Adam SmithAdam Smith, Behavioral Economist

Adam Smith Behavioral Economist

Nava Ashraf Colin F Camerer andGeorge Loewenstein

I n The Wealth of Nations published in 1776 Adam Smith famously argued thateconomic behavior was motivated by self-interest But 17 years earlier in 1759Smith had proposed a theory of human behavior that looks anything but self-

interested In his first book The Theory of Moral Sentiments Smith argued that behaviorwas determined by the struggle between what Smith termed the ldquopassionsrdquo and theldquoimpartial spectatorrdquo The passions included drives such as hunger and sex emotionssuch as fear and anger and motivational feeling states such as pain Smith viewedbehavior as under the direct control of the passions but believed that people couldoverride passion-driven behavior by viewing their own behavior from the perspective ofan outsidermdashthe impartial spectatormdasha ldquomoral hector who looking over the shoulderof the economic man scrutinizes every move he makesrdquo (Grampp 1948 p 317)1

1 A long-standing dispute has raged over whether Adam Smithrsquos view of human motivation as expressedin The Theory of Moral Sentiments complements or contradicts the view of human motivation expressed inThe Wealth of Nations Although much has been written about ldquodas Adam Smith problemrdquo of reconcilingthese texts most modern Smith scholarship asserts that there is no essential contradiction between thetexts As the editors of the Glasgow Edition of the Works and Correspondence of Adam Smith editionof The Theory of Moral Sentiments write (Raphael and Macfie 1976 p 20) ldquothe so called lsquoAdam Smithproblemrsquo was a pseudo-problem based on ignorance and misunderstanding Anybody who reads TheTheory of Moral Sentiments first in one of the earlier editions and then in edition six will not have theslightest inclination to be puzzled that the same man wrote this book and The Wealth of Nations nor tosuppose that he underwent any radical change of view about human conductrdquo

y Nava Ashraf is Assistant Professor in the Negotiation Organizations and Markets Group atHarvard Business School Cambridge Massachusetts Colin F Camerer is Rea A and Lela GAxline Professor of Business Economics California Institute of Technology Pasadena CaliforniaGeorge Loewenstein is Professor of Economics and Psychology Department of Social and DecisionSciences Carnegie-Mellon University Pittsburgh Pennsylvania Their e-mail addresses arenashrafhbsedu camererhsscaltechedu and gl20andrewcmuedu respectively

Journal of Economic PerspectivesmdashVolume 19 Number 3mdashSummer 2005mdashPages 131ndash145

The ldquoimpartial spectatorrdquo plays many roles in The Theory of Moral SentimentsWhen it comes to choices that involve short-term gratification but long-term coststhe impartial spectator serves as the source of ldquoself-denial of self-government ofthat command of the passions which subjects all the movements of our nature towhat our own dignity and honour and the propriety of our own conduct requirerdquo(Smith 1759 [1981] I i v 26) much like a farsighted ldquoplannerrdquo entering intoconflict with short-sighted ldquodoersrdquo (Shefrin and Thaler 1981 Meardon and Ort-mann 1996) In social situations the impartial spectator plays the role of aconscience dispassionately weighing the conflicting needs of different personsSmith (I i v 29) recognized however that the impartial spectator could be ledastray or rendered impotent by sufficiently intense passions ldquoThere are somesituations which bear so hard upon human nature that the greatest degree ofself-government is not able to stifle altogether the voice of human weakness orreduce the violence of the passions to that pitch of moderation in which theimpartial spectator can entirely enter into themrdquo

Adam Smithrsquos psychological perspective in The Theory of Moral Sentiments isremarkably similar to ldquodual-processrdquo frameworks advanced by psychologists (forexample Kirkpatrick and Epstein 1992 Sloman 1996 Metcalf and Mischel 1999)neuroscientists (Damasio 1994 LeDoux 1996 Panksepp 1998) and more recentlyby behavioral economists based on behavioral data and detailed observations ofbrain functioning (Bernheim and Rangel 2004 Benhabib and Bisin 2004 Fuden-berg and Levine 2004 Loewenstein and OrsquoDonoghue 2004) It also anticipates awide range of insights regarding phenomena such as loss aversion willpower andfairness (V Smith 1998) that have been the focus of modern behavioral economics(see Camerer and Loewenstein 2004 for a recent review) The purpose of thisessay is to draw attention to some of these connections Indeed as we propose atthe end of the paper The Theory of Moral Sentiments suggests promising directionsfor economic research that have not yet been exploited

Preferences and the Dual-Process Perspective

The Theory of Moral Sentiments is packed with insights about preferences usingthe dual-process framework of the passions and the impartial spectator Some ofthe discussion relates to aspects of individual preference and judgment what wewould today call loss aversion intertemporal choice and overconfidence Otherparts of the discussion focus on preferences that arise in social contexts altruismfairness and how they together generate trust in markets

Loss AversionApproximately 200 years before Kahneman and Tversky (1979) identified the

regularity in choices that has come to be known as ldquoloss aversionrdquo Adam Smith(1759 [1981] III ii 176ndash177) displayed an acute awareness of loss-aversion as anexperiential phenomenon ldquoPain is in almost all cases a more pungent sensa-tion than the opposite and correspondent pleasure The one almost always

132 Journal of Economic Perspectives

depresses us much more below the ordinary or what may be called the natural stateof our happiness than the other ever raises us above itrdquo Smith also drew attentionto what behavioral economists would now refer to as the underweighting of opportunitycosts relative to out-of-pocket costs Smith (II ii ii 121) notes that ldquobreach of propertytherefore theft and robbery which take from us what we are possessed of aregreater crimes than breach of contract which only disappoints us of what weexpectedrdquo2

