The Answer Is Transaction Costs

Adam Smith's Wealth of Nations: Episode #2--The "Model"

• Michael Munger • Season 3 • Episode 9

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Transaction costs provide the key to understanding Adam Smith's complete philosophical system and how his two great works form an integrated whole. 

• Smith's two essential claims: humans desire to learn proper behavior and have an innate propensity to truck, barter, and exchange
• Sympathy in Smith's view means synchronizing feelings with others—not perfect emotional matching but sufficient "concords" for social harmony
• Three core principles guide proper behavior: justice (respecting others' person, property, and promises), beneficence (proper use of what's ours), and prudence (sacrificing present comfort for future well-being)
• Self-command turns virtuous intentions into actual proper behavior
• Four sources of moral judgment: motive, reaction, convention, and consequence
• As societies scale up, we move from moral community (acting from love) to moral order (following rules from their utility)
• Smith's "Chinese earthquake" example anticipates the modern trolley problem by revealing how moral agency affects our decisions
• The "man of system" tries to impose ideal plans without regard for human nature or gradual change
• Smith's egalitarian views positioned economics against slavery and hierarchical social structures

Also posted, with resources for teaching and learning, at Adam Smith Works, thanks to Amy Willis. 



If you have questions or comments, or want to suggest a future topic, email the show at taitc.email@gmail.com !


You can follow Mike Munger on Twitter at @mungowitz


This is Mike Munger, the Knower of Important Things. Today we're moving to the second part of the introduction to the Adam Smith podcast series for Adam Smith Works and The Answer is Transaction Costs. Today we're going to talk about what I think of as the model that we should use to understand Adam Smith's contribution and the integration of his two great books, Theory of Moral Sentiments and the Wealth of Nations. Now, as I emphasized in the first episode, this is my particular view. If anything about it is right, it is because I have learned from the people that I have studied who talk about Adam Smith. If as is more likely I get parts of it wrong, that is entirely my fault. Straight out of Creedmore. This is TAITC Part Two of the introduction of the Adam Smith podcast series.

 

I thought they talk about a system where there were no transaction costs, but it's an imaginary system. There always are transaction costs. When it is costly to transact institutions matter and it is costly to transact. 

 

The second part of episode one is an overview and model of Smith's approach to a science of man. I'm going to claim that Smith makes two essential claims about human nature. First, humans have a desire to learn what constitutes proper and good behavior and they're guided in this by an attention to the reaction of others to our own actions or inactions over time. There's a substantial correspondence between approval and social good and disapproval and social harm. Second essential claim about human nature is that humans have an innate propensity to truck, barter, and exchange from those two claims about human nature, Smith derives his system. Neither is sustainable by itself. It is odd perhaps that Smith was not more careful about trying to integrate them because he wrote one book exploring the implications of each.

On the other hand, after Adam Smith wrote the Theory of Moral Sentiments in 1759, he revised it, but he then continued to work on lecture notes that probably predated the work on Theory of Moral Sentiments that had come from his earliest lectures. That's what eventually became the Wealth of Nations, which was published of course in 1776. After the publication of the Wealth of Nations, Smith continued to revise side by side Theory of Moral Sentiments and Wealth of Nations. If he’d regretted anything in Theory of Moral Sentiments or wanted to modify it, he could have. So I think it only makes sense to have these two books be part of an integrated system. So I am denying the existence of an Adam Smith problem that there's a contradiction between the two books and as James Otteson likes to say, this comes from German philosophers. Anyway, lacking creativity, they decided to call the Adam Smith problem, das Adam Smith problem.

That's a Jim Otteson joke. Don't blame me. The point is that there is no Adam Smith problem and I'm going to start from that premise. Smith actually offers a thought experiment about a person who grew up without any other human contact and the reason that that's useful is that it's sort of state of nature claim. It tells you something about what human beings essence is, that there are some things that are just innate in human beings. He mentions hunger and the passions that unite the sexes. They have two other desires or propensities. They care about each other and they truck, barter, and exchange, they do those things just like they have a desire for hunger or sex. I have to note that there was a really terrible movie decades ago called Blue Lagoon. In Blue Lagoon, two children happened to be on a ship. They were shipwrecked along with an elderly man who knew a lot about survival.

He taught them a lot about survival, but then he had a sudden heart attack and died when they were both six. By the time they were 15, of course, well nature took its course. No one had to tell them this was just something that happened. So human beings satisfy our hunger by eating. We satisfy our thirst by drinking, we just do those things. Smith also thinks that we satisfy our need to have other people care about us by acting in ways that makes them likely to care about us and make us feel that we deserve to be cared about. So here's Smith's thought experiment. 

Were it possible that a human creature could grow up to manhood in some solitary place without any communication with his own species? He could no more think of his own character of the propriety or demerit of his own sentiments and conduct of the beauty or deformity of his own mind than of the beauty or deformity of his own face. All these are objects which he cannot easily see. They are brought to his notice chiefly by the reactions of other people bring him into society and he's immediately provided with the mirror which he wanted before it is placed in the countenance and behavior of those he lives with, which always reflect his own sentiments and conduct back to him. He seasoned how hateful or agreeable they appear to them and he adjusts them accordingly. He becomes at last, more anxious to know how others will regard his conduct than how he regards it himself. 

