Tuesday, August 09, 2011

Adam Smith on Bargaining and My Experience Applying His Theory

I wish to elaborate on my post over the weekend Philip Pilkington On Rational Expectations Theory because it contained a comment on the most important thought of Adam Smith’s, often misunderstood and as often used (wrongly) to come to the wrong, even opposite, conclusion to that which Smith made. I refer to the famous reference by Smith to the “butcher, brewer, and baker” as the source of our dinner. Here is my last paragraph from my comments on Philip Pilkington’s post:

“In Moral Sentiments, Adam Smith did not restrict behaviour to “self interest” self-regarding only, but also wrote about the necessity for being “other-regarding” too. In Wealth Of Nations he did this very clearly in the oft-quoted passage about persuading the famous “butcher, brewer and baker” to provide our dinners, where he specifically advises us not to “talk of our own necessities” but to address their “self-love”. In short, we serve our self-interests by serving the self-interests of others - in contrast to that nasty libel of Smith’s legacy by Gekko of ‘Wall Street’ fame.”

But first, I want you to look up John Paul Rollert, a doctoral student at the Committee on Social Thought at the University of Chicago, who has posted a remarkably good article, “What Republicans get wrong about capitalism” (HERE) (how encouraging it is to read two articles that show their authors have at least read and understood Smith (which does not mean I endorse Paul’s political assertions about ‘top heavy’ sole beneficiaries of capitalist markets in today’s USA). Here are John Paul Rollert’s opening paragraphs that cover some of the ground of my earlier article:

Near the beginning of "The Wealth of Nations", Smith calls our attention to what, for him, is one of the fundamental qualities of human experience: helplessness. "[M]an has almost constant need for the help of his brethren," he says, for unlike animals, we cannot tend to even our most basic needs on our own. How exactly do we gain the help of others? The answer, says Smith, lies somewhere between the fawning cocker spaniel and the commands of an all-powerful king.

Let's hold the king aside for a moment. When a cocker spaniel wants to be fed, Smith says, "it has no other means of persuasion but to gain the favor of those whose service it requires." It wags its tails, licks its master's hand, and appeals to him with puppy dog eyes. The cocker spaniel will occasionally succeed, and so too will the fawning beggar, but such an approach is obviously not an optimal way to get what you want. Indeed, most times people will simply pass by you, leaving you hat in hand.
Thankfully, says Smith, human beings have a natural propensity to negotiate or, as he describes it, to truck, barter, and exchange. "Give me that which I want, and you shall have this which you want" is not only the manner in which we acquire most things in this world, but it is the building block for an economically advanced society. Thus, Smith declares in his most famous passage: “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.”

People who read this passage and nothing else of Smith tend to regard it as an affirmation of the virtue and efficacy of selfishness over and against the relative impotence of altruism. But that isn't its significance for Smith. Yes, our personal interests act as a sharper spur to action than the interests of others, but the same may be said for the cocker spaniel. The difference is not that we have selfish interests, but that only by understanding the interests of others are we able to fulfill our own. Indeed, the passage attests to the human capacity for empathy, the focus of Smith's other great work, "The Theory of Moral Sentiments". It is because of our natural tendency to stand in the shoes of others and see the world through their eyes that we can appeal to their interests. The commercial effect of this practice is that we individually learn how to make the kinds of exchanges that, in the aggregate, lead to the wealth of a nation.”

Many modern economists consider in this passage about the “butcher, brewer, and baker” sanctifies Smith’s praises of self-interest (and among leftish academics, it is “proof” that Smith saw “self-interest” as essentially, and decidedly, as a necessary selfish behaviour that drove what they call, but he did not, capitalism). Others see it has evidence of a contradictory fissure in the thrust of his two books, Moral Sentiments (1759) and Wealth Of Nations (1776). It is nothing of the kind. The so-called “Adam Smith Problem” is another myth, created by a lackadaisical reading of quotations from both books.

