Wednesday 21 October 2020

Adam Smith on positivity bias

There's an inside joke among economists that there has been nothing new in economics since Adam Smith. Personally, I'm continually surprised at how many 'modern' economic concepts can be traced back to Smith.

Recently, I've been reading The Winner-Take-All Society by Robert Frank and Philip Cook (book review to come soon). They pointed me to this passage from Smith's 1776 book The Wealth of Nations, where Smith seems to anticipate the behavioural economics idea of positivity bias:

The over-weening conceit which the greater part of men have of their own abilities, is an ancient evil remarked by the philosophers and moralists of all ages. Their absurd presumption in their own good fortune, has been less taken notice of. It is, however, if possible, still more universal. There is no man living who when in tolerable health and sprits, has not some share of it. The chance of gain is by every man more or less over-valued, and the chance of loss is by most men under-valued, and by scarce any man, who is in tolerable health and spirits, valued more than it is worth.

Positivity bias (or optimism bias) occurs when we overestimate our own abilities. It occurs when we either overestimate the benefits of things that we do, or underestimate the costs (including opportunity costs) of things that we do, simply because we are the ones doing them. After all, we are awesome! Positivity bias leads us to invest in things we shouldn't invest in (i.e. by 'over-valuing the chance of gain), and to take risks that we shouldn't take (i.e. by 'under-valuing the chance of loss). Although the ideas of behavioural economics are relatively recent, this is at least one idea that can be traced all the way back to Adam Smith.


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