So first sentence in Theory of Moral Sentiments, Adam Smith says,

How selfish, however man may be supposed. There are evidently some principles in his nature which interest him in the fortune of others and render their happiness necessary to him. Though he derives nothing from it except the pleasure of seeing it. 

In book one of Wealth of Nations, Smith adds another- the innate human propensity to truck, barter, and exchange one thing for another.

From these two aspects of human nature, Smith derives two dynamic processes. Neither is the result of intention but they result from human action. Those things are propriety and division of labor. We can't separate them. Propriety and division of labor are both required for the success of a family and for commercial society. Now it's fair to say, why did Smith separate them into two books? Maybe there's a different audience. Wealth of Nations is a handbook for legislators and lawmakers about what is good policy. Theory of Moral Sentiments, it was an investigation into what we would now call moral psychology. For whatever reason, even though they're two separate books, I'm going to integrate them as one system. The first implication is a system of propriety, a sense of right and wrong, which is anti-rationalist. It is emergent. It's based on a kind of groping towards what feels right.

(07:38)

It is the passion that reveals right and wrong, not reason, and it's based on sympathy, which for Smith had a very specific and important meaning. The origin of the word sympathy is related to sympathy in Greek. SYN is part of many word in English and it means with, together, or shared. As in synchronize pathos is feeling emotion or sentiment. Sympathy for Smith is therefore synchronizing feelings or sentiments. We sync up our feelings and sentiments with those around us. That's what sympathy is. We desire to do that just like we get hungry for food. It is innate. The feeling then is shared. It's something that exists between us as a collective or social matter. It's not atomized. I don't have my feelings, you don't have your feelings. Our sympathy synchronizes our sentiments. People care about having their pathos synchronized and that's what sympathy means. Now we're going to come back to this, but for now think about how this synchronicity is achieved in society.

Smith says in all such cases that there may be some correspondence of sentiments between the spectator and the person principally concerned, the spectator must first of all endeavor as much as he can to put himself in the situation of the other and to bring home to himself every little circumstance of distress which can possibly occur to the sufferer. He must adopt the whole case of his companion with all its minute incidents and strive to render as perfect as possible that imaginary change of situation upon which his sympathy is founded. Now what that means is the only way I can sympathize is to imagine myself in the situation of someone else and to imagine further that I have the same conditions and same views of that other person. I'm a spectator but I'm spectating myself in the situation of the other. The only means I have to feel what they feel as a matter of imagination.

After all this, however, the emotions of the spectator will still be very apt to fall short of the violence of what is felt by the sufferer: 

Mankind, though naturally sympathetic never conceive for what is befall another, that degree of passion which naturally animates the person principally concerned that imaginary change of situation upon which their sympathy is founded is but momentary thought of their own safety. 

The thought that they themselves are not really the sufferers continually intrudes upon them and though it does not hinder them from conceiving a passion somewhat analogous to what is felt by the sufferer hinders them from conceiving anything that approaches to the same degree of violence. The person principally concerned is sensible of this and at the same time passionately desires a more complete sympathy. 

He longs for that relief which nothing can afford him, but the entire concord of the affections of the spectators with his own to see the emotions of their hearts in every respect beat time to his own in the violent and disagreeable passions constitutes his soul consolation.

But he can only hope to obtain this by lowering his passion to that pitch in which the spectators are capable of going along with him. He must flatten, if I may be allowed to say so, the sharpness of its natural tone in order to reduce it to harmony and concord with the emotions of those who are about him, what they feel will indeed always be in some respects different from what he feels. And compassion can never be exactly the same with the original sorrow because the secret consciousness that the change of situations from which the sympathetic sentiment arises is but imaginary- not only lowers it in degree but in some measure varies it in kind and gives it quite a different modification. 

These two sentiments, however it may be evident, have such correspondence with one another as is sufficient for the harmony of society. Though they will never be unisons, they may be concords and this is all that is wanted or required.

That's in part one of Theory of Moral Sentiments. Chapter Four, “though they will never be unisons, they may be concords and that is all that is wanted or required and so people try to coordinate or synchronize their sentiments.” That's what sympathy is. I suffer something, you perceive it. I have to recognize you are not going to care as much about it as I do because it happened to me, not you. Still, you do make an effort to understand and to imagine at least the feelings that I'm going through the sufferer have to imagine what you are going through trying to imagine what I'm going through. Now this all seems complicated, but it is an interesting process that is much more advanced and likely accurate than the contagion theory that David Hume had suggested that was sort of a throwaway, didn't develop it fully, but David Hume had said, if I laugh, you'll start laughing.

If I cry, you'll feel sad. So I said, that's actually not right. What happens is that I may make an effort to put myself in your position, but I may not agree that if I were in your position I would have the same feelings that you have and the sufferer have to imagine what the onlooker is feeling. What Smith adds is that each of us actually wants to have concords, if not unisons. It's a musical metaphor. Obviously, the concords is chords, different notes that sound okay together. They're not discordant, they're concordant, and as a result, society just needs that. Each of us make that effort to reduce the difference among our feelings. So we might think that you should love your neighbor as yourself. What Smith is saying is that you should love yourself no more than you love your neighbor and that's much harder.

Love your neighbor as yourself as impossible. I'm always going to love myself more. What I need to do is tone down my own. If something has happened to me, I need to recognize that's not nearly as important to everyone else and I need to tone down my sentiments to something that other people can share and then they'll say, gosh, I'm sorry. I'm really sorry that that happened to you. It'll be true. They're just never going to be as sorry as I am. Smith defines different passions. He talks about the amiable passions, the gentle tender social emotions. They're amiable because they incline us to care, connect and express affection. So compassion, kindness, parental love. Our moral response is usually that we admire and sympathize with those who feel an act on amiable passions. Someone shows tenderness, a child, a loyalty to a friend, even a dog.

We feel warmth and moral approval and you notice that it is this red light greenlight process that Smith relies on for how people learn what things are good and what things are bad. If someone approves of something that I'm doing, that thing is socially good. If someone disapproves that thing is socially bad. Now Smith has a lot of faith in the process by which we come up with these reactions, but the process he's thinking of is evolutionary and collective. So it's a kind of emergent wisdom about what things are good and therefore admirable and what things are bad and therefore contemptible. Smith also talks about the awful passions and what he means by awful passions is full of awe, not that they're bad. So these are dark, solemn, authoritative, inspiring awe or commanding reverence. So anger, if it's just and not wrathful resentment, if it's in defense of an injustice, reverence, dignity, especially self-command.

(15:51)

Smith believes that all of us admire and hold in reverence the ability to exercise self-command and then moral indignation if it's justified. So we respect and venerate those who display the awful passions properly. Smith has three core principles, justice, beneficence, and prudence, justice, beneficence and prudence. He uses these our sense of justice, beneficence and prudence. Two develop what are the real key aspects of acting well in society? These are self-command and propriety. So justice combined with self-command gives us propriety. Beneficence combined with self-command gives us propriety. Prudence combined with self-command gives us propriety. Justice is the central pillar, the tent pole, the most important foundation beneficence he says is the ornament justice is required and it has to be protected by the awful passions. However, notice what a big advantage it is to have justice protected by the awful passions because that means if we see someone commit an act that is unjust, we become angry and provide the public good of norm enforcement.

We don't have to call a policeman. We don't say, oh, well that's bad, the state should do something. We will actually confront the person and say, “You're acting unjustly.” Now, not all the time and not perfectly, but to the extent that I feel bad if I'm seen to behave unjustly and if other people, if they see me to behave unjustly are going to confront me. That solves a lot of the transaction cost problem of contracting and acting in society. The definition of justice is the protection of what James Otteson calls the three Ps- person, property, and promise. So justice is the acting, well abstaining from what is another's, what things are another, their person, their property and things that I have promised to them. So Smith says the first sense of the word justice coincides with what Aristotle and the Schoolmen call commutative justice which consists in abstaining from what is another and in doing voluntarily whatever we can with propriety be forced to do.

Earlier in part two of Theory of Moral Sentiments, Smith had said,

As the greater and more irreparable the evil that is done, the resentment of the sufferer runs naturally the higher so does likewise the sympathetic indignation of the spectator as well as the sense of guilt in the agent. Death is the greatest evil which one man can inflict upon another and excites the highest degree of resentment in those who are immediately connected with the slain murder, therefore is the most atrocious of all crimes which affect individuals only in the sight of both man and of the person who has committed it to be deprived of that which we are possessed of is a greater evil than to be disappointed of what we have. 

Only the expectation. Let me insert into the quotation, he's not reasoning, he's observing. This is typical of Smith's method. It upsets us more as in asymmetry, but he's discovered the endowment effect, the fact that we're more upset if we lose something we're possessed of than to lose something we have only the expectation means that we care more about losing things we have than failing to gain things that we expect.

That's later. [Daniel] Kahneman called that the endowment effect. Smith is saying that that's not a pathology, that's actually the nature of humans and that aspect of human nature is an important way of understanding why it is that things that upset us more are more unjust. That is Smith's method. Things that upset us more are more unjust. Back to the quote, breach of property. 

Therefore theft and robbery, which take from us what we are possessed of are greater crimes than breach of contract which only disappoints us of what we expected the most sacred laws of justice. Therefore, those whose violations seem to call loudest preventions and punishment are the laws which guard the life and person of our neighbor. The next are those which guard his property and possessions. The last of all come those which guard what are called his personal rights or what are due to him from the promises of others.

