Once Again "Das Adam Smith Problem"

Pedro Swartz, professor at the San Pablo CEU University in Madrid, Spain and associate fellow at the Cato Institute, re-visits the so-called’Das Adam Smith problem’ in Spain Herald, 21 November, (read it at: http://www.spainherald.com/2068.html).

“In 1998, Nobel Prize winner Vernon Smith wrote an article titled “The Two Faces of Adam Smith” in which he contrasted Smith’s two theories with experiments carried out in a computer laboratory with real people and real money. In the “dictator game” one of the players receives 100 dollars and can decided how to divide it with another player; if the second player rejects what he is offered, both walk away with nothing. According to the theory in “The Wealth of Nations”, an acceptable division would be $99 to $1, given that the second player should not reject it as $1 is better than nothing. But in the games, the receiver often rejected much greater sums because he considered them unfair. Moreover, when the “dictator” could chat with the receiver, he tended to offer a higher amount than when the game was played anonymously.”

Vernon Smith’s dictator game is well known in negotiation courses in the US (less so in the UK). They are not decisive because there are several explanations for what is happening, observed over many plays of the game both inside and outside the computer laboratory. I have played it and observed it, and numerous variations of it. That many people do not accept the 99-1 dollar offer is not unique. In the whole area of the influence of past costs on decisions few choose the marginal additional cost over ‘bygones’ as being decisive.

Incidentally, “Wealth of Nations” does not contain a ‘theory’ that “an acceptable division would be $99 to $1”. That is purely speculation based on the modern interpretation of Chicago economics (sometimes presented inaccurately as Adam Smith’s).

Unfairness is one explanation for rejecting any offer not close to 50-50. There is also the version of repeated plays of the game, in which players tend to search for ‘better’ offers and, interestingly, the ‘dictators’ tend to make ‘better’ offers (remember they get nothing too if their offer is rejected).

When conversation is allowed – a proto negotiation situation – offers tend to improve. This is part of the dynamics of negotiation; negotiators prefer to make net gains rather than absolute losses and the process is one of mutual exchange of offers and demands. Smith accurately calls this bargaining: “Give me that which I want and you shall have this which you want” (“Wealth of Nations”: I.ii.2. page 26).

One might also wish to consider these points in the context of knowing that experiments show, using real people (not just graduate students), that when people are asked separately to set a price for something (even the most trivial item in a poor condition – a chipped cup) those designated as seller always (or as near as) set their selling price higher than the price set by those designated as buyers. This is also anonymously. They appear to give themselves negotiation room in both roles.

I think Professor Swartz is incorrect in his summary of the experiments as being evidence for the ‘Adam Smith problem’. “Moral sentiments” does not present a theory of human behaviour different from “Wealth of Nations”.

Pedro Swartz concludes:

“Vernon Smith argued that Adam Smith had intuitively discovered two types of co-existing human behavior: positive reciprocity in face-to-face exchanges and self-interest in impersonal exchanges on the economic market. When dealing with people we know, the Scottish master’s theory of moral sentiments comes into play. On the other hand, when the exchange is made between strangers, individuals look first to their own self-interest. In direct relationships, non-monetary reciprocity is operating, enforced by social sanctions. In the economic market, remuneration is monetary and repression of incompliance is provided by commercial or legal penalties. This is how free societies function.”

Society is more than the summation of its wealth (its annual output of goods and services); it also consists of the influences of its history, it systems of justice, its governance, its arts and literature, and so on. Two personalities active in the same body would not be stable. People manage to be most interested in their closest relatives and near indifferent to anonymous strangers (on most occasions).

The social cohesion arising from the causes that Smith analyses in “Moral Sentiments” is closely linked to the economic cohesion of “Wealth of Nations”:

“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 it is 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” (“Moral Sentiments”: II.ii.3.3: page 86).

That people have some “interest in the fortune of others” (“Moral Sentiments”: opening page), as quoted by Swartz, is stated by Smith to be despite a person’s ‘selfishness’ (“how so ever a man be supposed”). This is Adam Smith’s opening sentence to his volume explaining how such sentiments towards others cement society’s cohesion. Far from this being contradicted in “Wealth of Nations”, the same cohesive force operates. Our sentiments are strongest towards our immediate family and then dilute as ‘distance’ increases – acquaintances, strangers and anonymous others. Markets connect people in chains of anonymity and we express our self-interest by serving the interests of others (“Give me that which I want and you shall have this which you want”!) who appear in front of us when we make selling or purchasing decisions.

Why 19th century German economists launched “Das Adam Smith Problem” would provide a useful research topic. Perhaps they were schooled in Frederich List’s (1854) intemperate polemic against Adam Smith’s political economy, seeing it as an “English” (sic) assault on the rest of the world’s economies, disguised as ‘free trade’, and they were part of the increasing nationalism of the German states, flowering in the next century.