The Invention of Homo Economicus

Terence Netto writes on "Anwar Ibrahim at Berkeley in Din Merican: the Malaysian DJ Blogger: Remove Authorianism and Dictatorship" (8 October) HERE

"Anwar’s Bridging Ability

Anwar’s penchant for synthesizing thought from Islamic and western streams recently drew attention from an unlikely quarter. Sholto Byrnes, assistant editor of the British left wing publication, New Statesman, said in a column in the September 3rd edition, that Anwar had once commented that “Asian man was ‘Homo religiosus’ “.
Evidently, the term was derived from Adam Smith, the Scottish moral philosopher and economic theorist, who founded classical economics on the premise of the rational “economic” man – “Homo economicus”. Anwar is fond of quoting from Adam Smith’s books, especially The Theory of Moral Sentiments."

Comment
Adam Smith did not found ‘classical economics’ on the premise of ‘Homo economicus’. The idea of the perfectly rational man in economic behaviour came much later in the 1870s (Smith’s last edition of Wealth Of Nations was published in 1790, a few weeks before he died.

It did not mention or imply Homo economicus, which is associated with the ‘marginalist economics’ of Jevons, Walras and others, and is elaborated in the 20th century as neo-classical economics and general equilibrium theorists of the 1950s onwards.

It alleged association with Adam Smith is a modern invention.

Government Failure Also Endemic

Kevin Williamson writes in National Review Online, “Taming ‘Animal Spirits”
(‘Investors sometimes behave irrationally, and so do regulators’)
HERE:

“Animal spirits are indeed at play, and mischievously so, both in the marketplace and among those who seek to govern the marketplace. It is characteristic of our academic caste that Professors Shiller and Akerlof attend to the former case but are blind to the latter, and so they have produced an essay that is not so much conventional as convention itself, arguing, in a series of bland metaphors, that economic exorcists in Washington must be deployed against animal spirits in the marketplace: “If we thought that human beings were totally rational and acted mainly from economic motives, we, like Adam Smith and his followers today, would believe that governments should play little role in regulating financial markets. . . . But on the contrary, we believe that animal spirits play a significant and largely destabilizing role. Without government intervention, employment levels will at times swing massively, financial markets will fall into chaos, scoundrels will flourish, and huge numbers of people will live in misery.”

“There is no need to address the problems of that passage beyond cataloguing them: We have lots of government intervention in the economy, but employment levels do swing, financial markets have fallen into chaos, scoundrels do flourish with great exuberance, etc. And neither Adam Smith nor his intellectual heirs believe that economic man is an icy rationalist, or even that he is rational, broadly defined. Ludwig von Mises put the idea into theoretical form, but it has long been understood that man acts rationally in the sense that he takes actions that seem to him sensible in order to achieve a certain end, but that end itself may be irrational, erroneous, or criminal: Scientific researchers act rationally to achieve certain ends; so do serial killers, religious fanatics, drug addicts, and Wall Street traders.”

Comment
A most interesting article with which I mostly agree. Basically, it criticises the Homo economicus model of human(?) behaviour upon which so much of modern economics is based. Partly, the model was inevitable once it was decided to find a way to make political economy ‘scientific’, with maximum/minimum maths using calculus (Pareto, following Walras), out of which the mathematisation of economics into what it became from the mid-20th century.

The scribbles of modern economists influence public policy, often without the qualifying assumptions of the scribblers, and a whole host of dubious ideas get traction in the daily grind of politics.

The idea that markets are liable to fail, unless regulated, is having a renewed run just now, as if the regulators are some version of supermen and superwomen, who do no wrong, are immune to other than the public good and above reproach or suspicion. Being made of the same stuff as ordinary humans (absent from the models), regulators can be at least as bad as the worst market-makers, and on occasion, even worse.

I suggest you read Steven Medema’s, The Hidden Hand: taming self-interest in the history of ideas, Princeton University Press (2009), for an excellent account of the 1930s debate about the assumed probity of the selfless public servant in Pigou’s "Welfare Economics".

On Homo economicus

'Oz Andrew’, a correspondent writes a ‘Comment’ to my post "Evolution Challenges Homo Economicus", Friday last (13 February):

“As for the rational homo-economicus model itself, it will be staying in place until someone comes up with a superior and complete alternative. No amount of data contradicting the model can change that.”

To which I agree completely and replied:

“Homo economicus cannot be improved; it is just plain wrong as it pretends to model behaviour in an economy representative of the real world. It isn't. It models behaviour in an imaginary economy that does not exist.

It's like Des Cartes' model of the solar system with 72 concentric circles, which Adam Smith discusses in his "History of Astronomy" (1744-?).

That is the point I tried to make.

Unlike the solar system for which a better model was developed which can predict eclipses ten, a hundred, a million years hence. Homo economicus cannot predict anything outside of the assumptions of the model.”

