February 6, 2006

WEALTH OF NATIONS IS JUST A SEQUEL:

Adam Smith, Behavioral Economist?: Adam Smith is best known for The Wealth of Nations, but professor Nava Ashraf believes another of his works, The Theory of Moral Sentiments, presaged contemporary behavioral economics. (Ann Cullen, HBSWK)

Adam Smith's The Wealth of Nations, first published in 1776, helped create the discipline of economics with its conjuring of the invisible hand, self-interest, and other explanations of market forces that have influenced academics, governments, and business leaders ever since. But it's the insights from one of Smith's earlier works, The Theory of Moral Sentiments, that caught the attention of Harvard Business School professor Nava Ashraf and coauthors Colin Camerer and George Loewenstein.

In "Adam Smith, Behavioral Economist," published in the summer 2005 edition of The Journal of Economic Perspectives, the authors find that Smith's insights from 1759 can contribute to modern thinking on everything from our fascination with celebrity to the theory of loss aversion. In fact, says Ashraf, Moral Sentiments presages the emerging field of behavioral economics. [...]

Q: What do you think Adam Smith's impression would be of the current formal academic study of behavioral economics?

A: I think he'd probably be thrilled! Smith's two main works—The Wealth of Nations (WN) and The Theory of Moral Sentiments (TMS)—show him to be a brilliant economist and arguably a brilliant psychologist, but he was never fully able to bring the economics and psychology together. In TMS, he describes the psychological factors that underlie human decision making, motivation, and interaction, which of course have strong implications for what drives consumption and savings decisions, worker productivity and effort, and market exchange. Only rarely did he make deep links to this work in WN.
Smith’s advice to business leaders would likely be that they should weigh carefully the costs of breaking trust and of risking reputation.

The formal study of behavioral economics exactly relates psychological factors to economic behavior, and even more recently has been exploring the market-level implications of consumers and firms who may be subject to varying levels of psychological influences. Although the importance of psychological factors may be something that business leaders have long understood, the field of economics has only relatively recently been equipped with the tools to be able to study such phenomena rigorously and—importantly—to be able to make predictions about where such factors may be more or less important, when market forces can diminish or exacerbate these factors, etc.

Q: According to your article, Smith's Theory of Moral Sentiments argues that behavior is determined by a struggle between "passions" and the "impartial spectator." What did he mean by this?

A: Smith believed that much of human behavior was under the influence of the "passions"—emotions such as fear and anger, and drives such as hunger and sex—but these passions were moderated by an internal "voice of reason," which he called an "impartial spectator." The impartial spectator allows one to see one's own feelings and the pulls of immediate gratification from the perspective of an external observer. In the area of self-control and self-governance, the impartial spectator takes the form of a long-term interest (i.e., I won't have that cookie today because I can see that I will regret it down the road). In the area of social interaction, the impartial spectator allows us to see things from another's perspective rather than to be blinded by our own needs.

The conflict between the passions and the impartial spectator is the most fascinating part of Smith's TMS for me. The conflict is particularly important when studying savings decisions, since savings is exactly a decision to delay immediate gratification for a long-term interest, to stay the voice of a short-term pull for the voice of the impartial spectator.

With my coauthors I applied this framework to designing a savings product for a bank in the Philippines that helps clients act in line with their long-term interests. In this "commitment savings product," clients sign a contract with the bank that doesn't let them withdraw their own money until a certain amount or date has been reached. It gives their control over to the bank to help them overcome short-term impulses to spend. The product had a large and significant effect on clients' total savings, helping clients to buy land, improve their businesses, pay for large educational expenses, etc.


Wealth from worship: An economist finds that going to church is more than its own reward (The Economist, 12/20/05)
AT CHRISTMAS, many people do things they would never dream of the rest of the year, from giving presents to getting drunk. Some even go to church. Attendance soars, as millions of once-a-year worshippers fill the pews. In Britain, where most weeks fewer than one person in ten goes to church, attendance more than triples. Even in America, where two-fifths of the people say they go frequently, the share climbs in December.

Some of the occasional churchgoers must wonder whether they might benefit from turning up more often. If they did so, they could gain more than spiritual nourishment. Jonathan Gruber, an economist at the Massachusetts Institute of Technology, claims that regular religious participation leads to better education, higher income and a lower chance of divorce. His results* (based on data covering non-Hispanic white Americans of several Christian denominations, other faiths and none) imply that doubling church attendance raises someone's income by almost 10%.

The idea that religion can bring material advantages has a distinguished history. A century ago Max Weber argued that the Protestant work ethic lay behind Europe's prosperity. More recently Robert Barro, a professor at Harvard, has been examining the links between religion and economic growth (his work was reviewed here in November 2003). At the microeconomic level, several studies have concluded that religious participation is associated with lower rates of crime, drug use and so forth. Richard Freeman, another Harvard economist, found 20 years ago that churchgoing black youths were more likely to attend school and less likely to commit crimes or use drugs. [...]

So how might churchgoing make you richer? Mr Gruber offers several possibilities. One plausible idea is that going to church yields “social capital”, a web of relationships that fosters trust. Economists think such ties can be valuable, because they make business dealings smoother and transactions cheaper. Churchgoing may simply be an efficient way of creating them.

Another possibility is that a church's members enjoy mutual emotional and (maybe) financial insurance. That allows them to recover more quickly from setbacks, such as the loss of a job, than they would without the support of fellow parishioners. Or perhaps religion and wealth are linked through education. Mr Gruber's results suggest that higher church attendance leads to more years at school and less chance of dropping out of college. A vibrant church might also boost the number of religious schools, which in turn could raise academic achievement.

Finally, religious faith itself might be the channel through which churchgoers become richer. Perhaps, Mr Gruber muses, the faithful may be “less stressed out” about life's daily travails and thus better equipped for success. This may make religion more appealing to some of those who turn up only once a year. But given that Jesus warned his followers against storing up treasures on earth, you might think that this wasn't the motivation for going to church that he had in mind.


As Smith recognized, functional capitalism is dependent on an already moralized populace. Failure to recognize that truth is why the End of History won't be a boon for many peoples.

Posted by Orrin Judd at February 6, 2006 6:50 AM
Comments

Welcome back.

Posted by: erp at February 6, 2006 6:32 PM

For the curious, here's a link to the online version of the book:

http://www.econlib.org/LIBRARY/Smith/smMS.html

Posted by: Ptah at February 7, 2006 11:03 AM
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