Modern research has produced a wealth of evidence from human behaviorsupporting both of these effects and Capuchin monkeys also exhibit loss-aversion(Chen Lakshminarayanan and Santos 2005) Brain imaging technology has shownthat that losses and gains are processed in different regions of the brain(OrsquoDoherty Kringelback Rolls Hornak and Andrews 2001) suggesting that gainsand losses may be processed in qualitatively different ways Moreover a body ofliterature has shown that when loss aversion is combined with narrow bracketing ofdecisionsmdashthe tendency to take decisions one at a time without considering the bigpicturemdashits effects are evident in asset returns (Benartzi and Thaler 1997) laborsupply (Camerer Babcock Loewenstein and Thaler 1997) the reluctance to selllosing stocks and houses (Odean 1998 Genesove and Mayer 2001) and large gapsbetween buying and selling prices (Kahneman Knetsch and Thaler 1990)

Intertemporal Choice and Self-ControlIntertemporal choice offers a straightforward application of Smithrsquos dual

process model Smith (1759 [1981] IV ii 273) viewed the passions as largelymyopic ldquoThe pleasure which we are to enjoy ten years hence interests us so littlein comparison with that which we may enjoy to-day the passion which the firstexcites is naturally so weak in comparison with that violent emotion which thesecond is apt to give occasion to that the one could never be any balance to theother unless it was supported by the sense of proprietyrdquo ldquoThe spectatorrdquo incontrast ldquodoes not feel the solicitations of our present appetites To him thepleasure which we are to enjoy a week hence or a year hence is just as interestingas that which we are to enjoy this momentrdquo (IV ii 272)

The struggle between the myopic passions and farsighted impartial spectatorappears later in behavioral economics in the form of a ldquodoerrdquo and ldquoplannerrdquo inShefrin and Thaler (1981 see also Benabou and Pyciak 2002 Bernheim andRangel 2002) What are now called ldquoquasi-hyperbolic discounting modelsrdquo (Laib-son 1997) in a similar spirit have also been used by Angeletos Laibson Tobac-man Repetto and Weinberg (2001) to study life cycle saving by OrsquoDonoghue andRabin (1999) to study life cycle temptation and by Ashraf Karlan and Yin (2004) to

2 Thaler (1980) who first drew attention to the underweighting of opportunity costs relative toout-of-pocket costs attributes it to loss aversion opportunity costs are treated as foregone gains ratherthan as losses

Nava Ashraf Colin F Camerer and George Loewenstein 133

study demand for committed savings in the Philippines3 Moreover recent researchin which decisionmakersrsquo brains were scanned while they made intertemporalchoices vindicates Smithrsquos view that decisions that provide the potential for plea-sures that we may enjoy today activate emotional regions of the brain in a way thatdecisions involving only delayed outcomes do not (McClure Laibson Loewensteinand Cohen 2004)

OverconfidenceAdam Smith (1776 I x 1) wrote about the ldquoover-weening conceit which the

greater part of men have of their own abilitiesrdquo a pattern of judgment thatinfluences preferences over risky choices According to Smith ldquothe chance of gainis by every man more or less over-valued and the chance of loss is by most menunder-valued and by scarce any man who is in tolerable health and spirits valuedmore than it is worthrdquo

Smithrsquos ldquooverweening conceitrdquo reappears in modern behavioral economics inthe form of executive ldquohubrisrdquo that motivates the failure of so many mergers (Roll1986) and other business failures (Camerer and Lovallo 1999) and can be derivedtheoretically from evolutionary considerations (Waldman 1993 Compte and Pos-telwaite 2005) Moreover Smithrsquos caveat that overconfidence only applies to thosein ldquotolerable health and spiritsrdquo anticipates modern studies showing that peoplewho are not in tolerable health and spiritsmdashspecifically the clinically depressedmdashare the exceptional ones among us who are not optimistic wishful thinkers (forexample Taylor and Brown 1994)

AltruismJudging from the extensive treatment that Adam Smith gave to sympathy in The

Theory of Moral Sentiments he viewed it as one of the more important passionsHowever he also viewed sympathy as an extremely unreliable guide to moralbehavior sometimes falling short and sometimes exceeding what is morallyrequired

Smith argued that natural sympathy often falls short of what is morally justifiedby mass misery In one evocative passage he noted the striking lack of sympathy thata resident of Europe would be likely to experience if an earthquake eliminated thepopulation of China After expressing ldquovery strongly his sorrow for the misfortuneof that unhappy peoplerdquo Smith (1759 [1981] III iii 192ndash193) commented suchan individual would likely ldquopursue his business or his pleasure take his repose or hisdiversion with the same ease and tranquility as if no such accident had hap-pened If he was to lose his little finger to morrow he would not sleep to-nightbut provided he never saw them he will snore with the most profound security over

3 Using the terms of Laibson (1997) these are sometimes called ndash discounting models Mappedroughly onto Smithrsquos terms is the weight on all future outcomes so that 1 represents the relativestrength of the passions that prefer immediate rewards and is a conventional discount rate Smithrsquospassage above suggests that the impartial spectator uses 1


the ruin of a hundred millions of his brethrenrdquo Although modern media may helpto bring vivid images of distant tragedies into peoplersquos homes (like the 2004 IndianOcean tsunami) thus reducing social distance such imagery does so in a highlyselective fashion that only amplifies Smithrsquos concerns Recent incidents caught onvideotape capture the publicrsquos sympathies but more serious problems that societymay have adapted to or that donrsquot lend themselves to vivid imagery are as likely asthey were in Smithrsquos time to elicit a paucity of sympathy

In other cases Smith believed that people experience sympathy that is com-pletely out of proportion to the plight of the individual one feels sympathetictoward ldquoWe sometimes feel for another a passion of which he himself seems to bealtogether incapablerdquo Smith (1759 [1981] I i i 7ndash8) wrote ldquoWhat are the pangsof a mother when she hears the moanings of her infant that during the agony ofdisease cannot express what it feels In her idea of what it suffers she joins to itsreal helplessness her own consciousness of that helplessness and her own terrorsfor the unknown consequences of its disorder and out of all these forms for herown sorrow the most complete image of misery and distress The infant however feelsonly the uneasiness of the present instant which can never be greatrdquo Smith adds drylythat ldquowe sympathize even with the deadrdquo who themselves experience nothing

