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Tuesday, December 22, 2015

Adam Smith Was Wrong about This

People don't naturally want to exchange

Sometimes Adam Smith is wrong. Here’s one of those times. In Book I, Chapter 2 of the Wealth of Nations, Smith writes:

This division of labour, from which so many advantages are derived, is not originally the effect of any human wisdom, which foresees and intends that general opulence to which it gives occasion. It is the necessary, though 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.

But humans do not have a “natural propensity to truck, barter, and trade.” Worse, having such a propensity would be irrational, and it’s a good thing that we don’t have it.

That’s a strange claim, but I’ll do my best to defend it.

Let’s start with what I don’t mean. I do not mean to agree with Karl Polanyi’s claim that market behavior only recently came to human individuals. Polanyi argued that individual-level market behavior arrived perhaps only as recently as the eighteenth century, and only by the force of a government edict, no less. That claim has been thoroughly debunked. Individuals have participated in markets, and pursued profits within them, for thousands of years.

So why do I still say that trade isn’t something that we have a natural urge to do?

People don’t have a natural propensity to truck, barter, and exchange, if by “natural propensity” we mean that they enjoy these activities in themselves, or for their own sake, or for the pleasure that they derive from them. We can know this simply by observing human behavior. If we did get some natural satisfaction just from the act of trade, we would find human beings trading things of equal value for the pleasure of the act alone: I’ve got ten dollars. You’ve got ten dollars. Great, let’s trade, because trade is fun! And then we might do it again.

Almost nobody ever acts this way. Counterexamples are few and easily dismissed: Children learn how to make change, but only to acquire a skill. Travelers change money at a border, but that’s because their other money wouldn’t be accepted in stores, rendering it less valuable to themselves. Lots of people play Monopoly  in which all values are zero  but that’s for enjoyment, not for barter. Day traders are more like gamblers than they are like people who just like pushing coins around. And anyway, these are hardly the sorts of things on which we might base a claim of a universal human propensity.

Murray Rothbard agreed that Smith blundered here, but I’m not entirely sure that his own reasoning holds up. Rothbard writes: “Smith unfortunately shifts the main focus from mutual benefit to an alleged irrational and innate ‘propensity to truck, barter and exchange,’ as if human beings were lemmings determined by forces external to their own chosen purposes.”

Now, on some level our behavior might actually be determined by forces external to our own chosen purposes. Maybe so. But that’s irrelevant. What matters is that human behavior appears to falsify Smith’s claim. And for that we should be thankful; the image comes to mind of a computer stuck in an infinite loop, forever swapping money from one account to the other and back again. (“But are the traders happy?” a utilitarian might ask. I am also thankful that I am not a utilitarian.)

Rather than a propensity to trade, humans appear to have a propensity to seek perceived advantage. Indeed, they can hardly do otherwise. Acting to pursue advantage might mean trade, but it doesn’t have to. On that score, Rothbard was completely right. Now, defining “advantage” has methodological problems of its own, but we need not get into them here.

Our perceptions are also sometimes pretty screwy, and we might well wish that we were relatively more inclined toward trade than we currently are. We humans exhibit what is known as the endowment effect. Behavioral economist Dan Ariely describes it as follows:

Simply put, the endowment effect shows that we value the things we own more than identical products that we don’t own. This causes a mismatch between buyers and sellers, where buyers are often willing to spend less than the seller deems an acceptable price.

Lots of empirical research supports the existence of the endowment effect. And many other phenomena of behavioral economics likewise incline us against trade.

We would seem to have a natural propensity — if I may use the phrase  to overvalue whatever we already have, and actually to shun trade, particularly with strangers and members out-groups. On balance, these propensities make us trade less than we should for maximum comparative advantage. Our natural propensity is to mistrust, alas, and maybe we should wish that we mistrusted just a little bit less.

This post first appeared at