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Saturday, 28 August 2010

Studying Economics Makes You Mean

Not Predictable

It’s established by now that economics didn’t help stop some of the more spectacular misadventures of the financial community but it’s a bit less obvious that it was directly responsible for many of the mishaps. It’s all tied up with the dirty fact that economists are basically a bunch of untrustworthy, deceitful bums who shouldn’t be left alone with your child’s piggybank, let alone the world’s economy.

The trouble is that economists have a world-view that sees us all as self-interested moneygrubbers without an ethical thought in our heads. Perhaps that’s because that’s a pretty good description of economists themselves: they act like their models are true, the dirty rotten scoundrels.

Economic Arms Races

Academic economics is consumed by an arms race in which success is determined by how many papers you can get published. Such is the nature of the subject these days that in order to get into print you’ve got to liberally endow any ideas with a fair quota of mathematics, because economists see themselves as scientists, developing scientific theories which can be quantified and modelled. Unfortunately, this approach is undermined somewhat by the fact that they basically have no idea of what behaving like a scientist really means.

As we know economics is as much the study of people and their behaviour as it is of money: it’s a social science and, correspondingly, is much more difficult to get right than something simple like quantum chromodynamics, wave-particle duality or genetic sequencing. After all, if you push a pendulum a few times it doesn’t suddenly start avoiding you but if you prod a human hard enough they’ll start taking the long way home or bring their big friend with them next time. People are reflexive, they change what they do based on their experiences and this is the great problem of the social sciences. Economics of course, solves this by basically pretending to be something else.

Reflexivity or Math

Mathematics, you see, can’t handle reflexivity and, in particular, has no concept of moral values. All modern economic models are ethically neutral. The idea that people maximise that ephemeral concept known as utility is usually translated into the idea that we’re all trying to make as much money out of each other as possible and to hell with the consequences. The idea that people sometimes do things out of the goodness of their heart, for ethical reasons, isn’t something the mathematical models can handle. So, ever so conveniently, it’s ignored.

Yet we can see from the chaos around us that morals and ethics do matter, and matter greatly. You can’t simply explain the implosion of the world’s financial system on the basis of people being badly incentivised because that can’t explain why so many people didn’t take advantage. Morality and reflexivity are at the heart of pretty much all economic behaviour. However, if you build financial models assuming that people are governed by self-interest you shouldn’t be surprised if they end up that way.

Rationally Selfish

Perhaps, though, it’s simply that economists are building their models in their own image. When Marwell and Ames experimented on a bunch of economists and then asked them to describe what was fair in the experiment, they wryly reported:
“More than one-third of the economists either refused to answer the question regarding what is fair, or gave very complex, uncodable responses. It seems that the meaning of ‘fairness’ in this context is somewhat foreign for this group.”
Other studies have confirmed that economists are a breed apart. Frank, Gilovich and Regan in Does Studying Economics Inhibit Cooperation? looked at a bargaining game where two players – an allocator and a receiver – had to decide how to split a sum of money with neither getting anything if they couldn’t reach agreement. Since the allocator controls the offer and even one cent is better than nothing to the receiver self-interested economics predicts that the allocator will offer very little to the receiver, who will accept it.

Naturally, as we saw in When A Dollar’s Not Just a Dollar, most receivers refuse to accept anything like this derisory level of offer on the grounds of natural justice and the most common proposal is around 50-50. The economists in the experiment, though, had no truck with such realities and stuck rigidly to the theory. And presumably were surprised to be roundly rejected.

Not Science

Of course, economics may attract people who are basically unpleasant to start with, rather than simply ensuring they get trained that way, but it rather amounts to the same thing. If economists stuck to their ivory towers and concerned themselves merely with slinging brickbats at one another then this wouldn't matter. Unfortunately having generated their theories, apparently based on a model of human psychology taken from their own kind, they then set them loose on the rest of society.

Because economics is a social science and because inherent in this is the reflexive nature of humanity it’s even more important to pay careful attention to the data, and the experimental situation, than it is in science. Unfortunately the general economic approach is to make wild assumptions and then torture the data to prove the point - a process which leads to real -world problems. As Colander remarks in The Financial Crisis and the Systemic Failure of Academic Economics:
“Many of the financial economists who developed the theoretical models upon which the modern financial structure is built were well aware of the strong and highly unrealistic restrictions imposed on their models to assure stability. Yet financial economists gave little warning to the public about the fragility of their models … In our view economists, as with all scientists, have an ethical responsibility to communicate the limitations of their models and the potential misuses of their research”.
A responsibility they’ve signally failed to discharge. Always assuming they understood the problem in the first place this lack of honesty and ethicality at the heart of economics is presumably partially driven by the reflexive nature of an economics education which teaches aspiring financial whizz-kids how to behave. Unfortunately it means that while economics may clothe itself in the skin of science its behavior is often more akin to the worst kind of untested and untestable pseudo-social science.

Ecological Validity, Please

For this reason we need to carefully nurture that rare band of financial adventurers who put time and effort into creating experiments with real ecological validity, because these are the test cases upon which much of modern economics will eventually founder and from which something sensible, taking human behaviour into account, will eventually arise. All too many economic models are based on silly analogies with other types of system and aren’t validated against properly verifiable data.

Economists model humanity as mean, immoral, selfish, self-centred maximisers. Of course, this is reflexivity in action because they live in a community of people with just these attributes. Maybe one day they’ll learn that the proper subject of economics is not money, or mathematics. or other economists. It’s us.

Related articles: Be a Sceptical Economist, When a Dollar's Not Just a Dollar, Moral Corporations, An Oxymoron?

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