The invisible hand needs a hand
Adam Smith argued that everyone will ultimately benefit when each person acts out of self interest. For a long time now, economists have now shown that Smith’s view was naïve, and that even rational people will act in ways that leave everyone worse off. This dysfunctional process leads to an over-exploitation and destruction of common resources known as the Tragedy of the Commons:
Free access and unrestricted demand for a finite resource ultimately structurally dooms the resource through over-exploitation. This occurs because the benefits of exploitation accrue to individuals or groups, each of whom is motivated to maximize use of the resource to the point in which they become reliant on it, while the costs of the exploitation are distributed among all those to whom the resource is available (which may be a wider class of individuals than that which is exploiting it). This, in turn, causes demand for the resource to increase, which causes the problem to snowball to the point in which the resource is exhausted.
The October 19, 2007 issue of Science (available only to subscribers online) contains a short article about three economists (Leonid Hurwicz, Eric S. Maskin and Roger B. Myerson) who have recently been awarded a joint Nobel Prize in economics for their work regarding “mechanism design theory.” This theory
aims to find schemes, or mechanisms that in sure that acting in self-interest will indeed lead to benefits for all. Today, its applications range from how best to auction broadcast rights and other public resources to contract negotiations and elections.
How does mechanism design theory work? It starts with the recognition
that unbridled self-interest doesn’t always lead to the greater good. For example, if the people of the town were asked to chip in to build a bridge, each person would benefit by underestimating his or her share and letting others bear the cost. So for lack of funds, the bridge would never get built. That’s sort of a logically unavoidable lose-lose situation is known as a Nash equilibrium.
Hurwicz explored ways of tweaking the rules “so that the most beneficial state and the inevitable equilibrium state are one and the same.” It seems undeniable that the free market, if allowed to run amok, is destructive to our long-term societal needs. I was concerned about this issue in an earlier post, although I was perhaps melodramatic with my title. What kind of tweaks does mechanism design theory offer to the markets?
“It’s a little Machiavellian,” says Gabriele Demange of the Paris school of economics. “You design a game so that in the end the Nash equilibrium comes out to be what you want.” For example, each person could be required to pay what others think the bridge is worth, thus eliminating the incentive to lie.
The article in Science suggests that mechanism design theory has promising applications in areas such as climate change.
Unrestricted free-markets are a proven method of depleting valuable resources. It has happened over and over. One of the most dramatic examples is the lack of commercial fishing in the North Atlantic Ocean, formerly teeming with fish. Nonetheless, it is commonly argued among conservatives that government is incompetent and destructive whenever it intervenes in the economy, and that the freewheeling and unrestricted efforts of individual independent entrepreneurs are our only hope. This blind faith in the “free market” often takes on a religious fervor.
I don’t dispute that entrepreneurs are great at some things, such as stocking the shelves with goods and services demanded by consumers. It is equally clear, however, that a society with long-term ambitions needs to somehow hook its energies to those long-term aims.
The unregulated free market reminds me of the way natural selection works. Neither unregulated markets nor natural selection “see” into the future or “try” to achieve any particular at long range end. That which ultimately evolves from either process is not necessarily “sought” by the real-time actors. The result, again, is often the destruction of valuable resources upon which those short-term actors (and others) critically depend.
With notable and relatively few exceptions, corporations are short-term, shortsighted self-interested amoral entities seeking immediate high profit at the expense of preserving public resources. When they are not regulated, corporations have repeatedly functioned to destroy valuable public resources. They are especially pressured to run toward short term profit by the unregulated hedge funds that essentially run them.
I am not familiar with the nuts and bolts of “mechanism design theory” beyond the sketch presented in Science, but it sounds intuitively correct that free markets need to be tamed and tweaked in order to maintain some focus on critically important long-term needs.
- We need to hunt down and kill Adam Smith’s Invisible Hand.
- Bill Moyers: “Laissez-faire” is French for turning off the alarm until the burglars have made their getaway.
- “Push capitalism” turns us into full-time consumers and non-citizens
- It’s time to start paying as we go
- How to make a rubber hand magically turn into YOUR hand.
Erich said:
—I am puzzled by objections to these regulations on the basis that they “interfere with the free market,” in light of the widespread evidence that the free market (the invisible hand, if you will) is NOT protecting many people, much of the time.—
What’s the puzzle? Every delay—for research, for testing, for due consideration of potential customers’ rights, etc—means that a new product is not on the shelf being purchased and MAKING MONEY. Regulation means that, in the case of really new products, patents get delayed, and someone else might beat you to it. The objections are based purely on the false urgency of market “requirements”. (A not particularly harmful example is the barcode reader. Several companies were working on the tech. If the one that finally developed it had just waited a year or so, they could have figured out how to make it to read the numbers already there instead of barcodes. But they couldn’t wait. Competitors might have denied them they rightful marketshare.)
