Free Market Economics and Natural Selection
I’ve long thought that there are parallels between evolution by
natural selection and free market economics. In the first case,
mutations and recombination provide a variety of traits in a
population, and natural selection ruthlessly culls those less able to
survive and reproduce. In the second case, individuals come up with
lots and lots of ideas, are free to implement them, and the market
rewards those with successful ideas, and ruthlessly punishes the
unsuccessful ones.
Of course, like all metaphors, this one breaks if you push it too
hard. And note that natural selection applies to viruses, parasites,
and transposons; their analogs in a free market are thieves,
embezzlers, croneys who use connections to get cushy jobs, and people
in offices who work the system to make it hard to fire them even
though they don’t do anything.
Natural selection and free market economics are both good algorithms
for arriving at a good solution to a problem. But, as anyone who has
toyed with evolutionary computation (EC) or genetic algorithms (GA)
will tell you, you have to frame the problem very carefully, or else
the system will efficiently come up with a solution to the wrong
problem.
My friend
Mark
tells the story of a programming contest in which the goal was to
write a program to control a simulated soccer team. The game engine
took care of the game physics, such as determining where the ball went
once it was kicked; it also provided simulated soccer players who
could run, walk, kick, etc. The contestants had to write a program
that would direct these players, telling them when and where to walk,
run, kick, and so forth.
One entrant decided to use a genetic algorithm to come up with his
entry (that is, he wrote a program that would write a second program,
which would in turn control a third program, the game engine). He
noticed that the evolved program did something very odd: sometimes
soccer players would walk backward all the way around the field, then
shoot forward and kick the ball into the goal.
It turned out that his evolved program had discovered a bug in the
game engine: the simulated players grew tired the more they ran. That
is, each player had a “fatigue” number. Each time the player took a
step forward, the game engine added one to that number. The higher the
fatigue, the less well the player could run, and the less accurate his
aim.
The evolved program discovered that this worked in reverse as well: if
a player took a step backward, the game engine
subtracted one from the fatigue counter. So it had the
players walk backward around the field, which produced the same effect
as letting them rest for a few hours.
The moral of the story is that the evolved program solved the problem
that was given it, not the problem that the contest organizers had in
mind.
In the same way, elections are won not by the best candidates, but by
those best able to win elections. Students with high SAT scores are
not necessarily the smartest, but those who are best at passing
standardized tests. And the free market rewards not those who make the
best and cheapest products, but those who are best at making money.
Now, this is not an anti-free-market polemic. I like the free
market. It has given us dirt-cheap
computers[1],
oranges in winter, and a panoply of ethnic restaurants in Bethesda.
But it has also given us outsourcing, Enron, Jack Abramoff, and bogus
Medicare reform.
In evolution, it doesn’t make sense to ask whether, say, scales are
better than feathers. You always have to ask the question in a given
context. If a sparrow were born with scales on its wings instead of
feathers, it wouldn’t be able to fly as well, and wouldn’t be as
successful in gathering food or escaping predators as other sparrows
around it. Then again, if it were an ostritch or other flightless
bird, the scales might act as armor and give it some protection from
predators. It depends on the situation.
Likewise, in business, you may ask whether advertising works better
than bribery. If your company makes products with broad appeal, such
as cars, beer, or MP3 players, then advertising is a cost-effective
way of raising money. But if your company is a government contractor
that specializes in supporting one particular DoD program, then you
may find that it’s more cost-effective to lobby, schmooze, or bribe
the official in charge of that program. It depends on the situation.
As this last example demonstrates, even if the system is set up
correctly, sometimes the winning strategy is to change the rules of
the game. If you’re a lion and the other lion is stronger than you,
kill his cubs; that way, your cubs won’t have to compete against his
genes. If you’re a pharmaceutical company, and lawsuits over defective
products are cutting into your profits, hire a lobbyist to have the
law changed to limit damages; it’s cheaper than improving quality
control.
And this is where we have to be careful. The American Dream is “build
a better mousetrap, and the world will beat a path to your door”.