If humans were under the control of their passions one could expect toobserve extreme callousness alternating with remarkable generosity with little logicor consistency governing the transitions This tendency is manifested in the ldquoiden-tifiable victim effectrdquo in which people sympathize more with a known victim thanwith a statistical likelihood that a not-yet-known person is likely to become a victim(Schelling 1984 Small and Loewenstein 2003) In the political economy fluctu-ations in sympathy probably influence public policies creating huge inconsisten-cies in the implicit value that different policies place on saving a human life (Tengsand Graham 1996)

Controlled economics experiments show some fluctuations in expressed sym-pathy too For example in ldquodictator gamerdquo experiments people simply divide aknown sum of money between themselves and another person Absent any know-ledge about the target recipient people offer an average of 20 percent (offers ofnothing and half are most common Camerer 2003 chapter 2) When dictatorsknow the recipient is the Red Cross rather than a fellow student the averageallocation doubles (Eckel and Grossman 1996) When the recipient stands up andgives a few facts about him- or herself the average amount given goes up to half andthe variance increasesmdashas if dictator givers generally sympathize when they know alittle about somebody but also make snap character judgments of who is deservingand who is not (Bohnet and Frey 1999)

These fluctuations in sympathy are moderated according to Smith by theimpartial spectator Returning to the case of devastation in China Smith (1759[1981] III iii 192) asks whether his representative European would be willing toldquosacrifice the lives of a hundred millions of his brethrenrdquo to save the injury to hislittle finger Smith concludes that the answer is ldquoNordquo ldquoHuman nature startles withhorror at the thought and the world in its greatest depravity and corruption never

Adam Smith Behavioral Economist 135

produced such a villain as could be capable of entertaining itrdquo The impartialspectator recognizes (194) that ldquowe are but one of the multitude in no respectbetter than any other in itrdquo

FairnessAlthough Smith viewed altruism as a somewhat erratic force he believed that

other motivations played a more reliable civilizing role Chief among these wasfairness Smith (1759 [1981] II ii iii 125) writes ldquoNature has implanted in thehuman breast that consciousness of ill-desert those terrors of merited punishmentwhich attend upon its violation as the great safe-guards of the association ofmankind to protect the weak to curb the violent and to chastise the guiltyrdquo Smithbelieved this natural sentiment toward fairness was the source of the virtue ofjustice which he saw as the ldquomain pillar that upholds the whole edifice If it isremoved the great the immense fabric of human society must in a momentcrumble to atomsrdquo Moreover Smith (129) viewed the desire for justice as some-thing primal ldquoAll men even the most stupid and unthinking abhor fraud perfidyand injustice and delight to see them punished But few men have reflected uponthe necessity of justice to the existence of society how obvious soever that necessitymay appear to berdquo

Modern research suggests that an innate concern for fairness extends evenbeyond humans to other primates Capuchin monkeys will reject small rewardswhen they see other monkeys they perceive as undeserving getting more than theydo (Brosnan and de Waal 2002) Cotton-top tamarins will pull a lever to givemarshmallows (which tamarins love) to other tamirins who have altruisticallyrewarded them with marshmallows in earlier lever-pulls more often then they willpull levers to tamarins who were not previously altruistic (Hauser Chen Chen andChang 2003)

The impartial spectator plays an essential role in fairness by causing individ-uals to internalize other peoplersquos sense of fairness Smith (1759 [1981] III iii 195)argues ldquoThere is no commonly honest man who does not dread the inwarddisgrace of such an actionrdquo

Altruism Fairness and Market InteractionsMarket interactions require as Boulding (1969 p 5) points out ldquoa minimum

degree of benevolence even in exchange without which it cannot be legitimatedand cannot operate as a social organizerrdquo Arrow (1974) also notes the importanceof trust as a lubricant of exchange economizing on the costs of gathering infor-mation about trading partners For Adam Smith a mixture of concern aboutfairness (enforced by the fear of negative appraisal by the impartial spectator) andaltruism played an essential role in market interactions allowing trust repeatedtransactions and material gains to occur

Smith described the beginnings of market exchange thus ldquoin a nation ofhunters if any one has a talent for making bows and arrows better than hisneighbours 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 nooccasion to provide for himself as the surplus of his own labor does it moreeffectuallyrdquo (Smith 1762ndash1763 [1976a] p 220)

As Jeffrey Young (1997 p 62) remarks ldquo[T]he other regarding principles ofhuman nature which bind people together in society are a necessary condition forthe emergence of the exchange of surplus produce amongst neighbours Smithuses the moral side of human nature to help him explain why voluntary agreementand not violence takes place when these two hunters meetrdquo

In experiments norms of positive reciprocity often create trust where it has nobusiness flourishing (according to the textbook view that emphasizes moral hazardwhen contracts are incomplete)mdashamong strangers in one-shot transactions Forexample in simple ldquotrust gamerdquo experiments subjects decide how much money toput in a mailbox and their investment is tripled (representing a socially productivereturn) A second subject takes the tripled money out and can keep it all or repaysome to the original investor Most experiments show that the second subject doesrepay money even in one-shot games that control for anonymity and they typicallyrepay just enough to make the investment worthwhile (Berg Dickhaut and Mc-Cabe 1995 Camerer 2003 chapter 2) Experiments run in Russia South Africaand the United States showed that many trustors do not even expect to makemoney but are motivated to ldquoinvestrdquo by pure ldquowarm-glowrdquo altruism (Ashraf Bohnetand Piankov 2003) Simple models that incorporate a preference for fairness orequality have been developed and applied to a broad range of games (Rabin 1993in this journal Fehr and Gachter 2000)

Furthermore trust as measured in simple surveys is strongly correlated witheconomic growth (Knack and Keefer 1997) (though the direction of causality isunknown) An anthropology experiment involving 15 small-scale societies foundthat in societies in which people buy and sell more often in markets offers inultimatum bargaining games are perhaps surprisingly closer to equal sharing thanin less market intensive societies (Henrich Boyd Bowles Gintis Fehr and Cam-erer 2004)4 Adam Smith would not be surprised by the finding that markets areoften built on motivations of fairness altruism and trustmdashrather than on self-interest alonemdashyet this mixture of motivations remains a challenge to the moderneconomics profession

