I’ve written before (here) about the problems I have with the new trend in economics to misuse irrationality and to wrongly credit it for phenomena. So, a long-time reader sent along a Conor Clarke interview with Paul Samuelson, in which he discusses irrationality (boldface questions; italics mine):
Okay, what’s the distinction there? I’m curious what you think about some recent developments in economics, some of the movements that are hot right now — like behavioral economics, part of which wants to challenge the notion of humans as utility maximizing rational agents.
In my view behavioral science describes an extremely large and important part of the modern picture. However, whenever the economy turns in a very irrational way, that can create opportunities for very rational speculators to make a profit. So you can still get some approximation on the micro level of an efficient market. But there never has been a true macro efficient market. You just have to look at the record of economic history the ups and downs. Bubbles are self-generating.
And I’m not sure most of the people that get caught up in the middle of a bubble can be described as irrational. It seems pretty rational to buy a house and flip it in the next few weeks at a profit when that’s been happening for a long time. It works both ways.
The crowd mentality is maybe not rational.
Well, let’s put that differently. It’s not optimal. It’s what it is. You have to cope with people. Now, if all the people had gone to the Wharton School and become very sophisticated that doesn’t mean the society in which they lived and operated would be incapable of having a business cycle or bubbles. They’re self generating.
So are people utility maximizing and rational and can we make sense of interpersonal comparisons of utility in a mathematical way?
No. But you know, people say, ‘greed has suddenly increased.’ But it isn’t that greed’s increased. What’s increased is the realization that you’ve got a free field to reach out for what you’d like to do. Everybody would still like to retire with a satisfactory nest egg in real terms. And the tragedy of this unnecessary eight-year interlude is that much of what has been accumulated is gone and gone forever. And no amount of pumping is going to bring back into reality what were ill-advised overextensions of bridges to nowhere and housing developments for which there was no effective demand.
(For those who don’t know, Paul Samuelson–no relation to columnist Robert Samuelson who is the inspiration for the Samuelson Unit–is one of the preeminent economists of the last fifty years–anyone who wasn’t taught by the Chicago School probably used a version of his textbook).
Some thoughts–and some of them fall into the category of “I told you so”:
- In the larger context of an irrational system, people can act quite rationally. Duh.
- Not realizing precisely when the music will stop isn’t irrational either (although if you can do so, it’s very financially lucrative…).
- People don’t suck more than they used to; instead, the side effects of being a shitty person have been eliminated, and the costs of not being a shitty person have risen.
- The artificial ‘wealth’ created by the run up of housing prices was, well, artificial. Because peoples’ earnings have gone up in smoke–and people have lost money on housing–this is going to hurt for a long time.