The Austrian Economists

The Most Dangerous Fallacies of Fact and Theory

Things I think about while driving: 

What is the fallacy of fact and fallacy of theory that the reasonably well-informed layperson believes about economics that are most in need of correction?  That is, which ones do the most damage?

Here's are my nominees:

For "Fallacy of Fact":  that the economic well-being of the average American is on the decline.

For "Fallacy of Theory":  that consumption (rather than savings/investment) is the source of economic growth.

Both of these are utterly wrong and believing either has a tendency to lead to policies that make matters worse, and bring out the very thing they are trying to avoid (i.e., worsening the economic well-being of the average American and destroying economic growth).

And one note about the irony of the consumptionist view:  I have often found that my left-wing colleagues think that *I* (and other free market types) believe that consumption is the key to economic growth (if not personal Nirvana).  When I tell them that not only do I not believe that and that it's bad economics, but that the most prominent expositor of that view was a strong critic of free markets, namely Keynes, they are left utterly unable to respond.  It's kinda fun, actually.

Your nominees for the most dangerous fallacies of fact and theory?

Reflections on the Seminar at FEE

The Austrian seminar at FEE this year had close to 100 students, and they heard from 10 different faculty over the course of the week: Israel Kirzner, Mario Rizzo, Larry White, Roger Garrison, Peter Lewin, Bill Buots, Steve Horwitz, Pete Leeson, Chris Coyne, and myself.  In deciding on lecture topics, I wanted to highlight not only the history and basic concepts of the Austrian school of economics, but also to reflect current work and contemporary relevance.

Due to the size of the group, all the lectures were conducted in the FEE library and students sat in folding chairs.  Each lecture was a 90 minute period, and there were five lectures per day, followed by break-out discussion groups.  One discussion group was designated for advanced graduate students and we rotated the faculty -- Kirzner the first night, Mario Rizzo the second night, Caldwell the next, a night off, and then a macro panel consisting of Steve Horwitz, Roger Garrison and Larry White.  Faculty in general were rotated so that students were exposed to as many different voices as possible.

The schedule was too grueling, and the learning environment was not as comfortable as would be ideal --- though FEE's home in Irvington-on-Hudson, NY remains a wonderful environment in general.

After thinking about the seminar, I guess the following comments come to mind:

1. Kirzner is amazing

2. Pete Leeson is not a rising star, he is a superstar both in lecturing and in writing

3. It is increasingly hard to combine undergradutes and gradaute students together for these sort of seminars; better I think to separate them and limit size for more personal contact and a more intense intellectual experience at the graduate level especially

4. The teaching of the basic lessons of the Austrian school to students is a vital exercise in the promotion of economic education

5. Inspiring serious study and encouraging research should take priority in economic education over inspiring students to activism due to a sense of "injustice'

6. However, you can employ the sense of injustice to ignite the intellectual passion to figure things out

7. A lot of bad economics is taught at university world-wide, and perhaps worst at the graduate level.  Several participants were confused about the difference between scientific propositions ('inflation is everywhere and always a monetary phenomena') and ideological policy positions.  This causes a lot of problems in discussion, and note I used a phrase from Milton Friedman not Mises or Hayek to highlight the level of the problem.  This is not mere opinion, but the teachings of basic economics -- however if participatns deny the teachings of basic economics it is hard to know where to start.  In one discussion I even just went to discussing Friedman's graphs on inflation in FREE TO CHOOSE and also in MONEY MISCHIEF, but the gradaute students I was talking to were unimpressed. 

8. If you think about the problems we have discussing basic economic ideas related to free trade and the costs of inflation as economists in general, let alone Austrian economists, then you being to realize how much work we have to do to improve the communication of economic ideas to the public, our students, and even our peers in academic economics

9. Geoff Lea really did an outstanding job with the summer seminar line-up this year at FEE --- congratulations Geoff you did all your teachers very proud in the way you took the bull by the horns and focused on solid economic education and pushing the envelope on supporting the cutting edge of research in libertarianism

10. FEE has an extremely important niche to fill in our intellectual movement

I am sure there are others I could list, but I wanted to really ask any who attended the seminar to leave feed-back so that we can improve the experience.

