Adam Smith’s “Invisible Hand” and Evolution

I was inspired to write this post by a person named Cai in a comment on Clouds and Global Warming. Not that the suggestive part of Cai’s comment had anything to do with global warming, but was motivated by previous comments exchanged between us concerning capitalism, socialism, and Adam Smith’s invisible hand. For readers who have not followed the economic ideas explored on this website, Adam Smith’s invisible hand is the price system of a free market economy that seemingly spontaneously organizes producers of goods to provide for the needs of society.

Cai’s suggestion was to take a look at a post on the website bigthink.com that featured a discussion between the famous evolutionary biologist David Sloan Wilson (DSW) and the author of the post, Jag Bhalla (JB). The discussion was motivated by JB’s reading of the following paragraph in DSW’s book Does Altruism Exist?: Culture, Genes, and the Welfare of Others.

Large societies function well, to the extent that they do, only thanks to proximate mechanisms that evolved by cultural evolution and that interface with our genetically evolved mechanisms. We know about some of these mechanisms, especially those that we intentionally designed in our conscious efforts to improve the welfare of society (e.g., laws and constitutions). But large societies function well in part because of mechanisms that no one planned or intended, but that nevertheless caused some groups to outcompete other groups. This gives large societies an invisible-hand-like quality, as noted by early thinkers such as Bernard Mandeville and Adam Smith, but it was a monumental mistake to conclude that something as complex as a large society can self-organize on the basis of individual greed.

The emphasis in the last sentence is mine. JB starts out the dialogue by noting that the invisible hand causes the markets to self-organize for the “best overall outcomes”. So why does DSW disapprove? DSW responds by noting that Darwin’s invisible hand, evolution, can be either functional or dysfunctional and is not intrinsically good for the individual or the species. At this point I had the thought that while mutation might or might not be dysfunctional, the same could not be said of evolution, which includes the survival of the fittest together with mutation to enhance the over-all survivability of the new, mutated species. This thought, I think, is not mere nit-picking on my part. The overall action of evolution, mutation followed by the survival of the fittest, is mirrored in the actions of Adam Smith’s invisible hand. The remainder of the dialogue consists of making the same point that I just made: only “mutations” in the economy followed by a natural selection of mutations that are of benefit to society are worthwhile.

DSW’s confusion arises from a misunderstanding of the nature of Adam Smith’s invisible hand, that it includes both mutation and natural selection. I suspect his aversion to the word “greed” as the inspiration of the producer in creating the economic “mutation” is what generates his misunderstanding. Whatever the source of his misapprehension, it does inspire a very worthwhile question: Is Adam Smith’s invisible hand beneficial to society, or should some other means of deciding the quantity and prices of the economy’s goods be used?

First, let us look at the mutation part of the invisible hand. An entrepreneur views the market and decides, given the types, quantities, and prices in the market for goods in which he has interest, that he can either produce a particular good in a different way that makes it cheaper, or he can improve the product in some way, or he can produce a  superior product that would replace the older good (as cars supplanted horses). He might well be motivated only by greed, the desire to make a lot of money, as Adam Smith suggested. Another very real possibility however is that while he wants to make a lot of money, he might also want to be of service to society by supplying a superior product that would be of use to people. I suspect this might have been the case with people like Steve Jobs in producing the Macintosh computer, the iPhone, and the iPad. Whatever his motivation, he is brought information by the prices in the free market that motivate him to produce his new good. This is the mutation half of the invisible hand.

Next, we consider the natural selection half of Adam Smith’s invisible hand, i.e. the effect of information that market prices bring to consumers. In all of the products offered on the market, consumers have a plethora of choices in how they spend their assets. A single consumer may value some products and not others. Some products he might well buy if cheaper, but not at the offered price. Every single consumer has his own list of goods he would like to buy, and price ranges over which he would buy some quantity of various goods. He will buy only those offered goods he desires at prices with which he agrees. How the supplier of a particular good reacts to consumer decisions determines if the mutation survives. Perhaps he needs to do nothing, because he has judged the market perfectly. Perhaps he can lower his prices to make sales and still make a profit. Perhaps he has to go out of business. This is the natural selection side of Adam Smith’s invisible hand.

On both sides of this process of economic evolution, what drives the changes is the information brought to both buyer and seller by the prices of a free-market place. To the degree that an outside force, usually the state, coerces the decisions on types, quantities, and prices of goods, that almost certainly creates imbalances between supply and demand that generate recession or depression. The economy is entirely too complicated for a government to accurately guess what every consumer wants and in what quantity and at what price. I will repeat these words I wrote in Why Socialism Does Not Work.

Many prices in a complicated economy are highly correlated, especially if some goods are used to make other goods. If the price of one good is changed, the price of all correlated goods would have to be adjusted in just the right way or the supply and demand of all the goods become even more imbalanced. It is well known in mathematics and engineering that solving a nonlinear optimization problem with a large number of variables with constraints is an extremely taxing problem. In the case of the socialist economic calculation problem, the function to be optimized, i.e. maximized, would be some aggregate like the GDP. The GDP would be a function of some hundreds of millions of variables, at least several for each human being in the country, many of the variables being connected by mostly unknown constraints. This is a problem that we do not even know how to pose, let alone solve. It is no wonder then that no socialist economy in the history of the last couple of centuries has worked very well.

So why is it that individuals can make successful decisions when the state can not? The reason is that they have much simpler problems to solve. They do not have to make economic decisions for the entire economy, but only for their one tiny corner of it. The results of individual decisions in all the other tiny corners are propagated to the producer in prices of his input materials and labor required to make his good, and to the consumer in the prices of competing goods. The number of variables they have to solve in optimizing their outcomes is microscopic in comparison to those a government would have to handle for the entire economy.

My conclusion is that not only does Adam Smith’s invisible hand perform miraculous and beneficial functions for society, we know of absolutely no other way in which these functions can be practicably performed.

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