An Unothodox Critic of Rationality

For an unorthodox criticism of assumptions of rationality in economics see Dr. Michael Towsey, Queensland University [Warning, it is a very long article HERE]:

“The Biopsychology of Cooperation - Part 2”

"Numerous experiments have revealed that human economic decision making is far more complex than accepted by the simple theory of maximising gain. This turns out to be true even for animals. For example, if two monkeys perform the same task side by side, and one is rewarded a grape (big money) and the other a cucumber (small money), the latter will throw a tantrum and toss the cucumber out of its cubicle. Yet if both receive a cucumber, both eat happily. Conclusion: monkeys show an aversion to inequality. The reward does not even have to be physical - it can be the affectionate attention of laboratory staff. - Michael Towsey

Comment
I have no views on the source of the article. It may be worth a look, or not.

Stiglitz Takes on Rationality in Economics

Peter Boettke reports on Coordination Problem (HERE) comments on another speech by Professor Stiglitz, this time on rationality assumptions, the central core of neo-classical economics (Homo economicus for example), which is reported by Economist Online (HERE):

The speech originally was reported in Wall Street Journal.

The comments appended to the report show a clear tendency to attack Stiglitz for his complicity in teaching neo-classical mainstream economics (rather than take a ‘better a sinner who repents, etc., …’ approach and to question his status as one of the anointed priesthood.

A few Austrian commentators also make the point that if we adopted their approach there wouldn’t be much of a problem, which itself is a problem.

“Joseph Stiglitz didn't mince words when he kicked off the American Economic Association's annual meeting in Atlanta on Saturday. The Nobel laureate, who teaches at Columbia University, launched into a blistering attack on fellow economists for building models that rely on rational behavior when the financial crisis offers so much evidence of irrationality.

Wall Street also got a broadside. To Mr. Stiglitz, the purpose of a financial system is "to manage risk and allocate capital at low transaction costs." What actually happened? "They misallocated capital. They created risk. And they did it at enormous transaction costs.”

No doubt we'll read more about his speech.

A Psychologist Invites Modern Economists to His Couch

Jim Taylor, Ph.D. writes in Psychology Today HERE:

“Economics: Economists are Irrational!”

What are free-market economists thinking?

“I recently read an article by the Nobel Prize-winning economist Paul Krugman in which he described the renewed battle between so-called freshwater economists (so named because they are largely based at the University of Chicago and other Midwestern universities) and saltwater economists (based primarily at Princeton, MIT, Berkeley and other coastal universities). The freshwater economists are disciples of Adam Smith and espouse the free-market and rational actor models. The saltwater economists align with John Maynard Keynes and his belief in the need for regulation in financial markets and that people aren't rational actors.
The past 50 years have been dominated by freshwater economists who had a reverential faith in the power of free markets (Smith's "invisible hand") and the rationality of people in their financial decisions. Given what has happened to our economy in the last decade, noted for its multiple bubbles (e.g., Internet, housing, mortgage), it's hard to believe that any of these "efficient market" adherents still have jobs, much less credibility in how the economy actually works.”

Comment
You should read Jim Taylor’s article. It’s a great knock-about piece of popular journalism, much of which I enjoyed, some of which I thought not quite fair in its populism, and on occasion some elements of which he is wrong. This last is not Jim’s fault: he takes the claims of modern economists at face value and responds to them to his light-hearted rant.

Lost Legacy has never been slow in criticizing the ‘Chicago Adam Smith’, a person with ideas that are far from the ideas of the Adam Smith born in Kirkcaldy in 1723.

George Stigler’s boast that “Adam Smith is alive and well and lives in Chicago” (1976) reflects to invention of the Adam Smith of the “invisible hand” (a mere metaphor for Adam Smith whose single use of it in Wealth Of Nations referred to the unintended consequences of the risk-avoidance of some, but not all merchants – foreign trade with Europe, India, and the North American colonies, was a major contributor to the British economy – who preferred the home trade), and had nothing to do, at least in Adam Smith’s mind, with how markets worked, how banks should be regulated (yes, he favoured government regulations in banking!: WN II.ii.94: 324), or how the price system worked.

The belief that the “invisible hand” was a significant ‘idea’, ‘concept’, ‘theory’, or ‘paradigm’ was wholly invented in the 1950s by neo-classical economists on the back of general equilibrium mathematics (which interestingly did not include a term for the “hand”) and in support of a worthy criticism of Cold War, Soviet central planning. It is now taught in every economics 101 class as if it had historical validity, mainly by people who have never bothered to read Wealth Of Nations.

However, Adam Smith did not espouse a vision of ‘perfect competition’, of ‘Homo economicus’, or ‘rational actor models’. On this assertion Jim betrays a lack of appreciation of Adam Smith’s works.

Even when discussing price changes in a market, he spoke of ‘neighbourhood’ markets, not an economy (Book I, Wealth Of Nations). I don’t expect Jim to be familiar with the Kirkcaldy Adam Smith, or with economics generally (his three degrees are in psychology), but he might appreciate a glance through Lost Legacy to see how much he traduces Smith’s reputation by making light of the differences between what he as responsible for (“Theory Of Moral Sentiments”, 1759 and “Wealth Of Nations”, 1776) and what modern epigones invented in his name.

Jim says he “would love to put these economists on the couch and explore what is going on in their heads” (I assume no Freudian motives here!); I would rather that Jim sat in a library and read some Smith and Keynes for himself. As it is, he gives offence to the valid notion that inter-disciplinary familiarity is good for scholarship.

