Saving the Appearances (of Standard Finance)

Unbalanced

Back in the Europe of the Middle Ages there existed a curiously schizophrenic attitude to the question of whether the Earth was at the center of the universe. The doctrine of the established Catholic Church decreed that it was. The practical evidence suggested that it wasn't and the orthodox scientific theory endeavored to fit the evidence to the theory, at the expense of commonsense and logic.

Today there exists a similarly curious attitude to the question of whether or not economics is governed by people making rational decisions in consistent ways. The doctrine of the established economic theory says that it is. The practical evidence suggest that it isn't. And the orthodox economic theories endeavor to fit the evidence to the theory, at the expense of commonsense and logic.

Wandering Greeks

The word planet comes from the Greek for "wanderer", and that name arises from the Ancient Greek observation of wandering stars that confounded theories of an Earth-centric universe. If the Earth is stationary and the universe revolves around it then the stars should orbit us in a calm and predictable manner. What they shouldn't do is suddenly stop and then go into reverse before executing a reverse somersault and double pike. But they do.

Of course we now know that the other planets in the Solar System aren't orbiting us, and from our perspective this means that sometimes they will perform odd manoeuvres: they will wander, and this, you might think, rather buggers up the idea that we're at the center of everything. But never, ever underestimate the ingenuity of a clever person with a pet theory that they're committed to. 

Circular Reasoning

There was a second idea that needed to be incorporated in the model of the universe, the idea of circular motion. This seems to have arisen from Aristotle's belief that the circle was the perfect form, and led to the assumption that orbits were based on uniform circular motion. This was to cause a deal of trouble later on, but we'll come to that eventually.

So the ancient Greek philosophers were left with a bit of a conundrum: they needed a model of the universe with the Earth at its center and which ran on circles, but which could also account for the retrograde movement of the wandering stars. And this was needed to "save the appearances" of the Earth-centric model.

The ingenious solution to this is known as the Ptolemaic universe after the Greek philosopher Ptolemy, who probably didn't invent the idea, but may have written it down. The idea is that each planet perform circular orbits around the Earth but as it does so it is itself performing a circular orbit around its own fixed point, known as the equant. Each equant orbits the Earth, each planets orbits its equant, and the whole thing is the biggest load of nonsense since Bishop Ussher figured out the age of the planet by counting backwards in the Bible.

Heresy By Thought

The Greeks themselves were full of theories, some of which came perilously close to the truth, but the Catholic Church had a rather more limited view of the truth which included the idea of an Earth centered universe. Rather oddly, therefore, the church decreed that the pagan heretic Ptolemy's theory was the orthodox view and that arguing otherwise was, err, well ... heresy. 

For a long while the determination of the church to save the appearances of an Earth centered universe and the advance of science didn't come into conflict. As long as scientists didn't go around suggesting that their observations were anything more than an idea and suggesting that the Church was wrong then everyone was quite happy. In was in this environment that Copernicus came up with his heliocentric model of the universe.

Now the problem with the Copernican model is that it’s wrong. Or to be precise it isn't an improvement on the Ptolemaic model when it comes to one of the central purposes of a scientific theory – predicting stuff. In fact it's a lot worse; and this was because while Copernicus put the Sun rather than the Earth at the center of everything he remained wedded to the idea of perfect circular motion. So here we have a mid-way point - recognition that the old model is wrong and is merely saving the appearances and an insight into the way that the real universe works but a failure to throw away the underlying machinery of the old model.

Magic

It's almost impossible for us to put ourselves back in the minds of these medieval philosophers-cum-scientists, because they lived in a world in which religion, science and magic had no clearly defined boundaries. The huge and imaginative leaps forward that they made can't be easily fitted into our modern world view. Which is why the origins of modern astronomy appear to have been generated in the mind of a madman: Johannes Kepler.

Kepler, as any fool knows, came up with the idea of elliptic orbits – and it's throwing away the idea of perfect circular motion that gets us to a realistic working model of the Solar System. But he didn't do this through the process of scientific induction but through a bizarre combination of quasi-religious and mystical insight that involved him fitting the orbits of the planets into a set of the so-called perfect solids. By sheer fluke this happens to work (well, more or less) and out of this he happened upon the elliptical orbit idea as a mathematical description of a mystical universe.

It was this, coupled with Galileo's development of the telescope and actual observations that brought science into conflict with religion: when the appearances could no longer be saved and it became apparent that science was suggesting that doctrine was actually wrong then the Church acted. Although we should note that Galileo's troubles with the Church were not originally about his planetary observations but about his musings on atomic theory and transubstantiation. He was right, though.

Parallel Thinking

The parallels with modern economics are too wonderful to miss. We have the established Church of Standard Finance with its own priesthood. We have a wonderful theory of economics which saves the appearances of the standard theory, but only at the cost of being so ridiculous you'd have to be an idiot to really believe it. We have an alternative theory, behavioral economics, which on the face of it seems to make sense, but like Copernicus before us, it's still wedded to the financial equivalent of circular motion - in this case the non-existent but utterly ubiquitous concept of utility. And finally, we have some semblence of how this might be put together, if we abandon the rational model of human behavior and consider humans as rationally bounded and computationally limited rather than choice-bound automata.

Ptolemaic theory is not the only example of people believing in a scientific theory that doesn't accord with the evidence of their own eyes, but it is a startling example of how human belief systems can ensure not just that we believe in impossible things but that we build entire superstructures of power and control on top of them. 

Groping

Behavioral economics is slowly groping its way forward, as this recent paper by the ever excellent Meir Statman shows. It’s a partial theory, full of holes: but pointing out the flaws in the theory doesn’t mean that the standard theory of finance is correct – you can’t defend the indefensible by arguing simply that alternative theories are wrong: the Earth still orbits the Sun even though Copernicus’ theory was incorrect.

In the end the battle over economics is a battle over power. When Martin Luther set in motion the Reformation by nailing his treatises to the cathedral door at Wittenberg he wasn't just challenging the ideas of the established Church but seeking to undermine its power. War followed, because that's what happens when established power centers come under threat; we shouldn't expect any different in economics.

Homage

This matters to all of us, because standard economics is as much of a world wide belief system as established religion used to be. It's part of the fabric of society, the air we breathe. But it doesn't have to be like this, we have don't have to weigh up the economic value of every decision, we don't have to equate happiness with wealth and we certainly don't have to spend our lives piling up possessions and money to pay homage to the economic gods.

We're at a point where the appearances can no longer be saved. We need a better way of organizing society and lives than the morality free zone that is standard economics. All we need now is a grumpy old Italian with a telescope and an even grumpier German with a new way of seeing things. 

  

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• The Turkey Illusion, An Audience With Gerd Gigerenzer
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