Occupy Wall Street, Procrastination and The Battle of Ideas
October 26th, 2011 |
People know that something isn’t quite right with Wall Street, that some sort of sickness has infected the financial markets and captured public policy. We are suffering for it and many people’s tomorrows are ever bleaker. Out of frustration, Wall Street itself has been occupied by makeshift camps trying to focus attention on a solution. There is energy and desire to do something about the problem, but what? Fingers are pointed and scapegoats branded. Who is responsible? Is it the government, the banks, the CEOs? Somebody must pay!
And with that question, we have already been misdirected. Titans of power did act in their own self-interest and greed did run rampant, but this is nothing new. Greed is always going to cut a broad swath through human nature. The problem isn’t with people; they are a manifestation, a symptom, of an underlying condition. Rather it is the public policy that shoulders the blame and, even more so, the fundamental ideas that justified that public policy.
If we really want to change the financial system, we are going to have to confront the forces that determine its shape: the way the markets are run, what governments seek to allow or to prohibit, all flow from a system of ideas. Change the ideas and everything else falls into place. You don’t have to go far; I see it from my office. You see, I’m partly to blame, because I work at a business school. The font from which all this greed pours is mainstream economics, which every business school teaches.
Economics really is the gatekeeper of the social sciences. It is easily the most influential academic department when it comes to determining the rules of money. What economists say goes, and every top financial post is filled with a PhD in economics. It would be incredibly dangerous if such influential people were all operating with some basic ideas that were misguided or patently absurd. Imagine being operated on by a surgeon whose beliefs about your anatomy didn’t correspond to what’s inside your body. You’d be scared, and quite rightly.
Unfortunately, from what I’ve encountered over my career, there is a lot to be worried about. Economics is founded upon three core beliefs which concern me greatly when I think about our future.
Belief #1: People are rational.
This is a central tenet of mainstream economics, with origins stretching all the way back to Socrates (“No one goes willingly toward the bad”). Essentially, it means that we always make decisions in our best interests. This belief strongly justifies a completely unfettered free market, as it assumes that we would never make financial choices we would regret later or that would actually harm us. But, alas, this is an absurd assumption. Procrastination, for example, is an irrational delay in which we put things off despite expecting to be worse off for it. According to economists, it shouldn’t exist; in reality, we all do it, to some degree at least. Really, at best, we are quasi-rational — the brain is like one of Microsoft’s or Apple’s operating system; both have coding errors and computer vulnerabilities (yes, even Apple’s). As the world gets better at identifying these operating errors and hacking into them, the less rational and more “buggy” our behavior becomes. And, as I review in my book The Procrastination Equation, things are only getting worse. People are procrastinating more, finding ever-more elaborate ways to avoid doing the thing they know they really should be doing.
Belief #2: Markets are Rational
There is a second line of defense to the “people are rational” argument. It comes from a classic 1953 essay by famed economist Milton Friedman. He notes that when dealing with macroeconomic activity, simple unrealistic assumptions may be better than complex realistic ones. He acknowledges that economic assumptions may not hold true for the individual, but so long as they predict aggregate behavior, it does not matter. Most economists agree with Friedman, believing that individual rationality is not necessary for market rationality. This is an interesting hypothesis and I wouldn’t call it absurd, just misguided.
Until it is tested, a hypothesis is just a guess. Here’s what another researcher, Deniz Ones, and I found out about this hypothesis in our article “Personality and happiness: A national-level analysis.” Two scientists closely studied Friedman’s position: Ostroff in 1993, using an organizational perspective, and Van Raaij in 1984, using an economic perspective. Both explored how macrophenomena can have radically different effects from their component microphenomena, a point also made in the 1950s by the sociologist W. S. Robinson. What this means is that it is possible for what happens at the individual level to be replicated at larger group levels, or disappear, or even reverse itself. You simply don’t know, and to find out, you actually have to look. And when you do — well, I think the title of Justin Fox’s book says it all: “The Myth of The Rational Market.” And Fox is editorial director of the Harvard Business Review Group. Alternative, take a look at Matt Ridley, former editor of The Economist: “markets in assets are so automatically prone to bubbles and crashes that it is hard to design them so they work at all.”
Here’s a reply one economist gave me: “If markets are irrational and you know something about it, you should be running a hedge fund instead of teaching.” Let the teacher teach you two things. First, irrational doesn’t mean predictable. Second, the markets can stay irrational longer than you can stay solvent.
