David D Friedman Blog Post: Accidental Incentives ...
Paul Wakfer
for critique on this group since it is mainly comments on the current
society, rather than the highly fundamental philosophical writing that
he produced in the past. Some years ago I made a major critique of
Chapters 41-43 of his seminal book "Machinery of Freedom" (which
influenced my transition from libertarian objectivism to individualist
market anarchism at the turn of the 1980s) -
http://selfsip.org/dialogues/dfriedman/index.html, but David never
responded to that critique even though I sent it to him (twice). However
the following recent post on his blog caught my attention as potential
for a critique, which will be again sent to him along with an invitation
to join this group and respond. I will also post it as a comment to his
blog post to the extent that such a long comment is allowed.
At:
http://daviddfriedman.blogspot.com/2010/02/accidental-incentives-speculation-and.html
David D Friedman wrote:
> If a copper mine shuts down in Chile the price of copper goes up, giving other
> producers an incentive to produce more copper, consumers an incentive to consume
> less. The objective of the individual producer or consumer is to improve his own
> welfare, not the functioning of the economy, but he is led, as Adam Smith long
> ago pointed out, as by an invisible hand to achieve a desirable objective that
> is no part of his intent.
As shown in the treatise: "Social Meta-Needs: A New Basis for Optimal
Interaction <http://selfsip.org/fundamentals/socialmetaneeds.html>" a
long-range, wide-view thinking (rational) person will seek to maximize
hir Lifetime Happiness ("improve his own welfare") concurrently with
seeking the same for others ("improve ... the functioning of the
economy"), because s/he knows there is no conflict between those two
goals. Therefore, the "invisible hand" argument, while a highly original
notion and very useful description 235 years ago is now very dated and,
in fact, negative for any truly valid description of human action that
is now available based on modern science and technology. Just as modern
economic knowledge/thinking has significantly changed since Adam Smith
wrote "The Wealth of Nations", so too have discoveries and thinking in
the sciences of psychology and social behavior modified many ideas
concerning non-economic human behavior expressed by Smith.
> Seen from the individual's point of view, the effect on the market is an
> accident�indeed, an undesirable one.
This view ("an undesirable one") is an example of the "broken window
fallacy", originally described by Bastiat and explained so well for
readers of all levels by Henry Hazlitt in "Economics in One Lesson". If
the society is composed of rational humans and the complete picture of
all market and human value effects is examined, a rational producer will
see that the sum of all those effects is optimal for hir own Lifetime
Happiness. Even in current societies with many highly irrational people,
this "benefit from the sum of all effects" will generally be the case,
if one fully examines the situation. If David had written "Seen from the
individual's narrow, short-range point of view ...", then I would have
agreed with him.
> Producing more makes prices go down, which
> is not what the producer wants to happen. But seen in a broader sense, the
> market is a system of feedbacks, signals, that give the individual actors the
> right message, make it in their interest to produce more copper or consume less
> when and only when doing so improves the overall outcome. The gain to the
> individual actor is a measure of the social gain from his action.
>
This last part is now alluding to the point that I made above. However
without the definition of Lifetime Happiness and the underlying Theory
of Social Meta-Needs, David cannot make a good case for this being a
rational part of the original producer's goal. Instead he, like Adam
Smith 235 years ago, must refer to it as some kind of morally higher
(?), perhaps almost altruistic (?), improvement in "the overall outcome"
and "social gain from his action".
> There are some cases which look very similar but are actually quite
> different�where the link between what it pays an actor to do and the benefit his
> action produces is in some sense an accident.
At first I thought that David's use of the word "accident" here (and
before) was a little strange, but upon investigation of its etymology
and variations of meaning, I found that "unintended chance occurrence"
is its original meaning, which original meaning has no necessary
implication of negative consequences. As so often in the English
language, here is one more word that has been so distorted from its
original meaning that such meaning is now almost unknown. That is
undoubtedly why David thought it necessary to precede it with the
conditional "in some sense".
> One example is speculation. A successful speculator buys things when they are
> cheap, sells when they are expensive, and so both makes a profit for himself and
> smooths out price movements. The latter effect can be a very large benefit to
> other people. A speculator who sees a food shortage coming well in advance and
> takes the opportunity to buy up grain early gives other and less well informed
> people an incentive to use less grain, to plant more of other food crops, and
> thus to alleviate what might otherwise be a serious famine.
