The Double Life of Adam Smith

das adam smith problem poor man's son ronald coase externalities adam smith dilemma

Kwok Ping Tsang for AdamSmithWorks

September 8, 2021
When reading the two major works by Adam Smith one notices a conflict at the individual level. On the one hand, the story of the poor man’s son in The Theory of Moral Sentiments (hereafter TMS) tells us that pursuit of wealth and status is mostly futile:
The poor man’s son, whom heaven in its anger has visited with ambition, when he begins to look around him, admires the condition of the rich…It appears in his fancy like the life of some superior rank of beings, and, in order to arrive at it, he devotes himself for ever to the pursuit of wealth and greatness…For this purpose he makes his court to all mankind; he serves those whom he hates, and is obsequious to those whom he despises. (TMS IV.i.8)
Trying to get ahead, working for people you despise, leaving little time for friends and families, all the sacrifices the poor man’s son had made brought neither happiness nor a peace of mind.
Tragically, we only realize the meaninglessness near the end of life, as the poor man’s son did in the following passage:
It is then, in the last dregs of life, his body wasted with toil and diseases, his mind galled and ruffled by the memory of a thousand injuries and disappointments which he imagines he has met with from the injustice of his enemies, or from the perfidy and ingratitude of his friends, that he begins at last to find that wealth and greatness are mere trinkets of frivolous utility, no more adapted for procuring ease of body or tranquillity of mind than the tweezer-cases of the lover of toys; and like them too, more troublesome to the person who carries them about with him than all the advantages they can afford him are commodious. (TMS IV.i.8)
“To better one’s condition” seems like a wild goose chase.
But when we move to The Wealth of Nations (hereafter WN), the same motivation is seen in a much better light. It is the basic force behind economic progress, and it is also a remedy for some foolish government policies. The following famous passages come to mind.
The natural effort of every individual to better his own condition, when suffered to exert itself with freedom and security is so powerful a principle that it is alone, and without any assistance, not only capable of carrying on the society to wealth and prosperity, but of surmounting a hundred impertinent obstructions with which the folly of human laws too often incumbers its operations; though the effect of these obstructions is always more or less either to encroach upon its freedom, or to diminish its security. (WN IV.v.b.43)He seems not to have considered that, in the political body, the natural effort which every man is continually making to better his own condition is a principle of preservation capable of preventing and correcting, in many respects, the bad effects of a political œconomy, in some degree, both partial and oppressive. (WN IV.ix.28)In the midst of all the exactions of government, this capital has been silently and gradually accumulated by the private frugality and good conduct of individuals, by their universal, continual, and uninterrupted effort to better their own condition. (WN II.iii.36)
So which is it? Is it a meaningless pursuit or a move towards a more comfortable life? Which Smith should we listen to?
Instead of characterizing it as another form of the Adam Smith problem, it is more appropriate to call it the Adam Smith dilemma. It is a dilemma all of us face at the individual level, and it is a tradeoff that none of us can avoid in life. And, like all tradeoffs, we need to think about the benefits and costs of moving in any direction in order to find the best solution.
One purpose of this article is to clarify the pros and cons of pursuing wealth and becoming benevolent, or how Smith’s dilemma can be cast as an individual finding an optimum under constraints. Should we follow our self-interest, compromise our moral standards, and neglect our relationships? Should we give up the worldly pursuits, and focus on being a lovely and compassionate person? Smith clearly does not recommend going to the extremes (in the normative sense), and he does not think most of us end up in them either (in the positive sense). Balancing the relevant benefits and costs, most of us reach some sort of interior solution: not giving up the “rat race” in the marketplace, but also trying to be a decent person and an altruistic one. To Smith, the ideal life in the commercial society is not a corner solution.
The interior solution at the individual level also has a wider impact, and the second purpose of this article is to analyze it using the concept of externalities. To Smith, both our actions in the society and in the marketplace have effects that we do not take into account, or, using his famous analogy, that are guided by an invisible hand. By interacting with other people, we judge and are judged by others, and we all contribute to establishing the social norms and moral standards and building up a stable and harmonious society. By focusing on our own gains, our exchanges in the market also indirectly improve the livelihoods of others.
Our interior solution produces both externalities, or the invisible hand is allowed to operate on both sides of our double life. A particularly interesting nature of both externalities is their network nature. That is, a small group of people is not enough to form us into proper, balanced, and civilized individuals, just like a few traders are limited by the extent of the market. As most people are pursuing their own interior solutions, we all unintentionally produce benefits to others, bringing forth a more pleasant and affluent commercial society.