4 An ldquoultimatum gamerdquo has two players The first player is given a sum of money The player is instructedto offer some share of that money to the second player If the second player accepts the division thenboth players keep the money If the second player rejects the division both players receive zero In aone-shot play of the game if players are rational and self-interested then the first player should offer thesecond player only a minimal amount which the second player will accept because it is better thannothing But when the game is actually played small offers are commonly rejected (even for highstakes) and even in a one-shot game it is common for the first player to offer a 5050 split of the originalstake For expositions of the ultimatum game in this journal see Thaler (1988) and Camerer and Thaler(1995)


Consumption and Its Discontents

In The Theory of Moral Sentiments Smith argues that much economic activity isthe product of a forecasting errormdashpeoplersquos illusion that acquiring wealth posses-sions and status will make them permanently happy In fact Smith (1759 [1981]III iii 209) argued both pleasure and pain are often transient ldquoBy the constitutionof human nature agony can never be permanentrdquo Following a calamity he noteda person ldquosoon comes without any effort to enjoy his ordinary tranquilityrdquo Smithfurther observed that people not only adapt quickly to circumstances but under-estimate such adaptation and as a result often overestimate the duration of happyand sad feelings

A man with a wooden leg suffers no doubt and foresees that he mustcontinue to suffer during the remainder of his life a very considerableinconveniency He soon comes to view it however exactly as every impartialspectator views it as an inconveniency under which he can enjoy all theordinary pleasures both of solitude and of society He no longer weepshe no longer laments he no longer grieves over it as a weak man maysometimes do in the beginning

Considerable modern research backs up Smithrsquos contentions For example Fred-erick and Loewenstein (1999) review diverse lines of research showing that ongoingconditions such as health problems incarceration poverty and wealth have littlelong-term impact on subjective well-being Indeed Smithrsquos example of the manwith a wooden leg foreshadows a classic study by Brickman Coates and Janoff-Bulman (1978) showing that the happiness of paraplegics and lottery winners tendsto revert surprisingly close to a normal baseline after their respectively tragic andwonderful life-changing events

Perhaps even more important for economics than the fact that people adapt toongoing conditions is the equally well documented finding that people are gener-ally unaware of the extent to which they will adapt A large body of contemporarypsychological research suggests that people typically believe that pleasure and painwill last longer than they actually do (for example Wilson and Gilbert 2003 andLoewenstein OrsquoDonoghue and Rabin 2003 for a summary of research on thispoint and discussion of implications for economics) Smith (1759 [1981] IV I259) anticipated both points in The Theory of Moral Sentiments Anticipating laterfindings documenting adaptation to material conditions he expresses skepticismabout the pleasure derived from possessions ldquoHow many people ruin themselves bylaying out money on trinkets of frivolous utilityrdquo And he also devotes numerouspages of The Theory of Moral Sentiments to describing ways in which the anticipationof status gained was much better than the realization Only at the end of life whenit was too late to remedy the situation did Smith believe that the wealthy come to


recognize the folly of their waysmdashthe paucity of pleasure they derive from all thegoods they struggled so hard to procure (1759 [1981] IV i 260ndash261)

Through the whole of his life he pursues the idea of a certain artificial andelegant repose which he may never arrive at for which he sacrifices a realtranquility that is at all times in his power and which if in the extremity of oldage he should at last attain to it he will find to be in no respect preferable tothat humble security and contentment which he had abandoned for it It isthen in the last dregs of life his body wasted with toil and disease his mindgalled and ruffled by the memory of a thousand injuries and disappointmentswhich he imagines he has met with from the injustice of his enemies or fromthe perfidy and ingratitude of his friends that he begins at last to find thatwealth and greatness are mere trinkets of frivolous utility no more adaptedfor procuring ease of body or tranquility of mind than the tweezer-cases ofthe lover of toys

Smith would have done well to heed his own advice He worked himself so sick indrafting The Wealth of Nations that in 1773 he sent David Hume a letter makingHume his literary executor in case he should die before publishing his manuscripts(though as it turned out Smith outlived Hume by 14 years)

Because the rich pursue ends that fail to make them happy Smith (1759[1981] IV i 265) believed that they end up being no more happy than the poorldquoIn ease of body and peace of mind all the different ranks of life are really upona level and the beggar who suns himself by the side of the highway possesses thatsecurity which kings are fighting forrdquo and ldquoin what constitutes the real happiness ofhuman life [the poor] are in no respect inferior to those who would seem so muchabove themrdquo Indeed a large body of modern research on the determinants ofhappiness has quite consistently found surprisingly weak connections betweenhappiness and wealth or income especially over time or across countries (Easterlin1974 Diener and Biswas-Diener 2002 Frey and Stutzer 2002)

Yet while believing that consumption of goods as well as wealth and greatnessall provide only ldquofrivolous utilityrdquo Smith believed that the productivity of marketeconomy is driven by this ldquodeceptionrdquomdashthe misguided belief that wealth bringshappiness As Smith (1759 [1981] IV i 263ndash264) notes ldquo[I ]t is this deceptionwhich rouses and keeps in continual motion the industry of mankind It is thiswhich first prompted them to cultivate the ground to build houses to found citiesand commonwealths and to invent and improve all the sciences and arts whichennoble and embellish human life which have entirely changed the whole face ofthe globerdquo

Indeed Adam Smith even invokes the ldquoinvisible handrdquomdasha term that may be thethe most prominent legacy of his work although it occurs only once in The Wealthof Nations and only once in The Theory of Moral Sentimentsmdashto argue that as thewealthy seek out goods and status that ultimately bring them little pleasure they


inadvertently end up promoting the good of the poor5 Here is Smithrsquos invisiblehand (1759 [1981] IV i 264) in The Theory of Moral Sentiments

