Adam Smith on Overconfidence

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 spirits, 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. …

The contempt of risk and the presumptuous hope of success, are in no period of life more active than at the age at which young people chuse their professions. How little the fear of misfortune is then capable of balancing the hope of good luck, appears still more evidently in the readiness of the common people to enlist as soldiers, or to go to sea, than in the eagerness of those of better fashion to enter into what are called the liberal professions.

Adam Smith, An Inquiry Into the Nature and Causes of the Wealth of Nations, Book I, Chapter 10, paragraphs 29 and 32.  (Hat tip to Econtalk.)

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  • Eric Falkenstein

    I think I remember reading that the overconfident are generally more positive, friendly, which obviously has benefits. Also, Trivers argues that self-deception is helpful to persuading others. We didn’t evolve to find truth, but to balance persuasion (of ourself and others) and truth.

  • http://profile.typekey.com/zenkat/ Zenkat

    Well, so much for joining that start-up …

    😉

  • eddie

    Well, then, hip hip hurray for overconfidence! If progress is made through risk-taking, i.e. if entrepreneurship is a primary source of positive externalities (as many Adam Smith devotees would assert), then a rational individual would encourage this particular bias in others.

    Telling someone there’s gold buried in your backyard just so they’ll dig up the soil for your landscaping project is of course exploitative. But an altruistic and rational individual will encourage overconfidence in others even if he has nothing to gain from it personally just for the positive externalities it generates for the rest of society. So is it ethical to promote overconfidence, to encourage behavior in everyone that is irrational for each individual but a net positive for everyone?

  • eddie

    Is it even possible to be rational about risk?

    Risk tolerance and risk seeking are preferences. Playing the lottery is neither less nor more rational than buying insurance. What behavioral economists are gleefully trying to point out to the neoclassicists is that people aren’t merely irrational in their risk preferences, they are ignorant and inconsistent. Ignorance: people are miserable at estimating risk. Inconsistency: people value not losing a marginal dollar more than they value gaining a marginal dollar (framing effect, loss aversion). Those seem to be the very things that Adam Smith is griping about here.

    But so what? It might be a bias, but is there a response to risk that can be accurately described as unbiased? Isn’t any risk-related behavior – even one that accurately assesses risk and has consistent responses in equivalent circumstances – merely a preference? And if that’s the case, why would there be any merit or value in adopting more informed and consistent attitudes towards risk?

  • http://profile.typekey.com/robinhanson/ Robin Hanson

    Risk tolerance isn’t at all the same thing as overconfidence; a risk tolerant but not overconfident person would be more willing to take chances on other people’s abilities, for example.

    Anything that induces more of something that we have too little of is good in that sense, but overconfidence is not very well targeted toward producing more innovation; Smith mentioned going to war and going to sea as two big effects of career overconfidence, and neither of those are obviously big innovation drivers.

  • http://www.hereticatthegates.blogspot.com will mcbride

    If one is overconfident in his abilities to work with other people, to shape other’s behaviour, then he will be more willing to take chances on other’s abilities. Thus overconfidence builds trusting relationships, which facilitate innovation.

  • Keith Elis

    The successful salesman problem:

    A successful salesman has calculated that, on average over his career, for every 10 widget owners he speaks with he makes 1 sale. In order to speak with 10 widget owners he must speak to 100 people. In order to speak with 100 people he must make 1000 telephone calls.

    The 1 in 1000 odds of any one telephone call resulting in a sale are very slim. What makes him pick up the phone at all? Any one call seems irrational to me. There must be biases at work in the salesman’s decision to dial the phone, not just overconfidence in his own abilities, but a veritable cornucopia of irrationality: the gambler’s fallacy, control illusions, outcome bias, and so on.

    Is the successful salesman problem a cognitive bias paradox? Can one successful salesman’s thousands of small irrational decisions sum to a rational strategy?

  • TGGP

    Keith Elis, you have to calculate the cost of the calls and the benefit of the sale. If each sale is worth a lot and each call is essentially cost-less (which e-mail spam is) it could be perfectly rational.

  • Matias Forss

    I think eddie is right in seeing preferences in risk seeking and I don’t find this citation of Adam Smith very insigthful. A lot of these soldiers and seamen would have been second or third sons of the large families of the time, who would not have inherited land or their father’s profession. Sons from the small families of our time (in Europe & US) do not seek risk in the same scale.