Belief #3: Economics is the Best Available Option
This belief states that you have to assume rationality as nothing else works. Again, this is a question that we can actually test. Economists’ first position is to reject psychology, which they believe has nothing to offer. This comes from Stigler and Becker’s work of 1977. These two economists believe that tastes or preferences — that is, psychological personality traits — provide little or no prediction or explanation of human behavior. In other words, you don’t have to take human variation into account. I tackle this one in “Integrating Theories of Motivation.” This position was once only misguided but has now moved firmly into the absurd category (for example, see “Stigler-Becker versus Myers-Brigg” or “In Support of Personality Assessment”). If economists were right, we should select our employees and romantic partners pretty much randomly. Is that how you would suggest doing it?
Economists’ second offense is primarily against marketing. Marketers often ask people what they like and what would make them happy, such as “Would you like vanilla or chocolate ice cream?” Sounds pleasant enough, but economists disagree. They believe the only way we can know what people really want is by observing that they actually do. This is called “revealed preference” and fits in nicely with the rationality hypotheses. How do you know what is in your best interest? Well, that’s revealed by how you act. From this perspective, no matter what you do, from covering yourself in scalding hot tapioca to donating all your money to Bill Gates, it is all good. This logical loop is unassailable, but it is just wordplay — only good for finishing the Sunday crossword or getting the triple word score in Scrabble. I would rate this belief as misguided. So would my colleagues Vas Taras and Brad Kirkman, who address it with me in “Negative practice–value correlations,” where we show “revealed preference” has significant problems. Any single instance of observed behavior often tells you very little about what people typically like or would like in the future.
Economists’ last beef is with political science. This comes from Milton Friedman again. An advocate of public choice theory, he acknowledged that markets may not always be perfect; they may fail in a variety of ways, but this does not necessarily mean that intervention is required. Fiddling with regulatory remedies is dangerous as these are usually costly, so the cure can be worse than the disease. Asking the government to do more is inviting disaster, and Immanuel Kant’s quote is often bandied about: “Out of the crooked timber of humanity no straight thing was ever made.” Whatever the government is entrusted with, they will screw it up. I am inclined to agree with Friedman’s faith in markets, but only as a guideline. That is, go with markets first and when in doubt. To always go with free markets, however, makes it a rule, and absolute rules are very vulnerable. You only need a single exception to break them. How about the 2008 financial meltdown? You might have heard of it, especially since we are still experiencing the aftereffects. It was largely the result of a lack of regulation, partly from deregulation and more so from resisting new regulation appropriate for 21st century financial markets.
This belief was once misguided and now has moved firmly into the absurd. Regulation is neither inherently good nor bad. What it can be is excessive or poorly designed. In short, a sweeping dismissal of regulation isn’t possible; you are actually going to have think and then act on a case-by-case basis.
Don’t Mistake the Map for the Land
Economists are excellent mathematical modellers working with a pretty good model of human nature. It is amazing what they can predict so much with just two factors, Value and Expectancy. Consistently, we do respond to incentives (i.e., value) to the extent we believe (i.e., expect) that these are obtainable. In his book The Logic of Life, for instance, Tim Harford documents how incentives effect behaviour in everything from banking to sexual practices, with the latter being his opening example (“Regular sex is more costly than it used to be because of the spread of HIV/AIDS. HIV is much more likely to be spread by regular sex than oral sex”).
Now, those of you who have read The Procrastination Equation know that the economists’ model is abbreviated, representing just part of human nature. Reality and people are more complicated, rife with other important factors (e.g., impulsiveness). Economists get into problems when they treat their model as something more than just a mock-up and start believing it is the world itself. Relying on a model as reality, as an accurate description of what happens around you, is much like sailing a submarine undersea without radar or sonar but with GPS and a very good map. As long as the map is accurate and you know where you are, you don’t need to double-check. But if there is an uncharted underwater mountain, something that doesn’t feature in your model of the world, then disaster strikes at full speed ahead. On January 8, 2005, this is exactly what happened to the submarine USS San Francisco, which collided with a seamount, killing Petty Officer Joseph Ashley as well as injuring ninety-seven of the crew. Their map and the world were not exactly the same.
To get economics to reform — or even to acknowledge that their model has any limitations at all — seems to be an impossible task. No amount of evidence gathered or arguments made, even by winners of the Nobel Prize for economics themselves, has had much success so far (e.g., George Akerlof’s “Procrastination and Obedience”). Economics, ironically enough, just doesn’t seem to respond to reason. So I’m throwing my support behind the Occupy Wall Street crowd. Perhaps an emotional appeal from them will have more luck.