Friday, June 03, 2005

Smith on Bargaining and Self Interest

Prof. Wahiuddin Mahmud in an interesting article on “Ethics in Banking”, New Nation, Bangladesh, on 2nd of June 2005, makes a typical error, all too common today in interpreting Adam Smith’s legacy. He writes:

“Adam Smith was also a great believer of the virtues of the so-called "invisible hand" of the market, which is supposed to work through the self-interested behaviour of businessmen. As he made it clear: "it is not from the benevolence of the butcher............or the baker that we expect our dinner, but from their regard to their own interest." This was the origin of how 'rational' behaviour in economics, defined in terms of maximising self-interest, was implicitly given a moral validity. “

Professor Mahmud has not thought through his own statement. The market, which he confuses with the so-called invisible hand (another topic entirely), is “supposed to work through the self-interested behaviour of businessmen”.

But what about the consumers – the other parties to the transaction? Are they acting from self-interest too? Yes, of course, they are, but how then does the market work? If the parties to the transaction work solely through the maximisation of their self-interest how then can they agree on bargains? Or is it a zero sum game solely because what one gains the other loses? This contradicts Smith’s belief that in trade both parties gain.

Adam Smith is quite clear about what happens. In the same passage quoted by Professor Mahmud he advises you to appeal not to your own interest but to the self-interest of the ‘butcher and the baker’. And what is true of the buyer must also be true of the seller.

The butcher and the baker try to sell their products to people seeking their dinners by appealing to their customer’s self-interest and not their own. Now it gets interesting. If each party appeals to the other party’s self-interest and not their own they are acting as if they are maximising the self-interest of the other party in the transaction and not their own. Therefore, they are not ‘maximising their own self interest’ but modifying their own self interest by addressing the other party’s self-interest. And this makes Professor Mahmud’s interpretation of Adam Smith contradictory.

In short, Adam Smith did not teach that self-interest dominated market transactions in the manner that Professor Mahmud (and many others) assert. Markets harmoniously mediate the selfish motives of the parties through our endeavouring to obtain what we want from others who want something from us. This is the essence of transacting through bargaining: we serve their own interests best by serving the interests of others.

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