Yes, and there is no reason at all why the speculator could not have
intended all those benefits when taking hir action. In fact, knowing
that there would be such extended benefits might be a factor in
attracting even more speculation and thus more chance of such benefits,
than merely the speculator's weighing of the chance that s/he alone
would benefit. In the extended benefit evaluation, if s/he was correct
then s/he would make money as well as influencing other to benefit, and
if wrong, s/he would lose money and likely influence others to incur a
loss through unnecessarily invested resources at less than optimal
possible gain.
> Unlike the usual case, however, the profit to the speculator is not a measure of
> the benefit produced. To see that, consider a case where the speculator learns
> of the shortage only a short time before everyone else would have learned�short
> enough so that the increase in price due to his activity does not have any
> significant effect on other people's behavior. He can still make a lot of
> money�not because he has produced valuable information but because goods belong
> to him instead of someone else when their price goes up.
The problem with this example is that David does not consider whether
and how it would come to exist in a rational society. Ie. what is the
basis for his assumption that "the speculator learns of the shortage
only a short time before everyone else"? Of course in the current
society which is rife with secrecy, irrationality and insider
information, this certainly does often happen. However in a fully open
and fully rational society, with respect to such near-term impending
shortages, there will not be any clear "learning", but rather only a
pure chance guess. In such a situation, there will be just as much loss
by the speculator (and gain by those from whom the goods were bought) as
there is gain by the speculator (and loss by those from whom the goods
were bought). Therefore, any such chance speculation would be a pure
gamble and likely not done very much if at all. Instead, all speculation
would be of the planned in-depth study sort done by those who have saved
the necessary liquid capital to invest in bolstering the amount of
available goods during the coming shortage for the benefit of everyone.
In fact, an examination of the root meaning and origin of the word
"speculation", shows that "guesswork" is not a necessary part of its
meaning and is likely one more of those slanted meanings that has
appeared in modern usage of the word, whose purpose (that of the
originators of the new usage) is often to besmirch the inherent value of
this activity.
> One implication,
> pointed out long ago in a classic article <http://www.jstor.org/pss/1811850> by
> Jack Hirshleifer, is the possibility of inefficient speculation. A rational
> speculator might spend a million dollars acquiring information about future
> price movements whose social value is zero�his whole profit is coming at the
> expense of whomever would have held the goods when their price went up if he
> hadn't bought them first.
I am not saying that this will not sometimes happen in a fully rational,
free and open society, only that it will be minimal and will mostly be
little different than the benefit that accrues to anyone through some
chance good fortune or the harm that occurs through some chance
misfortune. To the extent that such an occurrence is due to secrecy and
insider information, this will become known, at least after the fact,
and strong Social Preferencing
<http://selfsip.org/solutions/Social_Preferencing.html> will be used to
censure it and prevent its re-occurrence.
> The point is illustrated by a famous law case, Laidlaw v. Organ
> <http://www.daviddfriedman.com/laws_order/index.shtml>. A tobacco trader in New
> Orleans somehow got advance word of the treaty that ended the war of 1812 and
> took the opportunity to buy a large quantity of tobacco at the low price that
> had resulted from the British blockade. When the seller discovered that the war
> was over he attempted to reneg on the contract. The court held that the contract
> was binding.
And this example is a very clear case of the highly negative aspects of
the operation of current societies (essentially government and business
in cahoots - what in the past was called mercantilism), which would not
occur in a fully free and open society.
> The same pattern occurs in at least one other important context. I buy a jacket
> from a department store that guarantees to refund the purchase price if I am not
> satisfied with the produce, and when I return it they refuse to give me back my
> money. It is not worth suing them, but it is worth telling my friends�and anyone
> else who will listen�how badly I have been treated. The result is that other
> people stop buying from the store. That is a good reason why stores should live
> up to their promises, even if they are not at risk of being sued if they do not.
Rather than being of the "same pattern" this example is fundamentally
different. It is an excellent example of Social Preferencing actually
working in the current society where there is still so much anonymity
and so little widespread non-anonymous (and therefore more credible)
publication of information about such broken promises.
> This sort of reputational enforcement surely plays a large role in encouraging
> commercial honesty.