The Challenge of the Anti-Commons

Is it right that too much private property can stall an economy?  This is Michael Heller's thesis.  Here is a nice summary of the argument from the New Yorker.

Wal-Mart Follow Up, Wherein my 12 year-old Daughter Demonstrates the Economic Way of Thinking

So I just went to Potsdam and back to pick up my daughter and her friend from their day at theatre camp.  On the way home, I noted to them, as we passed it, that the parking lot at the new Wal-Mart was PACKED (I didn't have time to drive through and count the SLU faculty parking stickers...).  That prompted the following exchange between the friend and my daughter in the back seat.

Friend:  Think of all the gas those cars wasted going to the new Wal-Mart!
Daughter:  But Friend, if they couldn't go to that new Wal-Mart, they'd just go replace their underwear with a million holes in it by driving twice as far to the Wal-Mart in Ogdensburg.

I've never been prouder as a father. 

Wal-Mart Comes to Potsdam

After several years of political and legal battles, a brand-new Wal-Mart SuperCenter opened at 7:30 this morning 10 miles up the road in Potsdam, NY.  For those keeping track, that's 400 new jobs and lower prices and more selection for one of the poorer counties in NY state.  When I drive by the new store later today (four times actually), I will feel genuine pride to have been a bit player in the fight to improve the lives of my fellow North Country residents.  I was part of a community forum in 2004 and continued the good fight on a faculty panel on campus after a screening of the anti-Wal-Mart film "The High Cost of Low Prices."  You can find my remarks at that panel here.

I've made the arguments for Wal-Mart on this blog and elsewhere before, but I want to add two additional pieces of evidence in its favor based on what's happened here in the Canton/Potsdam area:

1. Even before the new store opened, the strip of Route 11 it sits on has seen a new strip mall, bringing a couple of dozen new jobs, and talk about out-parcels around the new site is buzzing.  Potsdam is also reported to be close to a new Hampton Inn, and is breaking ground on a new Lowe's, both of which likely believe Wal-Mart makes Potsdam a better location.  There's another couple hundred jobs down the road.

2. For those who say that Wal-Mart lowers the quality of jobs in the areas it enters, consider this:  my 16 year-old son will be looking for a part-time job this fall.  My wife was chatting with a couple of local businesswomen, all of whom said the same thing:  it's a great time to find a part-time job in the smaller retail stores here in Canton because a large number of part-time retail folks have left those stores to take better paying, higher benefit jobs at Wal-Mart!  (Of course, it's possible that folks are abandoning what they perceive to be sinking ships, but that's doubtful, given that it's still 10 miles to Potsdam and having a drugstore, for example, here in town is VERY convenient.) 

In any case, so much for the myth that working at Wal-Mart sucks.  Yeah, it sucks in comparison to the pay and working conditions of your average, say, Sociology professor.  But compared to the real world jobs occupied by a decent number of North Country residents, who many of my faculty colleagues claim to be so concerned about, Wal-Mart is a big step up. 

As I said in my comments on the film:

Let me also suggest that my colleagues and students here at SLU who find Wal-Mart to be so troublesome may well be trapped in the very same “SLU Bubble” of complacency and elitism that they imagine themselves to be breaking out of....It's easy for us as the well-off minority to worry about protecting that “small-town” feel, or being concerned with every little bit of environmental impact or the aesthetics of big-box retailers (or just how much they offer in benefits).  But to allow the concerns that wealth can afford to overshadow the real basic needs of the rest of our community is to live in a bubble, and it comes across to our fellow citizens as the worst sort of elitism.

My challenge to you tonight is to break out of the bubble. Do something really radical and ask real people in real small town communities in St. Lawrence county or elsewhere in North America, or even in poor urban areas, what they think of Wal-Mart.  And then do something even more radical:  examine your own biases and prejudices and search for some more facts.  You might find that although Wal-Mart is not a paragon of perfection and virtue, it, without ever necessarily intending to do so, has made a difference, a big positive difference, in the lives of lots of folks who can use all the positives they can get.