Jim and I can agree that modern “economists” who dominate the profession presently, invented a mathematical world devoid of human beings. Adam Smith, incidentally, a talented mathematical scholar by 18th century standards, is totally innocent of such a charge. Those ‘guilty’ as charged can defend themselves and Jim should direct his ire, undergraduate humour, and psychological "explorations of their heads" to them.

Adam Smith and Rational Man

Justin Wolfers writes on ‘Steinbeck on the Crisis’ in Freakonomics, which is worth reading HERE:

As usual a Freakonomics article has attracted a large number of comments of varying quality, among which I found this from ‘thedude’:

“Unregulated capitalism will lead to the utter obliteration of civilization. Adam Smith claimed men were rational; therefore capitalism would be rational. As superstitions, magical thinking in gods, belief in black magic, witches and the occasional late purchase of a juicer attests to, man is not rational.
Luckily for the bankers the American people are too apathetic, ignorant and powerless to do anything about their current looting of the Treasury.”

Comment
I would not characterize Adam Smith as claiming that ‘men were rational’, in the sense that modern neoclassical economic theory makes such assumptions.

‘The dude’ follows up with what he assumes is the debilitating counter-point to Smith’s alleged claim for men’s rationality:

‘As superstitions, magical thinking in gods, belief in black magic, witches and the occasional late purchase of a juicer attests to, man is not rational.’

Strange argument to deploy against Adam Smith, who wrote The Theory of Moral Sentiments (1759) and the History of Astronomy ([1744] 1795, posthumous), which among other things detail and show the history (and concurrent) proclivity of humans for ‘pusillanimous superstition’ and many strange beliefs about ‘invisible beings’ (not just hands!) and, in Wealth Of Nations, for people, including ‘merchants and manufacturers’ and legislators and those who influence them to act in their selfish interests, which causes negative social affects (protectionism, monopoly, price-fixing, pollution, environmental disregard, and other negative externalities).

Rational expectations and the neo-classical paradigm are mathematical abstractions – the maths are beautiful, the prescriptions are inadequate, and the consequences of acting on them are woefully disappointing, as well as destructive.

If there are fault lines in the system, which is the gist of most comments, to Justin Wolfers’ article, they have nothing to do with Adam Smith, whose understanding of human nature was more than adequate to fix these problems.

Adam Smith is Not Guilty of One-Dimensional Rationality

David Wolfe's Ageless Marketing HERE:

‘The End of a Myth: The Rational Man Theory of Markplace Behavior'

‘This experiment and many more are discussed in Ariely’s provocative new book, Predictably Irrational: The Hidden Forces that Shape Our Decisions. I enthusiastically recommend Ariely’s book to anyone involved in product pricing in any category. You will likely come away from this read with a better handle on how to price products.

Classical economics has rested on a premise that Ariely shatters to smithereens. For well over two hundred years economists have based their thinking on the premise that marketplace trends are determined by the rational behavior of people acting in their own interests. This in fact is the keystone of Adam Smith’s book The Wealth of Nations, the Old Testament of capitalism.

Ariely is not the first to challenge the rational man premise of classical economics. A whole new subfield called behavioral economics has taken root because some brave-minded stalwarts in the dismal science decided the emperor was stark naked. The notion that marketplace trends reflect the outcome of human reasoning in an objectively fathomable world is every bit as illusory as the appearance that the earth is more or less flat.

The cat is out of the bad, so to speak. I would expect to start seeing more accurate economic projections in the future now that such prominent economists as those who wrote the books I’ve cited in this post have revealed just how naked the rational man theory is.’

Comment
David Wolfe bases his article on, ‘Economist’ Dan Ariely’s book, discussed on Lost Legacy earlier this week. Yet Adam Smith’s book, The Wealth of Nations, does not base its ‘thinking on the premise that marketplace trends are determined by the rational behaviour of people acting in their own interests’, where the implication is that all consumers share the same self-interests and to the same degree.

If Dan Ariely has read Wealth Of Nations, Books I and II he would know of the 60 plus incidents in these two books which deal with markets where the self-interests of individuals have negative consequences for others (externalities) and there is no common self-interest that is necessarily shared by all those in the market. People do not buy merely on price (that is a construct of the mathematics of the late 19th century Marshallian demand curve and is an axion of modern neo-classical, not classical, economics).

Even in the simple purchase of examples in Wealth Of Nations introduces a movement of prices: ‘A publick mourning raises the price of black cloth’ (WN I.vii.19: 76-77).

Some people try to buy despite the rise in price; they are in mourning; others do not buy at all – they may be in mourning, they may not be.

Some, but not all, people pay higher prices for a new commodity because they want to be ‘fashionable’, to ‘attract attention’, to ‘cut a figure at a ball’, and any of a dozen other ‘rational’ (to them) reasons. In Book IV of Wealth Of Nations there is a discussion in Chapter ii of the role of the 'delusion' of the 'beauty' or 'fitness' of a contrivance being more persuasive than its utility for soem people - Smith gives it a central role in the motivation of entrepreneurs and consumers.

There is no common rationality. Smith discusses this and more in Moral Sentiments (1759).

Homo economicus was invented as a concept in the late 19th century, not by Adam Smith (he died in 1790). It fits a certain kind of mathematics – the kind that needs to be determinate.

Its sponsors have to find a common explanation, even if their explanation is partial. When used to predict the future, for which large fees are paid (despite the lousy track record), it is at its most vulnerable to ‘events, dear boy, events’.

Behaviourists and psychologists are aware of the variability of human motivation and behaviour. All we have to do now is convince more economists, which, ironically in view of the partial knowledge of Dan Ariely about Adam Smith, means encouraging more of them to read both Moral Sentiments and Wealth Of Nations.