This week I am working on my paper “The Alleged Religiosity of Adam Smith: evidence from the History of Astronomy and Moral Sentiments” for presentation in the summer, and I am checking references in Moral Sentiments, and I came across this short note by Adam Smith on the other-worldliness of mathematicians, which I think says a great deal about the continuity of their temperaments through the ages:

“Mathematicians, on the contrary, who may have the most perfect assurance, both of the truth and of the importance of their discoveries, are frequently very indifferent about the reception which they may meet with from the public. The two greatest mathematicians that I ever have had the honour to be known to, and, I believe, the two greatest that have lived in my time, Dr. Robert Simpson of Glasgow, and Dr. Matthew Stewart of Edinburgh, never seemed to feel even the slightest uneasiness from the neglect with which the ignorance of the public received some of their most valuable works. The great work of Sir Isaac Newton, his Mathematical Principles of Natural Philosophy, I have been told, was for several years neglected by the public. The tranquillity of that great man, it is probable, never suffered, upon that account, the interruption of a single quarter of an hour. Natural philosophers, in their independency upon the public opinion, approach nearly to mathematicians, and, in their judgments concerning the merit of their own discoveries and observations, enjoy some degree of the same security and tranquillity.”

Smith goes on the compare mathematicians with other men of letters:

"The morals of those different classes of men of letters are, perhaps, sometimes somewhat affected by this very great difference in their situation with regard to the public.

Mathematicians and natural philosophers, from their independency upon the public opinion, have little temptation to form themselves into factions and cabals, either for the support of their own reputation, or for the depression of that of their rivals. They are almost always men of the most amiable simplicity of manners, who live in good harmony with one another, are the friends of one another's reputation, enter into no intrigue in order to secure the public applause, but are pleased when their works are approved of, without being either much vexed or very angry when they are neglected." (TMS III.2.20: p 124-5)

How true this remains I could not say, but high-level mathematicians among economists, do tend to be exclusisve among themselves, and are distant from the general public; they also have a reputation for not looking outside their windows.

They don't share the comfort of their astronomer relations, who at least see their work vindicated by observations. After 130 years of mathematicising economics, pray tell us what they have either explained about events that have past, or predicted about events which actually happened, the last a much vaunted test of a 'hard science'?

Evolution Challenges Homo Economicus

Gary Marcus, a professor of psychology at New York University, is author of "Kluge: The Haphazard Evolution of the Human Mind" (Houghton-Mifflin, 2008), tell us to: “Forget About Survival of the 'Fittest'” in Wall Street Journal, HERE:

“Evolution usually makes do with 'good enough'”

“To the extent that evolution has often been forced to make do, contemporary economics has a serious problem. A great deal of contemporary economic theory has been premised on the assumption that individual human beings are "rational agents," people capable of reliably acting in their own self-interest, assessing costs and benefits with a sure eye toward making optimal choices.

If we were really creatures that invariably acted in the interests of our "selfish genes," the so-called homo economicus or "rational man" theory would have some substance. It would make sense to try to predict the actions of the multitudes by assuming that each individual would act in the interest of his (or her) own selfish genes.

In reality, we often don't. Although any fool will instantly realize that winning $5,000 is better than $500, daily life is filled with decisions that cannot be said to be rational, optimal or otherwise maximally fit. At the micro-level, we'll drive across town to save $25 on a $100 microwave, but not to save the same $25 on a $1,000 flat-screen TV, showing both that we are blind to the cost of our own labor, and confused about the fact that money is an absolute rather than relative commodity.
The average American watches three to four hours of television a day, which does nothing for our "reproductive fitness" or even for our happiness (regular TV viewers are actually less happy than those who watch rarely, as several studies have shown). Our brains often have trouble keeping our minds on track, even when vital decisions are at stake. We procrastinate on important projects until we have too little time to complete them properly, often making careless errors as a result, and we frequently sabotage long-term goals (like living a long, healthy life) in favor of ephemeral short-term pleasures (like smoking cigarettes). Such self-defeating choices afflict even the powerful and the brilliant (witness the decline and fall of Eliot Spitzer -- or the many who lost millions by investing in Bernie Madoff).
All this matters because endeavors like economics and social policy are all built around theories about what human beings are and how they function. We allow consumers access to credit cards, for example, because we assume (despite ample evidence to the contrary) that they will be smart enough to balance their short-term needs as consumers with their long-term capacity to maintain a fiscally sensible reality.

The new discipline of behavioral economics is aimed at addressing these issues, but is not taken seriously enough. Even now, in the eye of the worst fiscal storm in recent memory, we trust citizens to do the "right thing," without factoring in the quirks of our evolved psychology.

As we deal with the current crisis and in the years to come, it will behoove us as a society to recognize that evolution equipped us not with foolproof, steel-trap rational minds, but something more like a "kluge," a clumsy and inelegant mental patchwork that is good enough to get the job done, but far from perfect.

If humans were truly the fittest possible creatures one could imagine, the rational-man model would make sense. But the "fittest" that survived are not necessarily the fittest possible. We are flesh and blood creatures, filled with cognitive quirks that are the detritus of evolution. If we are to move past perpetual cycles of fantasy-driven booms followed by devastating busts, we must recognize evolution's limits, and confront them head-on.”

