, Indianapolis: Liberty Fund, 1981.

Smith, Adam, The Theory of Moral Sentiments, D.D. Raphael & A.L. Macfie (eds.), The Glasgow Edition of the Works and Correspondence of Adam Smith, Indianapolis: Liberty Fund, 1982.

Smith, Adam, Lectures on Jurisprudence, R.L. Meek, D.D. Raphael & P.G.Stein (eds.), The Glasgow Edition of the Works and Correspondence of Adam Smith, Indianapolis: Liberty Fund, 1982.

Thaler, Richard, “Behavioral Economics: Past, Present, and Future,” American Economic Review 106, no. 7 (July 2016): 1577-1600.