1. The Circles of Life
Smith’s system of life can be represented as a graph in the style of von Thünen (Figure 1). In the middle we have you (the decision maker), the center of the discussion. The immediate circle includes your close friends, families, significant others, and other people with whom you have a deep level of mutual understanding. As we expand the circle, we include colleagues, classmates, and other acquaintances that are increasingly distant from you. Beyond that we have strangers, and even within that circle we can further divide them into those that are closer (say, those that belong to your ethnic group) and those that are less so (say, people in another country thousands of miles away, like those unlucky earthquake casualties in TMS).
Within the context of our discussion, you make two decisions. One is to spend time interacting with people at different distances from you, and the other is to expand or narrow the circles themselves. The first decision is familiar: buying things in the store, eating out with friends, chatting up with colleagues, working in a company, or watching television with family members. We are constantly making the second decision as well: meeting new friends, distancing yourself from others, knowing people sharing your hobby, or joining a social club. Even the circle of strangers can be expanded: with the internet, we can communicate and trade with virtually anyone in the world. It is evident that TMS is more about the inner circles, and WN is more about the outer ones.
We are constantly modifying the circles and moving around them, and our decisions are influenced by the different benefits and costs identified throughout TMS and WN.

2. The Dilemma as an Optimal Choice
Right from the beginning of WN Smith tells us about the substantial gains from division of labor and, as a result of that, voluntary exchanges with others. The more we specialize, and the more we barter, truck, and trade with others, the better is our standard of living. To take advantage of this, we need to get out from our inner circles, since relying only on people we know is usually not enough. As mentioned in WN, even a beggar cannot just depend on the benevolence of others: “Nobody but a beggar chuses to depend chiefly upon the benevolence of his fellow-citizens. Even a beggar does not depend upon it entirely.” (WN 1.ii.2). Through trading, we can enjoy a variety of goods that bring us conveniences, making it possible to have a life beyond bare subsistence.
Taking advantage of the benefit of specialization comes at a cost too. We all have to become the poor man’s son to some extent, sacrificing our tranquility for busyness and nervousness in life. We are also likely to be corrupted by luxuries and the worship of wealth.
That wealth and greatness are often regarded with the respect and admiration which are due only to wisdom and virtue; and that the contempt, of which vice and folly are the only proper objects, is often most unjustly bestowed upon poverty and weakness, has been the complaint of moralists in all ages. (TMS I.iii.3.1)
Another benefit comes from the process of empathy. Being around people in synchrony with us is a source of bliss, and that cannot happen unless we have enough “practice” with others.
But whatever may be the cause of sympathy, or however it may be excited, nothing pleases us more than to observe in other men a fellow-feeling with all the emotions of our own breast; nor are we ever so much shocked as by the appearance of the contrary. (TMS 1.i.2.1)This natural disposition to accommodate and to assimilate, as much as we can, our own sentiments, principles, and feelings, to those which we see fixed and rooted in the persons whom we are obliged to live and converse a great deal with, is the cause of the contagious effects of both good and bad company. (TMS VI.ii.1.17)
In TMS there are plenty of descriptions of how friendship enriches our life. Here is one example.
Whenever we cordially congratulate our friends, which, however, to the disgrace of human nature, we do but seldom, their joy literally becomes our joy. We are, for the moment, as happy as they are: our heart swells and overflows with real pleasure: joy and complacency sparkle from our eyes, and animate every feature of our countenance, and every gesture of our body. (TMS I.iii.1.11)
To Smith, the most ideal form of friendship exists between people of virtue.
But of all attachments to an individual, that which is founded altogether upon the esteem and approbation of his good conduct and behaviour, confirmed by much experience and long acquaintance, is, by far, the most respectable…The attachment which is founded upon the love of virtue, as it is certainly, of all attachments, the most virtuous; so it is likewise the happiest, as well as the most permanent and secure. (TMS VI.ii.1.18)
