Adam Smith and the Nirvana Fallacy

Adam Smith was no anarchist. Indeed, at the time he was writing, he was a fairly conservative liberal (interesting that those of us who follow Adam Smith’s teachings are considered radical). Adam Smith did have a strong presumption of liberty, but this presumption was not absolute. Under certain conditions, a jural superior (such as a sovereign or magistrate) could violate this presumption of liberty.

But Smith’s analysis did not stop there. He also explored the nature of the jural superior. While Smith does have a science of the legislator, he also repeatedly emphasized that jural superiors are also human beings like us.

To give one such example, in the Theory of Moral Sentiments, Smith writes on how it is a natural human reaction to feel resentment and revenge when once does something against us. Indeed, not rendering gratitude where gratitude is due can cause this passion to arise (see Part 2, and especially Section 2). This jealousy can cause us to act in a harmful and unjust manner; beneficence cannot be extracted by force. But, while Smith is examining jural equal relations here, he also applies this same sentiment to national governments and legislators. In The Wealth of Nations, when Smith is discussing a potential use of tariffs to reduce/eliminate tariffs by other governments, he begins by stating that, when one nation raises tariffs on another “[r]evenge…naturally dictates retaliation, and that we should impose the like duties and prohibitions upon the importation of some or all of their manufactures into ours. Nations, accordingly, seldom fail to retaliate in this manner“ (Page 467.38). Revenge, that natural emotion according to Smith, is applied to national governments here and not just individuals. Smith goes on to tell of a trade war between the Dutch and French which became a shooting war.

After this story, Smith lays out his potential exception to the aforementioned presumption of liberty (Emphasis added):

There may be good policy in retaliations of this kind, when there is a probability that they will procure the repeal of the high duties or prohibitions complained of. The recovery of a great foreign market will generally more than compensate the transitory inconveniency of paying dearer during a short time for some sorts of goods. 

Page 467.39

However, he immediately follows it up with a reminder that we are dealing with people here. The science of a legislator may recommend this policy, but we must remember we are dealing with people with passions, not necessarily a dispassionate legislator:

To judge whether such retaliations are likely to produce such an effect does not, perhaps, belong so much to the science of a legislator, whose deliberations ought to be governed by general principles which are always the same, as to the skill of that insidious and crafty animal, vulgarly called a statesman or politician, whose councils are directed by the momentary fluctuations of affairs.

Page 467.39

He then brings us back to the presumption of liberty:

When there is no probability that any such repeal can be procured, it seems a bad method of compensating the injury done to certain classes of our people to do another injury ourselves, not only to those classes, but to almost all the other classes of them. his may no doubt give encouragement to some particular class of workmen among ourselves, and by excluding some of their rivals, may enable them to raise their price in the home-market. Those workmen, however, who suffered by our neighbours prohibition will not be benefited by ours. On the contrary, they and almost all the other classes of our citizens will thereby be obliged to pay dearer than before for certain goods. Every such law, therefore, imposes a real tax upon the whole country, not in favour of that particular class of workmen who were injured by our neighbours prohibition, but of some other class.

Page 467.39

By starting with a reminder that revenge is a natural passion within our breast and a story about a war of jealousy between two nations, Smith argues that the probability that higher domestic tariffs will lead to the reduction of foreign tariffs is not particularly high.

Smith avoids the trap that many economists after him would fall into: the Nirvana Fallacy. A term first coined by the late Harold Demsetz, the Nirvana Fallacy is when one compares an imperfect current situation to an idealized alternative. Mid-Century economists often made this mistake by pointing to market failures and justifying some policy to correct these failures. Public Choice economics expanded on the Nirvana Fallacy by assuming government actors are just like market actors. Smith did not fall into this trap, and thus his presumption of liberty was extremely strong in his eyes.

The fun thing about reading Adam Smith is seeing insights in his work that would, for one reason or another, be lost to economists only to be discovered centuries later. The example above of the Nirvana Fallacy is one, but Smith also had many insights into Law & Economics.

Adam Smith had a presumption of liberty, and while that presumption was not absolute, he was under no impression that the mere existence of a justification for policy X or Y was in any way sufficient to create policy X or Y. After all: “They whom we call politicians are not the most remarkable men in the world for probity and punctuality” (Lectures on Jurisprudence, Pg. 539).