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.
mikethemadbiologist
I managed to get through a BS in economics at a non-Chicago university without Samuelson’s text, but I believe I purchased three (!) Greg Mankiw textbooks in the process. While I have to say that he writes a good textbook, Mankiw is an economist’s economist. He knows how to extract maximum producer surplus. I was half surprised that he didn’t convince instructors to change editions halfway through the semester just to get another $140 from us.
Couple of points.
1 “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.” The rationality of the statement seems to depend on what you call a ‘long time’ I think it’s exactly this type of research that’s going on. If things happen once are people likely to bet on it in the future? If the same thing consistently happens for 6 months? 6 years? 600 years? Finding that line defines how ‘rational’ we are, or put a better way, what biases we have in our decision making skills.
2. I like the phrasing he used in referencing optimal rather than rational. I think it moves the discussion in the right direction.
3. But then in the very next sentence he is kind of begging the question “You have to cope with people.” That really should be the entire focus of what’s going on. You have to cope with people, so we should know what sorts of sub-optimal scenarios emerge from large groups of people get together. To do that, you need to understand the (small) ‘irrationalities’ at a micro level, and they extrapolate to large groups.
4. As my father likes to say, it’s all “the difference between a good decision and a good outcome”. I think that traditional economics has focused too much on the outcome, and not enough on the decisions that created that outcome.
I think the most interesting quote from Samuelson is
This sounds like a pretty significant moderation from the general claims only a few years ago that markets rapidly exploit and clear behavior that’s at odds with the main pillars of classical economic theory.
Markets do tend that way, but not instantaneously nor without fail. As with every other organ, human brains are shaped by evolution, and as such are built to be adaptive for a very different time and place. At a minimum, we should expect a pretty hefty pull to the past in terms of our behavior.
Holy crap! My comment was mentioned on Greg Mankiw’s blog. That’s as close as I’ll ever come to having Mankiw cite me. I’ll take it.
Professor Mankiw, if you’re out there reading this, I will admit that I still have my hardcover copy of Macroeconomics. That would probably be true even if they weren’t nearly impossible to resell due to version skew.
eroticshop
That was always a microclaim. Keynes laid down the gauntlet more than sixty years ago that micro can be efficient yet macro suffers from “animal spirits”, that is, there are emergent behavioral effects. This is easiest to see in the “paradox of thrift”: each saver is acting rationally in planning for his own long term, but collectively the economy tanks.
Of course, economists are rediscovering Keynes all the time, so it perhaps seems brand new and all.
I like very much the writings and pictures and explanations in your adress so I look forward to see your next writings.
While I have to say that he writes a good textbook, Mankiw is an economist’s economist.
biber hapı
vakum pompası
possibility of sharing and social solidarity at a level just fine