Sunday, September 21, 2008

Is There a Darwinian Case for Bailouts? A Response to David Sloan Wilson

Yesterday, I posted my "Darwinian Conservative Case Against Bailouts." I argued that a Darwinian view of human nature supports private property and free markets under the rule of law with limited government, and I argued against the current mania for bailing out financial institutions as a foolish manifestation of market-socialism that will promote economic crisis while rewarding imprudent behavior.

Today, at the Huffington Post, David Sloan Wilson has posted an article entitled "The Invisible Hand is Dead. Long Live (Smart) Regulation". Wilson argues against my position, because he claims that Darwinian science actually shows that the bailout of financial firms is necessary to promote cooperation and punish cheaters. Although I have the greatest admiration for Wilson's contributions to evolutionary theory, I must say that his reasoning here is incoherent.

Wilson says that the guiding metaphor of capitalist economics is "the invisible hand," which assumes that "the narrow pursuit of self-interest miraculously results in a well-functioning society." According to Wilson, Adam Smith was wrong to offer this defense of narrow self-interest in his Wealth of Nations, although Wilson notes that Smith presented "a more nuanced view of human nature" in his Theory of Moral Sentiments.

Rational choice theory took the invisible hand metaphor literally in trying to explain all human behavior by narrow self-interest. But, Wilson explains, "the collapse of our economy for lack of regulation was preceded by the collapse of rational choice theory," because research in experimental game theory has shown that cooperation arises through moral sentiments that reward cooperators and punish cheaters. Wilson identifies this enforcement of moral norms through moral emotions as "regulation," and he implies that government bailouts of financial firms is an example of such moral "regulation" to secure cooperation.

Wilson then speaks of beehives as examples of "self-organization" that is more than "self-interest." "Beehives and other social insect colonies are indeed self-organized. There is no single bee commanding the troops, certainly not the queen."

For an elaboration of his argument, Wilson recommends reading the book Moral Sentiments and Material Interests: The Foundations of Cooperation in Economic Life, edited by Herbert Gintis et al.

Wilson then concludes: "We can argue at length about smart vs. dumb regulation but the concept of no regulation should be forever laid to rest."

This is a very confusing essay. First, Wilson attributes the idea of completely unregulated markets based on narrow self-interest to Adam Smith. But he doesn't tell his readers that at the end of the Wealth of Nations, Smith has a long section on the public works and institutional structures that government must provide to facilitate commerce. Smith recognizes the need for regulation. But he worries that governmental schemes for central planning of the economy are often harmful because of the "folly and presumption" of politicians who think they have the knowledge and the virtue to direct an economy in all of its details. Does Wilson disagree with this?

Wilson points to Smith's "more nuanced view of human nature" in the Theory of Moral Sentiments. But he doesn't explain that Smith in that book defends a view of morality based on natural moral sentiments that was taken up by Charles Darwin in his theory of the evolution of the moral sense. Smith saw human beings as social beings who combined self-interest and moral sentiments. In fact, the title of the Gintis book to which Wilson refers captures Smith's view of human nature as moved both by "moral sentiments and material interests." In my book Darwinian Conservatism, I show how Darwinian science supports morality as rooted in moral sentiments, moral traditions, and moral judgments, and how such a morality sustains private property, free markets, the rule of law, and limited government.

Wilson implies that Smith's "more nuanced view of human nature" has been lost because "modern economic and political discourse is not about nuance." But, in fact, leading proponents of free market economics like Ludwig von Mises and Friedrich Hayek have emphasized the importance of cooperation in sustaining capitalist economics. Mises wrote: "It is the social spirit, the spirit of cooperation, which forms, develops, and upholds societies. Once it is lost, the society falls apart again. The death of a nation is a social retrogression, the decline from the division of labor to self-sufficiency. The social organism disintegrates into the cells from which it began." People like Mises and Hayek have stressed the importance of capitalist free markets in promoting extended cooperation through a division of labor. In recent years, a growing number of economists have looked to evolutionary theory to explain how cooperation and "moral markets" emerge from the moral dispositions of evolved human nature.

Wilson says that free markets suffer from a "lack of regulation," and that the governmental bailout of financial institutions illustrates the need for regulation that will reward cooperators and punish cheaters. Really?

Free markets with private property under the rule of law regulate economic behavior by providing incentives to prudence. Individuals and firms with a stake in the outcome make decisions based on their processing of information. The rewards and losses from their decisions are concentrated on them rather than on taxpayers. When individuals and firms take on too much debt and too much risk, they bear the costs of their imprudent behavior.

When the federal government uses taxpayer money to bailout individuals and firms that have made bad decisions because of their greedy imprudence, this rewards such imprudence and punishes taxpayers. We thus create what economists call "moral hazard." When people do not bear the costs of their imprudent behavior, because their losses are insured by the taxpayers, we are rewarding and thus promoting imprudence. How exactly does Wilson think that federal bailouts avoid this problem of moral hazard?

Wilson assumes without argument that our present financial crisis has been produced by a lack of government regulation. Is that true? Or is it possible that this crisis has a lot to do with the Federal Reserve lowering interest rates artificially below market rates to promote more and more borrowing? Is it possible that this crisis has a lot to do with the regulations of the Security and Exchange Commission in raising debt-to-capital ratios for financial firms?

Wilson might respond by saying that he is advocating "smart regulation," but not "dumb regulation." But how exactly do we get "smart regulation" in complex, self-organizing systems where no one has perfect knowledge? Is Wilson assuming that the regulators who will manage our bailouts will have enough knowledge of the economy to know exactly what they are doing? Economists like Hayek have argued that a large, complex economy cannot be centrally planned because the central planners will never have enough knowledge or virtue to be trusted to do such planning. Does Wilson disagree? If so, he needs to explain how a beehive could be centrally planned by a queen and her economic advisers. He also needs to explain why a prudent queen's regulation of her beehive would include bailouts for those bees who consume more than they produce and save.

In today's New York Times (September 21), the front-page article by David Herszenhorn on the bailout proposal opens with these two paragraphs:

"The Bush Administration on Saturday formally proposed to Congress what could become the largest financial bailout in United States history, requesting virtually unfettered authority for the Treasury to buy up to $700 billion in mortgage-related assets from financial institutions based in the United States.

"The proposal was stunning for its stark simplicity: less than three pages, it would raise the national debt ceiling to $11.3 trillion. And it would place no restrictions on the administration other than requiring semiannual reports to Congress, allowing the Treasury to buy and resell mortgage debt as it sees fit."

Read over those sentences very carefully. "Virtually unfettered authority." A proposal of "less than three pages." "No restrictions" other than semiannual reports. "As it sees fit." David Sloan Wilson says that we should be cheering this as wise and moral "regulation." But from my Darwinian conservative perspective, I see no reason to cheer such naive faith in the perfect knowledge and perfect virtue of a few bureaucrats in the Treasury Department.


Pantheist said...

This whole entry takes issue with a straw man. Wilson doesn't argue for bailout, he argues for re-regulation.

Massimo Pigliucci said...

I think both David and Arnhart are off the mark here. My third view is presented here: