Natural Rationality | decision-making in the economy of nature


Greed—for lack of a better word—is not necessarily good: the other Adam Smith and the economics of altruism

In one of the most quoted passage of the Wealth of Nations, Adam Smith argue that economic self-interest leads to collective optima:

It is not from the benevolence of the butcher, the brewer or the baker that we expect our dinner, but from their regard to their own interest. We address ourselves not to their humanity but to their self-love, and never talk to them of our necessities but of their advantages. Nobody but a beggar chooses to depend chiefly upon the benevolence of their fellow-citizens.
Everybody will remember the famous Gordon Gekko's speech in Oliver Stone's Wall Street (1987):

The point is, ladies and gentlemen, that greed—for lack of a better word—is good. Greed is right. Greed works. Greed clarifies, cuts through, and captures the essence of the evolutionary spirit. Greed, in all of its forms—greed for life, for money, for love, knowledge—has marked the upward surge of mankind.

Things may not be that simple. While the standard Homo Economicus model represents agents as exclusively motivated by their material self-interest, economic theories of fairness put forth the picture of Homo Reciprocans, an agent whose utility function incorporates social parameters (Bowles & Gintis, 2002; see Fehr and Schmidt, 2003, for a review). Economic theories of fairness fall into two categories: outcome-based models and intention-based models. The former explains fairness as the product of players’ aversion to inequity (Bolton and Ockenfels, 2000; Fehr and Schmidt, 1999; see also this post). Players are sensible to the distributive consequences of strategic interactions and prefer resources allocations that reduce inequity: they negatively value a discrepancy between their own payoff and an equitable payoff (whether it’s the mean payoff or another player’s payoff). The latter explains fairness as the product of players’ reciprocation of perceived kindness or unkindness (Rabin, 1993 ; Dufwenberg & Kirchsteiger, 2004).). More than the outcome of an interaction, fairness is motivated by the attributed intention. For instance, in a ultimatum where the proposer’s behavior is restricted to two options (50/50 and 80/20 split), the second option is the most rejected; when the proposer’s options are 20/80 and 80/20, however, the first option is rejected less often (Falk, Fehr & Fischbacher 2003). Decision-makers value differently the same option whether it is perceived as an intention to be fair (valued positively) or not (negatively). Since both parameters appear to be important, many models integrate both intentions and outcomes (Fehr & Schmidt, 2003; Falk & Fischbacher, 2006).
A common feature of these models is the preservation of the optimality assumption: although they all suggest that standard utility function should incorporate different parameters, they do not reject the idea that agents are internally rational: they maximize a non-classical utility function.

Hence it is not surprising that contemporary research is more interested by the "first" Adam Smith, who wrote in the Theory of Moral Sentiments:
How selfish soever 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. Of this kind is pity or compassion, the emotion which we feel for the misery of others, when we either see it, or are made to conceive it in a very lively manner. That we often derive sorrow from the sorrow of others, is a matter of fact too obvious to require any instances to prove it; for this sentiment, like all the other original passions of human nature, is by no means confined to the virtuous and humane, though they perhaps may feel it with the most exquisite sensibility. The greatest ruffian, the most hardened violator of the laws of society, is not altogether without it.
In "Adam Smith, Behavioral Economist", Ashraf et al. (2005, The Journal of Economic Perspectives, 19, 131-145) discusses the relevance of Smith for experimental economics. In "The Two Faces of Adam Smith" (Southern Economic Journal, 65, 1-19), another Smith (Vernon) analyses the dual nature of Smith's (Adam) writing.

Finally, (found thanks to Mind Hacks) there is an excellent paper in the last Scientific American on the economics of fairness and other moral sentiments:

Is Greed Good?
Economists are finding that social concerns often trump selfishness in financial decision making, a view that helps to explain why tens of millions of people send money to strangers they find on the Internet
By Christoph Uhlhaas
There will be a conference a conference to commemorate the 250th anniversary of The Theory of Moral Sentiments in 2009 in Oxford (see CFP on PhilEcon website).

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