On Adam Smith's Major, Original Contributions to Economic Theory and Decision Making

Abstract

The current dominant belief among economists that Smith made no original contributions to economic theory outside of presenting an original system of thought that was composed of the original analysis of other thinkers is incorrect.

Smith made four unique contributions which have been overlooked. The first contribution was a clear cut recognition that probabilities could not be calculated exactly using precise, single number answers. Probabilities were indeterminate and/or imprecise. The mathematical laws of the probability calculus can’t be applied, in general, to decision making in the real world. Smith rejects any decision making approach based on fair, or mathematical, lotteries. Secondly, Smith was the first to explicitly recognize that real world decision making was very uncertain, as opposed to being based on the mathematical concept of risk which was based on known probabilities and outcomes leading to expected value and expected utility calculations a la Jeremy Bentham’s rational economic calculator of probable odds model. Third, Smith was the first to recognize that, as long as the probabilities were greater than 0, retaliatory tariffs might lead a country that had imposed a tariff on another country to rescind that decision. There was room for a set of strategies in conflicts between nations over tariffs involving war, threats, negotiations, mediation, and retaliation implying tit for tat or chicken strategies. Fourth, Smith recognized that the main threat to economic prosperity originated from projectors, prodigals, and imprudent risk takers (J M Keynes’s speculators and rentiers), who were able to obtain bank loans in order to try to leverage their debt position many times over. The result would be that the bank’s deposits would be wasted and destroyed. This will lead to a recession or depression. Smith did not add this last sentence because it is obvious.

Keywords: Smith, indeterminate or imprecise probabilities, uncertainty, speculators, projectors, decision making

JEL Classification: B23, B30, B41, E12