Comment
I am a regular critic of Homo economicus and rational agents, so I feel able to offer a correction to the statement from Gary Marcus, without being misunderstood:

“A great deal of contemporary economic theory has been premised on the assumption that individual human beings are "rational agents".

The correct statement is slightly, but importantly, different. Gary Marcus should have written:

“A great deal of contemporary economic theory has been premised on the assumption that individual agents in their theoretical models are "rational agents".

There can be no pretension that in the real economy individuals act as ‘rational agents’, nor that ‘Homo economcus’ is other than a theoretical abstraction first postulated in the late 19th century when the first steps were made by ‘smart’ economists to abandon ‘political economy’ in favour of mathematical make-believe.

Gary Marcus is absolutely correct in the general tenor of his article. Myths of ‘rational agents’ being representative of human beings are now so firmly entrenched in our discipline (often with a mixture of enthusiastic pride and disdainful put-downs to those who protest that far too much is concluded about so much of economic life from too narrow a connection with reality).

Any study of evolutionary theory, and of human history (and pre-history!) shows how varied are any species in their behaviours in their multiple environments, including at, and beyond, their normal localities.

Indeed, natural selection shows many biological cul-de-sacs, so to speak; social evolution among humans shows as many ‘dead-ends’ in social forms, of which the large stone detritus strewn around Europe and beyond, and small stone artifacts, cave paintings, and ‘grave goods’, strewn everywhere else, are strong reminders.

The ‘religion’ of rational man is due for a quiet burial. It offers little as a reliable explanation of the current crisis (it caught its exponents ‘off-side’, as we say in football). Whether ‘behavioural’ economics is the answer remains to be seen, but it certainly looks like a step forward.

[I have ordered Gary Marcus's "Kluge: The Haphazard Evolution of the Human Mind" and shall report in due course on its merits.)

A Gem Amidst the Dross

It is a positive sign that not every commentator on current affairs in the current corporate finance crisis purveys the inaccurate nonsense that a source of the problem lies in anything written by Adam Smith, the man born in Kirkcaldy in 1723.

Eli Cox, Chair, department of Marketing at McCombs School of Business, writes in McCombs Today (‘News from the McCombs School of Business’) HERE (30 September).

“Cox: Creed of Greed Not Supported by Adam Smith

“Ordinary Americans have a deepening mistrust of free-market capitalism as our nation has gone from Enron, WorldCom, Adelphia and Tyco to Bear Sterns, Freddie Mac, Fannie May and Lehman Brothers. Sadly, this mistrust is justified because too many corporate executives have adopted the creed of greed. This creed is based on the false view that Adam Smith believed that that personal greed generates the public virtue of economic growth. In fact, Smith would have been revolted by this misrepresentation of his views, as he actually wrote the following:

“Justice [the human virtue of not harming others]…is the main pillar that supports the whole building. If justice is removed, the great fabric of human society which seems to have been under the darling care of Nature must in a moment crumble into atoms….Men, though naturally sympathetic, feel so little for others with whom they have no particular connection in comparison to what they feel for themselves. The misery of one who is merely their fellow creature is of so little importance to them in comparison to even a small convenience of their own. They have it so much in their power to hurt him and may have so many temptations to do so that if the principle of justice did not stand up within them in his defense and overawe them into a respect for his innocence, they would like wild beasts be ready to fly upon him at all times. Under such circumstances a man would enter an assembly of others as he enters a den of lions.”

Smith is most famous for The Wealth of Nations (1776) but he discussed the ethical foundations for a free-market system in his first book, Theory of Moral Sentiments (1759). The quote found above is drawn from The Wealth of Nations states that unbridled greed destroys a free market system.

The pernicious view that “economic man” is selfish and rational and that Smith’s invisible hand will clean up the mess has been perpetuated by the Chicago School of Economics. Milton Friedman (Nobel Price 1976) argued that corporate managers should be economic men who should maximize profits without engaging in socialist activities like caring for workers or the environment. What he failed to recognize is that corporate managers may and often do try to maximize their own wealth at the expense of stockholders as well as customer.”

Comment
How true! At last a sign that some of the vast faculty of economists, trained in the academic world that has long been dominated by Chicago since the early 50s and by those who went onto teaching across the Western World’s universities, colleges, and school, have not lost their critical faculties – they show signs of actually reading what Adam Smith wrote and not what their tutors told them.

[I have long expressed the view to students over 35 years teaching that the patron saint of students was Saint Thomas – ‘don’t trust what you are told by tutors – read it for yourself!]

I commend Professor Eli Cox for his gem of truth amidst the current dross that passes as acceptable in the plethora of published pieces during these last two weeks.

He is right to assert that the myths of the majority fed on Chicago’s misappropriation of Adam Smith’s legacy contributes to the popular groundswell of distrust of markets and in consequence strengthens the corporate statists in favour of even bigger government.

Friedman, and the many others, who linked free markets to their myths about invisible hands, laissez faire and the elision of self interest into greed, severely damage the constant struggle for clean markets, open and transparent competition, and tolerable levels of public goods in place of big government in too close an alliance with big corporate interests.

Markets, operating under a regime of justice (and the prosecution of corporate criminals), are part of the solution; they are not the problem.