In his 1776 work An Inquiry into the Nature and Causes of the Wealth of Nations, Scottish moral philosopher Adam Smith identified the cause in a single variable: “the propensity to truck, barter, and exchange one thing for another.” Today we call this free trade or market capitalism, and since the recession it has become de rigueur to dis the system as corrupt, rotten or deeply flawed.

If we pull back and take a long-horizon perspective, however, the free exchange between people of goods, services and especially ideas leads to trust between strangers and prosperity for more people. Think of it as ideas having sex. That is what zoologist and science writer Matt Ridley calls it in his book The Rational Optimist: How Prosperity Evolves. Ridley is optimistic that “the world will pull out of the current crisis because of the way that markets in goods, services and ideas allow human beings to exchange and specialize honestly for the betterment of all.”

Sex evolved because the benefit of the diversity created through the intermixture of genomes outweighed the costs of engaging in it, and so we enjoy exchanging our genes with one another, and life is all the richer for it. Likewise ideas. “Exchange is to cultural evolution as sex is to biological evolution,” Ridley writes, and “the more human beings diversified as consumers and specialized as producers, and the more they then exchanged, the better off they have been, are and will be. And the good news is that there is no inevitable end to this process. The more people are drawn into the global division of labour, the more people can specialize and exchange, the wealthier we will all be.”

In the teeth of the recession and the reality of more than a billion impoverished people in developing countries today, this thesis sounds ripe for skepticism, indeed almost blindly Pollyannaish. But Ridley systematically builds a case through copious data and countless studies that “the vast majority of people are much better fed, much better sheltered, much better entertained, much better protected against disease and much more likely to live to old age than their ancestors have ever been. The availability of almost everything a person could want or need has been going rapidly upwards for 200 years and erratically upwards for 10,000 years before that: years of lifespan, mouthfuls of clean water, lungfuls of clean air, hours of privacy, means of traveling faster than you can run, ways of communicating farther than you can shout,” and with more access to “calories, watts, lumen-hours, square feet, gigabytes, megahertz, light-years, nanometers, bushels per acre, miles per gallon, food miles, air miles, and of course dollars than any that went before.”

Trade does something even more important than enrich our lives. It makes people behave more fairly. In a March 18 article in Science entitled “Markets, Religion, Community Size, and the Evolution of Fairness and Punishment,” University of British Columbia psychologist Joseph Henrich and his colleagues engaged nearly 2,700 people in 15 small communities around the world in two-player exchange games in which one subject is given a sum of money (the equivalent of a day’s pay) and allowed to keep or share some or all of it with another person. You would think that most people would just keep all of the money, but in fact the scientists discovered that members of hunter-gatherer communities shared about 25 percent, whereas members of societies who regularly engage in trade gave away about 50 percent. Although religion was a modest factor in making people more generous, the strongest predictor was “market integration,” defined as “the percentage of a household’s total calories that were purchased from the market, as opposed to homegrown, hunted, or fished.” Why? Because, the authors conclude, trust and cooperation with strangers lowers transaction costs and generates greater prosperity for all involved, and thus concepts of fair trade emerged as part of a larger process of social evolution to maintain mutually beneficial exchanges even when the participants were not bound by kinship, status or other social ties.

In other words, our ancestors had sex with people they knew, but their ideas had sex with strangers, and this form of trade led to trust and prosperity.

How did we evolve from ancient hunter-gatherers to modern consumer-traders? Why are people so irrational when it comes to money and business? Dr. Michael Shermer argues that evolution provides an answer to both of these questions through the new science of evolutionary economics. Drawing on research from neuroeconomics, Shermer explores what brain scans reveal about bargaining, snap purchases, and how trust is established in business. Utilizing experiments in behavioral economics, Shermer shows why people hang on to losing stocks and failing companies, why business negotiations often disintegrate into emotional tit-for-tat disputes, and why money does not make us happy. Employing research from complexity theory, Shermer shows how evolution and economics are both examples of a larger phenomenon of complex adaptive systems. Along the way, Shermer answers such provocative questions as: Do our tribal roots mean that we will always be a sucker for brands? How is the biochemical joy of sex similar to the rewards of business cooperation? How can nations increase trust within and between their borders? Finally, Shermer considers the consequences of globalization and what will happen if nations allow free trade across their borders.