In spite of their natural selfishness and rapacity though they mean only theirown conveniency though the sole end which they propose from the laboursof all the thousands whom they employ be the gratification of their own vainand insatiable desires they divide with the poor the produce of all theirimprovements They are led by an invisible hand to make nearly the samedistribution of the necessities of life which would have been made had theearth been divided into equal portions among all inhabitants and thuswithout intending it without knowing it advance the interest of the society

While perhaps overstating the case when Smith refers to the equitable distributionof the necessities of life he is arguing that the distribution of things that actuallybring happiness to people is far more equitable than the distribution of tweezer-cases and other ldquotrinkets of frivolous utilityrdquo That the things that really matter forhappiness are more equitably distributed than those that donrsquot may help to explainwhy cross-sectional differences in income seem to bring such small increments inhappiness

Unexploited Ideas

Adam Smithrsquos Theory of Moral Sentiments is not only packed with insights thatpresage developments in contemporary behavioral economics but also with prom-ising leads that have yet to be pursued Here we enumerate four of them 1) thedesire to be well-regarded by posterity 2) negative reactions to being misjudged3) mistaken belief in the objectivity of tastes and 4) sympathy for the great and rich

A desire to be well-regarded by posterity certainly drives the efforts of many creativeprofessionalsmdashartists writers architects and academic economists As Smith (1759[1981] I ii 169) comments ldquoMen have voluntarily thrown away life to acquire afterdeath a renown which they could no longer enjoy Their imagination in themeantime anticipated that fame which was in future times to be bestowed uponthemrdquo A concern for onersquos reputation to posterity might be thought of as reservedfor the richest and most powerful members of society such as those whose namesadorn buildings in universities and hospitals but it is not limited to the richEconomists have studied the bequest motive which is no doubt partly fueled by thismotive but they have not yet explored what may be more potent effects of posterityon current decisions

Economics generally assumes that people care about outcomes not about the

5 For discussion in this journal of the context for the ldquoinvisible handrdquo in The Wealth of Nations see Persky(1989) For a discussion in this journal of the ldquoinvisible handrdquo in the context of The Theory of MoralSentiments and Adam Smithrsquos ethical system see Evensky (1993)


source of outcomes However Adam Smith pointed out that people have negativereactions to being misjudged that go beyond the outcome Smith (1759 [1981] III ii174) drew special attention to one particular situationmdashthat of ldquounmerited re-proachrdquo which he noted ldquois frequently capable of mortifying very severely evenmen of more than ordinary constancy An innocent man brought to thescaffold by the false imputation of an infamous or odious crime suffers the mostcruel misfortune which it is possible for innocence to sufferrdquo Research on ldquoproce-dural justicerdquo shows a substantial concern for whether a trial was fair for exampleas well as for the outcome of the trial (Lind and Tyler 1988) One study showedthat the propensity to file wrongful-termination lawsuits after firing is correlatedwith workersrsquo perceptions of whether their firing was just (controlling for expectedpayoffs from litigation Lind Greenberg Scott and Welchans 2000) This insighthas interesting implications for principal-agent theory Smithrsquos insights suggest thatgoodwill could be seriously eroded if a principal penalizes an agent who produceda low level of output due to bad luck rather than poor effort

Ample evidencemdashbeginning with the huge cross-cultural differences in tastesfor foodmdashsuggests that tastes are subjective based on culture familiarity and so onHowever Smith argued that people underestimate such influences having insteada mistaken belief in objectivity of tastes Smith (1759 [1981] V i) commented ldquo[F]ewmen are willing to allow that custom or fashion have much influence upontheir judgments concerning what is beautifulrdquo and they ldquoimagine that all the ruleswhich they think ought to be observed in each of them are founded upon reasonand nature not upon habit or prejudicerdquo Ross and Ward (1996) refer to thetendency for people to think their own tastes and beliefs are more legitimate andmore widely shared than they really are as naıve realism Naıve realism has poten-tially important implications for a variety of economic issues gift-giving negotia-tions in which both parties are likely to think that their own preferences are sharedby the other side more than they are principal-agent situations in which theprincipal has to set rewards for the agent and sales and marketing (Davis Hochand Ragsdale 1986) It can also lead to cultural conflict If those in one societybelieve that eating monkey is inherently disgusting then we are likely to disparagemonkey-eaters rather than treating the tastes of those who disagree as akin to tastesfor opera or smelly cheese

Finally contrary to the sensible notion that one should sympathize with thoseless fortunate than oneself Smith (1759 [1981] iii ii 72ndash73) argued that there isa natural tendency to experience sympathy for the great and rich

When we consider the condition of the great in those delusive colours inwhich the imagination is apt to paint it it seems to be almost the abstract ideaof a perfect and happy state It is the very state which in all our waking dreamsand idle reveries we had sketched out to ourselves as the final object of all ourdesires We feel therefore a peculiar sympathy with the satisfaction of thosewho are in it We favour all their inclinations and forward all their wishesWhat pity we think that any thing should spoil and corrupt so agreeable a


situation It is the misfortunes of kings only which afford the proper subjectsfor tragedy

Smithrsquos description recalls the outpouring of grief after the accidental deaths ofPrincess Diana and John F Kennedy Jr Popular Magazines like People and US andsimilar highly rated TV shows are filled with stories about where athletes and starsshop what they eat and wear and the ups and downs of their love lives Fascinationwith celebrity of this sort also has a direct economic effect through the use ofcelebrities as marketing vehicles

Smith believed both that this sympathy for the rich was a form of corruptionbased on a moral mistake and also that it provided an important underpinning forsocial stability Smith (1759 [1981] I iii iii 84) described the moral mistake in thisway ldquo[T]hat wealth and greatness are often regarded with the respect and admi-ration which are due only to wisdom and virtue and that the contempt of whichvice and folly are the only proper objects is most unjustly bestowed upon povertyand weaknesses has been the complaint of moralists in all agesrdquo Indeed Smithfurther argued that the ldquodisposition to admire and almost to worship the rich andthe powerful and to despise or at least to neglect persons of poor and meancondition is the great and most universal cause of the corruption of ourmoral sentimentsrdquo However Smith also held that this sympathy was ldquonecessary bothto establish and to maintain the distinction of ranks and the order of societyrdquo Thissympathy for the rich may help to explain one of the puzzles of capitalism thefailure of the majority democratic societies to impose extremely high taxes on therichest members Smithrsquos perspective suggests the possibility that people donrsquot wantto tax the rich not because they expect to become rich themselves as some havesuggested but because average citizens donrsquot want to ldquospoil and corruptrdquo what theyperceive as the ldquoagreeable situationrdquo of the rich

