Friday, February 02, 2007

John Nash Was Not Right about Adam Smith Being Wrong

I found a most interesting piece of commentary that is one of those that goes almost far enough, but not quite in its thinking, and I would like to examine its good points and suggest how it might be made completely accurate. The extract states what the author considers a difference between Adam Smith and John Nash, or rather an Hollywood scriptwriter’s version of the differences. Fine. I am not snobbish and given only to contesting the ideas of tenured professors out of Chicago; I’II take on Hollywood scriptwriters too, yes Sir.

The author is someone from The Amrita School of Business blog (2 February), but I know no more about him or her. The author writes:

As the great Adam smith stated, - the market benefits when everyone does what is good for him; we are unknowingly following his path, and take for granted that the whole market is benefited.

However, instead of following Adam smith, only if we follow the versions of Prof. Nash, we all would be in a better situation.

Prof. Nash suggested that the market benefits, when one does what is good for him and also for the group. Following this idea, if we try doing well for ourselves and at the same time, think for gain of the whole group; we all would be in better situation.

By following Adam Smiths principle (self interest), we are actually blocking each others way and giving rise to ambiguity and dissatisfaction .Instead if we think of others (Prof. Nash’s Theory) and follow what is stated below every one will be benefited
.”

Comment
John Nash wrote a seminal paper for Economica in 1950, ‘On the Bargaining Problem’, which set out certain far reaching and basic assumptions that, in effect, eliminated from consideration the process known as bargaining, and substituted instead a consideration of the outcome after two parties bargained. In short it is a study of the solution of bargaining, it is not a study of how two (or more) bargainers arrive at a solution.

The optimal solution (Pareto efficient) shows that the division of an amount of the various items available for trade with varying numerical utilities for the bargainers is the one where the product of the net gains in utility of each bargained set is maximised. Any attempt to redistribute the sets would make one or both of them worse off.

Hence our author concludes that “if we try doing well for ourselves and at the same time, think for gain of the whole group; we all would be in better situation.” However, accepting as true the conclusion, it does not solve the bargaining problem. The problem is not one of achieving an optimal outcome, so much as one of how to achieve that optimal outcome. Nash eliminated the most interesting part of the problem by his assumptions (the boys in his example had perfect information about each other’s utilities for the items available for trade, their bargaining skills were eliminated, and they both knew what each would trade their items for in the bargaining.

Mathematic modelling is only determinate (has a solution) if these conditions operate. They don’t, so apart from being an instructive exercise into the nature of an optimal solution, it is also non-operational.

Smith wrote on the bargaining problem in Wealth of Nations (Book I), but he discussed the process not the solution. So Smith and Nash were addressing different parts of the problem, and like apples and pears, it is difficult to see how a valid comparison can be made between their different solutions. Following ‘the versions of Prof. Nash … instead of following Adam Smith’, will not get us very far because the Nash version is non-operational, it does not address how we conduct the process.

Smith said bargainers address each other in something like the following manner: ‘Give that which I want and you shall have this which you want’ and ‘it is this manner that we obtain from one another the far greater part of those good offices which we stand in need of.’ (WN I.ii.2: p 26) Now he doesn’t say how they should formulate their solution at this point, but he hints very strongly how this should be done (in fact he is quite prescriptive on the point).

In that most famous quotation from Wealth of Nations, of the transaction (process) among the ‘butcher, brewer, and baker’, he observes: ‘it is not from their benevolence … but from their regard to their own interest.’ So, if the bargainers want something from the other party they have to take full account of theirs, not their own, self-interest. Yes, they have to think of the other person’s self-interests first and bargaining allows for a mediation of their different interests into the common interest of a voluntary settlement. We call that negotiation; ‘the process by which we obtain what we want from someone who wants something from us.’

Yet, the author of the piece from Amrita Business School asserts: that following Adam Smith’s advice “we are actually blocking each others way and giving rise to ambiguity and dissatisfaction.” Having shown that is not what Smith said (anywhere in his writings), I think the author needs to rewrite his sentence.

But we have not yet done, because Smith said more. He advised prescriptively (so Smith did not consider it optional) that ‘we address ourselves, not to their humanity, but to their self-love’, which is clear enough in advising the bargainer not to address herself to her own self-love. To make this clear, he also advised her ‘never to talk of them of our own necessities, but of their advantages’. Again, it is clear: don’t think of your needs, think of their advantages from completing the bargain with you, and to do this effectively you must look for what advantages trading with you has for him, not yourself.

