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: [1]
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 [2](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. [3] 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. [4] 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. [5]
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. [6]
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.
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