Rethinking Economics: Let’s Get This Schism Started

Doctors of Doctrine

In the wake of the great crash of 2008 a lot of young people suddenly became interested in finance and signed up for university courses to learn about the detail of what went wrong. Instead, what they got was a load of nonsense dressed up as learning that bore little relation to the real world. Well, what did they expect, they chose to study economics?

Our of this was born the Rethinking Economics movement, an attempt to introduce new ideas and concepts into economic education, to adopt a pluralist approach. The problem with this, well meaning though it is, is that reforming economics is akin to Martin Luther nailing his theses to the door of All Saints' Church in Wittenberg: all it does is create a schism in a religious cult. Economics doesn't need re-thinking, it needs to be put out of its misery.

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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.

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SCOTUS Breaches the Efficient Frontier

Back to the Future

As you'll know the Psy-Fi Blog spends a lot of time pointing out to a (largely disinterested) audience of investors that there's a huge amount of psychological research out there that we can use to guide our investing behavior. In fact there are vast reams of the stuff, far too much for me to ever even summarize, let alone analyse. But as we saw in Behavioral Law and Disorder the Supreme Court, like most investors, has failed to take account of this by requiring investment professionals to benchmark themselves against the Efficient Markets Hypothesis, a failed meme if there ever was one.

Well, no more. The Supreme Court of the United States (aka SCOTUS) has donned kipper ties and white suits and boogied into the late-mid-twentieth century with a ruling that markets can no longer be regarded as entirely efficient. Somewhat surprisingly, however, the justices have based their findings not on the wealth of research that's accumulated over half a century but on an op-ed piece in the New York Times. It makes you wonder why you bother.

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Thatcherism: The Irony of Economics

Nuance-onomics

We’ve previously looked at some of the evidence that suggests Studying Economics Makes You Mean.  The general idea is that learning about the market economy and the benefits of natural selection tends to make us less generous and less empathetic towards the travails of others.

However, like so much research quoted here this only offers up part of the story. It’s possible that we’re looking at a false correlation – it may be that it’s not studying economics that makes you a nasty grasping son-of-a-bitch but that you study economics because you already are one.  And, as usual, the truth is, at best, nuanced.

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Born Rich, Born Greedy

Recidivists of the World Divided

Research suggests that the upper classes are more morally ambivalent than the rest of us. Or, to put it more bluntly, they’re a thieving bunch of recidivists with the ethical inclinations of a polecat in a henhouse.

Adam Smith predicted this years ago, and skewered the argument that many make in favour of predatory capitalism – that self-interest is the best way to allocate capital. A little enlightenment may come in useful for those wanting to debate the issue.

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Bah, Humbug … The Value of a Child’s Gift

Adulthood

One of the neat things about economics is that it provides different ways of thinking about problems. Take adulthood for instance. This, you might think, is a vague concept which has something to do with children no longer borrowing money from you and not giving it back. Or even leaving home and not returning. An economist, though, sees it differently: adulthood is the moment your child’s spending on Christmas gifts exceeds the value of those they receive. Bah, humbug.

The creep of economics out of its natural domains, finance and resource management, into other areas has a name: economic imperialism. This creep has supposedly been going on for a long time, and has happened so insidiously that it’s been hard to spot. Yet given that we all know that economics is less a science than an invocation of the dark arts of the necromancer this isn’t necessarily a good thing. Maybe, though, this points us in the direction of some overdue reforms of markets, shareholder rights and, perhaps, even capitalism itself.

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Exit the Walras, followed by Equilibrium

Blinkered

As we saw in Economics and Psychology: The Divorce, the two queenly social sciences long ago parted ways. What we haven’t yet seen is quite what the economists did next, when they abandoned the idea that people had any part to play in economic behaviour.

To do this they chose to follow a path predetermined for them by physicists, which would have been all very well were it not for the fact that the bit of physics they choose to use turned out to be incomplete. Unfortunately, by cloistering themselves away from new research for nearly a century, this new reality was missed and by the time they emerged from their bunkers economics wasn’t so much wrong as irrelevant.

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Religion in EconoLand

Religion is not a single thing. It is a body of behaviour unified by our failure to find a simple rational explanation for it when seen from the perspective of the individual.

(James Dow, A Scientific Definition of Religion)

Priestly Predictions

EconoLand is a peculiar place. Although its people are perfectly normal in all other respects they place their trust and their futures in the hands of a cadre of strange, secretive and almost entirely incomprehensible priests. They name these divine intermediaries “economists”.

It seems that only these “economists” can intercede with the god of the land, who is imbued with superhuman powers of omniscience and perfect foresight, yet is wholly and totally devoid of emotion or any trace of human sympathy. It’s an odd fact that, although this god is believed to be perfectly rational and incapable of error, the predictions of the economists never, ever agree with each other. What’s even more odd, no one ever seems to notice.

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Breaking the Guild of Macroeconomists

Economic Entertainment

In an entertaining piece Economics is Hard. Don't Let Bloggers Tell You Otherwise Kartik Athreya of the Fed in Richmond has suggested that financial bloggers are a mentally incontinent bunch, pathologically incapable of stopping themselves from opining on financial matters on which they actually offer no insight. Now, leaving aside the question of whether we want our professional economists to be entertaining, this opens up the question of whether untrained commentators can provide any useful insight into matters financial.