Contrast the “butcher, brewer, and baker” passage with the opening paragraph in Moral Sentiments:

However selfish man maybe supposed, there is evidently some principle in his nature, which interest in the fortune of others, and render their happiness necessary to him, though he derives nothing from it except the pleasure of seeing it. … The greatest ruffian, the most hardened violator of the laws of society, is not altogether without it” (TMS 9).

This propensity or capacity for concern for the “fortune of others” kind, captured in Smith’s first book, is surely the antithesis of pure self-interest, especially of the hyper-calculating kind represented by the rational, utility-maximising kind that is still popular among many neo-classical economists.

Our moral sentiments drive us to be concerned for others, in modern jargon, our ‘other-centred’ natures, is counter-poised by other ‘natural propensities’ that drive our self-interests to be supremely ‘self-centred’ and not ‘other-centred’. But is this supposed dichotomy a true representation of Adam Smith’s two books?

I don’t think so. Maybe I am almost alone in seeing something deeper in Smith’s “butcher, brewer, baker” than commonly found in the meaning he placed on bargaining. Remember, Smith’s characterisation of what happens when people bargain came in Book I, chapter 2, of Wealth Of Nations. There is good reason to acknowledge that these ideas were of older vintage than 1776 among his writings. His Lectures on Jurisprudence were taken down by students in 1763-4 (prior to France and his meetings with the Physiocrats) and were probably developed in his earlier years at Glasgow (from 1751), if not in Edinburgh 1748-51. They follow his presentation of “The division of Labour” in Chapter 1. They are the key-stone of his historical approach, which showed the division of labour as the “very slow and gradual consequence of a certain propensity in human nature which has in view no such extensive utility; the propensity to truck, barter, and exchange one thing for another”, which was probably “the necessary consequence of the faculties of reason and speech”. In short, from the very beginning of the formation of the proto-human bands hunting in the forests, long, long before self-interest in anything like markets had emerged.

My own interests in the evolution of bargaining in pre-history (“The PreHistory of Bargaining", unpublished ms) has continually brought me back to Smith’s chapter II, partly fed by a long period in Business Schools teaching and consulting on negotiation skills with business enterprises across Europe, North America, Asia, South Africa and Australia. I raise this bit of biography only to claim considerable practical experience with negotiators in the real modern world.

That is why I read chapter II with reference to what negotiators do in practice, not with preconceived theories about what they would do if the mathematical certainties of utility maximisation applied outside neoclassical classrooms and neoclassical imaginations. Smith didn’t make it up; he saw and heard traders and customers bargaining their exchanges using persuasion and sales patter in the market stalls and shops along Kirkcaldy High Street where he grew up, and in busy Edinburgh, Glasgow, and London (and almost certainly in French market fairs too, of which there were thousands all over France (there still are hundreds in many small towns and centres, including around where I live, part of the year).

Smith didn’t see much of the self-centred stubbornness implied in most modern theories of bargaining – aggressive concession convergence, modulated by threats and sanctions, and so on.

… 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. 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).

A simple game that I included in every negotiation workshop that I ran from 1972-2005 (when I retired) was the ‘red-blue’ (prisoner’s Dilemma) game, in which I used to introduce beginner (and 'old hand') negotiators to the consequences of pure self-interested bargaining, and it showed clearly the folly of only considering one’s own interests in transacting with others. Over the years it revealed some interesting data about those consequences.

The game is played in pairs, randomly sorted. It is played first thing on the first day. They are given two coloured disks, one red and one blue. They are told the rules (no talking with partners), and given absolutely no advice on how to play or what they will learn, or what was the point of the exercise. They scores are simply shown on flip charts for the four possible outcomes of each play, and told to commence playing with a partner anywhere in the room, standing or sitting.

The scores were for each play: Both play ‘Blue-Blue’ = +4 points each; both play ‘Red-Red’ = -4 points each; one plays ‘Red’ and the other plays ‘Blue’, then the Red player = +8 points and Blue player = -8 points; or, one plays ‘Blue’ and the other plays ‘Red’, then the Blue player = -8 points and the Red player = +8 points.

