!DOCTYPE html PUBLIC "-//W3C//DTD XHTML 1.0 Strict//EN" "http://www.w3.org/TR/xhtml1/DTD/xhtml1-strict.dtd"> Streamline Training & Documentation: Charles Darwin vs. Adam Smith

Sunday, July 12, 2009

Charles Darwin vs. Adam Smith

Robert Frank, a professor of economics and management at Cornell, has a thought-provoking column in today's New York Times. (An earlier version appeared in The Guardian in May.)

Frank contrasts Adam Smith's views of the dynamics of competition with those of Charles Darwin:
Smith’s basic idea was that business owners seeking to lure customers away from rivals have powerful incentives to introduce improved product designs and cost-saving innovations. These moves bolster innovators’ profits in the short term. But rivals respond by adopting the same innovations, and the resulting competition gradually drives down prices and profits. In the end, Smith argued, consumers reap all the gains.

The central theme of Darwin’s narrative was that competition favors traits and behavior according to how they affect the success of individuals, not species or other groups. As in Smith’s account, traits that enhance individual fitness sometimes promote group interests. ...

In other cases, however, traits that help individuals are harmful to larger groups. For instance, a mutation for larger antlers served the reproductive interests of an individual male elk, because it helped him prevail in battles with other males for access to mates. But as this mutation spread, it started an arms race that made life more hazardous for male elk over all. The antlers of male elk can now span five feet or more. And despite their utility in battle, they often become a fatal handicap when predators pursue males into dense woods.

In Darwin’s framework, then, Adam Smith’s invisible hand survives as an interesting special case. Competition, to be sure, sometimes guides individual behavior in ways that benefit society as a whole. But not always.

Individual and group interests are almost always in conflict when rewards to individuals depend on relative performance, as in the antlers arms race. In the marketplace, such reward structures are the rule, not the exception. The income of investment managers, for example, depends mainly on the amount of money they manage, which in turn depends largely on their funds’ relative performance. ...

In cases like these, relative incentive structures undermine the invisible hand. To make their funds more attractive to investors, money managers create complex securities that impose serious, if often well-camouflaged, risks on society. But when all managers take such steps, they are mutually offsetting. No one benefits, yet the risk of financial crises rises sharply.
The solution, Frank argues, is regulation "to reconcile conflicts between individual and collective interests."

Frank, one of several economists who contribute to the Times's weekly "Economic View" column, has received heightened, well-deserved public attention since publication of The Economic Naturalist in Search of Explanations for Everyday Enigmas in 2007. The book is based on Frank's experience giving beginning economics students plenty of deliberate practice in apply fundamental economic concepts, such as opportunity cost and cost-benefit analysis.

The video below lets you watch the engaging talk about The Economic Naturalist, that Frank gave to Google employees in July 2007.


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