Vernon Smith on Adam Smith and the Human Enterprise
What this covers
Vernon Smith, a Nobel laureate economist, sits with Russ Roberts to argue that Adam Smith's Theory of Moral Sentiments offers a far more accurate account of human behavior than the Max U) framework that has dominated modern economics. Rather than positioning the two as complementary, Smith contends that the neoclassical model actively displaced Smith's richer vision. The conversation moves between philosophical foundations and laboratory evidence: trust-game experiments reveal that roughly half of subjects cooperate despite predictions of self-interested defection, and this cooperation hinges crucially on whether participants can read intentions. Adam Smith's propositions about beneficence, resentment, and the gains/losses asymmetry directly predict these experimental anomalies and, Smith argues, ground property rights and law itself.
The conversation ranges across the intellectual history that led to the current state of economics. William Stanley Jevons and the marginal revolution, rooted in Jeremy Bentham's utilitarianism, did not merely extend classical economics but inverted it, treating preferences and technology as primitive givens. Smith contends instead that Adam Smith's account runs the other direction: the propensity to trade comes first and generates prices, comparison, and specialization—a process view incompatible with the standard framework. The discussion also explores where Max U works and where it fails: it succeeds in simple supply-and-demand markets for perishables with fixed buyer-seller roles, but breaks down in re-tradeable asset markets like housing or stocks, where instability and bubbles emerge. Throughout, Smith emphasizes that human conduct is fundamentally social and rule-following—governed by norms of propriety, praise and praiseworthiness, and readings of intention—not reducible to utility maximization. A recurring theme is that naming behavior (like calling it "reciprocity") is not the same as explaining it.
Vernon Smith argues that human motivation is fundamentally social and rule-following rather than utilitarian, and that Adam Smith's Theory of Moral Sentiments explains experimental anomalies (like trust-game cooperation) far better than the neoclassical Max U model, which displaced rather than supplemented Smith's deeper account of human conduct.
- Trust-game experiments show roughly half of subjects cooperate, contradicting Max U predictions, and cooperation depends on whether intentions can be read.
- Adam Smith's propositions about beneficence, resentment, and the gains/losses asymmetry directly predict experimental behavior and ground property rights.
- The marginal revolution (Jevons) reduced economics to utility maximization, inverting Smith's process view in which the propensity to trade generates prices, comparison, and specialization.
Adam Smith's account centered on social sentiment and intention, not preference satisfaction, explains cooperation better than utility maximization.
- Although Adam Smith assumes self-love (non-satiation) as a stoic axiom, he holds that actual decisions are governed by social criteria -- the desire for praise and praiseworthiness and the avoidance of blame and blameworthiness -- so one can tell a complete story of human interaction without invoking a utility function at all.
“Smith says, We desire praise and to be praise-worthy. We desire to avoid blame, and blame-worthiness. So in other words, it's the social criteria that drives and governs our choice.”
- Adam Smith's framework explains trust-game cooperation by holding that intentions are central to the meaning of actions: a beneficent action from proper motives merits reward, and observers can infer proper motives because they can see what the actor could have done but chose not to, making actions readable signals of intention -- something the Max U common-knowledge-of-self-interest model has no room for.
“Adam Smith emphasizes over and over in The Theory of Moral Sentiments that intentions are central to understanding the meaning of actions.”
- In the anonymous one-shot trust game, Max U predicts the first mover stops the game for the safe equilibrium payoff, yet about half of first movers pass, and two-thirds to three-quarters of second movers reciprocate cooperatively rather than defecting and taking all the money, falsifying the self-interest prediction even with extreme payoffs.
“Half of the subjects moved down on that game... And two-thirds to three-quarters of those assigned $15 to the first mover and take $25. In other words, they do not defect and take all the money, predominantly.”
- In a controlled comparison, when the second mover can see that the first mover voluntarily gave up an outside option, cooperation is twice as high as defection; but when the first mover had no choice (no outside option to forgo), defection becomes twice as high as cooperation -- demonstrating that the ability to read intention drives reciprocal cooperation.
