The December 20 issue of The Economist has an excellent article "Why we are, as we are". It touches on a fascinating theme: "As the 150th anniversary of the publication of 'On The Origin of Species' approaches, the moment has come to ask how Darwin’s insights can be used profitably by policymakers."
Inspired by the article, I started to reflect on how the lessons of Darwinism can be applied to help us understand the fundamental roots of the ongoing global financial crisis. In addition, given my continuing faith in open markets and free trade, my thoughts also turned to my favorite economist - Adam Smith, - whose views I felt would also be quite relevant in helping us make sense of the situation.
Many have said that the underlying cause of the financial crisis is greed - that is, the pursuit of wealth, possessions and power beyond the need of the individual. That is way too simplistic an answer. To a greater or lesser extent, greed is part of the human condition, along with the other seven deadly sins and other vices. Powerful evolutionary forces drive the quest for money and power, as The Economist article observes
"For a Darwinian, life is about two things: survival and reproduction. Of the two, the second is the more significant. To put it crudely, the only Darwinian point of survival is reproduction."
"Girls have always liked a rich man, of course. Darwinians used to think this was due to his ability to provide materially for their children. No doubt that is part of it. But the thinking among evolutionary biologists these days is that what is mainly going on is a competition for genes, not goods. High-status individuals are more likely to have genes that promote health and intelligence, and members of the opposite sex have been honed by evolution to respond accordingly. A high-status man will get more opportunities to mate. A high-status woman can be more choosy about whom she mates with."
"Status, though, is always relative: it is linked to money because it drives the desire to make more of the stuff in order to outdo the competition. This is the ultimate engine of economic growth. Since status is a moving target, there is no such thing as enough money."
Few of us would leave our teen age children alone for a week while we go on vacation. No matter how well behaved the children are under our watchful eyes, we would rightfully worry what the combination of raging hormones and peer pressure might lead to absent adult supervision. Primal human drives must be factored into our parental responsibilities, as well as into our organizational and management constructs. Greed is clearly one such drive.
While greed is part of the human condition, so is a sense of justice. ". . . ideas of revenge and punishment lie deep in the human psyche," further says the article. Many evolutionary biologists feel that justice and punishment "are among the things that have allowed humans to become such a successful, collaborative species. In the small social world in which humans evolved, people dealt with the same neighbours over and over again. Punishing a cheat has desirable long-term consequences for the person doing the punishing, as well as for the wider group. In future, the cheat will either not deal with him or will do so more honestly. Evolution will favour the development of emotions that make such reactions automatic."
Human behavior - as is the case with all higher social animals - is the result of a very delicate balance between the energies driving the actions of individuals and the controls driving the interests of the group, the community and the larger society.
Adam Smith wrote about a similar balance between the human drives and fierce competition inherent in open free markets, and the sense of justice and community well-being found in properly functioning societies.
In his most famous work, "The Wealth of Nations" published in 1776, Smith wrote about wealth creation in a competitive, free-market economy. He believed that an individual pursuing his own self-interest will also promote the good of his community - "the free market, while appearing chaotic and unrestrained, is actually guided to produce the right results by this so-called invisible hand."
Some people think that Smith was expressing a view of open markets as reflecting a kind of survival of the fittest competition in which anything goes. Nothing could be further from the truth. Adam Smith was a very moral man. In his earlier major book, "The Theory of Moral Sentiments" published in 1759, he wrote that "humans have a natural tendency to care about the well-being of others for no other reason than the pleasure one gets from seeing them happy." He believed that such feelings of sympathy are required to achieve socially beneficial results.
Smith thus advocated a balanced view between self-interest and sympathy in order for individuals and society to both thrive. He felt that individuals in such a society would find it in their self-interest to develop sympathy toward their fellow men, as this would enhance their prestige and power in their communities. This balanced view between the interests of individuals and society is very similar to the Darwinian arguments in The Economist article.
So, under the watchful eyes of Charles Darwin and Adam Smith, how can we best analyze and explain the root causes of our financial crisis? Why didn't the human sense of sympathy and justice temper the worst excesses of greedy individuals? Why didn't the senior financial executives charged with managing their companies, as well as the financial regulators charged with managing the overall financial system stop the party before it got out of hand?
