Monday, April 20, 2009

Invisible Hand v Irrational Hand

This is better than Alien v Predator. In one corner we have Adam Smith's invisible hand. He says that when each of us pursue our self-interest, the aggregate will promote the general welfare. Although we are all selfish, by pulling in opposite directions we cancel each other out.

In the other corner we have Dan Ariely's (and many others) behavioral economics research that shows that we are all quite irrational in our decision making. This creates cascades that pull the aggregate way out of balance. The recent stock market bubbles and real estate bubble are pretty good evidence too.

Adam Smith's invisible hand is also challenged by the problem of asymmetric information. When some people have better information than others, they can exploit their advantage in the market.

If the Irrational Hand is stronger than the Invisible Hand, we need some kind of oversight (not necessarily government) to help out. The problem we have had over the years is that our regulations have been equally biased and irrational, so they don't help as much as they could and certainly don't SOLVE the problem. Maybe we need to elect fewer lawyers and former lobbyists and more behavioral economists.