Adam Smith: Essays on Adam Smith, John Maynard Keynes, and Their Interval Valued Approaches to Probability, Decision Making, and Uncertainty

By Michael Emmett Brady

Adam Smiths original path-breaking work on decision making, uncertainty, and public policies to minimize the impact of uncertainty in the economy has been overlooked for well over two hundred years. One need only peruse the badly analyzed work of Smith in this area, as presented by Henry D. MacLeod in his The Elements of Political Economy, on pages 212220, or Henry Sidgwicks The Principles of Political Economy, on pages 359361, as well as the misevaluations of Smiths contributions made by Jacob Viner in 1927, Joseph Schumpeter in 1954, Murray Rothbard in 1995, or Salim Rashid in 1998 to realize that Smiths important contributions were never recognized. The claim that Smith made no original contributions to economic theory or economics is simply false.

• Language: English
• Publisher: Xlibris US
• Release date: Aug 14, 2015
• ISBN: 9781503595224

Michael Emmett Brady

Michael Emmett Brady received his PhD degree in economics from the University of California. He received his BA and MA degrees from California State University as well as in completing all requirements for a BA in Mathematics. He has done graduate level work in mathematics.

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COPYRIGHT © 2015 BY MICHAEL EMMETT BRADY.

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Rev. date: 08/14/2015

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TABLE OF CONTENTS

Introduction

Essay 1

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

Essay 2

Adam Smith’s Definition of Uncertainty and his Application of his Uncertainty concept in Part I, Chapter XI of The Wealth of Nations

Essay 3

Adam Smith’s Interval Valued Approach to Probability: Why was It Overlooked by Academics for 239 years ?

Essay 4

Adam Smith’s Original Application of an Interval Estimate Approach to Probability in the Wealth of Nations (1776)-A Technical Note

Essay 5

On Adam Smith’s Anti –Utilitarianism in the Wealth of Nations

Essay 6

The Economic Consequences of G L S Shackle’s Ignorance of Keynes’s Theory of Probability, Uncertainty, and Decision Making

Essay 7

J M Keynes’s Concept of Uncertainty has Nothing to do with Paul Davidson’s Ergodic-Non Ergodic Distinction, which Requires that the Limiting-Relative Frequency Interpretation of Probability to be the General Case

Essay 8

A Study of Ramsey’s Extremely Poor Reading of Chapter III of J. M. Keynes’s A Treatise on Probability and the Refutations Made by J M Keynes and Bertrand Russell

Essay 9

How is it possible for Keynes’s Theory of Logical Probability to be Non –Probabilistic ? Answer. Only if you have been confused by reading Frank P. Ramsey’s Reviews of Keynes’s A Treatise on Probability

Essay 10

Interval Probabilities, and not Ordinal Probabilities, are the Foundation of J M Keynes’s Approach to Probability

This book is dedicated to His Excellency, Pope Francis.

The theoretical support for his Economic,

Political and Social reform initiatives has been

provided by Adam Smith and JM Keynes.

Introduction

Adam Smith’s original, path breaking work on decision making, uncertainty and public policies to minimize the impact of uncertainty in the economy has been overlooked for well over two hundred years. One need only peruse the badly analyzed work of Smith in this area as presented by Henry D MacLeod in his The Elements of Political Economy on pp.212-220 or Henry Sidgwick’s The Principles of Political Economy on pp.359-361, as well as the misevaluations of Smith’s contributions made by Jacob Viner in 1927, Joseph Schumpeter in 1954, Murray Rothbard in 1995, or Salim Rashid in 1998 to realize that Smith’s important contributions were never recognized. The claim that Smith made no original contributions to economic theory or economics is simply false.

Smith’s recognition as a Great economist is currently based on a two conventional opinions. The first reason for categorizing Smith as a great economist was that he was a great synthesizer who created the first systematic study of micro, macro, and economic growth. He was able to use the ideas of others, which, supposedly, he did, while simultaneously not giving them credit for their work, in order to create an overarching system of economic thought.

The second reason for Smith’s categorization as Great was that he was the only one who supposedly was able to recognize the operation of an Invisible Hand which, supposedly, led to the coordination of all decision makers’ competing/conflicting expectations in an optimal fashion over time as long as there was no governmental intervention, exogenous shocks and/or interference in the economy in the form of wage/price controls or government regulation.