So that's justice- person, property, and promise. Protection of the person is most important. How can we tell? Well, it's because that's what upsets us most. Violation of contract. Okay, that happens. It has to be enforced, but it's not nearly as offensive as if I hurt or kill someone. Beneficence is the other aspect of how we judge people's action, and it is the second sense of justice. The definition of beneficence, remember the definition of justice was abstaining from what is another's. Beneficence is the becoming use of what is our own, the becoming use of what is our own. This is a kind of justice. The rules for which Smith says are loose, vague, and indeterminate. The violation of the rules of beneficence are not cause for state action. We may disapprove them, but the violence of our disapproval is far, far less. Smith says the second sense of the word justice coincides with what some have called distributive justice which consists in proper beneficence in the becoming use of what is our own.

But there's a footnote. Footnote is on distributive justice. Footnote says The distributive justice of Aristotle is somewhat different. It consists in the proper distribution of rewards from the public stock of a community, and there's a lot of argument then about what distributive justice means. It could mean that it is the overall distribution of wealth, power and so on, and the becoming use of it requires that it's equal if you're an egalitarian. What Smith is actually saying it seems is that the becoming use of what is our own, he means each of us has our own. I have my own, you have your own. Each of us has our own and distributive justice or beneficence is then the becoming use of that. However, if I choose not to be beneficent, I am not denying something that has been promised. I may have violated your hope that I would give you some kind of gift, but I haven't made you very much worse off.

And so, violations of beneficence are what Smith says we should think of as an ornament of a proper civilized society, violations of justice or the very core, they cannot be allowed violations of justice if they happen mean that society itself cannot operate violations of beneficence. We can get along. Smith is concerned that insufficient beneficence might attract the attention of the law giver or the superior and he admits that it might be necessary sometimes for the legislator to intervene in especially unjust distribution of power and wealth. But he says, and this is in section two, chapter one of Theory of Moral Sentiments, “Of all the duties of a law giver, however, [this meaning redistribution] is perhaps that which requires the greatest delicacy and reserve to execute with propriety and judgment to neglect it altogether exposes the commonwealth to many gross disorders and shocking enormity and to push it too far is destructive of all liberty, security and justice.”

So making no changes in beneficence in the distribution among people creates gross disorders and shocking enormity, but to push it too far is destructive of all liberty, security, and justice. So Smith's very concerned about moderating the impulse to say, I'm going to be generous with other people's money. He would much prefer that each of us engages in the becoming use of what is our own. But it may be he's clear. It may be that sometimes the state may need to intervene, but my perception is he sees these occasions as being rare and that it should be done only with great circumspection. Well, I mentioned also prudence as an important consideration. This is from part six, section one of Theory of Moral Sentiments, in the steadiness of his industry and frugality. 

It is steadily sacrificing the ease and enjoyment of the present moment for the probable expectation of the still greater ease and enjoyment of a more distant but more lasting period of time. The prudent man is always both supported and rewarded by the entire approbation of the impartial spectator and of the representative of the impartial spectator. The man within the breast, the impartial spectator does not feel himself worn out by the present labor of those whose conduct he surveys, nor does he feel himself solicited by the importunate calls of their present appetites. 

So in other words, prudence means that I sacrifice now to be able to have more comfort later to not do that is therefore prudent. Now that doesn't mean that it's unjust, people get to do that, but we approve of people who act prudently. So prudence when directed, quoting again, “Prudence when directed merely to the care of the health of the fortune and the rank and reputation of the individual., though it is regarded, respectable and even some degree amiable and agreeable, yet it never is considered as one of the most endearing or most ennobling of the virtues. It commands a certain cold esteem but seems not entitled to any very ardent love or admiration.” 

So it's more like and of it's more like the failure to act. Prudently is a cause of disapproval. We don't approve when people act prudently. They should just do that, but the failure to act prudently means that they have lost our sympathy. Well, the other concept that I had mentioned as being important was self-command In theory of moral sentiments, part six, section three Smith says of self-command, 

The man who acts according to the rules of perfect prudence, of strict justice and proper benevolence may be said to be perfectly virtuous, but the most perfect knowledge of those rules will not alone enable him to act in those manner. His own passions are very apt to mislead him sometimes to drive him and sometimes to seduce him to violate all the rules which he himself in all his sober and cool hours approves of the most perfect knowledge if it is not supported by the most perfect self-command will not always enable him to do his duty.

(26:53)

Well, that certainly sounds familiar. I'm an addict of food. It's not just that I eat sometimes. I like very much to eat, I would prefer to weigh less, but apparently I would not prefer it enough to actually act in that way. So, self-command is to cultivate the ability to act on what you know is right. Self-command is the mechanism for turning virtue into justice. I need to be able to turn virtue into beneficence. I need to turn virtue into prudence. So propriety is a combination of justice, beneficence and prudence as a way of achieving actual good character that requires self-command. The impartial spectator has correct judgments about propriety. When a person does what the impartial spectator demands, then it's propriety not instrumentality that dictates that action. So if I eat several pieces of key lime pie, well I'll regret it if I don't eat several pieces of key lime pie, if I don't eat any key lime pie at all, it may not be because I'm thinking now I'm going to gain weight.

