LSE lecture: Darwin economy

Sunday, November 13, 2011

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Darwin Economy

Last week I took some of my pupils to the LSE for Professor Robert Frank on “Liberty, Competition and the Common Good: The Darwin Economy”, chaired by Paul Mason. Frank’s book is about the fact that Charles Darwin understanding of competition offers a better guide to economic reality than Adam Smith and rational choice theory. Smith’s view is putting us all at risk by preventing us from seeing that competition alone will not solve our problems.

Smith’s theory of the invisible hand, which says that competition channels self-interest for the common good, is probably the most widely cited argument today in favor of unbridled competition—and against regulation, taxation, and even government itself. Instead Darwin’s insight that individual and group interests often diverge sharply is more helpful. Far from creating a perfect world, economic competition often leads to “arms races,” encouraging behaviors that not only cause enormous harm to the group but also provide no lasting advantages for individuals, since any gains tend to be relative and mutually offsetting.

With over 200 years of Adam Smith taught in economics, modern free market enthusiasts see his ideas of self interest, with people guided by the invisible hand (“It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.”)
However, what these modern free market disciples gets wrong is that markets don’t work magic, and the individual good is not the same as the common good – the market does not always do the right thing.

He brings Darwin into the story by using the example of the bull elk which has giant antlers: the evolution of the bull elk has meant that antlers have grown in size, because it helps to survive a fight with other male elks, to be able to take as many mates as possible to continue its own individual survival. Thus natural selection here takes place based on the size of the elk’s antlers. But as these antlers become bigger, they also place the elk at a disadvantage to its prey, and it is vulnerable to wolves since it slows it down in escapes. Thus the key is that the bull elk does not need big antlers in absolute terms but simply needs bigger antlers than the other elks – that is it is relative size that matters. But if all bull elks have large antlers, it gives no elk a relative advantage, but just slows them all down when the wolves come hunting. That is, an equilibrium that may be beneficial for the individual is not beneficial for the group.

Schelling also made a similar observation in ice hockey players behaviour – when asked individually in a secret ballot all players unanimously vote to have helmets as compulsory; and yet when they actually played the game, they all pursue self-interest and try to get a competitive edge by choosing to remove their helmet (to help them with their vision / movement and get an edge over their opponents). However, since they all remove their helmets, there is no relative competitive edge to be had and all that happens is that the players are more likely to injure themselves in a match.

In Smith’s world, since he saw people as rational actors, this would be justified that these players value the edge more than the risk of injury. Thus the pursuit of self interest ends up with an equilibrium in which nobody is better off – hence why the role of regulations which forces helmets to be worn needs to be instituted. But if no one is left better off by this action, wouldn’t we be better off by not doing it in the first place?

The same logic can be applied to nuclear armament races (whereby countries use scarce resources to get a political advantage over each other, but all that happens is all countries become nuclear powers with no relative advantage). It is not that it is irrational, but rather that the individual interest doesn’t match the group one.

Darwin’s evolution understands the extinction of species. And Smith too understood that firms went extinct or bankrupt due to bad ideas or strategies. But the elk example illustrates a key difference in their ideas – that is, the elk is competing with its own kind, not against its environment. That is these self-cancelling behaviours need not occur. And thus Frank’s point is that the government could offer gentle changes to incentives to guide resources away from waste.

Frank stresses the point that relative rank matters not absolute. Whilst a libertarian is against ideas such as taxing, and safety regulation; Frank believes that it is better in some scenarios e.g. it is better to have a zoning law, than a free market where each individual firm tries to put up bigger and brighter signs than the rest to attract business – this just leads to everyone having big and bright signs everywhere, but no one has a relative advantage.

He points out that the libertarians are only right if there are no externalities from private market decisions. For example as wages get bid up by individual behaviour in a labour market, because we all want that bigger house or bigger extension, this competition just serves to bid up the price of houses in a particular area, with no real advantage to the buyers.

That is, whilst EU/US income inequality has risen over recent decades, there is an inefficient consumption pattern – individual desires to match others (‘keeping up with the joneses’ and beyond), has led to everyone spending more on coming of age parties and on bigger houses, causing the median person to spend more and more, but no one would argue that people are getting more satisfaction from turning 21 or getting married than in 1960 – all that is happening is we are spending more in it in absolute terms. Whilst the median real wage has remained unchanged in recent years, the average wedding now costs $28,000 in compared to $11,000 in 1980 – this extra expenditure is mutually offsetting.

To tame the Darwin economy, the best solution is not to prohibit harmful behaviors but to tax them. By doing so, we could make the economic pie larger, eliminate government debt, and provide better public services, all without requiring painful sacrifices from anyone.

A progressive consumption tax

Frank’s proposal would be to scrap income tax altogether and have a steep progressive consumption tax which would encourage savings behaviour (to address the lack of domestic US and UK savings), and encourage consumption only up to what people actually need (deterred by a high marginal rate of tax). In this way, people won’t go for the $4 mln extension to their mansion but just go for the $2 mln one.

Thus the rich will scale back their extensions and only build half as much – which everyone will do too – smaller extensions but everyone will be just as happy. And more critically (to address the point that this means the construction industry won’t now gain as much as it was before) this saving on excess expenditure will be spent in more worthwhile ways (such as savings to address a credit crunch, and loans for R&D drugs cures).

Frank makes a good point in that most economic models ignore context – but in fact context matters a lot. It is assumed that the utility of a house depends on absolute qualities; but he gave his own example of his experience of living in a mud hut in Nepal – compared to the UK it was very uncomfortable living, but within Nepal it was comfortable.

Frank accepted that governments fail too in their regulations, which is why he does not propose taxing everything in the same way. The libertarians talk about having choice, and no government dictating its decisions. But he gave the example of libertarians wanting to open their stores on Sundays because it is their choice. The individual store owner now has to open his store on a Sunday because if he doesn’t and everyone else does, he loses customer loyalty. So they all open on Sunday, but no one makes much in extra sales, but lose their Sunday with their family.
Some people argue taxing is theft but he would argue it is through taxing that we provide public goods and voluntary taxes never work. And those who don’t want a government, would never want to live in a country in the world that genuinely has no government control such as some African countries.

The idea of kin selection and altruism was also discussed (apparent strategies in evolution that favor the reproductive success of an organism’s relatives, even at a cost to the organism’s own survival and reproduction, discussed by Darwin), talking about Hamilton’s work.

The talk was enjoyable but I will have to read his book to see if he actually goes beyond the essential findings of the Prisoners’ Dilemma that the individual good is not the same for the common good – which was effectively what all his examples were referring to. Its one thing to say Smith’s insight is outdated, but I couldn’t see he put much of a case forward for Darwin replacing Smith (as was posited in his lecture introduction).

Categories: AS and A2 Specifications AQA Economics Unit 3 EdExcel Economics Unit 3 A2 Micro AS Micro Behavioural Economics Game Theory Market Failure Externalities Teaching of Economics
Tags: competition, economics, incentives, adam smith, robert frank, prisoners' dilemma, charles darwin

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LSE lecture: Darwin economy

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