Adam Smith is often regarded as the “father” of economics, given that his “An Inquiry into the Nature and Causes of the Wealth of Nations” of 1776 is the fundamental cornerstone of classical economics. Non-economists sometimes belief that economics favours or defends business interests, but this is not the case. Economics defends the public interest, which is not necessarily the same. In fact, Adam Smith’s book was a massive attack against business interests and business’ privilege-seeking from the government. Nowhere in his book does Adam Smith have anything good to say about businessmen. On the contrary, he regarded them as sort of low-life characters who are involved in dishonest behavior. In the Wealth of Nations he wrote that merchants and manufacturers are
“an order of men, whose interest is never exactly the same with that of the public, who generally have an interest to deceive and even to oppress the public, and who accordingly have, upon many occasions, both decieved and oppressed it” (The Wealth Of Nations, Book I, Chapter XI).
The miracle of the market economy and competition was exactly that it aligned businessmen’s incentives in such a way that by promoting their own gain they ended up – as though led by an invisible hand – promoting the public interest even though that was no part of their intention. Or as Adam Smith put it:
“It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages.” (The Wealth Of Nations, Book I, Chapter II).
This idea that the pursuit of self-interest, depending on the institutions, can be in the social interest was one of the major insights of economics. Good institutions align self-interest with the public interest. But that only works if everyone plays by the rules, and businessmen – so Adam Smith – would rather prefer to avoid price competition and instead collude with potential competitors to keep prices up:
“People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices” (The Wealth Of Nations, Book IV Chapter VIII).
However, this behavior does not seem to be restricted to businessmen. Nowadays, it is increasingly algorithms that price goods and services rather than humans. And it turns out that algorithms are even better at colluding than humans. Emilio Calvano et al. studied experimentally the behavior of algorithms powered by Artificial Intelligence and they found that even relatively simple pricing algorithms systematically learn to play collusive strategies. The strategies that generate these outcomes involve punishments of defections! The algorithms learn these strategies purely by trial and error. They are neither designed or instructed to collude nor do they communicate with one another. Thus, without leaving any trace or proof of collusion, these AI pricing algorithms manage to raise prices above the competitive level in a coordinated fashion. A though case for antitrust policy.
References:
Calvano, Emilio, Giacomo Calzolari, Vincenzo Denicolò, and Sergio Pastorello (2020). “Artificial Intelligence, Algorithmic Pricing, and Collusion.” American Economic Review, 110 (10): 3267-97.