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Fixing The Financial System: Adam Smith Vs. Jeremy Bentham

How do we create a “change in culture”?

I do now regard [the Benthamite tradition] as the worm which has been gnawing at the insides of modern civilisation and is responsible for its present moral decay. We used to regard the Christians as the enemy, because they appeared as the representatives of tradition, convention and hocus pocus. In truth it was the Benthamite calculus… -John Maynard Keynes, “My Early Beliefs”

More than two years ago, the Archbishop of Canterbury, Justin Welby, called for the financial system to return to “a broad sense of promoting the wellbeing” of those whom it serves (Welby, 2013). He argued for what he called a “change in culture”, and then continued as follows:

What does that mean in a world of business and competition? It means that companies should be communities of common interest which serve the common good. For that to happen there needs to be a store of value in them: a sense of what is right that is independent of our individual achievement; compassionate in its acceptance of us [ i.e. of other members of the community]; [and] empowering in its interaction with us … [T]rust and confidence … have been lost and there needs to be drastic action … to get them back. -Justin Welby

How to think sensibly about what needs to be done? In what way can the economics profession help?

Economists often assume that agents are self-regarding, pursuing their private interests in ‘unsympathetic isolation’ based on self-regarding, and entirely selfish, motivations. They like to appeal to Adam Smith’s Wealth of Nations as they do this.

It is not from the benevolence of the butcher, the brewer or the backer that we expect our dinner but with regard to their own interest….each is led by an invisible hand to promote an end which was not part of his intention. -Adam Smith

Modern economists have explored how trustworthy behaviour can be sustained in these circumstances, through the pursuit of reputation in the context of “repeated games”. In this account, individuals can become trustworthy as a result of repeated interactions over time. A desire for future profitable trades creates a constraint on actions in the present which are likely to harm others, even amongst such purely selfish people. Such people will abstain from conduct which damages others so long as they expect to derive a benefit from repeated interactions with others in the future. Promises are kept by individuals only to the extent that they perceive such benefit but are broken as soon as they do not.

This view argues that financial institutions have become untrustworthy essentially because the rewards to keeping promises became too small, essentially because the financial incentives to break promises became too extreme. Reform will come about - this view suggests - as and when individuals working in the financial services industry come, once again, to find it worth their while to build, and sustain, their longer term reputations. Such a change in circumstances will be enough, it is said, for such individuals to become trustworthy again.

By contrast, philosophers and political scientists have long believed that such reputation-seeking behavior only enables a shallow and unreliable form of trust to emerge. Their arguments are highly convincing. There is always the risk that selfish persons will decide that they will not be found out if they cheat, and so that their reputation will survive even if they behave badly. Sometimes it may even be worthwhile for such persons to cut and run - to go and live in the Bahamas where a reputation for being a fair financier will never matter again. More than this, things always turn out slightly differently from what had been imagined, always in unexpected ways. Those who have made promises may well, if they are selfish, decide, when the time comes, to find a way to argue that the promises made are not relevant in the circumstances which emerge; it is nearly always possible to find a way to wriggle out of promises. Such people may even end up in court arguing that reneging on their promises is ‘entirely appropriate’. More than all of this, the repeated-games justification of trustworthiness suffers from “an infinite regress” problem. If the costs of sustaining trustworthy relationships are expected to be greater than the benefits at some time in the future then knowledge that relationships will eventually break down will cause them to unravel all the way back to the present. In sum, the economist’s arguments about trustworthiness appear flimsy. And so, like philosophers and political scientists, we do not believe that a trustworthy financial sector can re-emerge merely as a result of individuals – and firms – carrying out calculations about how to pursue and defend their reputations.

Most philosophers instead argue that the underpinnings of trustworthy behavior are much more fundamental than the precarious repeated-games setup examined by economists. Such behavior, they argue, can only emerge if it is underpinned by a sense of moral obligation. And such an obligation, they argue, can only be found if it comes from motivations which pay attention to the needs of, and outcomes for, other people. Adam Smith believed that people do indeed have such motivations. The very first sentence of his other famous book The Theory of Moral Sentiments reads as follows:

How selfish soever man may be supposed there are evidently some principles in his nature which interest him in the fortunes of others and render their happiness important to him, though he derives nothing from it except the pleasure of seeing it. -Adam Smith

Adam Smith

The form of trust which is likely to emerge from such other-regarding motivations will not be vulnerable to unexpected outcomes. In particular, even if things turn out in unexpected ways, a person guided by a sense of obligation to others may still believe that he or she should abide by whatever promises have been made, even if it is at some cost to himself or herself. And this person will hold that belief even if the person to whom the promise has been made is no longer present – and even if they are quite incapable of administering a punishment.

Many people – not just philosophers and political scientists – believe that untrustworthy behaviour in financial institutions did not emerge for the reason proposed by economists, namely that individuals ceased to think it valuable to defend their reputations. Instead – these people argue - those working in the financial services industry ceased to behave in a professional manner. By this we mean the following. A surgeon carrying out a liver transplant would not, at the same time, remove kidney and sell it on the black market. And that is not just because his colleagues might catch him doing this. Doctors just do not do that sort of thing. By contrast the employees of Goldman Sachs might well do such a thing. The reason that doctors do not behave in this way, is because they are professionals. A professional is someone who has a concern for the well-being of his or her clients, that is to say a person who has the kinds of motivations identified by Adam Smith. Many of those working in the financial services industry do not have these motivations.

