October 12, 2003
I'd like to start thinking more
about economics, so I've decided to
write a sort of diary on the subject.
I'm starting with a strong feeling that the world is screwed up in a bunch of closely linked ways. There seems to be a growing concentration of economic power in the hands of organizations and people that aren't concerned with justice: multinational corporations, big investors, the Bush administration, and so on. The institutions that rein in these tendencies seem to weakening. For example, at least in the United States it seems that most successful political campaigns are so dependent on fundraising that the winning candidate winds up beholden to the folks who gave him the money. And this has all sorts of side-effects worldwide: big agricultural subsidies which wind up devastating the economies of poorer countries, rejection of the Kyoto Accord and other measures to reduce pollution and CO2 emission because they would hurt the petroleum/automobile industry, and so on.
Of course, the world has always been screwed up, so one might ask: what's the big deal? I'm not such an optimist that I think things will ever be fine and dandy. In fact, people seem so inherently messed up - myself included - that in some ways it makes more sense to simply get used to it and focus attention on more pleasant things.
However, there are some qualitatively new features to the current situation. Most importantly, we are currently amid a major extinction of plant and animal species, one which will probably rank right up there with the Permian and Cretaceous extinctions - but caused by humans rather than an asteroid impact (or whatever it really was). Many species are already gone, and many more are going fast. More than the usual miseries that humanity brings on itself, this will mean an irreversible loss of precious information. And what's particularly bizarre is that this is happening right when people are figuring out the mysteries of the genome. Unless we do something quick, we will awaken to the immense value of something such as a tiger, a lemur or an orangutan right after we've managed to kill them all off.
There are a few conclusions I draw from this. First of all, if we don't change how economics and politics are done, quite soon, we will ruin the world in a quite permanent way. Second of all, there's something inherently shortsighted about how business is being done now. We don't have adequate mechanisms to ensure decisions take into account the true value of something like the continued existence of a species or an undisturbed ecosystem, or the true cost of something like polluting the air or destroying an Antarctic ice shelf. In the lingo of economics, these are currently just "externalities" - not part of the balance sheet.
So, I'd like to see if some new ideas on economics and politics could help do something about this.
A lot of people have thought about this stuff, and I need to learn more about what they've thought. However, I want to avoid getting pulled into the game of drawing up plans for a more just economy without paying attention to the immense forces that are arrayed against the implementation of such plans. In other words, I want to keep my eye on realpolitik.
In particular, I want to understand how economic forces corrupt the discipline of economics, turning it away from an effort to understand and improve things, towards being a tool for the powerful to gain more power.
For example, I want to understand how the "rational agent" that I learned about in my university course in economics - the imaginary person who is always "maximizing his utility" - oversimplifies the behavior of actual living breathing human beings. And I want to understand how this oversimplification plays into the hands of those who have much to gain from the current economic system: how it legitimizes unjust actions.
And I'd really like to see how we could change things a bit - to find some points of leverage where pressure can be applied in an effective way.
Among other things, I want to start by compiling some references that I've found enlightening. Here are a few:
This is a wonderful book that would take a long time to summarize. Amartya Sen won the Nobel prize for his work on economics, and it's easy to see why. I'll just mention one thing here: his criticism of "rational choice theory", for example his attack on such underlying assumptions as these:
Self-centered welfare: A person's welfare depends only on her own consumption and other features of the richness of her life (without any sympathy or antipathy towards others, and without any procedural concern).
Self-welfare goal: A person's only goal is to maximize her own welfare.
Self-good choice: A person's choices must be based entirely on the pursuit of her own goals.
A reflective person need only state these assumptions to realize that they are either false or, by clever definition of terms, true but only vacuously. However, many economic theories are based on these assumptions, treating them as both true and non-vacuous. As Sen points out, this has the effect of treating people as "rational fools" who are unable to sympathize with others, deliberately choose not to maximize their welfare, or cooperate in pursuing someone else's goals. Policies and ideologies based on these assumptions have a debasing effect on our society: they tend to actually make people into rational fools. People are always looking for a framework to justify their actions - a religion, one might say - and rational choice theory based on the above assumptions is one of the particularly pernicious religions of our time.
There's much more to say about this book, but I don't have time now.