You’re free to start from nothing, open your own business, and by dint
of hard work and perseverance, build that up into, well, the sky’s the
limit.
The fly in that ointment is that if your dream is to open a bookstore,
you’re going to be competing against Borders and Amazon.com. If you
want to open a sporting goods store, you’re going to be competing
against Wal-Mart. If you want to develop and sell a new Internet chat
system, you’re going to be competing against AOL and Microsoft. In an
ideal world, your business would spur them to improve their products
until they’re better than yours. In reality, however, it may be
cheaper and easier for them to out-advertise you, harass you with
protracted patent lawsuits, or sell their products at a loss until you
go out of business. And if that happens, the end-user doesn’t get a
superior product. The free market system has failed.
This is why I’m wary of rah-rah cheerleaders for capitalism. It
doesn’t work to say “let people put money into personal savings
accounts instead of Social Security, and let the free market sort
things out”. You need to try to align things so that what’s best for
the companies is best for you. That is, you want companies to compete
to see who can provide you (or us, as a society); not to job the
system to maximize their profits without providing a better service.
[1] Compare the price of computers in Silicon
Valley to the price of real estate (dirt) in Silicon Valley. I rest my
case.
Update, Apr. 28, 2006: James Galbraith has an article in Mother Jones that puts a name to what I’ve been talking about: “Predatory economy”:
In a predatory economy, the rules imagined by the law and economics crowd don’t apply. There’s no market discipline. Predators compete not by following the rules but by breaking them. They take the business-school view of law: Rules are not designed to guide behavior but laid down to define the limits of unpunished conduct. Once one gets close to the line, stepping over it is easy. A predatory economy is criminogenic: It fosters and rewards criminal behavior.
Ooo! I got a mention in your blog!
This reminds me of a conversation I had at school with a colleague last week. I brought up my neologism “computational civics” — that is, using computational models for governance, which would naturally include some form of low-level granularity simulation. We currently have the computational resources for that kind of simulation and modeling. I said that rules, laws, ordinances, and regulations warped the economic fitness landscape by creating , altering, or destroying “basins of attraction” for certain behavior, among other things. So, a total laissez-faire system would have basins for robber barons. A properly optimized government would fill in that basin with appropriate laws or regulations.
I need to write up something more detailed later. Right now I’m nursing a hang-over, so this is going to have to stay inchoate for a bit longer. Bleah.
My first thought was “chaos”. That, and the fact that it’s unlikely that a simulation could keep track of all relevant details. But maybe you can fudge it, perhaps lumping elements as diverse as labor unions and the blogosphere together as “people power”, or some such.
Maybe you should talk to some economists. If anyone has experience modeling a universe with tens of thousands of variables, populated by perverse actors, it’s them.
I too have thinking about that there are parallels between evolution by natural selection and free market economics….Great to know that you too having the same thinking..wow!
Don Lapre Max
webmaster@donlaprejones.com
http://www.donlaprejones.com
Don:
According to one source, Darwin had read Adam Smith’s The Wealth of Nations, and considered natural selection to be analogous to division of labor (though I don’t see how).
At any rate, there’s a parallel here, in that in economics, there are thousands of individual transactions and decisions (e.g., “Ooh, that’s a good price on oranges! I’ll buy some” or “I know this price is a rip-off, but the only other place that sells these is 15 miles away, so I’ll pay it” or “I need to buy socks, but not urgently, so I’ll wait until they’re on sale”). Together, these thousands of decisions and transactions add up to Adam Smith’s “invisible hand” regulating the economy.
Likewise, in nature, there are millions upon millions of individual beings. Sometimes the cheetah catches the gazelle; sometimes the gazelle gets away; sometimes the cheetah gets killed by a meteor. These countless events add up to natural selection, an emergent property just like the invisible hand.
