Vernon L. Smith, Chapman University:

The Theory of Moral Sentiments (TMS, 1759) concerns human sentiment as the source of the rules we follow that accounts for our sociality. It also provides a unique framework for analyzing and modelling decisions in two-person games such as “trust” games. Neo-classical economic (game) theory failed to predict action in these experiments in the 1990s. If we had known and applied Adam Smith’s model based on mutual fellow-feeling these results would not have been unexpected. I will use propositions from TMS to show why, and indicate how, Smith’s model was more appropriate for explaining/predicting these results than the traditional neo-classical (and game-theoretic) models that displaced—rather than supplemented—his model.

Smith sees individuals as simultaneously self-interested and highly social. Our sociability takes the form of learning to “humble the arrogance of our self-love and bring it down to what others will go along with.” Common knowledge that individuals are self-interested is necessary in Smith’s model for people to know who benefits and who is hurt by an action, and is essential in learning social competence through processes that punish intentionally hurtful acts and reward intentionally beneficial acts. Out of such consent processes emerge ancient rules of morality in which propriety governs virtues like trust and trustworthiness. In the larger civil order these rules of propriety become the basis for a broad conception of property, as rights to take action without reprisal applied to both possessions and contracts. In that extended order of markets our sociability enters axiomatically in the form of our “propensity to truck, barter and exchange.” This propensity, combined with third party enforcement of property—a natural extension of the practiced cultural rules of conduct—enables self-interested action among strangers to create wealth through specialization.

Hence, Adam Smith provides a seamless account of other-regarding behavior in our more intimate social groups, setting the stage for our pursuit of specialization in the extended order of impersonal markets.