Notice how much investment is involved to achieve such friendships (“long and intimately acquainted” and “much experience”). While they are “the happiest” and “most permanent,” they take a lot of work. Such friendships take time and effort, and you just do not have time and resources to reach such a level of understanding with everyone. He reminds us how difficult it is just to build and keep a friendship: “He has not time, however, to do this upon every occasion. In civilized society he stands at all times in need of the cooperation and assistance of great multitudes, while his whole life is scarce sufficient to gain the friendship of a few persons.” (WN 1.ii.2)
Since we have limited time and resources, we can only be close to a small number of people. Much as we cannot expect “great multitudes” from strangers, we cannot provide to others the same level of help and consideration too. When dealing with strangers, Smith points out that only the idea of justice is invoked and we are down to a minimum standard of morals. The impartial spectator does not require us to be benevolent, generous, brave, and compassionate to all people, and our sentiments weaken as we move towards the outer circles.
Society may subsist among different men, as among different merchants, from a sense of its utility, without any mutual love or affection; and though no man in it should owe any obligation, or be bound in gratitude to any other, it may still be upheld by a mercenary exchange of good offices according to an agreed valuation. Society, however, cannot subsist among those who are at all times ready to hurt and injure one another. (TMS II.ii.3.2)Justice, on the contrary, is the main pillar that upholds the whole edifice… In order to enforce the observation of justice, therefore, Nature has implanted in the human breast that consciousness of ill-desert, those terrors of merited punishment which attend upon its violation, as the great safe-guards of the association of mankind, to protect the weak, to curb the violent, and to chastise the guilty. (TMS II.ii.3.4)
Ronald Coase has elaborated on this perspective at length. In Coase (1977), he points out that “[w]e just do not have time to learn who the people are who gain from our labors or to learn their circumstances, and so we cannot feel benevolence towards them even if benevolence would be justified were we to be fully informed.” Since we cannot treat the numerous people we interact with in the marketplace the way we interact with friends, we need to adopt a more basic moral standard. Coase (1976) puts it nicely: “the observance of a moral code must very greatly reduce the cost of doing business with others and must therefore facilitate market transactions.” Hence, it is wrong to cheat, steal, or coerce in the marketplace, but beyond that we do not expect much, as expecting people to be benevolent and generous when trading will make market activities too costly. Medema (2009) rightly points out that the impartial spectator is a “transaction-cost minimizer”.
To Smith, we never stop balancing the above factors and reaching some optimum. Our circumstances change, and the society also changes, and the various marginal costs and benefits do not stay the same over time. In a backward society where transportation is difficult, division of labor is limited and we rely more on our community for subsistence. As technology advances, it becomes easier for us to trade with strangers and our activity in the outer circles increases.
There are extreme cases, and both are mentioned in TMS. First we have those who are utterly selfish:
In the superior stations of life the case is unhappily not always the same…To attain to this envied situation, the candidates for fortune too frequently abandon the paths of virtue; for unhappily, the road which leads to the one, and that which leads to the other, lie sometimes in very opposite directions…They often endeavour, therefore, not only by fraud and falsehood, the ordinary and vulgar arts of intrigue and cabal; but sometimes by the perpetration of the most enormous crimes, by murder and assassination, by rebellion and civil war, to supplant and destroy those who oppose or stand in the way of their greatness. (TMS I.iii.3.6).
Such are people who appear in history books. Then, in the same section of the book, we have the saintly individuals: “They are the wise and the virtuous chiefly, a select, though, I am afraid, but a small party, who are the real and steady admirers of wisdom and virtue.” (TMS I.iii.3.2). Both types of people are rare, and most of us are in between, with some closer to one extreme and some closer to the other.

