Tuesday, May 31, 2011

Adam Smith on Bargaining

Amol Agrawal posts in Mostly Economics HERE

How Vernon Smith has helped us understand Adam Smith better…

Maria Pia Paganelli of Yeshiva University has this nice paper on the topic.

She says most economics bases itself on self-interest. However, this is not always the case as we see humans valuing cooperation and fairness as well. Adam Smith’s The Theory of Moral Sentiments was based on these ideas. AS said humans value other things as well- sympathy, and innate desire to be both praised and praiseworthy.

Vernonm Smith extended Adam Smith’s ideas and showed via experiments that indeed people valued cooperation and fairplay and were sympathetic to others. This led to people monitoring and giving punishment for non-cooperative behaviors or by following internalized rules of conduct that promote fair and cooperative behaviors.

In experimental results in industrialized countries, cooperation and fairness are routinely observed. Cooperation and fairness may vary with the degree of anonymity, because subjects do respond to incentives. Nevertheless, even with complete anonymity, a relevant amount of cooperation and fairness is observed. For example, using undergraduate subjects from the University of Arizona, even with double blind procedures, 29% of second movers choose $25 for self and $15 for other, over $40 for self and $0 for other, after the first movers have forgone $10 for self and $10 for other (Cox and Deck 2005). Additionally, cooperation and fairness are also observable in many foraging societies across the globe, although in different forms from the ones observed in industrialized countries.

Fairness seems to be universally present among humans, even if it varies with different incentives and across cultures (Henrich et al. 2004). Interestingly, similar experiments done with non-human primates also show some level of cooperation and “fairness.” Non-human primates help each other in getting food and reciprocate the help received. They get upset if one gets an “unfair” share: if one primate undeservedly gets a larger portion or tastier food, the other primate screams in protest (de Waal 1996 and 2003 de Waal and Berger 2000, de Waal and Luttrell 1988, Brosnan and de Waal 2003, Jansen, Hare, Call and Tomasello 2006).

The paper looks at this linkage of Adam Smith thoughts to Vernos Smith’s experiments:

This paper develops as follows. The first section describes some of the hypotheses used to explain cooperative behaviors in the existing literature. It is followed by the explanation of how Adam Smith may help us understand the mechanism through which we may be able to move from personal to impersonal exchange, namely the internalization of rules of cooperation achieved through sympathy, reducing the transaction costs present in complex anonymous societies. The Smithian explanation is subdivided in three sections: the generation and internalization of cooperation at the individual level, at the social level, the institutionalization of the rules of cooperation which may be seen as a feedback mechanism caused by and causing increasing cooperation. The final section of the paper briefly examines some limitations for developing cooperation.

I had the privilege of hearing an early version of Maria Pia Paganelli’s paper in 2009 at the Summer School on the History of Economic Thought at Richmond University, Virginia and commenting on her paper. Maria is a rising – probably by now, a risen – star of Adam Smith scholarship. (Apologies if the above link to it does not work; it failed to do so on my Apple Macbook Pro).
I shall cover briefly the gist of my thoughts on Professor Veron Smith’s work, as I understand it.

Modern economists have lumbered Adam Smith with ideas he did nto have, at least in the form as it is commonly presented. Smith was not a singular theorist who boiled everything down to pure self-interest, often eliding into ‘selfish self interest’. This is so far from Adam Smith’s presentation that I am often provoked into critiquing it on Lost Legacy and elsewhere when it is invoked, usually in reference to the famous (and misunderstood) paragraph on the ‘butcher, brewer, and baker’ example in Wealth Of Nations. First check out the preceding lines:

But man has almost constant occasion for the help of his brethren, and it is in vain for him to expect it from their benevolence only. He will be more likely to prevail if he can interest their self-love in his favour, and shew them that it is for their own advantage to do for him what he requires of them. Whoever offers to another a bargain of any kind, proposes to do this. Give me that which I want, and you shall have this which you want, is the meaning of every such offer; and it is in this manner that we obtain from one another the far greater part of those good offices which we stand in need of’ (WN I.ii.2: 26).