They choose the colour they intend to play behind their backs for each round and each revels their plays simultaneously on a common signal. They note their score for each round according the score sheet. They play the next round without talking. After the first four rounds they pause for a 5-minute conversation, perhaps recriminating on the other’s plays or defending their own, and perhaps agreeing on how to play the next four rounds, under the same rules and scores. Again, after round 8, they stop for a 5-minute conversation, perhaps again recriminating if one or both defected on their agreement from the previous 5-minute break. The last two rounds are played with all scores doubling, to give paired-blue play = +16 points each; paired red play = -16 each; one plays blue and one plays red = +16 points to the red player = -16 points to the blue player.

Then we discussed the resulting total scores over the 10 rounds from each pair. Over the years the pattern of plays across all levels of management, experience, countries of origin and domicility, moral (religious) labels, ages (from youngest school children to retired), education levels, private and public sector employees, caring professions, hard-nosed financial traders, all nationalities, mixed groups, both sexes, politicians, health staff (from porters to surgeons), and beginning and experienced sales and buying staffs, showed relative stability.

Now the maximum score from total cooperation (no defections) was 48 points each. I found that over the years this score was achieved by only 8 per cent of the players. A competing (but friendly, as you would expect from two teachers of negotiation) consultant, John Carlyle, reported achieving maximum scores among 17 per cent of his attendees, but I do not know if, or how much, he briefed his players before they commenced playing. I gave absolutely no pre-game briefing other that described above. The 8 per cent was too stable to be influenced by prior briefings. Despite almost always being asked to identify the objects of the exercise, I said nothing other than ‘maximise your individual scores’.

Players could suffer from the other’s early red play and subsequent defections (no sanctions were suggested nor imposed on defectors, other than the almost predictable retaliatory Red play defections of former Blue players, some fairly drastic red play from Round 5 onwards to round 10 (and almost certainly from round 9). Counter-defectors from broken promises by red players could reduce the early defector’s scores, even though they also ended with a high minus score. No red player with early counter defections reached +48 (the Blue-Blue score) or better. On two occasions only in 33 years did a Red player reach +96 - because the other player played Blue every round and they were unconcerned at their constant losses to -96.

In a large minority (sometimes a majority) of plays of the game, early defection was followed by unbroken promises to pay blue in every round, which though the total positive score was less than +48 (perfect no-defections), it was at least +32 each and sometimes better.

In brief, players could learn that playing a co-operative blue each round after early defections could result in a better score than defecting to gain at their partner’s expense, who would retaliate. It was not a perfect exchange, but zero-sum bargaining never was better than non-zero bargaining as identified by Smithian bargaining:

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.”

The rest of our workshops showed how to achieve non-zero sum bargaining in the real world.

[Please note you can read my book on negotiation teaching in “Kennedy On Negotiation”, Gower, 1995 (apologies: the publishers chose the title!]



Blogger michael webster said...

The low level of coordination in the 2 person dilemma doesn't surprise me - many people are simple unable to parse the game in the short period of time, and then just "try" things.

Here is a version of a 4 person dilemma game.


In this exercise, even when the joint surplus is pointed out, people have a hard time getting to it.

3:32 a.m.  
Blogger Gavin Kennedy said...


I refer to the two-peson dilemma game because I observed several thousands of plays of it. Its significance for me was that the parse problem also revealed the learning process by which the players changed their tactics. For those that opened Red-Red (over 90 per cent), most switched from round two to four (5 minute break for discussion) to blue-blue plays (the largest number), with some also switching by round 6. Defections of one player to Red were seen sometimes in round 7 were uncommon, interestingly often the play whose initial Before their partner switched to blue=blue play- acting on their grievance to the last round 10, when their partner could not respond.
Only a few, c.2 per cent ended, end with low joint scores from mostly red-red play.

I have compiled a note applied to Smith's 'conditional bargain' assertion (If-Then) and when readable, I shall post it.

8:18 a.m.  
Blogger michael webster said...

Gavin, did you ever post your note about Smith's conditional bargain?

5:01 a.m.  
Blogger Gavin Kennedy said...

I have responded to your 2012 question in a January 19 2012 post in case people do not scroll back to 201i.

4:43 p.m.  

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