Thanks to all in the area who devoted their time and resources to fighting the good fight.  And for those who opposed it, I'm sure I'll be seeing you at the new SuperCenter, loading up on the better selection of food and buying cheaper supplies for your senior seminar on the evils of capitalism and hypocrisy of capitalists. 

Reforming Forensic Science

Radley Balko and Roger Koppl have a Slate piece suggesting reforms to forensic science.  Here is the conclusion:

The continuing stories of forensics error and wrongful convictions are troubling but not all that surprising. Our criminal justice system is centuries old. It just hasn't adapted well to the dramatic advances in science and technology over the past 30 years. But as forensic evidence becomes more and more important in securing convictions, the need for monitoring and oversight grows exponentially. Every other scientific field properly requires peer review, statistical analysis, and redundancy to ensure quality and accuracy. It's past time we applied the same quality-control measures to criminal forensics, particularly given the fundamental nature of what's at stake.

Here is a link to the Institute for Forensic Science Administration (IFSA) where Roger is the Director.

The teaching/research trade-off --- never believed it!

Here is a discussion among 4 economists of the teaching/research trade-off.

Personally, I never believed a trade-off exists and instead have thought that those who argue for the trade-off are either lazy researchers who don't want to teach or who are boring researchers who don't have much to say; or they are lazy teachers who don't know how to write and don't know how to think.  Those are harsh assessments I know. But every great teacher I have encountered, loved the subject they were teaching and if you love a subject you want to read in it, think about it, and tell others in written and spoken word. Really great teachers are obsessed with their discipline.

Also, how do we judge teaching success?  Student popularity?  That doesn't quite work.  Knowledge retention of the discipline?  Do we have a test for that?!  How about the number of students you teach that decide to major in your subject?  We do have some objective measures of that.  How about the number of students who major in the subject, who decide to pursue the discipline for their own profession?  To me this is the measure of success in teaching.

A truly great teacher gets students excited about the subject, inspires them to inquiry in the field, and they get so excited about the discipline they want to contribute to its teaching and research.  Outside of that, I have no idea what people are talking about in terms of "he/she is a great teacher."  Really?  What evidence do you have for that?

Teaching should be a transformative experience for students, if not, then you aren't doing your job.  And to transform someone you have to exhibit an excitement for the material, constantly be open to learning new ideas in the field, and genuinely enthusiastic about sharing what you yourself are learning. That menas you need to be a life-long learner yourself --- in short, a researcher.  Research is an input into outstanding teaching.

Now the rewards in academia do not always align incentives correctly.  Those in teaching schools say they don't have time to research due to their teaching. Well, Frank Knight taught a 4-4 teaching load, heck even I was able to write my dissertation on a 4-4 teaching load.  As Dr. Hans Sennholz told me many years ago -- 'You should be a professor, you only have to work 12 hours a week and the rest of the time is for your own writing and research.'  Sennholz wrote for newspapers, magazines and chapters in books, rather than professional journals.  But he was an active economic commentator until he died.  He wrote daily on economic issues and traveled around the country lecturing on economics throughout his career at Grove City College --- which during his time had a M-W-F, and T-Th-Sat teaching schedule.  But Sennholz was never boring, he lectures communicated economics with a sense of urgency.  When he retired after 30 years of teaching, 300 former students came back to GCC to honor him at their own expense --- a number of them where working in academia, public policy, research and educational foundations, or financial services inspired by the economic teachings of Dr. Sennholz.

I was one of the fortunate ones to have a dynamic and active professor teach me economics.  But  research can be ridiculously boring, high quality teaching is underappreciated, and bad research and bad teaching in the field of economics actually seems to be a stable equilibrium.  At research institutions, professors actually get rewarded with lower and lower teaching loads with the ideal being no teaching responsibilities whatsoever.  And the research they conduct is often not memorable beyond a nano-second.  It may get in a journal, but its shelf-life in terms of impact is non-existent.