It may be because I recognize that self-command requires that I act in a way that is prudent. So it doesn't have to be instrumental, it's for the reason of acting properly in the first place. Manners tell us how to act in ways that are not instrumental, but that allow us to internalize rules which if followed do have good instrumental benefits. Theory of Moral Sentiments, part three, section two, Smith says, 

The all wise author of nature has in this manner taught man to respect the sentiments and judgments of his brethren to be more or less pleased when they approve of his conduct and to be more or less hurt when they disapprove of it. He has made man, if I may say so, the immediate judge of mankind and has in this respect as in many others, created him after his own image and appointed him his vice regent upon earth to super intend the behavior of his brethren. They are taught by nature to acknowledge that power and jurisdiction which has been thus been conferred upon him to be more or less humbled and mortified when they have incurred his censure and to be more or less elated when they have obtained his applause. 

The nice thing about that is that it means that if we act according to propriety and manners, we will act in the way that we would have wanted to act if we had thought about it and had known more about the instrumental aspects that map actions into consequence. But all we need to do is act according to propriety and we can learn propriety by looking at the red light green light signals in the faces of other people around us and we want to do that. We are not acquiring propriety for instrumental reasons. We care as a primitive that was Smith's first assumption.

We care about deserving the approval of the people around us. Well famously, in Theory of Moral Sentiments, Smith says there are four sources of moral sentiments and the relationship among these sources of moral sentiments is complicated, and it'll take us a few minutes to describe this. One way to summarize it is that the four sources of moral sentiments are motive, reaction, convention, and consequence. Motive, reaction, convention, and consequence. In Theory of Moral Sentiments. Section three, chapter three, Smith says, 

When we approve of any character or action, the sentiments which we feel are according to the foregoing system, derived from four sources, which are in some respects different from one another. First, we sympathize with the motives of the agent. Secondly, we enter into the gratitude of those who receive the benefit of his actions. Third, we observe that his conduct has been agreeable to the general rules by which these two sympathies generally act. Last of all, when we consider such actions as making part of a system of behavior which tends to promote the happiness either of the individual or of the society, they appear to derive a beauty from this utility, not unlike that which we ascribe to any well contrived machine. 

So first we sympathize with the motives of the agent. That's motive. Secondly, we enter into the gratitude of those who receive the benefit, that's reaction. Third, we observe that his conduct has been agreeable to the general rules that's convention last. We look for a system that creates the happiness of the individual or the society. They appear to derive a beauty from this utility, not unlike that which we ascribe to any well contrived machine. That's consequence. Those four things can be in conflict and it's not clear that the fourth one is really natural. That is that we just automatically understand it.

It is easy to understand motive. I look at someone, they act and I think, well, are they trying to help or are they trying to hurt this other person? Then I look at the reaction that the person acted upon. Even if I have good motives, the person I'm acting upon might not appreciate it. That's not what they wanted. And then I look to see if by convention these rules are acceptable or these the ways that we actually act. Those three things are all pretty understandable. So you might imagine that a judge has before them, someone who has committed a hit and run, they ran over a pedestrian and killed them and then they panicked and left and the judge said, you know that's understandable. Anybody can panic. I'm going to let you go with probation. Well, the judge appears to be acting according to good motives in the sense that that's a generous thing to do.

The defendant who committed, hit and run, they're certainly very grateful, but judges don't get to do that. Judges don't get to say, well, I'm going to decide in this case we're just going to forgive a hit and run. It's a more serious crime than that. It would violate the convention. So it would be fine on the first motive, it would be fine on the second. The reaction to the defendant is very positive, but in terms of convention, it would be wrong, and I might be offended if I'm watching, even though it checks the first two boxes, it fails to check the third. Well, Smith thought about this quite a bit and it appears became concerned about the idea of consequence because he realized that in commercial society you need to be able to operate at very considerable scale and it appears that both because he had been giving lectures on a kind of handbook for legislators anyway, and out of his concern that people do not understand the good consequences of commercial society often because they may be impersonal and you act at a remove.

You don't know directly the people that you're dealing with in a commercial society. Adam Smith decided to write another book. That's what Wealth of Nations is. The Wealth of Nations is, let's take the first three- motive, reaction, and convention is given. Let's understand what are the consequences of acting in a commercial society according to division of labor in ways that enable an enormous increase of what Smith called opulence and widely shared prosperity. So Smith was so taken by the problem that people don't understand consequences. That is a well contrived machine, which is what a commercial society is that it may seem that the fact that people's motives is at least partly self-interested violates number one, even in a commercial society where it has good consequences. So Smith wrote Wealth of Nations to explain why, not that motive is unimportant, but that motive is not everything. You have to understand that sometimes good consequences may allow us to give a green light to what appears to be a self-interested action.