It's unusual to see a hard-hitting piece of socioeconomic criticism in the Notices of the AMS; this comes from a talk given at the August 22, 2002 International Congress of Mathematicians in Beijing. As a mathematician I'm particularly interested in how numbers are used to legitimize activities by giving them a superficial appearance of objectivity, and that's what Mary Poovey is talking about. Let me quote a bit:
Recent economic events in Asia, South America and the U.S. have made it clear that over the last twenty years a new axis of power has emerged, which is now making itself felt all over the world. This axis runs through large multinational corporations, many of which avoid national taxes by incorporating in tax havens like Hong Kong. It runs through investment banks, through nongovernmental organizations like the International Monetary Fund, through state and corporate pension funds, and through the wallets of ordinary investors. This axis of financial power contributes to economic catastrophes like the 1998 meltdown in Japan and Argentina's default in 2001, and it leave its traces in the daily gyrations of stock indices like the Dow Jones Industrials and London's Financial Times Stock Exchange 100 Index (the FTSE). Intrinsically, this axis of power is neither good nor evil. In some countries, like China, it has helped raise the nation's overall standard of living, and in others, like the U.S., it has allowed some people to retire early or with more money than they ever dreamed possible. But it has also widened the gap worldwide between rich and poor. It has led countries all over the globe to abandon their welfare societies in favor of a U.S.-style shareholder culture, where basic services, like health care, are individual responsibilities. And, as we saw in the spring of 2002, it has permitted - even encouraged - corporate crime on a scale that takes one's breath away, not to mention the life savings of thousands of individual workers as well.This new axis of financial power has many dimensions, many causes, and many effects. In this essay I will be able to discuss only a small part of what one analyst has called "financialization" and I call the culture of finance. Specifically, I will discuss some of the ways that the culture of finance uses numbers and mathematics to reorganize the relationship between value and temporality.
[....]
The starting point for my discussion is an obvious historical observation: the emergent culture of finance differs from an economy of production in that finance generates profit primarily through investment, through moving and trading currencies, and through placing complex wagers that future prices will rise or fall. This is in stark contrast to an economy of production, which generates profits by turning labor power into products that are priced and exchanged in the market. [...] what we have seen in the U.S. since 1995 is a change in the ratio between the wealth generated by production and the wealth generated by finance: in 1995 the sector composed of finance, insurance and real estate overtook the manufacturing sector in America's gross national product. By the year 2000 this sector led manufacturing in profits. Not incidentally, in the same year this sector also became one of the biggest donors to federal elections in the U.S., and its representatives spent enormous sums of money lobbying Congress in Washington.
[....]
In the new culture of finance, value can be created without labor, agency is tranferred to an unstable mixture of mathematical equations and beliefs, and responsibility for disasters is pinned on an individual (a "bad apple") or simply dispersed as analysts blame their investor's losses on flawed computer programs or unforseeable market forces.
The bulk of the article is a description of five financial instruments currently in use, and their dangers:
I showed this diary to a friend and he said it was a bit rambling at the beginning... he also said he was more skeptical than me about the possibility of doing anything about this stuff.
As for it being rambling, well, it is a diary after all. But I also looked at what I'd written and realized the discussion of extinctions, collapsing ice shelves and the like may seem to many people like a digression from economics. To me it's not; one of my main interests is the interaction of economy and ecology - two forms of housekeeping if you believe the Greek root of the word - and how we might make the transition from being exploiters of the planet to stewards of the planet. Or might not!
As for being skeptical, well, I'm skeptical too. I didn't feel like starting out this diary on a note of gloom and doom, but I've certainly been pondering a lot of dark possibilities, and I actually do want to talk about them.
For starters, it's quite possible that intellectual theorizing about economics is unable to create changes that go strongly against the existing trends. I read yesterday in Mary Poovey's article that in 2001 the total amount of derivatives sold was 100 trillion dollars - more than the gross world product over the last millenium. What can anyone do against a financial whirlwind like this? One might as well try to talk a hurricane into changing course. Maybe the language of economics is simply not listened to unless one is describing a way for the rich to get richer - the Black-Shoales equation, for example. Or listened to, but not heeded.
When I get really pessimistic about this sort of thing, I start thinking about how people are a tool for money to make money, and imagine a future where just as single-celled organisms have completely merged to form multicellular creatures, people have completely merged into corporations - a future in which it makes no more sense to analyze what's going on in terms of the motives of individual people than it does to analyze the motion of my hand in terms of the motives of individual cells. People unaffiliated with corporations may still exist, just as bacteria exist now, but they just won't be the point of it all anymore - instead, it'll be these profit-maximizing entities interacting with each other that count.