The answer, speaking as an economically untrained scribbler, is almost certainly no: the vast majority of financial blogging opinion on any matter of prediction is worthless and that which isn't is indistinguishable from the rest. Unfortunately this is a conclusion of limited usefulness, because most trained economists can't actually offer any useful predictions either and following Athreya's prescription would almost certain deny us any opportunity for useful advances in the world of macroeconomics.

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Metaphors of Mind and Money

Theories of Mind

The question of how psychologists come up with their theories of how the mind works is one that’s long troubled philosophers. Now this might not seem like a very serious concern, especially to those of us more worried about whether our stocks are going up or down, but this is misleading: how our minds work is part and parcel of how financial systems operate and our theories about this process are important in developing sensible approaches to safe and profitable investment.

Unfortunately psychologists and cognitive scientists who study such things are as likely to suffer from the pain of the availability heuristic as anyone else. The general approach to theory of mind that is now most commonly used is simply based the latest set of tools available to the researchers, who view the mind as a computer. It has ever been thus because we need metaphors to think about things and without metaphors we have nowhere to start from. This brings with it a long legacy of hard to remove but wrong ideas about financial systems.

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John Kay’s Obliquity

Oblique

Many of the great mistakes of history, including the problems financial markets have continualy re-experienced, have been caused by a basic error of judgement – the idea that it’s possible to define, plan and control the outcomes of the world around us despite the rampant uncertainty we daily take in our strides. So instead of relying on expert judgement and feeling our way carefully towards outcomes we’ve found ourselves traduced by people with tunnel vision and a strong but unjustified confidence in their ability to navigate unerringly to a correct solution, whatever that might be.

This is the argument presented in a new addition to the popular literature on human decision making by the economist John Kay. At the heart of this book, Obliquity, are many arguments readers here will find familiar, but perhaps the most notable is the idea that those economists who argue that people are irrational are wrong. It’s the economists who misunderstand the nature of human decision making, not their subjects,

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Physics Risk Isn’t Market Uncertainty

Physics Envy

The idea that economics should be modelled on the concepts of physics has been prevalent for the best part of a century. It’s a deliciously engaging idea, that the steadfast and unbending rules of science should be the template for the queen of the social sciences. The only trouble is that in economics human beings are part of the system and don’t tend to behave as economists would wish them to.

On the other hand the ideas generated by analogies between physics and economics have generated a whole bunch of truly great economic ideas and are the basis of the whole of microeconomics. Although it’s tempting to argue that these ideas don’t truly make sense it’s actually quite hard to make this accusation stick. Economics and physics are connected – only just not quite the way economists like to imagine.

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Greed’s Not Good For Shareholders

Don't Aim to Maximise Shareholder Value

When we look at the genuinely successful business people of our time, that happy band of folks who’ve created true shareholder value, enriching themselves and their followers to an astonishing degree, we find an extraordinary thing. The vast majority of these people are not particularly interested in money and their companies are generally not dedicated to some New Age declaration of shareholder value maximisation.

Greed is not a quality that seems to drive the world’s greatest creators of shareholder value and creating shareholder value is not the aim of the companies that are best at it. In fact we can pretty much guarantee the alternative: wherever you find over-rewarded executives presiding over companies whose main aim is to increase their market capitalisation we should pick up our skirts and get the hell out of it. Corporate greed is bad for ordinary shareholders.

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Laplace’s Hammer: The End of Economics

Clever Man, Stupid Idea

Simon-Pierre Laplace was a Very Clever Man who did many Very Clever Things. Unfortunately, like many clever men, having got hold of a Brilliant Idea he was rather inclined to go off and use it on everything in sight, which led to a number of Very Odd Conclusions. In fact as far as science goes, he may well have been the original man with a hammer; taking aim at every problem as though it was a nail.

As is the way of these things economists got hold of Laplace’s ideas, converted them to their own and started developing delicate and intricate webs of theories and practices. Unfortunately, over the succeeding three hundred years they’ve failed to keep up with advances in physics and biology, rather leaving economists as the only believers in an approach that suggests we have no free will, a position from which they’re having to be dug out and defused, one unexploded theorist at a time.

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Monty Hall Economics

God and the Economists

Apparently the Monty Hall test is one that Wall Street firms commonly use to see if potential applicants are suitable material for the madness that is a trading desk in the heartlands of financeland. In so using the test these corporations are, knowingly or not, addressing some of the most hard to overcome behavioural biases that often defeat legions of unprepared investors.

In fact, this particular test has been a source of delight for grant seeking academics of all persuasions. The thing is that the Monty Hall test can be explained in many different ways, most of them simultaneously contradictory. However, it does increasingly look like this blatantly irrational behaviour is hard-wired into our neurons. It seems God really doesn’t like economists.

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Unpredictably Rational

Common Sense

As we go about our everyday lives we don’t spend a lot of time reflecting on the irrationality of the people around us. Certainly from time to time people do stupid things, but by and large most of us make it through most of our days without driving the wrong way up roads, roasting our dogs in microwaves or buying stocks in stupid companies. Even when we do odd things there’s usually some recognisably rational reason for us doing them.

This version of human rationality is virtually unknown to all brands of economics which largely insist on defining rationality in an irrational way and then sniggering at the human race when it fails to live up to the standards that some rather over-focused economists think it should. The problem for them is that we’re not the irrational ones, they are. The problem for us is that the people that matter listen to them, not us.

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