“in the game where I see what you gave up and I can read meaning into your action, the cooperation is twice as high as the defection. If the player two can't see that, then the defection is twice as high as the cooperative outcome.”
- Human psychology is fundamentally social: using Adam Smith's mirror metaphor, an individual raised in total isolation could no more grasp a deformity of his own mind than of his own face; society provides the looking-glass through which we see ourselves as others see us, so there is no self without a 'we'.
“bring him into society and you give him the mirror he needed before. In other words, the looking glass in which we are able to see ourselves as others see us.”
The marginal revolution displaced Smith's framework with a preferences-and-resources model that inverted his actual account of economic life.
- The marginal revolution led by Jevons (rooted in Bentham's utilitarianism) did not merely add marginal utility to classical economics but displaced Adam Smith's framework, turning the Wealth of Nations on its head by recasting the economy as given preferences, technology, and resources whose prices let people satisfy preferences at lowest cost.
“that wasn't just added to what the classical economists like Smith did. It displaced them.”
- Economists reduce everything to utility maximization mainly so they can make efficiency statements, but Adam Smith would say there is time enough for efficiency judgments later; first one should find out on the ground why people actually do what they do -- their immediate motivations and emotions.
“I did it because you want to be able to make an efficiency statement... And I think Adam Smith would say, hey, there's time enough for that; let's first find out, on the ground, why people do this.”
- In Adam Smith's account the propensity to truck, barter, and exchange comes first and drives everything: trade produces prices (spread by gossip if not public), prices enable calculation and comparison that prompt new questions, and this process transforms people and creates specialization -- reversing the neoclassical view in which preferences, technology, and resources are primitive and specialization is presupposed.
“tendency to trade. What does that do? It leads to prices. Price, then, become known. If they are not public, people learn about them through gossip... as soon as there's prices, people can start to make comparisons.”
Competitive markets work smoothly only when goods are non-durable, non-tradeable, and roles are fixed; tradeable assets generate instability and bubbles.
- Even transparent experimental asset markets with a known common dividend produce price bubbles, as people get caught up in self-reinforcing expectations of rising prices; these bubbles diminish with trader experience, paralleling real-world housing bubbles like the one behind the Great Recession.
“These markets are very subject to bubbles in the lab. And people get caught up in self-reinforcing expectations of rising prices. We don't know where that comes from.”
- In markets where participants can switch between being a buyer or a seller depending on price (like stock or housing markets), prices become unstable and erratic, unlike role-specialized markets such as haircuts where one is always a buyer.
“that's very different from the stock market, or even the housing market, where, depending upon the price, you may switch from being a buyer to a seller. And that accounts for a lot of the problems.”
- Non-durable consumer goods (about 75% of private product) cannot be re-traded and behave stably both in the lab and the economy, while all macroeconomic instability comes from the other 25%, mostly durable, re-tradeable assets like housing.
“nondurable consumer goods--and of course a lot of those are also services--that's 75% of private product... All of our macroeconomic instability comes from the other 25%. Mostly housing.”
- The maximizing-utility (Max U) model works well in ordinary supply-and-demand markets for perishable, non-re-tradeable commodities (like hamburgers and haircuts) because participants have fixed buyer/seller roles, property rights are perfectly enforced, and goods cannot be re-traded, reducing dependence on trust.
“that model works well in in ordinary supply and demand markets--which are the kind of thing that it has to do with flows. And those really have to do with perishable commodities.”
Smith anticipated loss-aversion asymmetry and used it to explain why criminal law punishes differently than civil law.
- Adam Smith stated and used the asymmetry between gains and losses -- that we suffer more falling from a better to a worse state than we gain rising from worse to better, across fortune, reputation, and esteem -- anticipating the loss-aversion asymmetry that Kahneman and Tversky later documented in individual decision-making.