Conclusion

Adam Smithrsquos actors in The Theory of Moral Sentiments are driven by an internalstruggle between their impulsive fickle and indispensable passions and the impar-tial spectator They weigh out-of-pocket costs more than opportunity costs haveself-control problems and are overconfident They display erratic patterns of sym-pathy but are consistently concerned about fairness and justice They are motivatedmore by ego than by any kind of direct pleasure from consumption and thoughthey donrsquot anticipate it ultimately derive little pleasure from either In short AdamSmithrsquos world is not inhabited by dispassionate rational purely self-interestedagents but rather by multidimensional and realistic human beings

y Thanks to Kim Border for an apt Adam Smith quotation to Eric Angner James HinesJesse Shapiro Jeremy Tobacman Timothy Taylor and Michael Waldman for helpful com-ments and to Ed Glaeser and Andrei Shleifer for encouragement


References

Angeletos George-Marios David Laibson Jer-emy Tobacman Andrea Repetto and StephenWeinberg 2001 ldquoThe Hyperbolic ConsumptionModel Calibration Simulation and EmpiricalEvaluationrdquo Journal of Economic Perspective 153pp 47ndash68

Arrow Kenneth 1974 The Limits of Organisa-tion New York Norton

Ashraf Nava Iris Bohnet and Nikita Piankov2003 ldquoIs Trust a Bad Investmentrdquo KennedySchool of Government Working Paper No 03-047 November

Ashraf Nava Dean Karlan and Wesley Yin2004 ldquoTying Odysseus to the Mast Evidencefrom a Commitment Savings Product in the Phil-ippinesrdquo Mimeo

Benabou Roland and Marek Pyciak 2002ldquoDynamic Inconsistency and Self-Control APlanner-Doer Interpretationrdquo Economics Letters773 pp 419ndash24

Benartzi Shlomo and Richard Thaler 1997ldquoMyopic Loss Aversion and the Equity PremiumPuzzlerdquo Quarterly Journal of Economics 1101pp 73ndash92

Benhabib Jess and Alberto Bisin Forthcom-ing ldquoSelf-Control and Consumption-Savings De-cisions Cognitive Perspectivesrdquo Games and Eco-nomic Behavior

Berg Joyce John Dickhaut and Kevin A Mc-Cabe 1995 ldquoTrust Reciprocity and SocialHistoryrdquo Games and Economic Behavior 101pp 290 ndash307

Bernheim Douglas and Antonio Rangel2004 ldquoAddiction and Cue-Triggered DecisionProcessesrdquo American Economic Review 945pp 1558 ndash590

Bohnet Iris and Bruno Frey 1999 ldquoTheSound of Silence in Prisonerrsquos Dilemma andDictator Gamesrdquo Journal of Economic Behavior andOrganization 381 pp 43ndash57

Boulding Kenneth E 1969 ldquoEconomics as aMoral Sciencerdquo American Economic Review 591pp 1ndash12

Brickman Philip Dan Coates and RonnieJanoff-Bulman 1978 ldquoLottery Winners and Ac-cident Victims Is Happiness Relativerdquo Journal ofPersonality and Social Psychology 368 pp 917ndash27

Brosnan Sarah F and Frans B M de Waal2002 ldquoA Proximate Perspective on ReciprocalAltruismrdquo Human Nature 131 pp 129ndash52

Camerer Colin F 2003 Behavioral Game The-ory Experiments on Strategic Interaction PrincetonPrinceton University Press

Camerer Colin F and George Loewenstein

2004 ldquoBehavioral Economics Past Present Fu-turerdquo in Advances in Behavioral Economics ColinF Camerer George Loewenstein and MathewRabin eds New York Russell Sage pp 3ndash51

Camerer Colin and Dan Lovallo 1999 ldquoOver-Confidence and Excess Entry An Experimen-tal Approachrdquo American Economic Review 891pp 306 ndash18

Camerer Colin and Richard Thaler 1995ldquoMore Dictator and Ultimatum Gamesrdquo Journalof Economic Perspectives 92 pp 209ndash19

Camerer Colin F Linda Babcock GeorgeLoewenstein and Richard Thaler 1997 ldquoLaborSupply of New York City Cab Drivers One Day ata Timerdquo Quarterly Journal of Economics May 111pp 408ndash41

Chen M Keith Venkat Lakshminarayananand Laurie Santos 2005 ldquoThe Evolution of OurPreferences Evidence from Capuchin MonkeyTrading Behaviorrdquo Working paper Yale Avail-able at httpwwwsomyaleeduFacultykeithchenpapersLossAversionDraftpdf

Damasio Antonio R 1994 Descartesrsquo ErrorEmotion Reason and the Human Brain New YorkPutnam

Davis Harry L Steven J Hoch and E KEaston Ragsdale 1986 ldquoAn Anchoring and Ad-justment Model of Spousal Predictionsrdquo Journalof Consumer Research 131 pp 25ndash37

Diener Edward and R Biswas-Diener 2002ldquoWill Money Increase Subjective Well-Beingrdquo So-cial Indicators Research 572 pp 119ndash69

Easterlin Richard 1974 ldquoDoes EconomicGrowth Improve the Human Lotrdquo in Nationsand Households in Economic Growth Essays inHonor of Moses Abramovitz Paul A David andMelvin W Reder eds New York AcademicPress pp 89ndash125

Eckel Catherine and Philip Grossman 1996ldquoAltruism in Anonymous Dictator GamesrdquoGames and Economic Behavior 162 pp 181ndash91