In what manner can this ever be described as ‘blocking’ or causing ‘dissatisfaction’, if the bargainers are doing exactly the same by addressing the other party’s interests and the other party’s ‘advantages’? Is this not exactly what Nash was supposedly suggesting? If it is different, enlighten me. Are we reading from the same page?

However, I think there is another problem, apart from the weakness of the Nash solution addressing the outcome of the optimal bargain but not able to offer any help with how to get to it, and the weakness of the author’s understanding of Adam Smith’s contribution, which dealt with the process, and that is the possibility that our author is mixing up the Prisoner’s Dilemma solution with the Nash Theorem. They were both published around the same time in 1950, and are often mixed up (especially in examinations from poorly prepared candidates).

Prisoner’s Dilemma shows that the choice is between doing best for oneself or doing best for both parties. People play ‘co-operate’ or ‘defect’, and those that defect do so for one of two reasons. In effect, the defector acts to protect himself from possible defection by the other (‘I defect, not because I want to, but because I must’), or the defector does so because he intends to exploit the other player (‘I defect not because I must, but because I want to’). Unfortunately, depending on the pay-offs in the game, defection is the majority choice by a long way in my experience of conducting thousands of games in my negotiation courses (about 92 per cent play the defection ‘red’ against the co-operators ‘blue’).

Interestingly, its creators wrote to Nash not long after the papers circulated, but Nash did not reply to their request for his comments. But that’s a long way from the Hollywood scriptwriter, who stuck into Russell Crowe’s/John Nash’s speech the side-attack on Adam Smith’s alleged views.

We don’t’ need to look far for where the script writer got these absolutely wrong views he attributed to Smith; they come from the Chicago version of Adam Smith and not the man from Kirkcaldy. Chicago never has understood Smith on bargaining (let alone the entire corpus of Smith’s works), and they have a lot to answer for in their miss education of generations of economists in what Adam Smith actually wrote about.

It’s not as if it is difficult to get a hold of a copy of Wealth of Nations…

Read the author’s piece at: http://asbians.blogspot.com/2007/02/consider-this.html

6 Comments:

Blogger Gabriel Mihalache said...

You shouldn't take it so seriously. The text you quote is almost exactly the same, word by word, as a few lines from the film A Beautiful Mind, where Nash's ideas are misrepresented heavily, especially in that part.

In any case, Nash equilibria have nothing to do with what's best for the group. It's about your best choice given everyone else's best choice, when facing the same problem as you are.

Even so, by core convergence/Edgeworth conjecture, under certain attractive assumptions, the Nash equilibrium converges to the competitive and Pareto efficient equilibrium.

The people at The Amrita School of Business should better stop stealing lines from superficial movies and start reading on the real deal.

10:22 pm  
Blogger Maurice Carbonaro said...

I am with Gabriel Mihalache...
"People shouldn't take it so seriously"...
but unfortunately this page is still showing up at the first place of search engine results when you google "Adam Smith John Nash" keywords...
You can check yourself...
http://www.google.it/search?hl=it&q=adam+smith+john+nash&meta=

8:23 am  
Blogger Unknown said...

POdríamos decir que Nash hace un estudio Normativo de la Economía, de lo que debería ser, y Smith ha hecho un análisis positivista de la economía, de lo que realmente sucede en la psiquis humana.

We could say that Nash makes a normative study of economics, than it should be, and Smith has done a positivist analysis of the economy, of what actually happens in the human psyche.

9:47 pm  
Blogger Unknown said...

We could say that Nash makes a normative study of economics, than it should be, and Smith has done a positivist analysis of the economy, of what actually happens in the human psyche.

Podríamos decir que Nash hace un estudio Normativo de la Economía, de lo que debería ser, y Smith ha hecho un análisis positivista de la economía, de lo que realmente sucede en la psiquis humana.

9:48 pm  
Blogger Unknown said...

Podríamos decir que Nash hace un estudio Normativo de la Economía, de lo que debería ser, y Smith ha hecho un análisis positivista de la economía, de lo que realmente sucede en la psiquis humana.

We could say that Nash makes a normative study of economics, than it should be, and Smith has done a positivist analysis of the economy, of what actually happens in the human psyche.

9:48 pm  
Blogger Tommy said...

I disagree with many of the other comments. With the extremely strong gut-feeling that most people did not know who John Nash was until the movie appeared (or even Adam Smith!), I think it is very valuable for someone to point out important discrepancies between fiction and reality. As a case-point, I actually did previously believe John and Adam were talking about the exact same problem -- go figure! I learned something new today and I'm content. Thank you author.

6:13 am  

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