On the flipside of this, there is the quite legitimate concern that government regulatory agencies can be bought. I remember back in the 70s when plastic bottles were being introduced, that two companies were in direct competition for FDA approval—DuPont and Monsanto. Now Monsanto gets a lot of grief and you have to wonder why sometimes. They’d developed a bottle that was both reusable and biodegradable. DuPont got the approval for their non-reusable, nonbiodegradable bottle. Why? The testing labs determined that the Monsanto bottles were carcinogenic. How did they determine this? They ground bottles up and shoved the powder up the vaginas of female rats UNTIL A TUMOR DEVELOPED. It was later determined that to absorb the same quantity of particulate, one would have to drink something like a hundred gallons of Coke a day for months on end for particle migration to deliver the same level. Who paid for the tests? DuPont.
It really is a Who Do You Trust question more often than not.
This can, of course, be fixed. But it leaves us with the aforementioned patent problem.
Mark T. writes: “Regulation means that, in the case of really new products, patents get delayed, and someone else might beat you to it.”
It’s not quite clear to me what point Mark is trying to make, but, as a former patent practioner myself, I must say that Mark’s above comment is flat wrong. In more than 15 years of practice, I’ve never heard of a patent getting delayed because of any “regulation.” Indeed, if I recall correctly, the only basis upon which the government can delay issuance of a patent is if the Defense Dept. declares the invention a national secret. Otherwise, inventors are *constitutionally* entitled to get patents for their inventions. This is not to say there aren’t sometimes serious delays in getting a patent, but these are due to a lack of qualified patent examiners in the PTO. Congress loves to raid the PTO budget to fund other pet projects.
As regards FDA approval, the FDA reviews evidence presented to it by the manufacturer. If a company wants FDA approval and doesn’t get it, then the problem almost always lies with the company. Agency delays are almost always the result of political pressure; for example, the Bush Administration causing the Agency to delay approval of RU486, or the delays in the 1990s for breast implants because the Agency was still smarting from the grilling it got from Congress for approving silicone implants that later turned to have problems.
I would ask Mark to elaborate on his arguments.
Grumpy,
The question Erich posed was why regulation is opposed. My response has to do with perception, not reality. Regulation that might actually work to keep bad products off the market are presented by corporations as wrenches in the gears. The reality, as you point out, rarely jibes with the perception, but there you have it. They are working against the possibility of regulation that would somehow prevent profit making. It is the mindset of those who feel that any hoop put in their path to jump through is a life or death threat to the “natural” processes of the market.
I did not mean to suggest that it has ever been the patent office’s job to determine safety. But what if it was? We have agencies to determine the suitability of food, of television and radio content, and after-the-fact agencies that trigger Recalls. Not much of a step from that to before-the-fact regulation.
It’s a species of paranoia.
One more point, Grumpy,
My comment on patent application had nothing to do with the patent office process—but if regulation meant a delay in the development of a new product by one factor which allowed a competitor to get there first, then regulation would be seen as Bad. I was talking about a situation in which the patent office would not even see the product due to other regulatory requirements.
Mark T. — thanks for following up. As regards gov’t regulation, the regs generally (at least ideally) impact all competitors equally — that’s often the reason why regulation is needed: because no individual competitor would take the necessary steps unless others do likewise. Environmental regs come to mind — the first company to spend on upgrades faces higher costs, causing the whole industry to delay until the gov’t steps in to demand it of everyone.
As regards safety, the PTO is not staffed with experts on that subject; thus, is unequipped to address it. Likewise for other agencies not tasked with addressing it. Likewise, assigning multiple agencies to address the same issue unnecessarily multiplies the cost of compliance, making U.S. companies at a disadvantage relative to non-U.S. competitors.
True, many products don’t make it to market for safety reasons, but this is true for all competitors. Seen from the vantage point of the consumer, forcing ‘bad’ products off the market creates opportunities for innovators who can build a ‘good’ product to satisfy the need, thereby benefitting the consumer in the long run.
I’ve decided that I need to learn more about the American libertarian movement. There are quite a few sincere and articulate people out there who swear that our societal problems would simply dissolve away if we intentionally weaken government. As I understand that assertion, I reject it, for the reasons I’ve stated above. In short, power can be asserted in many ways, only some of those through government. And I do find it ironic that so many libertarians act as though the court system will be pure and above it all once they cripple the legislative and executive branches.