Bad researchers make for bad teachers; and bad teaching more often than not reflects dull and boring research.  How else could it emerge that when you met people at parties and explain you are an economics professor they have 1 of 3 reactions: (1) ugh!, I had an economics course in college and it was horrible; (2) really, what do you think will happen to interest rates?; (3) wow, I had economics in college it was really interesting.  Reactions (1) and (2) dominate (3), but why?  And think about it, economics is not only the most important discipline in the social and policy sciences -- a subject constantly being discussed in the news and dealing with everyday issues that all citizens must confront --- occupational choice, consumption decisions, etc. -- but the economic way of thinking when taught properly opens the eyes of students to an intellectual framework that unlocks so many of life's mysteries in a way that NO other discipline can do.  With all of this in their hands, teachers of economics actually convince students that the discipline is boring and to be dreaded like the plague.  How can this be the case?

I would argue not because of the trade-off, but because when research input is dull and boring, teaching will be dull and boring.  The economics profession has in an ironic twist of fate encouraged really bad research among a vast majority of its members.  Garbage in, Garbage out.  Sterile math and boring statistics substitute for lively stories and compelling historical narratives.  Kenneth Boulding predicted this many years ago in his review of Samuelson's Foundations --- the flawless precision of mathematical economics will prove incapable of capturing the beauty and essence of economic reality in a way that the literary vagueness of an older economics did not.

So to you aspiring economists, don't buy into the myth of a trade-off.  Rather view research as an input into the teaching production proces, and view teaching as a testing ground for your ability to articulate your ideas in economics.  If you get excited about economics, you will want to study it seriously and you will want to communicate your results to others as clearly as possible.  Research with curiosity and passion, and teach with enthusiasm.  Just because you have a PhD you do not have a right to be dull and boring.  Economics is too important a field to be left to those who cannot get excited about their research efforts, the writing the research up in a clear and lively manner, and the communication of their results in spoken word to peers, students and the public.  If you are sleepwalking through class, you're in the wrong business.  Better to be bouncing off the walls with excitement for the new ideas you have about praxeology, thymology, and market process analysis.  Don't cheat economics.  If you forget what is at stake, go re-read the last few chapters of Mises's Human Action, part VII.

Thanks for Peter Klein for the pointer.

Does an Ideological Commitment Signal Political Sincerity to Voters?

Mario Rizzo sent me this summary of a new paper published in the EJ.

Extreme appeal: voters trust extreme positions more than moderate ones, study finds

Appealing to middle not best political strategy

Trying to appear moderate is not always the best strategy for capturing votes during an election, reveals a new study. Extreme positions can build trust among an electorate, who value ideological commitment in times of uncertainty.

"The current political advantage of the Republican Party stems from the ability of its candidates to develop 'signature ideas.' This strategy is rewarded even when the electorate has ideological reservations," says University of Southern California economist Juan Carrillo, adding that this poses a challenge for the Democrats.

In the current issue of The Economic Journal, Carrillo and Micael Castanheira of the Université Libre de Bruxelles (Belgium), show that voters who are unsure about the quality of a policy can be swayed by indications of trustworthiness.

As Carrillo explains, many tend to believe that a candidate's platforms should be tailored to appeal to voters, particularly swing voters. Instead, this research shows that instead of swinging voters, candidates should try to swing ideas by offering higher-quality positions that may be less popular.

In the United States, holding strong positions has already been shown to work on a few issues that have an ideological component, such as abortion and the death penalty, Carrillo notes.

"A rational electorate is reluctant to support someone who does not exhibit commitment to some ideology," Carrillo says. "Voters rightly perceive that someone without ideological commitment cannot have developed a valuable political program. They reason that, 'If you tell me what I want to hear, it probably means that you don't have any ideas of your own to share.'"

Carrillo and Castanheira's paper is an important challenge to the widely accepted median voter theorem. In the median voter theorem, voters who are fully informed will use their understanding when casting a ballot, choosing the platform that is closest to their own beliefs. Thus, it stands to reason that to attract the majority of votes, parties should try to appeal to the majority of voters.

But, as the researchers point out, it is rare for a voter to be fully informed in real life. More likely, voters will have incomplete and sometimes inaccurate information about how left-leaning or right-leaning stances actually translate into high quality proposals for, say, withdrawing troops safely or reforms.

This information comes from the press and other sources, such as campaign advertisements.