Hello. I am currently writing a dissertation for my business degree about selection. It is based on the premise that one can reduce selection to a universal principle and then reapply it to entities such as businesses. Completely laissez faire economics can’t exist, there must always be some bureaucratic regulation or else anarchy (itself unsustainable) would occur. In quite a few cases it is fitter to supply goods/services through bureaucratic or monopoly structures, which is the reason why they have evolved in the first place. With this, however, the variety necessary for selection to continue is severely reduced. I think you are right that the challenge is one of aligning interests, but should be careful not to impose subjective values (“good” and “bad”)on to what is an objective process. Perhaps we should align our conceptions of good and bad with what’s fit and less fit in the context of the whole (or as great a context as we can envisage), and align interests accordingly.
p.s. the bit about the soccer was most amusing. you also might like to read the tragedy of the commons. Its very relevant to all this, is availiable on line for free, and is relatively short. cheers.
geraldrtaylor@hotmail.com
gerald:
I’m not sure I buy this. It should be easy enough to find examples of markets unregulated by governments (e.g., primitive barter economies, ancient markets before kings started decreeing laws against various business practices, black markets, etc). Drug markets, in particular, seem to be in no danger of disappearing any time soon, even though they’re not regulated the same way that milk or stocks are.
What do you mean by “fitter”? In biology, fitness is related to the number of offspring an organism has: a porcupine that manages to have four grandchildren (by whatever means) that survive to reproductive age is more fit than a porcupine that only has three. (Similarly, a poor uneducated fundie with eight kids is more biologically fit than a well-to-do captain of industry with only one child.)
In my post above, I was measuring companies’ fitness purely in terms of how much money they make. In this sense, a thief who starts out with $1000 and steals $100,000 from people over the course of a year is more fit than a consultant who starts out with $1,000 in the bank and earns $70,000 in a year. They are both subject to selection, in that the thief can be removed from the marketplace by police, while the consultant might give bad advice, lose clients, and go broke.
(One important difference between organisms and companies is that companies don’t reproduce. Even in cases where a company splits, or one company copies another’s business plan, the new company does not slavishly copy everything from the original.)
I think here you misunderstand what I meant by “fit”, and I hope that the above clarified things. Here, “fitness” in the sense of “that which enables you to make more money” is indeed objective, but also completely amoral, in that it has nothing to do with what you or I consider “good” or “bad”.
Think of it this way: water flows downhill, and nothing we humans do can change that. But knowing that water flows downhill allows us to build towns in places where they’re not likely to be flooded, or build canals and dams to redirect water to where we want it to go. Similarly, Adam Smith’s invisible hand will affect markets in certain ways (toward greater profitability) no matter what we do. But knowing how markets behave allows us to channel them to behave the way we want them to, through regulation and deregulation, raising and lowering taxes, etc.
Yup. That’s a classic example of a case in which the interest of the individual market player is not aligned with the common good (or even the long-term interest of the individual).
Something I would have liked to hear your opinion on is the recent economic stimulus. Perhaps it’s nothing more than life support, delaying the inevitable? I entirely agree with your analogy–more so in the sense that “evolution is always smarter than you.” What I’m trying to say is that we should be suspicious of anyone to seeks to systematize something that is and should be organic.
In the selfish gene theory, we’re taught to rethink “survival of the fittest.” Evolution should be viewed as the passing of traits rather than the survival of specific groups. Perhaps the market should be viewed the same way? Our government seems more focused on preserving individual companies rather than preserving the ideals of the free market.
Andrew Says:
Possibly. It’s also possible that it’s treatment of a life-threatening symptom that would, unchecked, kill the patient while the body’s slower natural defenses are working to eradicate the core ailment. Time will perhaps tell.
Andrew:
I’m no economist, so don’t take my opinions as anything more than uninformed guesswork.
At any rate, from what I’ve seen, the stimulus seems to have had a positive effect, and perhaps that effect would have been larger if the stimulus package had been larger and/or better administered. I’ve also seen parallels between this recession and the Great Depression, where the economy improved when the government started spending huge amounts of money, and this recovery slowed when the government cut back on spending.
I think of the stimulus as the zappy-paddle thing EMTs use to revive patients who have gone into cardiac arrest: it can do good in some circumstances as a one-time thing, but you don’t want to do it all the time, or under normal circumstances.