(35:07)

So I think that's the way to understand the motivation for writing the Wealth of Nations. It is to explain the positive, beneficial social consequences of having commercial society. Now, there are many people from Karl Marx to many modern people on the right, right now who believe that commercial society, particularly international trade, is not a well contrived machine, and people could certainly disagree about that, but that's the perspective that I'm going to. In this regard, Smith develops an idea that there are three kinds, or levels, of connection in society, and I had not really understood this until I encountered a very nice paper written by James Buchanan entitled Moral Community, Moral Order and Moral Anarchy, and he develops Smith's insight this way. It foreshadows Smith's growing appreciation of a factor that he himself had not understood fully and that scale, scale turns out to be important because division of labor is the source of prosperity or opulence, but division of labor is limited by the extent of the market.

Smith's theory of propriety, and Theory of Moral Sentiments is essential to understand any of what happens in the wealth of nations. The system won't work without propriety because people need to internalize and care about justice simply because justice is the right way to treat each other. If we only act justly under the threat of enforcement or punishment, the system won't work In modern language, Smith's notion of propriety creates a self-enforcing set of rules of commercial behavior. It's far from perfect, but most people most of the time act according to the rules of justice that they all know. See if you can pick out the three levels here, moral community, moral order, and moral anarchy in this excerpt from Theory of Moral Sentiments: 

It is thus that man who can subsist only in society was fitted by nature to that situation for which he was made. All the members of human society stand in need of each other's assistance and are likewise exposed to mutual injuries where the necessary assistance is reciprocally provided from love, from gratitude, from friendship and esteem. The society flourishes and is happy. All the different members of it are bound together by the agreeable bands of love and affection and are as it were, drawn to one common center of mutual good offices. 

So pause for a second from the quote, that's a moral community. We all act together because we all like each other and know each other back to the quote. 

But though the necessary assistance should not be afforded from such generous and disinterested motives, though among the different members of the society, there should be no mutual love and affection. The society though less happy and agreeable will not necessarily be dissolved. Society may subsist among different men as among different merchants from a sense of its utility without any mutual love or affection, and though no man in it should owe any obligation or be bound in gratitude to any other, it may still be upheld by a mercenary exchange of good offices according to an agreed valuation.

So pause from the quote for a second. That's a moral order. We all agree with the rules because we all benefit from all of us following the rules. So it's not just that I want you to follow the rules, I follow the rules myself because I would feel guilty and it would be embarrassing for me to be found violating the rules. It's not because I do it out of love. I do this because the rules themselves are instrumentally valuable. I am committed to a moral order, but I don't follow the rules out of a sense of instrumental benefit. I follow the rules as we've already seen because I value my own propriety. Back to the quote. 

Society, however cannot subsist among those who are at all times ready to hurt and injure one another. The moment that injury begins, the moment that mutual resentment and animosity take place, all the bands of it are broke asunder and the different members of which it consisted are as it were, dissipated and scattered abroad by the violence and opposition of their discordant affections. If there is any society among robbers and murderers, they must, at least according to the trite observation, abstain from robbing and murdering one another. 

Beneficence therefore is less essential to the existence of society than justice. “Society may subsist though not in its most comfortable state without beneficence, but the prevalence of injustice must utterly destroy it.” That's from Theory of Moral Sentiments, section two, chapter three, as I said, James Buchanan called this Moral Community, Moral Order, and Moral Anarchy. Smith's problem is that he needs scale. Since he needs scale, he needs to have societies that can operate even though they may not know each other or be drawn to a center of good offices. But as long as we're all committed to justice and justice can be maintained, the society works pretty well, and in Wealth of Nations, Smith's discovery is that scale is required for division of labor.

So even though the book in 1776 was published long after the 1759fFoundation in Theory of Moral Sentiments, Wealth of Nations could not exist without Theory of Moral Sentiments. Well, there's three more kind of set piece quotes that I want to talk about in Theory of Moral Sentiments and then we will wrap up this long, very involved, first episode. These three are the Chinese earthquake, the man of system, and Smith's discussion of slavery. First the Chinese earthquake. What's interesting about the Chinese earthquake I have claimed is that Smith in effect discovers the trolley problem. Trolley problem indicates what seems like an inconsistency, but is in fact way of highlighting the importance that humans attach to moral agency. I might have preferences that seem selfish if I don't cause the bad effects on someone else, but if I'm cause of bad effects on someone else, then I am much more concerned about the welfare of others.

Let's go through the Chinese earthquake example. This is in Theory of Moral Sentiments, part three, chapter three. 

Let us suppose that the great empire of China with all its myriads of inhabitants was suddenly swallowed up by an earthquake. And let us consider how a man of humanity in Europe who had no sort of connection with that part of the world would be affected on receiving intelligence of this dreadful calamity. He would I imagine, first of all, express very strongly a sorrow for the misfortune of that unhappy people. He would make many melancholy reflections upon the precariousness of human life and the vanity of all the labors of man which could thus be annihilated. In a moment he would too perhaps if he was a man of speculation, enter into many reasonings concerning the effects which this disaster might produce upon the commerce of Europe, the trade and business of the world in general. And when all this fine philosophy was over, when all these humane sentiments had once been fairly expressed, he would pursue his business or his pleasure, takes his repose or his diversion with the same ease and tranquility as if no such accident had happened, the most frivolous disaster which could befall himself would occasion a more real disturbance. If he was to lose his little finger tomorrow, he would not sleep tonight. But provided he never saw them, he will snore with the most profound security over the ruin of a hundred millions of his brethren. And the destruction of that immense multitude seems plainly an object less interesting to him than this poultry misfortune of his own to prevent therefore this poultry misfortune to himself. Would a man of humanity be willing to sacrifice the lives of a hundred million of his brethren provided he'd never seen them? Human nature startles with horror at the thought in the world in his greatest depravity and corruption never produced such a villain as could be capable of entertaining it. But what makes this difference? 