The economists’ view described above emerged from the writings of Jeremy Bentham, John Stewart Mill, William Stanley Jevons and Alfred Marshall, and then from the work of more modern economists. These people have taken forward, and emphasised, the focus on self-interest which Adam Smith displayed in his Wealth of Nations. By contrast, the view of philosophers and political scientists has emerged from the work of Immanuel Kant, and then from the work of more modern philosophers who took forward the focus on other-regarding obligations which Adam Smith displayed in his Theory of Moral Sentiments. How did Smith come to have these two very different views?

This fact – that Smith believed two seemingly contradictory things at the same time - has become known as the ‘Adam Smith problem’. A rather simple response to this problem is to argue that Smith, rather like Keynes nearly 200 years later, was one of those great people capable of believing more than one thing at the same time. Which of the things is the correct thing at the time depends – such a person thinks - on the issue at hand. As Keynes once famously said “[w]hen the facts change, I change my mind. What do you do?”

Adam Smith’s work was an outgrowth of David Hume’s enlightenment project, carried out in Edinburgh and Glasgow in the mid eighteenth century. Both Hume and Smith grew up in stern-living Scotland. Those with whom they lived had been rescued by the Reformation from the intellectual domination of the Catholic Church. But for them the Scottish version of Calvinism was not a great liberation. It was Hume who came to see how an individual could be liberated from the burden of the pursuit of spiritual salvation, a burden which the Scottish Calvinists were still determined to impose. But it fell to Smith to carry out an important part of Hume’s project, namely to articulate exactly what it was that was to replace the pursuit of spiritual salvation, namely the pursuit of material advancement. Smith saw that self-interest was important for this latter pursuit, and in the Wealth of Nations he set out the kind of public policy that a successful pursuit of such advancement might involve – the liberation of markets, the freeing of international trade, etc, etc. These are the sorts of policy actions that modern neo-liberals delight in celebrating.

But, as the above very brief account makes clear, Smith was immersed in an eighteenth century Scottish world, in which other-regarding obligations were at the centre of everybody’s life. His big task, which he shared with Hume, was to extract mankind from the view that religious law laid down what these other regarding obligations were. That had been the object of the Theory of Moral Sentiments. His more specific task in the Wealth of Nations was to establish that self-interest can be important for getting some things done and that one does not need to rely on other regarding obligations for everything. That is, one can economise on virtue. Indeed self-interest can be even better than virtue in getting some things done. But he did not set out to show that virtue is unimportant.

Why have so many economists come to the view that virtue is unimportant? This is an interesting question on which many people have speculated. We do not, ourselves, have a very clear view yet. But our current idea is something like the following; we do not believe that anything quite like what follows has been said before.

As described above, Smith’s big idea in the Wealth of Nations was that the pursuit of material advancement might lead to human happiness. But he never provided an answer as to how, exactly, this might happen; the answer which he provided was left largely intuitive. (In some sense the answer to this question was deeply obvious; it needs to be remembered just how poverty-stricken were the majority of those alive in eighteenth century Scotland.) And yet Smith never really made clear just how that pursuit of material advancement might fit in to a more general achievement of human happiness. It fell to Jeremy Bentham to invent utilitarianism, as a means of articulating the idea which Adam Smith had put forward. This utilitarianism is the idea that individuals pursue their happiness by maximizing their utility where this utility, for each person, depends on things which happen to himself or herself, and only on these things.

Bentham’s utilitarianism leads immediately to the question - did it fully articulate Smith’s vision about the economy? To answer this question we need to ask whether Bentham really understood Adam Smith’s own solution of the Adam Smith problem. Our current conjecture is that Bentham deliberately simplified Smith’s message, in order that he (Bentham) might more clearly articulate Smith’s ideas about the contribution of self-interest to the achievement of good social outcomes. Our view is that, in effect, Bentham deliberately misunderstood Smith. Furthermore, it is our view that Bentham’s misunderstanding has had significant consequences for economics as a discipline right down to the present day, since it has influenced the way in which economists view the world. As will be clear from what we have said this view of the world has also influenced the reasons which economists give as to why the financial system is untrustworthy. If we are right then Bentham’s misunderstanding has significant implications for the way in which public policy should attempt to reform the financial system.

The players in this particular drama in the history of economic thought include some of the largest names in the subject. John Stewart Mill is particularly important, since he only partly subscribed to Bentham’s utilitarianism. The same is true of his more-or-less contemporary, Henry Sidgwick. But the originators of neoclassical economics – William Jevons, Wilfred Pareto and Francis Edgworth – showed an increased commitment to utilitarian models of analysis.They showed how utilitarianism could be used to underpin a theory of value and price: “nobody will pay more for a good than the utility which it provides to him”. And it was Alfred Marshall who articulated the importance of this kind of idea for the theory of the firm: in a competitive world no firm will produce something whose marginal cost is higher than its price.