Here’s a Wikipedia excerpt on Libertarianism:
http://en.wikipedia.org/wiki/Libertarianism
–
I do want to make sure that I’m not missing something big here. Therefore, I’ve subscribed to receive one year of a magazine: Reason: Free Minds and Free Markets. I received my first issue today. Here’s the focus of Reason (from the Reason website):
I’ll report on the progress of my Libertarian education periodically.
Grumpy said:
—True, many products don’t make it to market for safety reasons, but this is true for all competitors. Seen from the vantage point of the consumer, forcing ‘bad’ products off the market creates opportunities for innovators who can build a ‘good’ product to satisfy the need, thereby benefitting the consumer in the long run.—
Oh, I agree entirely. But as far as the producers are concerned, they are already in competition with each other, and the additional “burden” of meeting government regulation is viewed as an unwelcome impediment in that competition.
Another way to look at it, from the commercial viewpoint, consumers exist solely to benefit the producer. From the consumer viewpoint, producers exist only to benefit the consumer. The reality is that neither group could function without the other and both are producers AND consumers. But the ideological distinction (aritificial to be sure) is akin to the rejection by certain people that each individual has both a masculine and a feminine aspect. It only makes sense, but we’ve all talked to people, I’m sure, who simply won’t accept that. (Okay, so it’s a stretch, but it’s the only simile I could think of this early
)
Both parties are convinced that government is exceptionally skilled at doing things they want more of, and entirely incompetent when it comes to things they don’t like. http://www.tonywoodlief.com/archives/001312.html#001312
From Marty Kaplan at Huffpo:
[T]he second 9/11 — the slow-motion collapse of the American, and maybe the global, economy — has been caused by a catastrophic failure of intelligence about Wall Street rapacity. If the now five-year-old Iraq war was the inevitable, tragic consequence of the neoconservatives’ Project for the New American Century, then the subprime mortgage quagmire, the Bear Stearns bailout, and the foreclosure fiasco are the foreordained outcome of the Republican ideology which holds that regulation of corporate financial behavior is the domestic equivalent of Islamofascism.
The economic meltdown is the new 9/11, and it’s George W. Bush’s fault — his, and the fundamentalist free-marketeers who have been living high on the hog, feeding at the public trough, intimidating Democrats, and getting away with capitalist murder ever since Ronald Reagan made “government” a dirty word.
http://www.huffingtonpost.com/marty-kaplan/my-goat-ate-the-economy_b_91759.html
If I had a mil (1 tenth of a cent) for everyone that honestly believes that a free market economy means unregulated capitalism, I would be a very wealty man.
A free market is a theoretical economy drivent entirely by consumer demand. It is the total antithesis of what most people think of as capitalism.
Small pockets of free market economy exist for short periods around the country. The best example is the farmers’s market. The farmers are selling the same things, and the price is a direct function of consumer demand. If the customers on’t like the quality or price from one vendor, they just move on to the next until they find what they want for a price they are willing to pay.
The second any vendor runs out of an item, however, the free market ceases to be because the consumerslose a choice. If one vendor out of twenty fails to offer all items, it becomes a near free market. If only one vendor offers an item, it is a monopoly.
Pure unfettered capitalism favors monopolies and cartels, which result in low quality and high prices for the consumers. Monopolies and cartels manipulate the supply to maximize profit, and by doing so harmsthe consumer.
This is why one of the most important functions of government is to regulate the suppliers and level the playing field between the well established suppliers and the new ones entering the market. However since the introduction of the voodoo theory of “Trickle down economics”, we have seen an ever increaseing percentage of the nations wealth becoming concentrated in a greadually shrinkg percentage of the population.
It could be argued that we are seeing a repetition of history going on. A major cause of the great depression was the lack of regulation of the financial institutiions, but the extreme disparities in income is often overlooked as an important factor by mainstream historians. The economy had grown top-heavy with managment and middlemen, and when disaster hit the source of production, and the poorest of the poor could no longer pay for their needs, it all came crashing down.
It was the poorest of the poor who were least affected by the great depression, as they had already adapted to a lifestyle with little or no money.
Here’s a story about how the “free market” works when it comes to coal-burning electrical plants;
http://www.chron.com/disp/story.mpl/business/steffy/5676803.html
Some are now suggesting the end of capitalism:
[T]he hands-off brand of capitalism in the United States is now being blamed for the easy credit that sickened the housing market and allowed a freewheeling Wall Street to create a pool of toxic investments that has infected the global financial system. Heavy intervention by the government, critics say, is further robbing Washington of the moral authority to spread the gospel of laissez-faire capitalism.
http://www.msnbc.msn.com/id/27112481/