This event took place January 29, 2008 at Google Headquarters in Mountain View, CA.

The 19th-century French economist Frederic Bastiat expressed a principle applicable in the 21st century: “Where goods do not cross frontiers, armies will.”

In my new book, The Mind of the Market, I describe in detail how in the modern world of nation states, economic sanctions are among the first steps taken by one nation against another when political diplomacy fails, as when the United States enforced them on Japan after its invasion of China in the 1930s, and these became a prelude (among other factors) to Japan’s retaliatory bombing of Pearl Harbor in 1941 and our involvement in the greatest war in history. More recently, economic sanctions were imposed by the U.S. and Japan on India following its 1998 nuclear tests, and more recently by the U.S. on Cuba, Iran, and North Korea.

Economic sanctions send this message: if you do not change your behavior we will no longer trade with you. And by Bastiat’s Principle, where our goods do not cross your frontiers, our armies will. Not inevitably, of course, but often enough in history that the principle retains its veracity. Economic sanctions are not a necessary or sufficient cause of war, but they are almost always a prelude to war, whether you are a consumer-trader or a hunter-gatherer. Consider the Yanomamö people of the Amazon, sometimes called the “fierce” people. There is good reason for the moniker because warfare has long been a part of Yanomamö life. As the anthropologist Napoleon Chagnon discovered, however, the Yanomamö are also sophisticated traders, and the more they trade the less they fight. The reason is that trade creates alliances. One village cannot go to another village and announce that they are worried about being conquered by a third, more powerful village, since this would reveal weakness. Instead, they mask the real motives for alliance through trade and feasting, and as a result not only gain military protection but insure inter-village peace. Most interestingly, even though each Yanomamö group could produce its own goods for survival, in fact they don’t; they set up a division of labor and system of trade. They do this not because they are nascent capitalists, but because they want to form political alliances with other groups, and trade is an effective means of so doing. The end result is that when goods cross Yanomamö frontiers, Yanomamö armies do not.

The cooperation that goes into making trade successful accentuates amity and attenuates enmity between strangers and can even be seen at work in brain scans. Scientists at Emory University had 36 subjects play an exchange game while undergoing a functional magnetic resonance imaging (fMRI) brain scan. They found that the areas of the brains of cooperators that lit up were the same areas activated in response to such stimuli as desserts, money, cocaine, attractive faces, and other basic pleasures. Specifically, there were two broad areas dense in neurons that responded, both rich in dopamine (a neurochemical related to addictive behaviors): the anteroventral striatum in the middle of the brain (the so-called “pleasure center”), and the orbitofrontal cortex just above the eyes, related to impulse control and the processing of rewards. Tellingly, the cooperative subjects reported increased feelings of trust toward and camaraderie with their game partners.

How does trust translate to trade? At the Center for Neuroeconomics Studies at Claremont Graduate University, Paul Zak has demonstrated the relationship between trust, trade, and economic prosperity. He shows, for example, how trust is directly related to neurological chemicals such as oxytocin, a hormone synthesized in the hypothalamus and secreted into the blood by the pituitary. In women, oxytocin stimulates birth contractions, lactation, and maternal bonding with a nursing infant. In both women and men, it increases during sex and surges at orgasm, playing a role in pair bonding, an evolutionary adaptation for the long-term care of helpless infants. In exchange games, the more subjects are behaving in trusting ways, the more money they exchange and the higher the levels of oxytocin that are released by the brain. To find out if cooperating and trust lead to the release of oxytocin or if increased levels of oxytocin lead to more cooperation and trust, Zak infused oxytocin into subjects’ brains through a nose spray that is quickly absorbed by the body and discovered that it causes them to act more cooperatively.