We'll pause in the quote for a moment. The answer is moral agency. He doesn't use that word, but the answer is clearly moral agency. Back to the quote. 

When our passive feelings are almost always so sorted and so selfish, how comes it that our active principles should often be so generous and so noble when we're always so much more deeply affected by whatever concerns ourselves than by whatever concerns other men? What is it which prompts the generous upon all occasions and the mean upon many to sacrifice their own interests to the greater interests of others? It is not the soft power of humanity. It is not that feeble spark of benevolence which nature has lighted up in the human heart that is thus capable of counteracting the strongest impulses of self-love. It is a stronger power, a more forcible motive which exerts itself upon such occasions. It is reasoned principles, conscience, the inhabitant of the breast, the man within the great judge and arbiter of our conduct. 

So notice the way that he sets this up. He says, I would be upset but not very upset if I learned that a hundred million people far away whom I don't know died in an earthquake. I would be more upset if I thought that tomorrow morning I was going to have to go out in the public square and have my little finger chopped off. However, suppose that someone came to me and said, well, a hundred million people are going to die tomorrow unless you go out to the public square and have your little finger chopped off. Would I go out and have my little finger chopped off? Almost certainly the answer is yes, particularly if it were done in public.

That is, everyone knows that I could sacrifice my little finger and save a hundred million people. You'd have to be a monster not to do that. And Smith says that most people most of the time will make that sacrifice. Is that a paradox? I care more about my little finger than the a hundred million people, but I will sacrifice my little finger to save the a hundred million people. The reason is in the second case, I'm causing the deaths of the a hundred million people. That's exactly what we find in the trolley problem that often people would say, well, it's better to have one person died rather than five. But if you are the one that has to pull the lever to switch the trolley from hurdling towards five people to a siding where there's only one person, a lot of people are not willing to do it.

(45:58)

So moral agency really matters. What that means is that Smith has recognized, again something that hundreds of years later we think we have discovered. And so that notion of moral agency, the fact that maybe we have beliefs about the world, but if we're the ones who is going to cause the pain, it changes. The problem is an important discovery by Smith and one that should be recognized. The second example is the man of system. Smith first describes the good person of public spirit and then the man of system, who is much less successful as the legislator even though they may have good ideas. Here's the quote:

The man public spirit is prompted altogether by humanity and benevolence will respect the established powers and privileges even of individuals and still more those of the great orders and societies into which the state is divided. Though he should consider some of them as in some measure abusive, he will content himself with moderating what he often cannot annihilate without great violence. When he cannot conquer the rooted prejudices of people by reason and persuasion. He will not attempt to subdue them by force but will religiously observe what by Cicero is justly called the divine maximum of Plato never to use violence to his country no more than to his parents. He will accommodate as well as he can, his public arrangements to the confirmed habits and prejudices of the people and will remedy as well as he can, the inconveniences which may flow from the want of those regulations which the people are averse to submit to. When he cannot establish the right, he will not disdain to ameliorate the wrong, but like Solen, when he cannot establish the best system of laws, he will endeavor to establish the best that the people can bear. The man of system on the contrary is apt to be very wise in his own conceit and is often so enamored with the supposed beauty of his own ideal plan of government that he cannot suffer the smallest deviation from any part of it. He goes on to establish it completely and in all its parts without any regard either to the great interests or to the strong prejudices which may oppose it. He seems to imagine that he can arrange the different members of a great society with as much ease as the hand arranges the different pieces upon a chessboard. He does not consider that the pieces upon the chessboard have no other principle of motion besides that which the hand impresses upon them. But that in the great chess Board of Human Society, every single piece has a principle of motion of its own altogether different from that with the legislature might choose to impress upon it. If those two principles coincide and act in the same direction, the game of human society will go on easily and harmoniously and it's very likely to be happy and successful. If they are opposite or different, the game will go on miserably and the society must be at all times in the highest degree of disorder.

Now it's interesting, there's a piece by Michael Clark [and Luke Hollister] on AdamSmithWorks that points out that there was a 1788 letter from a French man, DuPont de Nemours, that Adam Smith apparently in part used in writing this passage. Now you might say 1788, wait, that's long after 1759. It is. But this passage about the man of system was added to the 1790 edition. It wasn't in any of the earlier editions. And what's interesting about the DuPont de Nemours letter is that it is, although it's urging free markets and the absence of restrictions on commercial processes, de Nemours is also saying, you can't go too fast. You can't try to impose too much. So we usually read the man of system as, oh, he's talking about the left. He's also talking about the right. Someone who tries to go too quickly or too far in the direction of free markets is going to harm his own cause because people are just not persuaded that that's really the right thing to do.

