Darwinian or Smithian competition

Econtalk recently held an interview with Robert Frank, author of the book "The Darwin Economy".
The most interesting part starts with the statement:

"I start with a prediction that I won't live to see whether it comes true or not: I predict that if we were to poll professional economists a century from now about who is the intellectual founder of the discipline, I say we'd get a majority responding by naming Charles Darwin, not Adam Smith. Smith, of course, would be the name out of 99% of economists if you asked the same question today. My claim behind that prediction is that in time, not next year, we'll recognize that Darwin's vision of the competitive process was just a lot more accurate and descriptive than Smith's was."

I think he is right, but am hopeful we do not have to wait an entire century.

The competition of Adam Smith is the competition between lion and gazelle. It makes both fast and strong. You could say, it also makes the group better of, on evolutionary time scales. Charles Darwin was aware that this is not always the case, competition between males can lead to aggressive and too strong males, competition between trees for the sun makes them tall (inefficient) and fragile (storm damage). In these cases collaboration between members of a species would make everyone better of.

The irony for economics, the study of how humans allocate their resources, is that humans are one of the most cooperative species on earth (we are strong reciprocators). You can see this everywhere, if you have an eye for it. You can see it in its most distilled form in economic games performed in laboratories, such as the ultimatum game and the common goods game.

Productivity and context

Just listened to Econtalk with Bob Lucas, Nobel Laureate and professor of economics at the University of Chicago, on economic growth. Naturally they also touched on productivity. It was almost funny how they avoided one conclusion. It was on the tip of my tongue as the ending of many sentences.

They talked about a person raising chickens in Indonesia, producing about 50 eggs per chicken per year and having to pick them himself. They asked themselves the question why he did not use modern technology to produce 300 eggs a year. Lucas answer was the lower cost of labor in Indonesia and he stated that this cost is determined by people working in factories in the cities. Lucas: "Economic growth is always associated by a move out of agriculture and into the city environment."

Then the host Russ Roberts asked Bod Lucas why an unskilled immigrant makes so much more money as soon as he (illegally) crosses the US border. Or in other words why he suddenly becomes more productive, while his human capital did not change. Lucas said that it is about cooperation with other people, how productive you are, e.g. as a busboy, depends on the quality of the waiters and of the cooks. Furthermore, the richer people in America are willing to pay more for a dinner.

Roberts then notes that it is a beautiful and interesting problem, that he is probably not more intelligent than his dad, but his standard of living is much higher. Lucas avoids answering, but states: "The other thing is: How many people are competing with you at your level?" "Don't drop out of high school!"

The answers hint at the following: Context is very important in determining productivity and wages. In the two examples, the farmer and the immigrant, context determines their wage, not their skill, not their education, not their human capital. For the farmer it is important that other people get better wages in the city, for the immigrant is is important where he works.

Productivity thus cannot be determined by looking at a person, it is not defined at the level of a person. Scientifically put: it is a nonlinear computation, not a linear one. In the latter case you could isolate one element, one person. Strictly speaking productivity is only defined at the global level. It is still reasonably well defined for nations and probably for large companies. (Even the productivity of companies is determined strongly by their network of partners and institutional factors.) Thus it is also not possible to compute how much a worker should earn. It is up for negotiation. And you certainly cannot claim that someone deserves to earn a certain amount.

Of course, the employee does need to work and often needs skills. Lets not start a nature-versus-nurture-type debate. Productivity is determined (almost) 100% by context and 100% effort. Just as an organism is determined 100% by nature (genes) and 100% by nurture (environment; context) and you can only split these two factors for a given variability in the environment.

It is thus very well possible that top managers get better salaries because they have a better bargaining position, not because they are more productive as it often stated in the media. Doubling the salary of all workers would be a problem to a company. However, a company does not go bankrupt because their CEO gets a double salary; there is only one CEO and there are basically no market forces to reduce it until it becomes extremely excessive. That may be an important reason for the differences in salaries, rather than skills.

Further reading

More posts on economics.