"Competition motivates self-interested people to act virtuously and that we don’t need to have extensive knowledge about the the people we trade with in order for that trade to make both parties better off."

See The Adam Smith Problem at Cafe Hayek. From Russ Roberts.

"Anthony Annett of the IMF has a thoughtful review of my Adam Smith book in the IMF publication, Finance and Development. He likes my overall summary of The Theory of Moral Sentiments but he is not so enamored of my explanation for the so-called Adam Smith problem:

An enormous amount of ink has been spilled over the years over the famous “Adam Smith problem”—how to reconcile the emphasis on benevolence in Moral Sentiments with the emphasis on self-interest in The Wealth of Nations. The most obvious answer is that the latter focuses on the bare minimum conditions for beneficial market exchange, while the former focuses on the deeper underpinnings of our broader social interactions.­
As Sen put it, Smith’s insight was narrowly confined to exchange, ignoring equally important concepts like production and distribution. And even in pure exchange, self-interest can take us only so far and must be supplemented with shared trust and mutual confidence in the ethics of all involved. In other words, moral sentiments are never too far from the surface.­

Roberts takes a different tack. He argues that Smith’s two books are about different and nonoverlapping spheres of human interaction. Borrowing from economist and philosopher Friedrich Hayek, he argues that “we need to inhabit two different worlds at the same time to interact within our families and then move into the commercial sphere and interact with strangers.” Thus Moral Sentiments is about our “personal space”—the world of friends, family, and close acquaintances—while The Wealth of Nations is more about interpersonal exchange in a “world of strangers.” Different worlds, different norms of behavior.­

Reading Smith through these Hayekian bifocals is not at all convincing. Imposing Hayek’s crimped philosophical worldview on Smith does him a disservice. It narrows the scope of his contribution far too much.­

Ultimately, Smith is concerned with virtue—especially benevolence, courage, temperance, justice, and prudence. Indeed, Deirdre McCloskey argued that Smith is the last of the virtue ethicists, following in a long tradition that began with Aristotle. And when we start with virtue, we are naturally inclined toward human flourishing—in all aspects of life. There are no bifurcated or disembodied virtues!

Because Roberts draws such a fine line between the different spheres of life, he never really teases out the implications of Smith’s moral philosophy for today’s economy—what we really should care about. This is a pity, because Smith’s insights would be especially valuable right now.­

For example, what would the impartial spectator say about the behavior of the financial sector in recent years, when extreme recklessness and short-termism swamped all notions of virtue? Or more generally, what would she say about a business model that puts short-term profit above duty to stakeholders like workers, clients, the natural environment, and society in general? These are the important questions that are not really answered in this book.­

I agree that Smith is concerned with virtue and I have many examples in the book of the challenges of being virtuous in the workplace—telling your boss, for example, that a particular approach damages the reputation of the firm or is unethical. I think the Smithian approach of being loved and lovely definitely plays a role in how we treat our employees and colleagues. Smith encourages us to remain lovely even when it costs us a raise or a promotion. I also speculate on why the financial sector appears to be less virtuous than it used to be. I agree with Annett that these are important questions. Where I disagree with his assessment is how Smith can help us do better in these areas. I think one of the lesson of Smith’s two books is not to be overly romantic or optimistic about how much virtue can be introduced when we interact with strangers. I think Smith is very Hayekian in the sense that he too believed the world of face-to-face interaction is very different from how we interact with strangers. We care more about people near us than people who are far away. We might wish that we felt otherwise but I don’t think Smith thought it was possible.

The triumph of The Wealth of Nations is that even when dealing with people who are far away, we don’t have to be so virtuous. That doesn’t mean we should cheat them or that we do. But Smith’s point is that competition motivates self-interested people to act virtuously and that we don’t need to have extensive knowledge about the the people we trade with in order for that trade to make both parties better off.

In short, I don’t agree with Annett that the Hayekian “two worlds” perspective shortchanges Smith. I think it is one way to describe what Smith understood about the limits of virtue and the power of the impartial spectator.

You can read a lengthy excerpt from the chapter Annett is criticizing here."