"To attract a majority of votes, parties cannot simply try to appear 'median.' Quite the contrary," Carrillo says. "Winning an election is generally about crafting a convincing philosophy that the electorate will view as superior to that of the opponents."

The researchers point to several real-life examples, including the 1995 Belgian election. According to the authors, the VLD – a traditionally right-wing party – sought the opinion of voters on a number of key issues and pledged to follow popular will if elected. The experiment failed. Four years later, the VLD returned to a rightist platform, and their candidate was elected prime minister.

###

Carrillo, Juan and Micael Castanheira, "Information and Strategic Political Polarization." The Economic Journal: July 2008.

Rizzo asks rhetorically what are the implications outside of politics?  What should academics learn from this study for their academic work?

To me this sort of work reinforces the older argument put forth by W. H. Hutt on the economist and the public --- basically that the economist should never compromise his message for concern of what is politically possible.  Hutt's argument was concerned mainly with the problems associated with politicians watering down the message of the economist to the point of non-recognition, and also the impossibility of predicting in human affairs what opportunities may arise in policy space from what year to the next (i.e., what is politically unimaginable may in fact be very politically feasible within a short period of time --- e.g., the fall of the Soviet Union).  But the Carrillo and Castanheira piece represents a different argument --- it is not about the purity of the economists message, but the credibility of the messenger.  Those who make constant compromises are viewed as unprincipled and unworthy of our support.

James Buchanan always taught us it wasn't just the courage of our convinctions that matter, but the courage to withstand the critique of your convinctions that mattered.  Stand firm if you believe you have discovered truth, and state it clearly and forcefully.  Truth is often unpopular with many, but science should "hurt" and the "truth is not optional".  It turns out if this study is accurate, that the populace already knows this.

Ambrose Evans-Pritchard on the current financial situation

In the Daily Telegraph (UK), Ambrose Evans-Pritichard argues that government caused our current problems but capitalism is getting the blame.  What do you think?

Thanks to Ed Weick for the pointer.

On a related matter David Boaz points to this Washington Post article on the ever-expanding Fed.

The history of the Fed, I have often stated in class, is like a baseball manager in dealing with a short-stop who keeps letting balls go through his legs, hands the short-stop a bigger mit each time rather than finding a more nimble and skilled alternative.   The more nimble and skilled alternatives, in my story, come in the form of different monetary policy regimes -- k% rule, currency boards, gold standard, free banking, etc.

Which alternative do you think could address our current problems best, and what probability would you place on seeing that alternative seriously discussed during the next 4 years?

The Business of Social Philosophy and Political Economy

Karl Marx famously argued that the problem with all previous philosophies was that they merely seeked to understand the world whereas his purpose was to change the world.

At the FEE conference last week, I made a distinction between the teaching intent of Austrian economists to provied students wtih a "Inspire to Inquiry" and "Inspire to Activism" and argued that the primary purpose of the conference at FEE, and the particular professors there was to "Inspire to Inquiry", but that for those that were not necessarily interested in a research and teaching career there was in fact good reason to still be inspried to inquiry.  In short, I argued that the inspiration to activism will be better served by IF the inspiration to inquiry is ignited in their minds because they would have a firmer foundation on which to base their social change activities.  Calling upon Bastiat, I informed the students that serious students of society should never worry about harsh criticisms of their position (and instead invite them to sharpen their minds), but they should ALWAYS concern themselves with the weakest presentation of their ideas.  There are positive returns to careful study, and negative externalities associated with shabby presentations.

Does this ultimately imply an acceptance on my part of Marx's argument about the business of philosophy?  And if so, what are the most important criticisms of that proposition?  In other worlds, do readers here think that the distinction I brought up is correct or not, and what implications would you derive?

Why do one-way tickets cost more than round-trips?

Well with the greatest minds in Austrian economics assembled here at FEE, we are pondering an interesting economics puzzle, put to me by a former SLU colleague (from our math department):

Why do most airlines charge substantially more for a one-way ticket than a round-trip ticket on the same route?

For example, my colleague can buy a round-trip for about $250 whereas a one-way will cost him almost $700 on the same route.  What gives?

Professors White and Lewin have offered two possible answers:

1. It's price discrimination - one-way fliers might need specific times and flights in a way that makes their demand more inelastic.

