ON SMITHIAN PATERNALISM: Evaluating Adam Smith’s Perspectives on Modern “Libertarian Paternalism” Cindy Shen Professor Henry Clark Adam Smith & Political Economy 20 November 2020 Shen 1 Best known for introducing the concept of the invisible hand, Adam Smith appears (at least on the surface-level) to be the founding champion of laissez-faire economic theory. Both ​ ​ economists and libertarians deify Smith for supposedly pioneering a market framework consisting of purely self-interested participants. But as game theorists continue to prove that people do not solely consider their own payoffs when making decisions, economic scholars have had to reconsider their neoclassical models pointing in favor of a fully deregulated economy. 1 Among left-leaning political circles, these inconsistencies in classic economic theory ​ have ​ added fuel to the notion that Smith’s ideas are merely archaic relics resting on false assumptions (see Norman 2018). These circles of thinkers are considered paternalists, who are thought to be deeply skeptical of free choice (see Goodin 1991). By nature, it follows that paternalists cannot possibly embrace the libertarian schools of thought so pervasively tied to Smith’s legacy. Given the mounting evidence against fully selfish market players, is it fair for paternalists to discard Adam Smith’s economic views as obsolete? This question miscontextualizes Smith’s beliefs. In reality, Adam Smith is neither the firm advocate of human self interest nor the staunch enemy of state interventionism his colloquial reputation has ascribed to him. While Smith praised free trade and market equilibrium, he also recognized a need for some state intervention and outlined government roles like collecting taxes and regulating banks, among others (see Rockoff 2010; Smith 1976, II.ii). Smith thus balanced respecting an individual’s autonomy with paternalist skepticism of it: he emphasized the value of letting people make their own choices all while conceptualizing institutions that would encourage them to make better decisions. Accordingly, Smith’s moral and economic framework outlined in both The Theory of Moral ​ Sentiments and The Wealth of Nations attempt to balance paternalist ideologies with those of ​ ​ ​ 1 See Sendhil Mullainathan and Richard Thaler’s encyclopedia article for more on the inconsistencies of classic economics, available online at: https://www.econlib.org/library/Enc/BehavioralEconomics.html Shen 2 libertarianism. Smith thus implicitly subscribes to a form of what’s known today as “libertarian paternalism.” To fully assess the extent to which Smith proposes his own form of libertarian paternalism and the extent to which he deviates from modern libertarian paternalists, I’ve divided this paper into three parts: first, I draw parallels between the core components of Smith’s moral theory and modern game theory to argue that Smith’s moral account of human nature is both empirically-backed and essential to shaping Smith’s views on an ideal system of justice and what role the government should play in protecting it; second, I highlight how Smith’s distinction between his conceptions of “justice” and “beneficence” mark how his moral sentiments determine his views on the level of paternalism a government can reasonably exhibit; and third, I compare the modern libertarian paternalism first coined by Cass Sunstein and Richard Thaler with Smith’s perspectives on individual liberty and government intervention. I’ve structured my argument in this way as a comparison on two fronts: (1) on the micro-level, between Smith’s moral theory and behavioral economic studies, and (2) on the macro-level, between Smith’s political economy and libertarian paternalism. In both comparisons, the macro-level is an application of the micro-level theory to a systemic political, philosophical, and economic framework. I conclude that a form of Smithian libertarian paternalism can be formed from understanding the interaction of smith’s moral and political theory. Smith’s Sympathy, as Quantified by Game Theory Understanding Adam Smith’s moral framework in The Theory of Moral Sentiments is a ​ ​ critical part of drawing parallels between Smith and libertarian paternalism. Libertarian paternalism is informed from recent behavioral economic literature citing the important role of irrational decision-making in the economy. In a similar fashion, Smith’s understanding of Shen 3 political economy is informed from his moral theory. Smith specifically bases his moral theory ​ ​ on the fact that people do not principally act out of self interest, but rather by their innate sense of what he calls ‘sympathy.’ This sympathy instills a sense of inherent justice in all of us, which in turn affects broader economic transactions. Smith begins TMS by declaring that regardless of 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” (Smith 1982, I.i.I.1). In this opener, Smith does not deny that we look after our own interests, Smith simply states that it is a fact of human nature that we care about people other than ourselves (Otteson 2002, 16). Smith further highlights this sense of sympathy: “But whatever may be the cause of sympathy, however it may be excited, nothing pleases us more than to observe in other men a fellow-feeling with all the emotions of our own breast” (Smith 1982, I.i.2.1). Smith argues that our desire for mutual sympathy is one of our strongest social desires, and achieving the sympathy of others gives us pleasure; thus we “behave in ways that generate this mutual sympathy” (Otteson 2016, 646). He adds, “Nature, when she formed man for society, endowed him with an original desire to please, and an original aversion to offend his brethren” (Smith 1982, III.2.6). Smith not only recognizes that humans are social beings with a “desire to please,” but also believes that this sociality is fundamental to our understanding of human interaction. Modern game theorists have empirically tested versions of Smithian sympathy. Even in the simplest of decision settings, neoclassical economic predictions (the ones assuming pure self interest) routinely fail. In the ultimatum game, players are given cash that they can offer to a stranger who can choose to accept or reject that offer. Players routinely deviate from self interest; Shen 4 often, players reject offers that would benefit them even if the alternative is zero reward whatsoever (see Camerer 2011). While deviations from maximizing a player’s own payoffs may appear to suggest that the aforementioned player behaves without reason, these deviations are systematically replicated. Research thus suggests that players factor in some consistent rationale when making choices and that self interest is not the only factor at play. To Smith and to game theorists today, one of these rationales is that we factor in the livelihood of others when we make decisions (Irwin 2014, 6). Smith argues that our sympathy for others instills us with a strong sense of justice because we feel the joys and sorrows of those around us, albeit to a lesser extent (Smith 1982, I.i.I.2). In TMS, Smith argues, “Nature has implanted in the human breast that consciousness of ill-desert, those terrors of merited punishment which attend upon its violation, as the great safe-guards of the association of mankind, to protect the weak, to curb the violent, and to chastise the guilty” (Smith 1982, II.ii.3.4). Justice for Smith is an “innate and instinctive reaction” against the injustice and injury done to others, and we are able to measure what is just because of our intrinsic sympathy for those around us (Irwin 2014, 6; Smith 1982, I.ii.3.1). Justice can be empirically measured by our sense of fairness. Further research on game theory demonstrates that people are averse to unequal payoffs: in other words, people care about fairness. In a study conducted in Indonesia to investigate high-stakes rejections in the ultimatum game, Cameron concludes that while increasing the prize money in a game (or the stakes) decreases rejection rates for unequal offers, some participants still rejected large sums of money if the split was not even (Cameron 1999). Furthermore, participants even rejected shares where they were given larger shares than their counterparts. Shen 5 But confined to the ultimatum game, in cases where the first mover offers half the share, we cannot rule out the possibility that the first mover acts solely out of self interest: the first mover may have offered to split not because they value fairness but because they expect a lower offer will be rejected. To test this logic, researchers introduced the dictator game. The only difference between the dictator game and the ultimatum game is that second movers cannot reject offers. We expect that a player who offered half of the share out of self interest in the ultimatum game would offer nothing in the dictator game, but the first mover often offers positive amounts even in a dictator game where the first mover has complete anonymity (Hoffman et al. 1994). Smith would find these results unsurprising. Smith remarked that due to our sympathy for those around us, mankind has “a very strong sense of the injuries that are done to others” (Smith 1982, I.ii.3.2). This intrinsic fellow-feeling accordingly leads us to place a high valuation on fairness. Moreover, Smith contended that this desire for fairness, or “justice,” gives rise to resentment. Smith views resentment as “the safeguard of justice,” since resentment leads us to desire punishment, or retribution for wrongdoings (Smith 1982, II.ii.I.10). As a result, we hate the villain and love the hero, and we “delight as much in the punishment of the one, as we are grieved at the distress of the other'' (Smith 1982, I.ii.3.2).