3. The Interior Solution Produces Externalities
It is also a happy accident that most of us find an interior solution, as both our urge to better our conditions and our urge to be benevolent have positive effects on others. Such unintended externalities are mentioned frequently in both books. The two “invisible hand” references from the two books immediately come to mind. When we are blindly pursuing our own interests, chasing for the highest profits and maximizing wealth, our selfish actions indirectly benefit others. What is less obvious is the network nature of the externalities, as Smith explains here:
As it is the power of exchanging that gives occasion to the division of labour, so the extent of this division must always be limited by the extent of that power, or, in other words, by the extent of the market. When the market is very small, no person can have any encouragement to dedicate himself entirely to one employment, for want of the power to exchange all that surplus part of the produce of his own labour, which is over and above his own consumption, for such parts of the produce of other men’s labour as he has occasion for. (WN I.iii.1)
The division of labor among a small number of people is not enough to bring forth the benefits of trade. Besides the restriction of transportation, if most of us abandon the pursuit of wealth and choose to be self-sufficient (or to rely on friends for help), there will be few people to trade with or the market will have a limited extent. When there are few trading opportunities, people are in turn discouraged to specialize and focus on a few tasks. Buchanan and Yoon (2000) provide a similar interpretation of Smith’s view.1
Something similar is at work in society too. Our worship of the wealthy and powerful, though stupid and corrupt by itself, indirectly contributes to a stable social structure and brings peace for all.
When we consider the condition of the great, in those delusive colours in which the imagination is apt to paint it. It seems to be almost the abstract idea of a perfect and happy state. It is the very state which, in all our waking dreams and idle reveries, we had sketched out to ourselves as the final object of all our desires. We feel, therefore, a peculiar sympathy with the satisfaction of those who are in it… Upon this disposition of mankind, to go along with all the passions of the rich and the powerful, is founded the distinction of ranks, and the order of society. (TMS I.iii.2.2-3)Nature has wisely judged that the distinction of ranks, the peace and order of society, would rest more securely upon the plain and palpable difference of birth and fortune, than upon the invisible and often uncertain difference of wisdom and virtue. (TMS VI.ii.1,20)
Clearly, just like the division of labor is limited by the extent of the market, the stability mentioned here also depends on most of us having such preferences. If most of us “find that wealth and greatness are mere trinkets of frivolous utility”, then the stabilizing effect goes away.
The establishment of appropriate behaviors or social norms also rely on such externalities. “To approve of the passions of another, therefore, as suitable to their objects, is the same thing as to observe that we entirely sympathize with them; and not to approve of them as such, is the same thing as to observe that we do not entirely sympathize with them.” (TMS I.i.3.1)
By participating in the society, we are always judging others and being judged, from that interactive process we learn how to behave. What we expect of us and others contributes to the kind of society we live in. If most of us try to be benevolent and altruistic at least to those close to us, the same sort of behavior will become the social norm and encourages more of the same behavior. Smith describes an ideal state as follows: “Where the necessary assistance is reciprocally afforded from love, from gratitude, from friendship, and esteem, the society flourishes and is happy. All the different members of it are bound together by the agreeable bands of love and affection, and are, as it were, drawn to one common centre of mutual good offices.” (TMS I.ii.3.1)
If, when interacting with others, we are down to the bare minimum level of moral standard only, that of not hurting or stealing from others, the society deteriorates. “But though the necessary assistance should not be afforded from such generous and disinterested motives, though among the different members of the society there should be no mutual love and affection, the society, though less happy and agreeable, will not necessarily be dissolved.” (TMS I.ii.3.2)
Smith then describes how society will collapse if we cannot even uphold such a low standard. The sort of society we get depends on the sympathetic process among people. Again, a network element is involved, as the social norm will be directed towards what most of us do and expect others to do. A small number of selfless and compassionate people are not able to change the norm, nor can a small number of sociopaths who have no feelings towards others.
In addition, by merely participating in society, our presence contributes to a moderating effect that benefits everyone, including strangers. The sympathy process induces us to find the right “pitch” with other people, and we need to tone down both our positive and negative sentiments in the presence of others. The less other people know of us, the harder it is for them to sympathize with our sentiments and the more toning down is needed. It leads to the intriguing calming effect of society.
We expect still less sympathy from an assembly of strangers, and we assume, therefore, still more tranquillity before them, and always endeavour to bring down our passion to that pitch, which the particular company we are in may be expected to go along with. Nor is this only an assumed appearance: for if we are at all masters of ourselves, the presence of a mere acquaintance will really compose us, still more than that of a friend; and that of an assembly of strangers still more than that of an acquaintance… Society and conversation, therefore, are the most powerful remedies for restoring the mind to its tranquillity, if, at any time, it has unfortunately lost it; as well as the best preservatives of that equal and happy temper, which is so necessary to self-satisfaction and enjoyment. (TMS, I.i.4.9-10)
The tranquility effect is the result of each of us participating in the society as a friend, acquaintance, or just a stranger that is not necessarily benevolent. Again, it is a form of externality; it is clearly not our intention to calm others down.