Although there may be legitimate political reasons for imposing trade embargoes on nations behaving badly, there are economic consequences that lead directly to a breakdown of trust. By contrast, free trade makes people more trusting and trustworthy, which makes them more inclined to trade, which increases trust … creating a self-enforcing cycle of trust, trade, freedom, and prosperity.

National Capital Area Skeptics, Arlington, VA (January 12th, 2008)

LISTEN to part 1 (audio podcast)
LISTEN to part 2 (audio podcast)

Tattered Cover, Denver, CO (January 17th, 2008)

Living along the Orioco River that borders Brazil and Venezuela are the Yanomamö people, hunter-gatherers whose average annual income has been estimated at the equivalent of $90 per person per year. Living along the Hudson River that borders New York State and New Jersey are the Manhattan people, consumer- traders whose average annual income has been estimated at $36,000 per person per year. That dramatic difference of 400 times, however, pales in comparison to the differences in Stock Keeping Units (SKUs, a retail measure of the number of types of products available), which has been estimated at 300 for the Yanomamö and 10 billion for the Manhattans, a difference of 33 million times!

How did this happen? According to economist Eric D. Beinhocker, who published these calculations in his revelatory work The Origin of Wealth (Harvard Business School Press, 2006), the explanation is to be found in complexity theory. Evolution and economics are not just analogous to each other, but they are actually two forms of a larger phenomenon called complex adaptive systems, in which individual elements, parts or agents interact, then process information and adapt their behavior to changing conditions. Immune systems, ecosystems, language, the law and the Internet are all examples of complex adaptive systems.

In biological evolution, nature selects from the variation produced by random genetic mutations and the mixing of parental genes. Out of that process of cumulative selection emerges complexity and diversity. In economic evolution, our material economy proceeds through the production and selection of numerous permutations of countless products. Those 10 billion products in the Manhattan village represent only those variations that made it to market, after which there is a cumulative selection by consumers in the marketplace for those deemed most useful: VHS over Betamax, DVDs over VHS, CDs over vinyl records, flip phones over brick phones, computers over typewriters, Google over Altavista, SUVs over station wagons, paper books over e-books (still), and Internet news over network news (soon). Those that are purchased “survive” and “reproduce” into the future through repetitive use and remanufacturing.

As with living organisms and ecosystems, the economy looks designed — so just as humans naturally deduce the existence of a top-down intelligent designer, humans also (understandably) infer that a top-down government designer is needed in nearly every aspect of the economy. But just as living organisms are shaped from the bottom up by natural selection, the economy is molded from the bottom up by the invisible hand. The correspondence between evolution and economics is not perfect, because some top-down institutional rules and laws are needed to provide a structure within which free and fair trade can occur. But too much top-down interference into the marketplace makes trade neither free nor fair. When such attempts have been made in the past,, they have failed — because markets are far too complex, interactive and autocatalytic to be designed from the top, down. In his 1922 book, Socialism, Ludwig von Mises spelled out the reasons why, most notably the problem of “economic calculation” in a planned socialist economy. In capitalism, prices are in constant and rapid flux and are determined from below by individuals freely exchanging in the marketplace. Money is a means of exchange, and prices are the information people use to guide their choices. Von Mises demonstrated that socialist economies depend on capitalist economies to determine what prices should be assigned to goods and services. And they do so cumbersomely and inefficiently. Relatively free markets are, ultimately, the only way to find out what buyers are willing to pay and what sellers are willing to accept.

Evonomics helps to explain how Yanomamö-like hunter-gatherers evolved into Manhattan-like consumer-traders. Nineteenth-century French economist Frédéric Bastiat well captured the principle: “Where goods do not cross frontiers, armies will.” In addition to being fierce warriors, the Yanomamö are also sophisticated traders, and the more they trade the less they fight. The reason is that trade is a powerful social adhesive that creates political alliances. One village cannot go to another village and announce that they are worried about being conquered by a third, more powerful village — that would reveal weakness. Instead they mask the real motives for alliance through trade and reciprocal feasting. And, as a result, not only gain military protection but also initiate a system of trade that — in the long run — leads to an increase in both wealth and SKUs.