2. Some people might pay a premium for a one-way ticket in order to leave their return open-ended.

My own thought was that it's a matter of not wanting an empty seat coming back the other way given the low probability of a "double coincidence of one-way tickets."

None of us are very confident at all in our answers.  Thoughts from our wonderful commentariat?

Historical Memory and the Gulag

In a previous post on the Milton Friedman Institute and the critique of professors on the left, Steve Horwitz correctly points to the experience with communism throughout East and Central Europe and the former Soviet Union, as well as in Cuba and Latin America (and we can add in China and Africa as well).  The horror of socialism in practice in terms of mass murder and economic depravation must never be forgotten.

When I was a visiting fellow at the Russian Academy of Sciences in the early 1990s, there was talk of establishing a permanent monument to the victims of Stalinism outside of the former KGB building, it has never really materialized.  Back in DC, there was a movemnt led by Lee Edwards to establish a Museum of Communism to remember those who suffered under this ideology world-wide similar to the Holocaust Museum, but it also hasn't broken ground.  When I was teaching in Prague, I actually required the students to visit the Museum of Communism there so they might remember the devastating destruction this ideology wrought through the 20th century.  However, the best source to my mind easily available on the delusion and destruction of communism is probably Bryan Caplan's web-site Museum of Communism (written primarily I believe when Bryan was just an undergraduate at Berkeley --- I wonder how many visitors he has gotten in the last decade, I have often recommended to my students --- especially those in my comparative classes --- to spend a lot of time at Caplan's site and learn the history of, and the ideas that motivated it, communism/socialism in practice in the 20th century).

Tyler Cowen has a nice post today remembering Alexander Solzhenitsyn, who died of heart failure on Sunday in Moscow.  Whatever flaws Solzhenitseyn had as a man, courage was not one of them --- he was the man (as Bryan Caplan has put it) who stared down Soviet power at its height and outlived it by 17 years.  His literary monument to the victims of communism will hopefully be more lasting than the efforts to date to establish a physical monument to honor those who sufered so much for so little due to communist ideology.

It's Just Like the Blog, Only Real

Well the gang's all here at FEE.  Pete B, Pete L, Chris and I are all here at FEE for the week-long Austrian economics seminar, along with Peter Lewin and Roger Garrison (with Larry White, Bruce Caldwell, and Mario Rizzo to follow), and, for tonight and tomorrow morning, Israel Kirzner.  We have about 100 students here and we'll try to do some live-blogging over the week to keep folks up to date on what's going on.  Maybe we'll even include some pictures!

Pete B and I were standing around chatting before things started this afternoon and a student walked up and saw us and said "It's just like the blog, only real!"  I felt the same way at dinner tonight when Pete and I ate with two of our regular commenters - Brian Pitt and Matt Mueller. 

It should be a terrific week...if I can keep a safe distance from Leeson's stinky cigars anyway. ;)

The Negative Externality of One’s Colleagues’ Politics

Much has been said recently, including by Pete here, about the newly proposed Milton Friedman Institute and the objections of some of the University of Chicago faculty, primarily from the humanities. One of the best comments was by John Cochrane, who wrote:

If you’re wondering “what’s their objection?”, “how does a MFI hurt them?” you now have the answer. Translated, “when we go to fashionable lefty cocktail parties in Venezuela, it’s embarrassing to admit who signs our paychecks.” Interestingly, the hundred people who signed this didn’t have the guts even to say “we,” referring to some nebulous “they” as the subject of the sentence.  Let’s read this literally: “We don’t really mind at all if there’s a MFI on campus, but some of our other colleagues, who are too shy to sign this letter, find it all too embarrassing to admit where they work.” If this is the reason for organizing a big protest perhaps someone has too much time on their hands.

I think Cochrane is largely right here, and I suppose if I try to put myself in the shoes of those faculty, I can understand how they feel as though there’s a huge negative externality to them because of Chicago’s free market reputation. That said, I’ll take their complaints more seriously when they spend some time in my shoes.