Clearly, Adam Smith is emphasizing the important point (crucial to understanding his approach) that relying on someone else’s benevolence is not enough (nobody, be they benevolent in the extreme, has sufficient of anything, to donate it to everybody else who might need it). That is the limitation of benevolence, our admiration of it as a virtue, notwithstanding. He goes to on make his point even clearer:

“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 own necessities but of their advantages” (WN I.ii.2: 26-7).

As clearly, Adam Smith did not counter the evident limitations of the virtue of absolute benevolence with a reliance on self-interest alone. That might justifiably be termed selfish. But he didn’t draw that conclusion at all. Instead, he said that one’s self-interest is best served by addressing the self-interests/ ‘self-love’ of the other party (butcher/brewer/baker or whomsoever. In sum, Adam Smith, asserted that self-interests are realized in our bargaining transactions with others by serving their (not our!) self-interests.

So, when Maria Paganelli says that ‘most economics bases itself on self-interest” she is reporting how modern economists (not Adam Smith) have reduced economics to this single assumption and build its neo-classical Homo economicus upon it (it suits the maths much better to arrive at its claimed determinate conclusions).

No wonder on this inaccurate interpretation that modern economics is under siege from practical attempts to model actual behaviours in the fascinating games that Professor Vernon Smith and others have devised in what has become known as the school of behavioural economics. The modern assertions of Adam Smith’s view are exposed convincingly by the numerous experiments conducted across the world, but Adam Smith never made such narrow assertions about self-interest in the first place.

The ingenious experiments designed by Professor Vernon and others for their observations of the behaviours of graduate students have produced many remarkably consistent results exposing the near fallacy of the pure self-directed, self-interest thesis as proclaimed by most modern economists (rational behaviourists). And in the main, I applaud their work with the provisio that they recognize their fundamental error of attributing the limited concept of self-interest to Adam Smith.

My own experience, where from 1970-72, I observed live negotiations at a Shell Refinery for my MSc degree in 'Productivity Bargaining', and since 1972 through Strathclyde Business School to 1983, and then through Edinburgh Business School to 2005, where I was involved in observing thousands of real world bargainers at real work for real stakes, felt by them to be important to the welfare of their businesses or countries and, ultimately, to themselves and their families, all of which invariably showed Adam Smith’s insight in Book 1 of WN was confirmed time and time again.

People learn, one way or another, that demanding the other party give them all of what they want without in some measure offering some of what they want in return, seldom works and that mostly it doesn’t. Self-centred egoists refusing to move, more often than not find it leads to ‘no deal’; but formulating their offers in some version of: ‘Give me that which I want, and you shall have this which you want’, as Adam Smith advised, more often than not leads to a mutually acceptable agreements.

Selfish, or narrow-minded would-be bargainers, who insist on their self-interests alone, seldom succeed, especially when they act as if they conform to the behaviour of the so-called ‘rational egoist’ beloved by so-called ‘scientific’ micro-economics taught across modern campuses.

In bargaining, where conversation is present, we can see what happens in the Vernon Smith game where the ‘so-called ‘rational egoist’ offers the other party 1 unit while demanding 99 for him/her self. By not accepting the offer, the idea that 1 unit is better than none (an heroic assumption that he/she would accept only 1 rather than nothing) the frustrated bargainer, says in effect, ‘then you shall have none too’ – a perfectly reasonable reaction, consisting of no surprises, in my experience of real-world bargainers. These games confirm Adam Smith’s insight; they do not revise it in any way. That the players in the games have single choices, without conversations, strongly confirms Adam Smith.

My message to the behaviourists is that they are not ‘extending’ Adam Smith, nor revising him. He is completely innocent on this subject. It is the so-called ‘rational’ school that is in the frame for revision, not Adam Smith. I suggest to everybody that they study Paragraph 2 in Book I of WN and understand the exact words of Adam Smith.



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