The Invisible Hand is Dead. Long Live (Smart) Regulation.

I hope that our economy recovers, but the time has come to declare its guiding metaphor dead. This is the metaphor of the invisible hand, which makes it seem as if the narrow pursuit of self-interest miraculously results in a well-functioning society.

The invisible hand metaphor originates with Adam Smith in The Wealth of Nations (1776). Bernard Mandeville made a similar point with his Fable of the Bees (1705), which fancifully describes human society as a wondrously productive bee hive, even though each bee is as selfish as can be.

Smith was critical of Mandeville and presented a more nuanced view of human nature in his Theory of Moral Sentiments (1759), but modern economic and political discourse is not about nuance. Rational choice theory takes the invisible hand metaphor literally by trying to explain the length and breadth of human behavior on the basis of individual utility maximization, which is fancy talk for the narrow pursuit of self-interest. For the general public, unfettered competition has been turned into a moral virtue and "regulation" has become a sin.

The collapse of our economy for lack of regulation was preceded by the collapse of rational choice theory. It became clear that the single minimalistic principle of self-interest could not explain the length and breadth of human behavior. Economists started to conduct experiments to discover the actual preferences that drive human behavior. The field of experimental economics was born and two of its founders (Vernon Smith and Daniel Kahneman) were awarded the Nobel Prize in 2002.

Actual human preferences are all about regulation. A microcosm of America's economic collapse can be created in the laboratory in a single afternoon. Yank a group of people off the street, give them a task that requires cooperation, and most of them will play along as solid citizens. Unfortunately, a few will game the system if there is any way to cheat. Once the solid citizens realize that they're being ripped off, they withdraw their cooperation as their only defense. Provide them with an opportunity to punish the cheaters, and some (but not all) punish with zeal. Even the cheaters punish other cheaters with zeal! Once the capacity for regulation is provided in the form of rewards and punishments that can be implemented at low cost, cooperation rises to high levels. Regulation is required or cooperation will disappear, like water draining from a bathtub.

These social preferences go beyond our own species. Cooperation and cheating are behavioral options for all social species, even bacteria, and cooperation survives only to the extent that it is protected against cheating. The eternal conflict between cooperation and cheating even takes place within our own bodies, in the form of genes and cell lineages that manage to game the system at the expense of the organism upon which they depend. We call them diseases, but they are really the failure of a vast system of regulations that enable us to function as organisms as well as we do.

Mandeville could not have been more wrong about actual nature of bees. There is a difference between self-organization and self-interest. Beehives and other social insect colonies are indeed self-organized. There is no single bee commanding the troops, certainly not the queen. Each bee plays a limited role in the economy of the hive, just as a single neuron plays a limited role in the economy of the brain. The intelligence of both can be found in the interactions among the parts, which have been shaped by natural selection operating over countless generations. But bee behavior cannot be reduced to a single principle of self-interest, any more than human behavior. There are solid citizens and cheaters even among the bees, and the cheaters are held at bay only by a regulatory system called "policing" by the biologists who study them.

Why are we so different from all other primate species? Because we are so cooperative. Why are we so cooperative? Because it is so easy to regulate each other's behavior in small face-to-face groups. It happens so naturally that we don't even notice it. Alexis de Tocqueville, the great French social theorist who wrote Democracy in America (1835, 1840), also said this about small human groups: "The village or township is the only association that is so perfectly natural that...it seems to constitute itself." This self-organizing ability to function as cooperative groups is "so perfectly natural" because it evolved by a long process of natural selection, in humans no less than bees.

By the same token, functioning as large cooperative groups is not natural. Large human groups scarcely existed until the advent of agriculture a mere 10 thousand years ago. This means that new cultural constructions are required that interface with our genetically evolved psychology for human society to function adaptively at a large scale.

These constructions can work well or poorly. They can arise by a raw process of cultural evolution--many inadvertent social experiments, a few that succeed-- or by a less wasteful process of intentional planning. Tocqueville marveled at the vitality of the American democratic experiment planned by the founding fathers, compared to French society as an inefficient accretion of history. He also perceptively observed that America's vitality could not be attributed entirely to intentional planning. Mexico copied the United State's constitution, but the results were not the same. Something more contributes to America's vitality that we vaguely call "culture" but must study to understand. Tocqueville also speculated that the American democratic experiment could unravel in an eerie premonition of our current turbulent times.