So Smith critiques an overly bright ideal plan of the man of system which mimics some of the language of de Nemours. He praises the moderate reformer who accommodates, and again, de Nemours had said it is more important to do well than to say, well, so rather than try to impose abstract ideals, try to negotiate and find the best system that people will accept. De Nemours emphasizes modest strategic communication to influence opinion without shocking. And Smith says that reformers need to respect natural human prejudices and work gradually rather than command absolute change. So while that passage is often read as a critique of the left, it also can be a critique of pro-market people. It is better to try to accommodate than to try to impose the entire system. Well the third interesting set piece quote is about slavery and implicitly about what Thomas Carlyle called the dismal science.

Smith is an egalitarian in some ways you can see this in his discussion of the street porter and the philosopher where he says the main difference between them is their life experiences, not necessarily talent or class. Smith is interested in leveling that is creating large class of equals that can deal with each other as equals Smith thought commercial society did that. So in part five, chapter two of the Theory of Moral Sentiments, Smith talks about slavery, and he says this: 

There is not a negro from the coast of Africa who does not in this respect possess a degree of magnanimity, which the soul of his sorted master is too often scarce, capable of conceiving fortune, never exerted more cruelly her empire over mankind than when she subjected those nations of heroes to the refuse of the jails of Europe to wretches who possess the virtues, neither of the countries which they come from, nor those which they go to and whose levity, brutality and baseness so justly exposed them to the contempt of the vanquished.

Well. So he's saying nations of heroes, the black Africans that are being enslaved are much better people and they actually look down on the refuse of the jails of Europe, which is the white people that are acting as slave traders. So it's interesting that Smith, he doesn't just say that slavery is unjust, he's saying that the people who engage in it are just awful people and that there's absolutely no justification for race-based slavery. Peart and Levy have an interesting article where they talk about the origins of slavery and class as Thomas Carlyle's famous phrase about economics being the dismal science. Classical economists, particularly those in the tradition of Adam Smith. You have to recognize argued for human equality, free labor, always against slavery based on principles of universal human nature and incentives. This is a very liberal in the classical sense view. Thomas Carlyle detested that kind of egalitarian outlook, especially when it was applied to the formerly enslaved peoples of the Caribbean.

His labeling of economics as the dismal science was rooted in frustration that economists were defending the liberty and equality of black people, which undermined the paternalistic hierarchical social structures that Carlisle favored. So Carlyle in his 1849 essay…that's 1849, it's quite a while afterwards. Occasional Discourse on the Negro Question is the essay where Carlisle explicitly uses the dismal science label in reference to economists opposing slavery. So he called him dismal because they thought slavery was bad and wouldn't work. Carlisle advocated for a return to forced labor for Black West Indians saying otherwise they'll just be idle and society's going to collapse. So from Carlisle's 1849 piece where the term emerges, “not a gay science, I should say like some we've heard of no, a dreary, desolate and indeed quite abject and distressing one, what we might call by way of eminence, the dismal science.” So he frames the dismal science in opposition to his desired social order based on racial hierarchy and class. Quoting. “The West Indies, it appears are short of labor as indeed is very conceivable in those circumstances... Black men, if they're to continue here, must actually be compelled to work and [he uses a racist name] will not work. He sits vacantly mumbling sweet potatoes, tobacco, and pumpkins. He rejoices in his idleness and his stripes of blue cotton. Carlyle's complaint is that economic science, by insisting on liberty and equality, prevents society from compelling people like his racist caricature of Black West Indians to labor for the benefit of well, Thomas Carlyle. So Peart and Levy's conclusion is that economics was dismal to Carlyle because it was morally egalitarian, not because it was gloomy were pessimistic. Classical economics, in defending universal human capacity for improvement, in self-interest undermined the argument for slavery, forced labor and social hierarchies based on race. Peart and Levy thus position economics as part of the intellectual tradition that opposes slavery compared to the myth that capitalism and economics is necessarily indifferent to moral questions.

Now we'll come back to this because the philosopher Liz Anderson has some interesting ideas about leveling and then to quote her, when markets were left well to foreshadow at the end of this lengthy, and I'm sorry, pre introduction, I said at the outset that Smith has two claims about human nature. One, humans care about each other. Second, humans truck barter in exchange. So far we've talked only about the first. What I've tried to establish is that the fact that human beings actually care about each other and care what other people think is essential for understanding the Wealth of Nations, which is what we'll start on next. Smith needed the claims made in Theory of Moral Sentiments to make Wealth of Nations work. As we will see, the problem is that Smith needed scale and the sources of moral sentiments one through three, which is motive the reaction and convention are not enough for scale. He needs an understanding of the well contrived machine, and that's where we'll turn next time to the propensity to truck, barter, and exchange. The system in TMS left Smith with a problem. Smith needed to justify scale. That's where the Wealth of Nations comes in.