Gavin Kennedy has demonstrated for many years that the Invisible Hand was a metaphor used by Smith in lieu of providing the extensive, detailed explanations necessary to explain the reasons why the majority of domestic manufacturers and merchants would choose to trade in their home markets as opposed to moving into foreign markets. The Invisible hand metaphor allow Smith to avoid spending a great deal of time. effort, and pages in the Wealth of Nations in explaining the reasoning of these businessmen. Kennedy’s answer, that the home countries business men were risk averse (WN;1776) is correct as a first approximation. However, his analysis needs to be expanded to incorporate a discussion of uncertainty/ambiguity averse behavior besides risk aversion.

Why Smith’s overall analysis of the role of uncertainty and his use of interval estimates to deal with uncertainty were overlooked for well over 200 hundred years is an essay in this volume, Volume II.

Smith’s actual originality in the fields of Political Economy and Economics are due to the following reasons. First, his understanding of the crucial importance of a society’s ethical foundations or lack of such foundations. Smith realized that the type of society that will result, if built on the sands of egoism, utilitarianism, and libertarianism, is completely different from a society built on the granite of virtue ethics. Smith had a clear understanding of the important role that Virtue Ethics would play in allowing the application of Aristotle’s Golden Mean when applied to evaluating the conditions that would promote economic growth that would lead to a very large middle class and small lower and upper classes. Second, Smith’s understanding of the uncertainty versus risk distinction. Third, his correct analysis of the meaning of uncertainty. Fourth, his realization that it simply would not be possible to apply the purely mathematical laws of the probability calculus to the large majority of decisions undertaken in the real world of partial, incomplete knowledge. Fifth, Smith’s realization that the probabilities would most likely be interval estimates and not numerical and ordinal probabilities. Sixth, his understanding of the importance of fixed capital and the role in using the central bank to assure that the sober people (middle class) received the majority of all bank loans.

The Wealth of Nations was constructed on a bedrock of Virtue ethics. Smith’s mastery of Virtue ethics, especially his understanding of the role that corruption can play in economic interactions and undertakings, allowed him to pinpoint the crucial area where corruption, if allowed to take hold and manifest itself, would impose the most damage on society by promoting exactly the opposite result aimed at above-a very large lower class, a small upper class and a small, diminishing middle class.

Jesus also recognized this problem:

Then Jesus said to his disciples, Truly I tell you, it is hard for someone who is rich to enter the kingdom of heaven. Again I tell you, it is easier for a camel to go through the eye of a needle than for someone who is rich to enter the kingdom of God. (Matthew;19:23-24). As in the parable of Lazarus, the rich man has allowed himself to become corrupted and becomes a prisoner of his baubles, trinkets, and other material possessions that he has spent his life collecting in the mistaken belief that material thing will make him happy and earn him prestige, recognition, fame, glory, and honors.

Smith recognized the crucial problem as being a banking industry that served the interests of upper class projectors, imprudent risk takers, and prodigals. These categories are the same as J M Keynes’s speculators (Smith used the term speculator in the WN to designate an entrepreneur trying his hand at a number of different businesses over time) and rentiers. Today, these categories would consist of your hedge funds, private equity firms, and banks and bankers like Morgan-Chase and Jamie Dimon.

The Wealth of Nations (1776) is an application by Smith of his Virtue Ethics approach to political economy. At the micro level, Smith recognized, just as Jesus did in his parable of the Good Samaritan, that in order to be able to help your neighbor, you first must have been able to help yourself become, to some degree, a business/financial/commercial success by developing the talents God had given you. This initial application of one of the Four Pagan virtues, prudence, is a necessary condition before a decision maker is able to help others. The Good Samaritan would be in no condition to help others if he has not helped himself first to become a financial success. The Good Samaritan in Jesus’s parable is just such a person. He is not a poor person. A poor Good Samaritan can help no one at all. He would have had no money, wine, oil or horse. He would not have been able to take the traveler who was left for dead by robbers to an inn, much less pay for his convalescence. He has silver coins and a supply of wine and oil with him. He is able to both pay the inn keeper an initial down payment of two silver denarii, in order to care for the traveler who was left for dead by robbers, as well as being able to offer to cover all of the innkeeper’s additional future expenses on his return trip home. The Good Samaritan was able help his neighbor because he had made himself a financial success. Thus, while Jesus’s main emphasis in his Good Samaritan parable is that everyone is our neighbor, an additional secondary emphasis in this parable that has been overlooked. It is the conclusion that the potential Good Samaritan can’t actually be an effective Good Samaritan unless he has been able to acquire the resources to, in fact, help others. This leads to the conclusion that the Good Samaritan is well off, wealthy, or rich. He was able to become wealthy because he was prudent in the management of the talents God had given to him. He was a frugal, parsimonious, careful, diligent, hardworking man who was circumspect and judicious. Note that the Good Samaritan does not care about the applause or praise of others concerning his actions. He had reached the final stage of moral development in that he is a noble, virtuous and valiant person whose concern is only with his self judgment.