Theories and metaphors are the cultural equivalent of genes. They influence our behaviors, which have consequences in the real world. Mother nature practices tough love. When a theory or a metaphor leads to inappropriate behaviors, we suffer the consequences at scales small and large. To change our behaviors, we need to change our theories and metaphors.

For those who wish to learn more about how economics is going beyond rational choice theory, I recommend a book titled Moral Sentiments and Material Interests: The Foundations of Cooperation in Economic Life (2006), edited by Herbert Gintis, Samuel Bowles, Robert T. Boyd, and Ernst Fehr. Gintis, Bowles, and Fehr are eminent economists while Boyd is an eminent evolutionary anthropologist, illustrating how integrative the new economic theory has become. I have also written an essay titled "The New Fable of the Bees" that explores the theme of this blog in more detail.

New theories are not good enough, however. We also need to change the metaphors that guide behavior in everyday life to avoid the disastrous consequences of our current metaphor-guided behaviors. That is why the metaphor of the invisible hand should be declared dead. Let there be no more talk of unfettered competition as a moral virtue. Cooperative social life requires regulation. Regulation comes naturally for small human groups but must be engineered for large human groups. Some forms of regulation will work well and others will work poorly. We can argue at length about smart vs. dumb regulation but the concept of no regulation should be forever laid to rest.

Comments

[royniles]

Actually you seem to be saying that there is no invisible hand that self-regulates organizational systems, as all such systems have cheaters who will not self-regulate. But then you demonstrate that all biological systems have developed to regulate cheaters without exception. Therefor, in effect, all biological systems self-regulate, Except that, as we already know, some do it quite badly.
In addition, you infer that biological systems are analogous to economic systems, which even if true, would negate your intended non-invisible hand hypothesis.
Except in addition to that, economic systems are more analogous to ecosystems with predatory components, so nothing at all has been demonstrated except that the present regulatory system as it deals with predators has underestimated the ingenuity and rapacity of predators, not to mention their self-destructive aspects.

[MassimoPigliucci]

I think both David and Arnhart are on the wrong track here. My third view is explained in detail at http://rationallyspeaking.blogspot.com/2008/09/wilson-vs-arnhart-on-darwinism-and.html

[david87501]

The board game of Monopoly ends when one player owns everything. Who says that the owner is going to allow us to change the rules at this point in time? Failure to impeach has left the liars in charge. Until the cancer is removed, the body politic will remain sick.

[nemonemini]

This article is already the object of a debate via Larry Arnhart's Darwinian Conservatism blog and the Darwiniana blog, at http://darwiniana.com. Here are two posts on the issues:

http://darwiniana.com/2008/09/21/darwinian-junk-theory-reaches-the-bailout-debate/

http://darwiniana.com/2008/09/21/a-question-from-darwinian-conservatism-blog/

Applying Darwinian theory to social situations is always at risk: the theory is not sound on its own terms, let alone the analysis of human societies, what to say of economic micro situations.

Darwinism, significantly, can't distinguish, it seems, bee hives and human societies. They really aren't the same thing. The ideas of Darwin don't work in such diverse contexts.
We need not only a new economic perspective, but a postdarwinian view of evolution.

[royniles]

Opinions based on whose authority, John Landon's? Wilson may be stretching the analogy, but that's not the fault of Darwinism.

[RussAbbott]

Nice piece!

[Arnhart]

I don't understand.

In free markets, individuals and firms that imprudently undertake too much debt and too much risk are punished for their foolish behavior. To have taxpayers bailing out these foolish individuals and firms creates what economists call a "moral hazard"--people are inclined to act foolishly if they are insulated from the costs of their foolish behavior.

But you say that bailouts reward cooperators and punish cheaters. How so?

[markus7]

Of course, the invisible hand is actually not dead and will function on as always – often with very good results. But I most sincerely hope intelligent people will be able to kill once and for all the foolish, faith based idea that the invisible hand is all that is needed to maximize the benefits of cooperation. Greed is definitely not always good.