Evensky Jerry 1993 ldquoRetrospectives Ethicsand the Invisible Handrdquo Spring 72 pp 197ndash205

Fehr Ernst and Simon Gachter 2000 ldquoFair-ness and Retaliation The Economics of Reci-procityrdquo Journal of Economic Perspectives 143pp 159ndash81

Frey Bruno and Alois Stutzer 2002 ldquoWhatCan Economists Learn from Happiness Re-searchrdquo Journal of Economic Literature 402pp 402ndash35

Fudenberg Drew and David Levine 2004 ldquoA


Dual Self Model of Impulse Controlrdquo Workingpaper February

Genesove David and Christopher Mayer2001 ldquoLoss Aversion and Seller Behavior Evi-dence from the Housing Market Quarterly Jour-nal of Economics 1164 pp 1233ndash260

Grampp William 1948 ldquoAdam Smith and theEconomic Manrdquo Journal of Political Economy 564pp 315ndash36

Heifetz A and Yossi Spiegel 2000 ldquoOn theEvolutionary Emergence of Optimismrdquo Discus-sion Paper No 1304 Northwestern UniversityCenter for Mathematical Studies in Economicsand Management Science

Henrich Joseph Robert Boyd SamuelBowles Herbert Gintis Ernst Fehr and ColinCamerer 2004 Foundations of Human SocialityEthnography and Experiments in 15 Small-Scale Soci-eties Oxford University Press

Hauser Marc D M Keith Chen FrancesChen and Emmeline Chang 2003 ldquoGive UntoOthers Genetically Unrelated Cotton-Top Tama-rin Monkeys Preferentially Give Food to ThoseWho Altruistically Give Food Backrdquo Proceedings ofthe Royal Society B 270 pp 2363ndash370

Kahneman Daniel and Amos Tversky 1979ldquoProspect Theory An Analysis of Decision Un-der Riskrdquo Econometrica 472 pp 263ndash91

Kahneman Daniel Jack L Knetsch and Rich-ard Thaler 1990 ldquoExperimental Tests of theEndowment Effect and the Coase Theorem Jour-nal of Political Economy 986 pp 1325ndash348

Kirkpatrick Lee A and Seymour Epstein1992 ldquoCognitive-Experiential Self-Theory andSubjective Probability Further Evidence for TwoConceptual Systemsrdquo Journal of Personality andSocial Psychology 634 pp 534ndash44

Knack Stephen and Philip Keefer 1997ldquoDoes Social Capital Have an Economic PayoffA Cross-Country Investigationrdquo Quarterly Journalof Economics 1124 pp 1251ndash288

Laibson David 1997 ldquoGolden Eggs and Hy-perbolic Discountingrdquo Quarterly Journal of Eco-nomics 1122 pp 443ndash77

LeDoux Joseph E 1996 The Emotional BrainThe Mysterious Underpinnings of Emotional LifeNew York NY Simon amp Schuster

Lind E Allen and Thomas R Tyler 1988 TheSocial Psychology of Procedural Justice New YorkPlenum Press

Lind E Allen Jerald Greenberg KimberlyScott and Thomas Welchans 2000 ldquoThe Wind-ing Road from Employee to Complainant Situ-ational and Psychological Determinants ofWrongful-Termination Claimsrdquo AdministrativeScience Quarterly 453 pp 557ndash90

Loewenstein George Ted OrsquoDonoghue and

Matthew Rabin 2003 ldquoProjection Bias in Pre-dicting Future Utilityrdquo Quarterly Journal of Eco-nomics 118 pp 1209ndash248

Frederick Shane and George Loewenstein1999 ldquoHedonic Adaptationrdquo in Well-Being TheFoundations of Hedonic Psychology Daniel Kahne-man Edward Diener and Norbert Schwarzeds New York Russell Sage Foundation Presspp 302ndash29

Loewenstein George and Ted OrsquoDonoghue2004 ldquoAnimal Spirits Affective and DeliberativeInfluences on Economic Behaviorrdquo Working pa-per Department of Social and Decision Sci-ences Carnegie Mellon University Available athttppapersssrncomsol3paperscfmabstract_id539843

Meardon Stephen and Andreas Ortmann1996 ldquoSelf-Command in Adam Smithrsquos Theoryof Moral Sentiments A Game-Theoretic Re-Interpretationrdquo Rationality and Society 81pp 57ndash 80

Metcalf Janet and Walter Mischel 1999 ldquoAHotCool-System Analysis of Delay of Gratifica-tion Dynamics of Willpowerrdquo Psychological Re-view 1061 pp 3ndash19

McClure Sam David Laibson George Loe-wenstein and Jonathan Cohen 2004 ldquoSeparateNeural Systems Value Immediate and DelayedMonetary Rewardsrdquo Science 3045695 pp 503ndash07

Odean Terrance 1998 ldquoAre Investors Reluc-tant to Realize their Lossesrdquo Journal of Finance535 pp 1775ndash798

OrsquoDoherty J M L Kringelbach E T Rolls JHornak and C Andrews 2001 ldquoAbstract Rewardand Punishment Representations in the HumanOrbitofrontal Cortexrdquo Nature Neuroscience 41pp 95ndash102

OrsquoDonoghue Ted and Matthew Rabin 1999ldquoDoing It Now or Doing It Laterrdquo American Eco-nomic Review 891 pp 103ndash21

Panksepp Jaak 1998 Affective NeuroscienceOxford Oxford University Press

Persky Joseph 1989 ldquoRetrospectives AdamSmithrsquos Invisible Handsrdquo Journal of Economic Per-spectives Fall 34 pp 195ndash201

Postlewaite Andrew and Olivier Compte 2005ldquoConfidence Enhanced Performancerdquo AmericanEconomic Review 945 pp 1536ndash557

Rabin Matthew 1993 ldquoIncorporating Fair-ness into Game Theory and Economicsrdquo Ameri-can Economic Review 835 pp 1281ndash302