But getting back to your question: in this particular case, I think the unfettered free market was the problem: as I pointed out in the OP, free markets do whatever makes money, just as genes do whatever will make more copies of themselves. So meaningful change has to come from reform; the stimulus just buys us some time and hopefully staved off collapse.
As I said in the OP, there are two ways to make money in a capitalist economy: you can produce goods and services, or you can game the system (or you can break the rules, so long as you don’t get caught).
In this case, a bunch of guys figured out that they could make money with exotic financial instruments, derivatives and futures and whatnot, and gambling that the whole edifice wouldn’t come crashing down. Basically, creating paper wealth at the expense of the things we want the market to produce, like giving lots of people homes they can afford.
Executive pay has also come up a lot, and that’s a good example of what sorts of behavior is rewarded: if I run a company and get a million dollars a year no matter what, then all I need to do is to keep the company solvent. If, however, I get half a million bucks in cash, and half a million bucks’ worth of stock, then I want that stock to go up in value.
In the extreme case, if my compensation consists of $1/year and a million dollars’ worth of stock, then the only thing I care about is the stock price. This makes the shareholders very happy, but it also provides me with an incentive to make the stock worth a lot on paper, even if my company starts making crappy products. And if I receive a big pile of stock options as a hiring bonus, and these options vest in five years, then my best strategy is to raise the stock price as much as possible in those five years, sell the stock, quit, and let the company collapse behind me.
As an investor, I’d prefer that the value of my investments (particularly my retirement fund) be more stable than that. And as a consumer, I want the market to come up with good and new and shiny products to make my life better. And that means rewarding managers for making good products.
Unfortunately, while that’s easy to say, it’s hard to write into law, since people have to obey the letter of the law, not the spirit. It’s easy to say “be excellent to each other”, but there still has to be a law against drunk driving.
There’s also the problem that having too many regulations can stifle the creativity of the free market. I don’t think the US is in any immediate danger of that, but it’s something to keep in mind.
Basically, the problem is that we want goods and services, but the market will do whatever makes money. We need to come up with a system where those two are aligned.
arensb,
As an econ nerd, I have to say that I think you’re spot on. Free markets and evolutionary algorithms are tremendously powerful tools to optimize for a given variable or set of variables. The problem is that any variables they’re not keyed into are likely to be shredded in the process if they’re negatively correlated with the target variables. Pollution vs profit is a classic example. The trick to regulation is to make sure that the relevant variables are taken into account.
People often forget that free markets are essentially a game and not The Natural Order of Things from Which All Morality is Derived. The byproduct of free markets is innovation and new products and services for us to consume. The reason we love free markets is because of this byproduct, not because they produce some sort of cosmically correct allocation of resources. People often forget this and assume that a free market is an end unto itself. For a free market to be useful, the rules need to be set so that those byproducts are maximized while minimizing the negative byproducts. As soon as people figure out a way to win the game without optimizing for our preferred variables, it’s time to tweak the rules.
The analogy I use is this: We pay professional basketball players to entertain us. They play to win. If we didn’t have a shot clock, they might choose to maximize winnings by running down the clock at the expense of entertaining action. Add a 24 second shot clock and we take a variable we want to maximize (entertainment), and attach it to a variariable that players will tend to maximize (victory). The trick to getting markets to work for you is the same. Capitalist markets minimize waste because that’s usually the easiest way to make bigger profits. If you add a per-unit surcharge on, say, pollution, then pollution becomes “waste” that will then be optimized out of the system.
Troublesome Frog:
This is also why I like the idea of cap-and-trade: it harnesses the creativity of the market. If you bought some number of pollution credits and figure out some way of not using them all, you can sell the surplus. And if you have a manufacturing process that absolutely requires large amounts of pollution, you’re a buyer for someone else’s creativity.
Of course, there’s also the fact that “pollution” is far easier to define than something like “economic health”. And so I’m not too bothered by the fact that as soon as there’s a cap-and-trade system, there’ll be pollution-credit brokers, companies that hoard their credits until the biggest polluters are ready to pay top dollar for additional credits, companies that try to undercut those companies, and so forth. It should work out with a minimum of regulation.