Helping others would be the Judeo Christian virtue of charity. Smith referred to charity as beneficence. This is the virtue that Smith regarded as being the ultimate virtue. However, in order to be able to reach this stage you must first have been able to become a success yourself. You had to be prudent (frugal, circumspect, parsimonious, careful, judicious). Smith’s term for this ultimate virtue in The Theory of Moral Sentiments (1759;sixth edition, 1790) is Benefience.

Both Jesus and Adam Smith realized, as mentioned above, that there was a very great and grave danger once a person had successfully accumulated riches, wealth, money, property, financial independence, etc. from his prudent behavior. He could be corrupted by his wealth. He would try to manipulate market, financial, and money exchanges so that he would gain while the other party to the transaction would lose. Smith completely rejected this view of the market place.

Smith’s view of economic exchange in the market place is an exchange that is beneficial to both participants. Both participants benefit from the exchange. The concept of handing off a Hot potato or lemon to the other participant in an exchange in the market place is completely foreign to Smith. Such behavior undermines the economic system. The goal of exchange is not to maximize one’s utility by getting the most in exchange and paying the other party the least. The goal is that both parties to the exchange are satisfied with what they have obtained after the exchange has taken place. This leads to the creation of long term trust between the parties that leads to expectations of future trading possibilities that will be beneficial to both parties.

The first volume dealt with points of analysis where the work of Smith and Keynes can be shown to be very close. Both Smith and Keynes are advocates of virtue ethics. Following Aristotle’s basic approach that ethics is an attempt to convince others to do the right thing, Smith seeks to persuade others, as opposed to laying down strict rules of behavior on the grounds that individuals face such a great range of situations that have many particular differences among them, so that no general rule or law will be applicable in the every given case. Smith promotes courage and fortitude, temperance, prudence, and justice. Virtues and Vices are positive and negative character traits, respectively.

Keynes’s version of virtue ethics comes from G E Moore. Keynes also has many of the same concerns as Smith regarding prudence and justice. Ethics is an attempt to persuade others to do good.

This second Volume deals in greater depth with Smith’s analysis of uncertainty and decision theory. The first set of five essays further develops Smith’s understanding, use, and application of uncertainty when analyzing decision making in his The Wealth of Nations in 1776. There is no contemporary of Smith in the eighteenth century or any economist in the nineteenth century who is close to Smith in understanding the role of uncertainty in the real world. For instance, Richard Cantillon, like Jeremy Bentham after him, used the word uncertainty to denote risk, since the supplier was able to include the cost of the uncertainties in the price that was being charged for the product. Cantillon viewed risk from the standpoint of the champagne bottle maker who was able to incorporate the risk of breakage into his market price by adding some percentage to his price to cover the loss by breakage.

A second set of essays in Volume II deals with J M Keynes’s decision theory. These essays go substantially beyond my exposition in my 2004 book on Keynes’s interval valued approach to decision theory. Keynes’s decision theory was based on the application of interval valued probability estimates, as opposed to numerical, single number, estimates (a cardinal approach) or comparative, ordinal, qualitative approaches, where the decision maker is only able to say that p1 > p2 or p1< p2. Both Keynes and Smith recognized that such a weak approach would be useless in real world decision making. Keynes followed Boole in applying an interval valued approach to probability in his A Treatise on Probability.

One of the essays covers the mistaken belief of Robert Skidelsky that G L S Shackle was a close follower of Keynes. In fact, Shackle rejected Keynes’s entire A Treatise on Probability based on a sloppy misreading of the first three chapters. Shackle erroneously believed that Keynes’s logical approach to probability did not leave any room for a residual hypothesis requiring non -additivity, non- complementarity and non -linearity in the probability relation. Of course, Keynes had succeeded, like Boole before him, in doing exactly7 what Shackle claimed Keynes failed to do.

The essay on Shackle also demonstrates the erroneous belief, held by, for instance, both Bradley Batemean and Robert Skidelsky, that Keynes yielded to Ramsey’s criticism. Keynes recognized that Ramsey’s betting quotient approach to estimating probabilities was only sound if the weight of the evidence, w, supporting the betting quotient approach was equal to 1 on a scale defined on the interval [0, 1]. A w=1 meant that the relevant evidence was total and complete. A w=1 results in probability estimates which are coherent in that they are consistent with the answers one derives when