“We suffer more when we fall from a better to a worse state than we ever gain when we arise from a worse to a better.”
- Adam Smith's proposition that hurtful actions from improper (intended) motives alone deserve punishment generates resentment, and these small-group rules of resentment-driven, proportional punishment are later carried over into civil law -- so law and property rights originate in cultural moral sentiments long before government codifies them.
“that proposition is the basis of property rights in The Theory of Moral Sentiments... When it comes time for civil government we just move those rules over and they become the law.”
- Adam Smith explains that theft and robbery carry greater punishment (and are criminal offenses) than violations of promises or contracts (which are only civil offenses) because robbery takes what we have already acquired while breach of contract merely frustrates our expectation of gain -- an application of the gains/losses asymmetry.
“robbery and theft take from us what we have already acquired. Violation of contract merely frustrates our expectation of gain.”
Conduct is culturally specific rule-following governed by propriety; reducing behavior to utility maximization obscures what people actually do.
- Explaining trust-game cooperation as 'reciprocity' is inadequate because reciprocity is merely a name for the behavior being observed, not a deeper account of why people do it -- analogous to how the Keynesian 'liquidity trap' just names the ineffectiveness of monetary policy without explaining it.
“Reciprocity--what is that? That's just a name for what it is they're doing. It doesn't really explain anything. It's like in Keynesian economics, the liquidity trap.”
- Reading Adam Smith with Samuel Johnson's 1755 Dictionary reveals that words had different meanings in his day -- notably that Smith's key term is 'conduct' (which involves rule-following and the circumstances behind actions) rather than 'behavior', which only appears paired with other words like countenance.
“His real word, the word that counts, is 'conduct.' And conduct has to do, is a thing that involves rule-following.”
- Norms of propriety are culturally and locally specific: the Korean hotel staff graciously declined a tip not because they preferred less money but because, in their cultural rule system, excellent service was their duty rather than a beneficent act above the call of duty, illustrating that conduct -- not utility maximization -- governs behavior and that both parties' apparent 'irrationality' dissolves once propriety is understood.
“it just tells you about the rules, how they can be very cultural. And local. And as you think about that, each of us knew that the other preferred more money to less.”
Experimental method requires earned money rather than endowments, comparison across conditions, and treating falsification as a learning opportunity.
- The fact that the United States actually repealed Prohibition by amending the Constitution is remarkable because legislative mistakes are rarely reversed, and it indicates the policy was failing miserably to warrant such effort.
“we actually repealed Prohibition... For anyone to get that kind of effort out, to go back and change the Constitution. When do we ever make legislative mistakes and then go back and correct them.”
- Because subjects behave differently with experimenter-provided endowments versus money they earned, earlier experiments using endowed 'experimental money' need to be replicated with earned money to test their robustness -- a methodological correction now underway.
“I've written a paper in which I argue that all those experiments that we did earlier using experimental--experimental money--endowments, need to be replicated”
- Contrary to the belief that competitive convergence requires complete information and a large 'sea' of buyers and sellers, experimental supply-and-demand markets converge to competitive equilibrium easily even with very small numbers of participants.
“here I was doing experiments with 15, 20, 25 people; and we were getting convergence easily. And then I did them with smaller numbers, and those supply-and-demand markets worked really well.”
- Experiments that fail -- that falsify the experimenter's beliefs -- are especially important because they force the crucial question of why expectations were so far off, which is where genuine learning occurs.
“Experiments that fail are very important, because you have to ask why were our expectations so far off.”
- The traditional mathematical and auction-theory framework is genuinely valuable for engineering applications: Smith and Rassenti used it to design experiments showing skeptics that competitive wholesale markets for electric power could work, helping Australia move from state-owned power to a national wholesale electricity market by 1998.
“When my colleague, Steve Rassenti and I started studying the electric power industry... we needed all of that framework. We need auction theory. We needed the stuff, we needed those tools.”