4. Private Compromise, Public Opulence 
To Smith, the most virtuous person is able to control his or her selfish impulses and act in the most considerate way towards others: “The man of the most perfect virtue, the man whom we naturally love and revere the most, is he who joins, to the most perfect command of his own original and selfish feelings, the most exquisite sensibility both to the original and sympathetic feelings of others.” (TMS III.3.35) Smith also knows that most of us are ordinary and weak, and are far from this ideal. His discussion of the poor man’s son example makes the point explicitly:
But though this splenetic philosophy, which in time of sickness or low spirits is familiar to every man, thus entirely depreciates those great objects of human desire, when in better health and in better humour, we never fail to regard them under a more agreeable aspect. Our imagination, which in pain and sorrow seems to be confined and cooped up within our own persons, in times of ease and prosperity expands itself to every thing around us.” (TMS IV.i.9)
Most of the time, we put the poor man’s son disillusion aside.
We are tempted by the life of riches; we are in awe of powerful figures; we are obsessed with the most frivolous trinkets and gadgets, but at the same time we are not completely selfish and think only about what is beneficial to us. Facing limited time and resources, the average person needs to compromise, much as we need to optimize our consumption choice given an income constraint. Choose when to be compassionate towards others, choose when to be calculating and bargain hard, choose how much family life to sacrifice and to focus on work, choose to be honest or insincere in our social life, we are constantly in the process of finding the right balance and getting the most out of life.
In this sense, it is meaningless to debate whether Smith is for or against various worldly pursuits. For Smith, it is a happy accident that most of us do not end up at the extremes, as our private compromise has an unintended consequence of leading to public opulence, both in the material and moral spheres. More goods to consume and conveniences in life, and also more agreeable interactions with others and stability and peace, Smith’s double life gets us the (second) best of both worlds.

  1. “To Adam Smith, mutually beneficial exchange emerges because of specialization, which, in its turn, implies the presence of increasing returns to the size of the exchange nexus. Even in a world of equals, trade offers mutuality of gain. There is no need for participants in the economic nexus to differ one from another.”

Related Links:
Erik Matson, Perspectives from Smith on Wealth and Happiness
An Animal That Trades: The Invisible Hand
Lauren Hall, Self Interest Rightly Understood

Buchanan, James. M., & Yoon, Yong J. (2000). “A Smithean Perspective on Increasing Returns.” Journal of the History of Economic Thought, 22(1), 43-48.
Coase, Ronald H. (1976). “Adam Smith's View of Man.” The Journal of Law and Economics, 19(3), 529-546.
Coase, Ronald H. (1977). “The Wealth of Nations.” Economic Inquiry, 15(3), 309-325.
Medema, Steven (2009) “Adam Smith and the Chicago School,” in Jeffrey Young, ed., The Elgar Companion to Adam Smith. Cheltenham: Edward Elgar Publishing, 346-57.
Smith, Adam (1976) [1759]. The Theory of Moral Sentiments, eds A.L. Macfie & D.D. Raphael, Oxford: Clarendon Press.
Smith, Adam (1979) [1776]. An Inquiry into the Nature and Causes of the Wealth of Nations, eds R.H. Campbell & A.S. Skinner, Oxford: Clarendon Press.