From here it was easy for economists to move to the fundamental theorem of welfare economics. One can, first of all, conclude that in a competitive equilibrium the marginal utility of each and every good that is purchased will be equal to its marginal cost of production. Because of this one can easily conclude, secondly, that that a competitive economy will deliver a Pareto optimal outcome. This ‘fundamental theorem’ of welfare economics has become a piece of analysis that carries a very large burden. On this theorem rested the determination shown by liberal economists to de-regulate markets in the pursuit of desirable outcomes. This, they thought, would lead to an increase in happiness.

It fell to Lionel Robbins to argue that an understanding of how markets should be regulated is all that economists can contribute to the study of public policy – that economists have nothing worthwhile to say about the distribution of income, and thus about inequality. Robbins’ book The Nature and Significance of Economic Science (Robbins, 1932) is precisely the book which one would expect someone clever to write who had studied Politics Philosophy and Economics in Oxford in the late 1920s. This was the time at which Oxford analytical philosophy was determined to delineate what could be said from what could not be said – and to declare that much that was commonly believed was actually nonsense. For Robbins, interpersonal comparisons of utility were something which could not be carried out. As a result, he said, the claim that redistributive policy is welfare-promoting should be declared non-intelligible. Such a claim, said Robbins, rested on the idea that for all people the marginal utility of income declines, as income rises, in the same way, and on the consequential belief that a transfer of income from rich to poor would lead to an increase overall social utility. But such a claim rested on the supposed ability to make interpersonal comparisons of utility, something which could be declared to make no sense. All that was possible to discuss – said Robbins - was whether Pareto optimality had been achieved. And all that was left for policy to discuss was whether market failures could be identified of a kind which prevented the achievement of such optimality.

It was this set of moves which created the underpinning of neo-liberal economic analysis, and the non-interventionist policy stance which goes along with it. But it also led to a situation in which reformers – those who act within the economics tradition – see their task as one of correcting market failures. It became the task of economists to identify a lack of competition (and the resultant monopoly power), or the imposition of externalities, or other such market failures and to suggest policy moves which would help to correct these market failures.

But the modern economist goes one move further beyond Robbins. Robbins denied the possibility of making interpersonal comparisons of utility. Modern Neoliberalism – and the economic theory which underpins it - is built on a claim much stronger than this. It is built on the claim with which we began this article. It is built on the presumption of selfishness – that is on a claim that each individual cares only about his or her own utility. Believing that one is not able to compare one’s own utility with the utility of others is one thing – it is a normative claim. Believing that individuals do not actually care about the utility of others is a much stronger – positive – claim. This is what most economists now believe. We think that this claim is factually incorrect; we think that much recent work in behavioural economics supports our view.

Once economists come to recognise the falsity of their basic assumption they will need to recognise a whole lot of other different work. In particular they will be forced to recognise the work of philosophers and political scientists that descends from the other Adam Smith – the Smith of the Theory of Moral Sentiments. And once they do this they will come to see that what reformers need to do involves more than just identifying market failures.

What reformers need to do is not nearly so clear as it is has been for those who work within the mainstream tradition of conventional economics, and seek to correct market failures. The challenge for reformers who work in this broader-than-modern-economics tradition will be to face up to two tasks. First it will be necessary to identify what other-regarding obligations are important for financial-service employees to recognise, in whichever part of the financial system is being analysed. Second it will be necessary to create a greater degree of professionalism within the financial services industry, so that those who work within it actually do come to recognise these obligations, and their corresponding responsibilities, and come to act in the light of them. This will require that these employees come to frame their everyday working life in such a way that they actually do carry out these obligations. Creating this professionalism will require that detailed attention be given to governance arrangements and to other mechanisms, and that an effective accountability regime is set up which holds to account those who do not fulfil these obligations.

These are big tasks – tasks on which many people are now already working.


Bank of England, HM Treasury and Financial Conduct Authority (2014), Fair and Effective Markets Review: Consultation Document. London: Bank of England

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Gold, N. (2014) ’ Trustworthiness and Motivations’Chapter 6 of Morris and Vines (eds) (2014) Capital Failure: Rebuilding Trust in Financial Services. Oxford: Oxford University Press.

Keynes, J. M. (1972) “My Early Beliefs”, Essays in Biography, Chapter 10, pp 433 – 451. (written in 1938, and first published in 1949 in a small book called Two Memoirs)

Phillipson, N. (2010) An Enlightened Life London: Phillip Allen.

Raphael, D. and A. Macfie (1976) ‘Introduction’ in Smith, A. The Theory of Moral Sentiments, Oxford: Oxford University Press

Robbins, L. (1932) And Essay on the Nature and Significance of Economic Science. London: Macmillan

Smith, A. (1759, 1976). The Theory of Moral Sentiments. Oxford: Clarendon Press.

Smith, A. (1776, 1976). An Inquiry into the Nature and Causes of the Wealth of Nations. Oxford: Clarendon Press.

Welby, J. (2013). ’ How do we fix this Mess?’, Speech given on Monday 21 April, (accessed 9 June, 2013).

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