Raphael David D and Alec Macfie 1976 ldquoIn-troductionrdquo in their edition of Adam Smith TheTheory of Moral Sentinents London Oxford Uni-versity Press

Roll Richard 1986 ldquoThe Hubris Hypothesis


of Corporate Takeoversrdquo Journal of Business592 pp 197ndash216

Ross Lee and Andrew Ward 1996 ldquoNaiveRealism in Everyday Life Implications for SocialConflict and Misunderstandingrdquo in Values andKnowledge T Brown E Reed and E Turiel edsMahwah NJ Lawrence Erlbaum AssociatesInc pp 103ndash36

Shefrin Hersh M and Richard H Thaler1981 ldquoAn Economic Theory of Self-ControlrdquoJournal of Political Economy April 892 pp 392ndash406

Sloman Steven A 1996 ldquoThe Empirical Casefor Two Systems of Reasoningrdquo Psychological Bul-letin 1191 pp 3ndash22

Small Deborah A and George Loewenstein2003 ldquoHelping a Victim or Helping the VictimAltruism and Identifiabilityrdquo Journal of Risk andUncertainty 261 pp 5ndash16

Smith Adam 1759 [1981] The Theory of MoralSentiments D D Raphael and A L Macfie edsLiberty Fund Indianapolis

Smith Adam 1762ndash1763 [1976a] Lectures onJurisprudence R L Meek D D Raphael andA L Macfie eds Oxford Clarendon Press

Smith Adam 1776 [1981] An Inquiry into theNature and Causes of the Wealth of Nations VolumesI and II R H Campbell and A S Skinner edsLiberty Fund Indianopolis

Smith Vernon L 1998 ldquoThe Two Faces ofAdam Smithrdquo Southern Economic Journal 651pp 2ndash19

Taylor Shelly E and Jonathon D Brown1994 ldquoPositive Illusions and Well-Being Revis-ited Separating Fact from Fictionrdquo PsychologicalBulletin 116 pp 21ndash27

Tengs Tammy O and John D Graham 1996ldquoThe Opportunity Costs of Haphazard SocialInvestments in Life-Savingrdquo in Risks Costs andLives Saved Robert W Hahn ed New York Ox-ford University Press pp 167ndash79

Thaler Richard 1980 ldquoToward a PositiveTheory of Consumer Choicerdquo Journal of EconomicBehavior and Organization 11 pp 39ndash60

Thaler Richard 1988 ldquoThe UltimatumGamerdquo Journal of Economic Perspectives Fall 24pp 195ndash206

Waldman Michael 1994 ldquoSystematic Errorsand the Theory of Natural Selectionrdquo AmericanEconomic Review 843 pp 482ndash97

Wilson Timothy D and Daniel T Gilbert2003 ldquoAffective Forecastingrdquo in Advances in Ex-perimental Social Psychology Mark Zanna ed NewYork Elsevier pp 345ndash411

Young Jeffrey T 1997 Economics as a MoralScience The Political Economy of Adam Smith Chel-tenham Edward Elgar


The ldquoimpartial spectatorrdquo plays many roles in The Theory of Moral SentimentsWhen it comes to choices that involve short-term gratification but long-term coststhe impartial spectator serves as the source of ldquoself-denial of self-government ofthat command of the passions which subjects all the movements of our nature towhat our own dignity and honour and the propriety of our own conduct requirerdquo(Smith 1759 [1981] I i v 26) much like a farsighted ldquoplannerrdquo entering intoconflict with short-sighted ldquodoersrdquo (Shefrin and Thaler 1981 Meardon and Ort-mann 1996) In social situations the impartial spectator plays the role of aconscience dispassionately weighing the conflicting needs of different personsSmith (I i v 29) recognized however that the impartial spectator could be ledastray or rendered impotent by sufficiently intense passions ldquoThere are somesituations which bear so hard upon human nature that the greatest degree ofself-government is not able to stifle altogether the voice of human weakness orreduce the violence of the passions to that pitch of moderation in which theimpartial spectator can entirely enter into themrdquo

Adam Smithrsquos psychological perspective in The Theory of Moral Sentiments isremarkably similar to ldquodual-processrdquo frameworks advanced by psychologists (forexample Kirkpatrick and Epstein 1992 Sloman 1996 Metcalf and Mischel 1999)neuroscientists (Damasio 1994 LeDoux 1996 Panksepp 1998) and more recentlyby behavioral economists based on behavioral data and detailed observations ofbrain functioning (Bernheim and Rangel 2004 Benhabib and Bisin 2004 Fuden-berg and Levine 2004 Loewenstein and OrsquoDonoghue 2004) It also anticipates awide range of insights regarding phenomena such as loss aversion willpower andfairness (V Smith 1998) that have been the focus of modern behavioral economics(see Camerer and Loewenstein 2004 for a recent review) The purpose of thisessay is to draw attention to some of these connections Indeed as we propose atthe end of the paper The Theory of Moral Sentiments suggests promising directionsfor economic research that have not yet been exploited

Preferences and the Dual-Process Perspective

The Theory of Moral Sentiments is packed with insights about preferences usingthe dual-process framework of the passions and the impartial spectator Some ofthe discussion relates to aspects of individual preference and judgment what wewould today call loss aversion intertemporal choice and overconfidence Otherparts of the discussion focus on preferences that arise in social contexts altruismfairness and how they together generate trust in markets

Loss AversionApproximately 200 years before Kahneman and Tversky (1979) identified the

regularity in choices that has come to be known as ldquoloss aversionrdquo Adam Smith(1759 [1981] III ii 176ndash177) displayed an acute awareness of loss-aversion as anexperiential phenomenon ldquoPain is in almost all cases a more pungent sensa-tion than the opposite and correspondent pleasure The one almost always























































Unexploited Ideas














Conclusion




References




































































































































Unexploited Ideas














Conclusion




References























































































Conclusion




References















































































References















































































Adam SmithAdam Smith, Behavioral Economist

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Transcript of Adam SmithAdam Smith, Behavioral Economist