For example, every summer I do IHS student seminars, and they often have a large number of central and eastern European students. I’d like the Chicago humanities faculty to tell me how I’m supposed to feel when these students ask me why so many US humanities faculty, including some of my colleagues at SLU, still think Marxism and socialism have social value when those ideas were the inspiration, even if wrongly interpreted, for thugs who engaged in the killing of tens of millions of innocent people and the destruction of the economies of billions. I’d like them also to tell me how I’m supposed to feel when a Cuban refugee who risked his life to come to the US asks me why some US college students, including some at SLU, think it’s cool to wear Che Guevara t-shirts, implicitly honoring a murder and torturer.

Whatever the flaws of free market capitalism as it was applied in the real world, its sins pale in comparison to those of really-existing socialism. When the Chicago humanities faculty have to explain to these students why my colleagues and students have sympathy for the ideas that motivated the impoverishment and death of millions of their fellow citizens, then maybe I’ll some sympathy for them having to explain away sweet old Milton Friedman.

Institutions and “The Adam Smith Problem in Reverse”

It has long been claimed that there is a fundamental inconsistency between Adam Smith’s two books (it’s called the Adam Smith Problem). In one account of the problem, The Theory of Moral Sentiments (TMS) is seen as promoting sympathy and benevolence, while The Wealth of Nations (TWN) is concerned with self-interest. Others have said that TMS deals more with natural rights while TWN is more utilitarian. The two books seem to rest on different views of human nature and their social consequences. So what did Smith really think?

In a recent paper published in History of Political Economy (not free access), Maria Pia Paganelli has an interesting take on the problem. She suggests that, contrary to what is generally accepted, both books account for self-interest and TMS displays a much more favorable account of it than TWN. In TMS Smith examines how self-interest (or self-love) is a force at the foundation of the self-regarding virtues (especially prudence). In TWN, self-interest plays a positive role in the development of commerce and society but is also at the origin of social ills. There is a main difference between the two books: in the first one, the excesses of self-interest are naturally kept in check, while in the second, they are not. As Paganelli puts it:

The two books differ in how Smith presents possible remedies against the abuses of self-interest. The portrait of self-interest in his 1759 treatise is more optimistic and less critical than the one in his 1776 work. In TWN, self-interest cannot successfully be constrained, leaving individuals and society more susceptible to its abuses. In TMS, self-interest is always successfully constrained so that both individuals and society are… unquestionably better off by its presence. This makes TMS, rather than TWN, the book promoting self-interest. (p. 372-3)

This is a very interesting claim, and Paganelli argues well to defend her thesis. One way to understand the difference between the two books is by looking at the role of institutions. The two books present different mechanisms through which self-interest is constrained. In TMS, the constraints are natural: individuals constrain the excesses of self-interest because self-interest tends to develop the virtues necessary to good self-conduct (prudence, etc). In TWN, the natural constraints break down because of the role of government. Government perverts the natural mechanisms that keep self-interest in check and offers (perverse) incentives for people to gain at the expense of others.

The novel idea in Paganelli’s paper is that the whole “Adam Smith Problem” can (perhaps) be solved by paying attention to the institutional story in Smith’s books. It seems to me that it is not so much that TMS promotes self-interest more than TWN, it is that TWN embeds self-interest in the institutions that Smith could observe in his days—institutions which, sometimes, could not prevent the abuses of self-interest but on the contrary magnified them. This leads Smith to conclude that merchants and manufacturers, who are rapacious in their behavior, do not seem to care about their conduct’s negative consequences for society. In TWN, because of government, merchant and manufacturers are willing to obtain the protection of government putting aside the moral rules and checks that naturally would have emerged. As Paganelli puts it:

With the introduction of government protection and the change in incentives they cause, self-interest can hopelessly deviate from a source of virtue and social well-being into a cause of mean rapacity and social impoverishment. (p. 377)

TWN is thus much more a book about public choice mechanisms than I had realized. Moreover, Smith may also hold the view that in the absence of government (i.e. in a state of anarchy) there are natural mechanisms (i.e. virtues) keeping the excesses of self-interest in check. Whether our sense of virtue is enough to make social cooperation in large social orders possible is another debate. In any case, the Adam Smith problem has perhaps never existed… once one understands his work with the filter of public choice.