Undoubtedly, some of the worst excesses can be attributed to a few individuals whose actions can only be explained by their lack of sympathy toward their fellow human beings. But, beyond this small number, I am sure that the vast majority of people in the financial community would have been much more careful, if they personally knew those being potentially hurt by their actions. Perhaps sympathy and feelings of community work well at the tribe or neighborhood level, but when communities reach a certain size, the kind of sympathy for our fellow humans that normally tempers our actions begins to decline. When we don't know the people getting hurt by our actions, when such people are beyond our lines of sight and our lines of feelings, - across a whole region and country, let alone around the world, - perhaps any notion of sympathy disappears altogether.
Evolutionary biologists have long known that xenophobia - a fear, aversion and hostility toward strangers and those that look different from you - is a deeply ingrained human characteristic. As The Economist article points out, ". . . it is known from the study of modern hunter-gatherers, and inferred from archaeological evidence about ancient ones, that neighbouring tribes are often hostile."
What that means to me is that there is likely to be a big difference in behavior between the neighborhood banker, and the anonymous trader in a global financial institution. As we keep discovering, managing a global enterprise requires a whole set of additional skills from the ones that have served us well in the past. Furthermore, no matter how strong a belief you have in the power of open markets, you now also need wise regulatory bodies to help control our worst excesses.
Global companies, industries and economies have been with us for many decades. What is new is the degree of global integration over the last ten years, especially the last five. "The World is Flat,", the international best-selling book by Tom Friedman seems to have been with us for a long time, but was only first published in 2005. In chapter one of his excellent book, appropriately titled While I was Sleeping, Tom writes that around the year 2000,
"we entered a whole new era: Globalization 3.0. Globalization 3.0 is shrinking the world from a size small to a size tiny and flattening the playing field at the same time. And while the dynamic force for Globalization 1.0 [1492 - 1800] was countries globalizing and the dynamic force in Globalization 2.0 [1800 - 2000] was companies globalizing, the dynamic force in Globalization 3.0 - the thing that gives it its unique character - is the newfound power for individuals to collaborate and compete globally."
So, why did senior executives and regulators fail to act? There is clearly no one answer to so complex a question. One reason was clearly that the financial world underwent major changes - the transition to Globalization 3.0 - in the last decade, the old rules of the road were no longer sufficient, and those in charge did not notice until the cars started crashing all around them.
To me, what this all means, is that we need to go back to the drawing board and figure out the right management models for our emerging globally integrated, fast changing, unpredictable knowledge economy. The new models need to encompass both the executives charged with managing companies as well as the government officials charged with regulating the economy. We need new management models not only for the financial services industry, but for every other global, fast changing industry as well.
We need to quickly get going and begin to figure out the rules of the road of the 21st Century global economy, so we are in a better position to anticipate and more effectively manage the next global crisis.
Have you any recommendations for "...the rules of the road of the 21st Century global economy?"
The answer to this is, I think, what vexes many of us. It's a question which I have been thinking about for some time. Answers with which I am both comfortable and confident do not emerge.
Now perhaps this is because the knowledge, skills, and experiences required to fathom the complexities of the world is beyond me.
On the other hand, I do think I am a reasonably well-educated, well-read citizen. My view is that it is people like me that need to comprehend the issues and participate in their resolution.
This leads me to suggest that the basis for "the rules of the road of the 21st Century global economy" is an education of the body politic.
Posted by: James Drogan | December 28, 2008 at 08:15 AM
I think there's a 'Rule of the Road' related to technology, and the difference between 'public' (Government) and 'private' (Business). It may come to the fore as the backwash of the $700B 'bail-out', which seems likely to cause a number of private businesses to fall into public hands.
It's noticeable that all US Government software is either 'secret' or 'free'. Here is NASA's pile http://www.nas.nasa.gov/Resources/Software/Open-Source/opensource.html . In neither case can you buy it; it's either 'unavailable' or 'available at no charge to everybody'.
At the other extreme, Microsoft make their money by selling cheap software by-the-copy; famously Windows and Office, but also video-games such as Age-of-Empires.
IBM fell off one rule-of-the-road and climbed on another when OS/2 saturated its market; I believe that instead of trying to sell 'authorisations to copy OS/2', IBM now tries to sell 'warranties for Linux' ... and Linux is, of course, free.
The body politic probably knows; after all, NASA is part of the 'body politic', and I presume Microsoft has people on payroll who lobby periodically.
But what will the body politic do ? And how will it change as the body politic takes direct ownership stakes in automobile manufacturers, banks, and whatever else falls out of the current crisis ?