Definitely! And it could play an even stronger role if the players were
more identifiably public about their views and action regarding such
occurrences. In addition, and by the same mechanism, it could strongly
influence (not "enforce", since no "force" is actually used) all
interactions between humans, rather than only commercial ones.
> But, just as in the case of speculation, the incentive that
> makes it work is not linked to the actual usefulness of the behavior. The reason
> my friends�and even enemies�stop buying from the store is not to punish it for
> mistreating me but to protect themselves from similar mistreatment.
Huh? Isn't such "protection" in itself very "useful"? - at least for
others who are still buying from the store. But also for the boycotters,
since once the store managers learn their lesson and begin to honor
their contracts, the boycotters can once again buy from that store. Of
course for this to work, the store manager needs to be fully informed
that it is occurring, by how many people and for exactly what reason.
Finally such boycotting, if sufficiently and public ly related to the
event of protest, may even result in restitution and a public apology by
the store to the person who was refused the refund and a promise to
never do it again. Such action certainly would be "useful" directly to
hir as well as indirectly through its benefit for all other store
customers. In fact, the intent of such action should never be to
"punish", since that is of no rational benefit to anyone, but *only* to
prevent the originally offending event from reoccurring and to possibly
gain restitution for harm caused by that event.
> To see why this matters, imagine a case where it is not immediately obvious
> which party to a dispute is at fault. In order for interested third parties to
> punish the right person, they have to know who it is. But they have little
> incentive to investigate the claims of each, since they have the easier
> alternative of no longer doing business with either. That "punishes" one of us
> for cheating, the other for reporting the cheat. Anticipating that I realize
> that, having been cheated, I am better off saying nothing. At which point the
> mechanism for keeping firms honest stops working.
This possibility is why all contracts need to be written and why all
events need to be recorded, just so that there is *no* doubt about who
is the wrongdoer. See
http://selfsip.org/solutions/Social_Ordering_Tech.html where it is made
clear that use of modern technology invariably removes the possibility
of any such doubt. In addition, full identification and consequent
earned reputation for credibility/honesty (or the reverse) will greatly
enable a determination by third parties of who is most likely to be at
fault.
> One conclusion is that reputational enforcement works only in contexts where it
> is cheap and easy for interested third parties to discover who was at fault;
> elsewhere
> <http://www.daviddfriedman.com/Academic/Course_Pages/legal_systems_very_different_10/china_to_cyberspace.htm>
> I have argued that one function of arbitration is to lower the cost to third
> parties of doing so. My point here is a more general one�that it is worth
> distinguishing between those feedback mechanisms that work because the incentive
> to act measures the value of acting, and those that work, as it were, by accident.
A major difference between me and David is that while David now-a-days
appears to be always attempting to analyze the highly messy situations
that occur in current societies, I am always first and foremost wanting
to see how such situations will operate in a future society where humans
generally act much more closely to the *best* characteristics that are
part of their nature and therefore entirely possible for them. Only once
the operation of such a society has been fully discovered and understood
will it be time to urge as many humans as possible to adopt that kind of
behavior with the least effort (since it is all so clearly rational) and
implement such a society as soon as possible, all without any
possibility of reversion as has occurred in all past betterment of
society attempts.
--Paul Wakfer
MoreLife for the rational - http://morelife.org
Reality based tools for more life in quantity and quality
The Self-Sovereign Individual Project - http://selfsip.org
Self-sovereignty, rational pursuit of optimal lifetime happiness,
individual responsibility, social preferencing & social contracting
Paul Antonik Wakfer
> Very little of what David D Friedman writes on his blog is appropriate
> for critique on this group since it is mainly comments on the current
> society, rather than the highly fundamental philosophical writing that
> he produced in the past. Some years ago I made a major critique of
> Chapters 41-43 of his seminal book "Machinery of Freedom" (which
> influenced my transition from libertarian objectivism to individualist
> responded to that critique even though I sent it to him (twice). However
> the following recent post on his blog caught my attention as potential
> for a critique, which will be again sent to him along with an invitation
> to join this group and respond. I will also post it as a comment to his
> blog post to the extent that such a long comment is allowed.
Although I was able to post my long critique as a comment to David
Friedman's blog entry, as of this date there has been no response by
him either there or to my invitation to join and respond here.
--Paul Wakfer
MoreLife for the rational -http://morelife.org
Reality based tools for more life in quantity and quality
The Self-Sovereign Individual Project -http://selfsip.org