Monday, March 13, 2006

Smithian Markets and Nash Equilibrium

Matt Asay writes in

“Open source in abundance....” [it’s about IT systems…]

I have taken four paragraphs (more would breach their copyright, and require IT translation):

Copyright, patent, trade secrets. These things are designed to exclude, to protect for one's individual benefit. Very proper and Adam Smith-ian of us, no doubt, but also arguably detrimental to both those around us and ourselves.

Which brings me to open source. We have an opportunity here. We can narrowly focus on self-interest, company by company. This, so classical, Adam Smith-style economics would tell us, is the way to maximize the overall "pie."

John Nash's equilibrium theory and common sense argue that in parallel with self-regard and self-seeking we should also seek the good of the group.
In seeking our own benefit we may tangentially benefit the wider population. But if we make enough room to maximize our own take while simultaneously seeking to do those things that will benefit the whole, I think we end up with a bigger market to monetize.”

Matt Asay has a narrow view of Adam Smith’s moral political economy, presumably because of the way Economics 101 was taught at his university. Given the total dependence of everybody on everybody else in the commercial society with which Smith was familiar, he did not advocate that people should act selfishly (the interpretation put on the meaning of ‘Smithian’ by Matt Asay).

Quite the reverse, in fact. People had to co-operate even to get their dinner from the ‘butcher, the brewer and the baker’ (“Wealth of Nations”: WN I.ii.2: pp 26-7) and he expressly insisted that ‘self-love’ was not enough. It was necessary to appeal to the other party’s self-interest and not just to create sympathy for one’s own. Merely seeking one’s own self-interest faced the problem that if two parties act this way there is likely to be no exchange transaction between them, unless one of them surrendered, but if both were determined not to surrender, then the two solutions they bring to the table would never be mediated into the single solution to which they can both agree.

Narrowly focussing on ‘self-interest on self-interest, company by company’ is a recipe for deadlock and strife. A copyright, patent, or trade secret enables its owner to bring to markets what they own and sell them, just as ownership of an amount of money (from earning it by working) enables people to go to markets as buyers. If nobody owned copyrights, patents of had trade secrets, nobody could own money and there would be no sellers or buyers. How then would that ‘maximize the overall "pie"?

It is the in the absence of markets that create wealth (the annual production of goods and services) that eliminates abject poverty. Country’s with limited markets, no private ownership of the products of labour, capital and technology, no law of contracts and an independent justice system, are all sunk in deep poverty. The ‘pie’ would contract.

John Nash (from the film ‘Beautiful Minds’!? – how about reading his articles; Econometrica 1950 and 1953?) does not help. For a start, Nash ignored the negotiating process by assumption, and set out the conditions for defining an optimum solution, none of which operate in the real world, e.g., perfect knowledge of each other’s numerical utility functions and arrived at the mathematical proof that the parties would maximize the product of improvement of net utilities when the assumptions operated. Useful as a limiting case, but hopelessly impractical. It showed what ought to happen, but, as David Hume showed, an ‘ought is never an is’.

While Nash was writing what ought to happen, Professor Tucker experimented with Prisoner Dilemma Games, producing some interesting results. In my experience of running thousands of such games with managers across business and public sector organizations, the most common result (92%) is for ‘defections’ among pairs, not for ‘Nash’ solutions. I have seen other results showing as few as 83% defecting pairs and 17% per cent of pairs, in place of my 8%, achieving Nash solutions, but experimental conditions and briefings may have varied.

In short, not knowing each other’s numerical utility preferences causes defection from the Nash equilibria. I believe the same applies in real world bargaining over real issues between two parties.

Negotiators can learn to move towards a Nash Equilibrium by training in Smithian ‘conditional bargaining’ (see my ‘New Negotiating Edge: a behavioral approach to results and relationships’ (Breeley, 1998) or my MBA Elective textbook, Negotiation, Edinburgh Business School, (1991) 2000, but neither requires we replace private property rights – it works with them.

It relies on choosing between ‘doing what is best for self’ (definitely not a Smithian behaviour) and doing ‘what is best for both of us’ (definitely a Smithian virtue), without destroying the operation of Smithian markets in the manner Matt Asay (naively?) suggests, the consequences of which would eliminate the manifest gains from markets in the form of the living standards of billions of people as effectively as the 20th-century experiments under various forms of Marxian ‘socialism’.

Oh, and yes BTW, Matt Asay’s article carries the usual ‘copyright’ warning to anybody lifting the article or reproducing it in any form in any media: “Copyright © 2006,
Reprints, Permissions, Licensing, IDG Network, Privacy Policy. All Rights reserved.”

Practice what you preach?

Read the article at:


Blogger Wess Eric Sharpe said...


Adam Smith was, remains, and shall forever be the father of the economic foundation. Those such as JFN and JMK are children with Nash being a stepchild at that. An organization that ordains a murderer such as Yasser Arafat as a peacemaker is likewise subject to prize a well written academic theory albeit fraught with logical fallacies of utopia while standing as no more than a subset of Adam Smith in the first instance. It is not that we can escape some degree of improved knowledge from Nash but that we must understand that his work has been placed far too high in the hierarchical scheme. Such is no less than a shame and no more than a lesson but only if accepted by those that seek to know. Wess

4:26 pm  

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