What if economists applied their own theories — to themselves? Part I
George Akerlof’s and Robert Shiller’s (Nobels in economics) new book, titled Phishing for Phools: The Economics of Manipulation and Deception declares on its first page that people “do not do what is really good for them; they do not choose what they really want.” It appears that a main preoccupation of economists – the self declared “behavioral economists” prominent among them – is to show how dumb people are as consumers and in assessing risks.
Drawn to logical conclusion, this implies that economists, advising benevolent dictators are the solution. If, indeed, people are often “irrationally exuberant,” plain dumb, uninformed, unable to learn from mistakes, easily manipulated – all the things Akerlof and Shiller suggest — why have markets drawing on mazes of contracts to start with? The book implies that the writers know what’s good for the “hoi-polloi” who suffers from temptations that these illustrious writers never succumb to and thus should advise governments (in a recent letter, Ralph Nader suggests that Mr. Akerlof should advise his wife – Ms. Yellen – about Federal Reserve policies).
To be fair, such elitism has precedent in Keynes’ famous “animal spirit” view in his General Theory (which was neither “general” nor ‘theory,” as Keynes himself acknowledged, promised to amend, but died before he managed). Keynes argued that governments must spend sometimes more and sometimes less to compensate for the crowd’s random bouts of optimism and pessimism, implicitly assuming that – hold your breath – politicians and bureaucrats are never subject to such lowly spirits.
Since much in the book implicitly relies on a brief article that brought Mr. Akerlof fame – “The Market for Lemons” — cited in his Nobel Prize award and included in economics courses, I’ll discard it first, and later all the “behavioral economics” fad – which at close inspection is neither “behavioral” nor “economics.” Perhaps if Mr. Akerlof and economists did some introspection and applied both the article and the fad to themselves, they would have re-written both the article and the book.
The 1970 paper titled “The Market for Lemons: Quality Uncertainty and the Market Mechanism” presented a simple mathematical model within which the quality of goods sold in a market degrade, because of what Akerlof calls “information asymmetry” between buyers and sellers, and buyers being easily manipulated. One of the model’s implications is that when sellers know more than the manipulated buyers, the latter end up buying “lemons,” defective products that is, of whose defects they become aware only after the purchase.
One reason for this implication is that Akerlof excludes the fact that people being aware of such “asymmetry” have institutions to mitigate it: asking friends and family for information; paying for Consumer Reports; companies advertising (spending large sums to signal that their product can be trusted, since the company must recoup the advertising spending) etc. The model excludes these options, and assumes that people buy the lemons because the price charged for the “lemons” and the higher quality “peaches” is the same. As sellers get rid of the lemons, the good quality sellers disappear, and the market collapses. I cannot think of examples to illustrate such sequence of events – except when there are no markets, and the government keeps the lemons supplied, and makes it appear to be peaches. The economic profession – not computers, i-phones, Ralph Lauren, cars or Chanel – turn out to be an example for such outcome.
Students, media, the public at large have little if any understanding of what the vast majority of economists write about, most of which these days consist of jargon, be it in English or translated to mathematics and statistics. Mathematicians and statisticians consider these models trivial and they do not double check it; for others the jargons are impenetrable. “Asymmetric” conditions thus fit this profession. An economist has a degree and even got a prize? Good enough for passing for a peach: After all people have only 24 hours a day, live once, and cannot spend time double checking everything.
But governments sustain this profession, the end result being that “peaches” quit it, and lemons stay. The market for the lemons does not collapse because governments sustain the perception that “science” underlies its policies, based on the lemony advice. It is not the first time in history that governments do this: creating and sustaining perceptions of “science” and “peaches.”
A few observations: The fact that there are thousands of students who have studied economics does not mean that they work as “economists,” practicing what they learned. Yes, lemons among them end up teaching economics or shuffling papers in heavily subsidized government offices, statistics bureaus, IMF, OECD, the Fed, universities etc. – institutions that do not have much to do with “markets.” Others – the peaches among them – work in a wide variety of professions which have little if anything to do with what they studied or they even make careers refuting economics textbook stuff in courts, among others.
True, Wall Street employs economists. But the vast majority does not work as “economists,” and the few who have titles of “chief economists,” are often little more than glorified public relation, isolated from the rest of the banks’ operations and sent to give speeches and entertain clients.
Of course Wall Street also employs economists previously working for governments and central banks, who actually give valuable insights. No, the insights are not into economics or financial matters, but in government processes, or into what models decision makers use, even if these models are off the wall. It matters if one knows what data influences the central banker more (even if the data are unreliable); whether or not by temperament he and the Board are more patient or not. This has nothing to do with economics though. People may consider “macro-economics” akin to astrology, but if governments and central banks rely on it, the models are helpful making buy and sell decisions. Briefly: when governments sustain demands for a profession, the outcome can indeed be of getting mainly “lemons,” though governments create perceptions that these are “peaches.”
They do so because governments and central banks have to legitimize decisions. Today legitimacy draws on what passes as “economics.” In primitive tribes, priests had the exclusive rights to cast lots, throw dice, and this priesthood passed for “peaches.” No smaller element of chance was perceived in their decisions, just as the word of the – government-imposed-cartel – of Moody and Standard and Poor rating agencies’ views were assumed to have nothing to do with randomness, incompetence or calculated blindness.
In ancient Greece people flocked to oracles and sought guidance. No decision on engaging in war, on signing treaties, or enacting laws was made without oracular approval. Later astrologers filled these roles. For more than a century, rulers had their astrological advisers and books, using complex – logically correct – geometry linked positions of stars to make forecasts. The mathematical complexity then as now, or languages declared sacred at one time, sustained the priesthood’s and astrologers’ claims to “asymmetric information.” And rulers advertised reliance on these select few obedient “peaches’” communications with deities and stars. But recall, Kepler wrote in his diaries, found after his death, that he did not believe a word of his astrological analyses, but had to make a living.
Today Councils of Economic Advisers, IMF, OECD, Nobel prizes sustain perceptions that “macro- strology” and much else of what economists do is “science.” If anyone disagrees with the above perhaps will explain how Mr. Akerlof got his Nobel for his “asymmetric information” jargon, and the fact that he and colleagues lacked introspection – or sense of humor to – Escher-like – test its implications on themselves first. Or another Nobel (Krugman) could repeatedly state: “Japan needs a 200% or 300% inflation rate … and the central bank declare its intention of acting irresponsibly” (italics in the original, in Richard Koo’s, Holy Grail of Macroeconomics, citing Koo’s debate with Krugman on the topic ) – and not laughed at. Indeed, lemons perceived as peaches – by some anyway.
Coming: Part II; Behavioral Economics if Neither Behavioral, nor Economics
Reuven Brenner holds the Repap Chair at McGill’s Desautels Faculty of Management. The article draws on his Educating Economists, Force of Finance and World of Chance.
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