I think it all has to do with competitiveness. And that's Darwin's speciality.
Posted by: Chris Ward | December 28, 2008 at 03:45 PM
Maybe the problem is simply that we had too many financial innovations that were running too far ahead of our ability to regulate them, regardless of whether it is government, industry, or the markets themselves who are doing the regulating.
Innovations can grow without regulation, but only as long as they do not become the "tail" that can "wag" the "dog" of the financial system. At that stage, regulation should become automatic and not a matter of ideological debate.
When growth of innovation continues unregulated beyond that stage, it should be no surprise that the system becomes compromised, regardless of the quality of the innovation.
I would suggest that the Federal Reserve should require banks to apply a discount to assets to reflect price movements that are significantly in excess of "historic norms" and also to discount asset prices for moderately deep recessions as well as global recessions which can impact all regions of a country.
This might have limited the amount of AAA-rated asset-backed securities that banks were holding and persuaded others that AAA does not mean risk-free.
Banks and other financial institutions need a solid foundation. Period. No "innovation" can eliminate that requirement.
Sure, we can certainly allow innovation in cash, money, capital, and credit without overly-intrusive government intervention, but stress testing for severe recessions must be a foundation requirement.
The Federal Reserve, FDIC, and other banking regulators must assure that stress testing is continuous, regardless of whether an asset is innovative or traditional.
Think of stress testing as "Darwin-light." Do it or you put yourself at risk of suffering from a "full Darwin" test in which failure means you do not survive. Simulate or perish!
-- Jack Krupansky
Posted by: Jack Krupansky | December 30, 2008 at 10:32 AM
A very interesting post.
I've long had an interest in evolution, genes, and human behaviour. Certainly for longer than my interest in management, which seems to be almost zero these days.
Here are some other thoughts to consider. Not all young women wish to marry old men, even if they'd like to marry a powerful (these days wealthy) man. So they've probably evolved some useful strategies - useful for recruitment for example, as well as dating. They might choose to date the sons of wealthy families, or maybe there are other indicators of future wealth? For example women seem to like men with a sense of humour. Which does seem to be linked to intelligence.
Yes, a sense of justice is clearly present in many people. Past generations of my family have volunteered for military service, some have lost their lives. Medicine and law enforcement have also drawn some. None have shown any interest in becoming financial regulators, though many are very good with maths. So perhaps the structure of such employment doesn't create the right feel for people so inclined - it's just another job, not a career that a young person dreams of.
Perhaps the greatest warning for our species from the work of Darwin should be that human intelligence is no longer a survival trait. By that I mean that where a prey animal runs fast it's because there's a fast predator about (and vice-versa). There is no longer any competitor to humans that is similarly intelligent - we now stand alone competing only with each other.
Posted by: Michael Saunby | December 30, 2008 at 12:47 PM
The question of what "caused" the recent economic issues in the United States can surely be answered on several levels. I suspect that one could investigate the details and begin to build a map of the detailed events involved. But I think we can also benefit from simply recognizing one of the macro issues.
In the United States we are taught that a significant reason that the US has prospered has been that we have an economy based on capitalism and open markets. The assumption being that these ideals have built in safeguards and self regulation. For many years this seemed sufficient as local economies grew. First person to person, then city to city and state to state.
But now we have a "global economy". We may still practice capitalism and open markets in the United States but every year more and more of the global economy does not. The implication is that the safeguards and self regulation built into our economy are no longer sufficient.
This is evidenced in many ways including the existence of monopolies such as OPEC, corporations that are "too big" to be allowed to fail, business's that are global and no longer feel any social responsibility, record numbers of Americans underemployed or unemployed.
At the end of the day, the United States needs to acknowledge and comprehend that we are no longer protected by the safe guards built in to capitalism. I certainly do not suggest that we isolate ourselves from the rest of the world but we certainly do need to build safeguards that ensure we have an equal chance in the larger/global economy.
To bring this full circle, it is clear that some of the implications of this issue have been major contributors to our current economic situation. Fuel prices driven upward by monoplies, whole industries moving to other countries driving umemployment higher and consumer confidence lower, large corporations no longer considering the impact of their decisions on individual countries and the erosion of the American workers ability to protect themselves from corporate excesses.
We can certainly improve the appearance of the current situation by artifical manipulation (stimulus packages, bailouts, etc) but we will never be healthy again until we address these underlying issues.
Posted by: Joe Metzger | January 07, 2009 at 06:12 PM