Who was history’s most important economic thinker? Most economists would point to Adam Smith, widely regarded as the father of modern economic theory, whose seminal “The Wealth of Nations” championed free markets and an “invisible hand” that guides individual self-interest to produce the greatest good for society.
Robert H. Frank, however, claims that a hundred years from now someone else will be considered history’s preeminent economist: Charles Darwin.
Darwin wasn’t an economist, but in a new book, “The Darwin Economy: Liberty, Competition and the Common Good,” Frank suggests that the 19th-century naturalist understood the nature of competition in a way that modern economic theory has yet to take into account.
Frank argues that Smith’s “invisible hand” doesn’t fully describe how markets actually work, especially in the 21st century’s technologically enhanced, hypercompetitive, global economy. He sees Darwin’s version of competition as more accurate: Natural selection favors traits and behaviors according to their effect on individual organisms, and while this can lead to invisible-hand-like benefits for groups, it can also harm them. Economists today miss the critical insight that successful competition can also end up doing enormous damage to the wider society at large. A better understanding of competition, Frank believes, would lead to a very different approach to taxes and economic policies.
Frank, an economics professor at Cornell University, talked to Ideas from Ithaca, N.Y.
IDEAS: How can Darwin help us understand economic dysfunction and markets in ways that Adam Smith’s invisible hand doesn’t?
FRANK: It’s just not true that individual interests are always in harmony with group interests, which is the presumption that modern disciples of Adam Smith start from: that if there’s competition, each individual — greedy though he may be — can go out and ruthlessly pursue his own interests and we’ll end up with the best outcome for society as a whole. It sometimes does turn out that way, but Darwin saw clearly that oftentimes you could have perfect competition and still you would get results that would be very different from what the group wanted.
IDEAS: Can you give us an example?
FRANK: The financial industry is a good example. If you think about the firms that are making deals to make money buying and selling assets, what’s really important is that you figure out what the right price of the asset is before anybody else does. So if you look at where they spend their money, they spend tens of billions of dollars on computer systems that can execute lightning fast trades on computer modeling systems . . . .[P]redicting where the price is going to go first really matters because you can make a fortune if you can. So they spend a fortune on the effort to try to be first in that prediction battle, and that’s essentially all money that gets [squandered] in the competition. You’re spending a lot of money for something that’s not really worth anything — getting the price 10 seconds earlier isn’t worth anything to society, but it’s worth a lot to the guy who gets the right price 10 seconds earlier.
IDEAS: And advances in technology have exacerbated this problem?
FRANK: The wedge between individual and group interests has gotten bigger because of modern technology. New technologies have let the most able performers in every domain expand their reach, which has been going on almost since the beginning of the industrial age: The printing press let the best storytellers serve a world market instead of just their local village market, the recording technologies of the last century extended the reach of the most gifted musicians from local concert halls to the world market . . . .So now there’s a bigger battle to see who gets to be the most highly ranked performer in each domain, and those battles have spawned the kinds of arms races that Darwin saw in the arena of sexual selection.
IDEAS: Why has this started to matter more over the past few decades?
FRANK: The more perfect competition is, the more acute these arms races become.
IDEAS: So the better the competition, the more difficult it becomes for society to function?
FRANK: Smith wasn’t wrong that competition often serves the public interest, and often it does. If a producer can come up with a better product design, he’s going to steal market share from his rivals, and eventually they’ll copy him. And competition that gets that innovation to spread quickly definitely serves society’s interests. But it also heats up these mutually rivalrous expenditures, too: Advertising budgets grow, and so on, to no avail to society as a whole.
IDEAS: I was interested in your theory on “expenditure cascades” — you emphasize the importance of context in people’s spending decisions.
FRANK: The simplest example would . . . be in the housing arena. You start with the fact that recent income growth happened mainly at the top so people have a lot more money. And what everyone does when they have more money is they spend more, say they build a bigger mansion: They already had a big one, but they build a bigger one because they can afford it. That’s not a moral failure on their part — most of them earned their money honestly, so well and good. The people just below the top, those people travel in many of the same social circles, so their frame of reference shifts when the people at the top build bigger mansions, so those people build bigger houses, too. And that occurs step-by-step all the way down the income ladder, and so by the time you get to the middle you have a family with no more real purchasing power than before . . . .They had to buy a house that is about 50 percent bigger than the ones the median earners bought in 1970 just to have the median-sized house. So it’s a huge, hugely larger expense for them just to be able to do what the family in 1970s could do with a smaller expense.
IDEAS: You’re an advocate of a “progressive consumption tax” — which would essentially replace federal taxes with steepening tax on people’s spending. Why isn’t that part of the discussion in Washington?
FRANK: All the Republican super committee members have pledged to not raise taxes. The eight presidential candidates in the first debate this fall said they would turn down a proposal with even one dollar of tax increases even if there were ten dollars worth of spending cuts. But I think the right wing can actually embrace a progressive consumption tax. I actually got a nice note from Milton Friedman when I first proposed a progressive consumption tax back in the ’90s and he sent me a copy of his own article when he proposed the same thing back in World War II.
The Tea Party people aren’t willing to talk about anything with the word “tax” in it, but adults realize you have to tax something, and so at some point we’re going to have to talk about what to tax. And once we bite that bullet, then I think this becomes the most attractive option on the table.
Christopher Dreher is a writer living in New York City. His website is http://christopherdreher.net.