The value I see in Dr Wilson’s piece is in pointing out that insights from game theory and evolutionary science can provide important guidance as to what laws, regulations, and standards of behavior are needed, working along with the invisible hand, to best increase the likelihood of maximizing the benefits of all the varieties of cooperation.

[DanAgin]

Aye, forever laid to rest. And also laid to rest the idea of enlightened self-interest when information necessary for judgment is withheld or controlled. Wonderful post, David. Much thanks. Dan Agin

[Pdubya]

argue all you want over regulation vs. deregulation. both are designed (some naives argue doomed to fail) to fail in a fiat currency system.

we do not have free markets. to blame the free market is bad reporting. we haven't had free markets in 95 years. Read The Creature from Jekyll Island.

we have corporatism - fascism. Socialism with shareholders.

regulate all you want, it won't change the feeding at the federal reserve trough by plutocrats on the hill and wall street, doling out the crumbs to us on high interest (inflation). just change how we calculate M3, monetize some more debt and pass it on to us.

the two heads of the same vulture are just arguing which arm to thrust the needle into.

http://www.c-spanarchives.org/library/index.php?main_page=product_video_info&products_id=281024-1&showVid=true

[royniles]

Excellent, but there's more to it than cheating - there's openly predatory behavior in our :genes" as well, and regulatory activities stem as much from that aspect of nature as from cheaters who are not necessarily at the same time predators. Unless you would call avoidance of the laws meant to deter predation as cheating. Or refer to cheating as essentially predatory.

[royniles]

Cheating implies that the cheater understood it was subject to the same set of rules as those being cheated. But predators don't understand or accept that they must play by any rules that will inhibit their predatory successes. So in my view predators are not cheating their prey from any point of view except that of the prey (or of their advocates, of course).

[royniles]

Is it that Wilson sees predators as a species oriented label, and that within a species, predators are rule breakers - and therefor a form of cheater? But within every species are remnants of genes or their equivalents from other species. And the dynamics of cheating and predatory behavior are simply not the same - one is not simply a degree of the other.

Example: Successful psychopaths are predators. Cheaters need not apply.

[markus7]

Beautiful comparison of the need to regulate financial markets with what game theory, experiments with people, and evolutionary theory tells us about how to maximize the benefits of cooperation.

[veracitatus]

Right on target. This author has used your work, among others, to work on those rules and metaphors.

Go to: http://questioneverything.typepad.com/question_everything/2008/08/index.html and scroll down to the Aug. 12 entry, Sapient Governance III. The prior posts in the series are linked from there so you can go back and read them first. Then the latter posts, up the page and into Sept. start laying out implications.

The fundamental thesis is that hierarchical control theory and the evolution of hierarchical control structures in nature are used to develop a model of governance and economy with strategic, tactical, logistical, and operational components.

[Clairvaux]

Excellent post.

It is not a coincidence that the party advocating an economic "invisible hand" is also the party that has shredded our constitution.

Our constitution is based on the idea that human nature is SUSPECT. Power must be divided. There must be checks and balances. Our bill of rights regulates governmental power, protecting us (in theory) from a would be unitary executive.

The Republicans have given us Bush and a disastrous economic collapse. They are both symptomatic of political hubris and a conveniently naive ideology.

[chrisro]

The Invisible Hand can never be dead....That's like saying gravity has been revoked.

[paixa3]

Yes, but in at least 60 percent of our economy, the invisible hand DOES NOT EXIST. Try drawing a supply demand graph with one data point, no bid collusion contracts, corruption et al. IMPOSSIBLE.

Because of large institutional investors, you cannot even create a reliable graph for stocks. I think you had better go back to some other theory, yours does not exist, nor work.

[BillZBubb]

Nonsense, gravity is real. The invisible hand is a myth. Get reality based, you'll understand a lot more.

[blindjester]

The "invisible hand" presupposes that people make rational decisions based on complete information.

Neither of those conditions are easily met.

If people were rational, Las Vegas would go out of business and the lotteries would dry up.

If we had complete information, nobody would buy products with carcinogens in them.

[Herrington]

In other words, if there are no cops the criminals take over. It happens on main street and on wall street. I wonder if this isn't at the root of conservative resentment of "regulation". Rhetorical question.