Of course, one could argue that this is already the case, or that it's all just a matter of interpretation. But I think most reasonable people realize that Homo sapiens can't be the last word in evolution, and this naturally raises the question: what's next? People talk about cockroaches taking over, or robots or or nanobots or cyborgs, but why not corporations? So, here's how my favorite science fiction dystopia goes. (It's due in part to this same friend of mine.) After corporations figure out how to mine the asteroids, a bunch of them will begin to spread through the solar system and beyond in the form of self-reproducing machines. In a race to beat the competition, these machines will eventually devour entire stars to power themselves so they can go at nearly the speed of light - and going this fast, they'll be unstoppable. Eventually they'll spread outwards like a forest fire across the galaxy, crushing any life that happens to exist, leaving nothing but ashes and waste in their wake... and if you ask why they must do this, the answer will be: because if they didn't, something else would do it first.
See? I told you I could get gloomy about this stuff! But somehow that doesn't stop me from wanting to think about it; I'm basically a happy fellow, so I'm not scared of a little gloom.
Everybody loves a fat pay rise. Yet over the past half-century, as developed economies have got much richer, people do not seem to have become happier. Surveys suggest that, on average, people in America, Europe and Japan are no more pleased with their lot than in the 1950s. This is curious, because at any given time richer people say they are happier than poorer people do. For instance, 37% of the richest quarter of Americans say they are "very happy", compared with only 16% of the poorest quarter. That might lead you to expect that, as a country grows richer and incomes rise, rich and poor alike would become happier. Here lies a paradox: an indvidual who becomes richer becomes happier; but when socieity as a whole grows richer, nobody seems any more content.Shocking stuff for the pages of The Economist! But it raises all sorts of questions not mentioned in this article.In recent years, the study of "happiness" - as opposed to more conventional economic measures, such as GDP per head - have attracted increased attention from economists. In a series of lectures earlier this year, Richard Layard, and economics professor at the London School of Economics, reviewed the various evidence from psychology, sociology and his own discipline to try to solve this paradox. One explanation is "habituation": people adjust quickly to changes in living standards. So although improvements make them happier, the effect fades rapidly. For instances, 30 years ago central heating was considered a luxury; today it is viewed as essential.
A second and more important reason why more money does not automatically make everybody happier is that people tend to compare their lot with that of others. [....] The implication of all this is that people's efforts to make themselves happier by working harder in order to earn and spend more are partly self-defeating: they may make more money, but because others do too, they do not get much happier. The unhappiness that ones person's extra income, argues Lord Layard, is a form of pollution.
[....]
If government's ultimate goal is to maximise the well-being (i.e. "happiness") of society as a whole, then, says Lord Layard, some highly controversial implications for public policy follow. Convention economic theory argues that taxation distorts the choice between leisure and income. Taxes reduce the incentive to work an extra hour rather than go home, or to put in extra effort in the hope of promotion. But Lord Layard's argument implies that people have a tendency to work too much. Far from being distortionary, taxes are therefore desirable. He suggests a marginal tax rate of 30% to deal with the "pollution" that one person's extra income inflicts on others, and the same again for habituation. The total of 60% is a typical European level of taxation (taking both direct and indreict taxes into account).
First, an obvious one. Should it be the goal of government to maximise the average happiness of its subjects? One can argue for and against this. Opponents of high taxation rates would likely argue that depriving one person of his hard-earned money is not justified by the fact that his wealth makes lots of people unhappy! However, since we are not philosopher kings with the power to run the world as we see fit, it's not clear that it's worth spending much too time on this question. Let's face it: it never has been the goal of any government to maximise the average happiness of its subjects. It probably doesn't even make much sense to think of governments as having "goals"! But one can certainly try to understand why there has been a constant governmental push for "economic growth" over the last century, even though this hasn't made people happier on average. And, maybe knowing the answer to this will help us think of some ways to improve things.
Here's another question, one I find more interesting. To what extent do people behave in a way that maximises their own happiness - and under what circumstances? The answer is obviously very complicated. Any sort of theory that claims people are rational agents constantly working to maximize their own happiness is, I claim, patent nonsense and an unsound foundation for economics. And yet surely there is some tendency for people to try to make themselves happier - at least sometimes.
I'd like to learn more about this. I'll start by reading the lectures Layard gave:
So, I'll just quote some interesting email that Joseph G. Haubrich sent me - he's an economic consultant at the Federal Reserve Bank of Cleveland. He brought this piece to my attention:
What is the behavioral basis for economics? What difference will changing the rationality assumption make? Without denying the often extreme calculating power assumed in many economics models, many parts of economics are based on simpler, more robust assumptions. A classic paper is:(All this expresses Haubrich's personal views, not the position of FRB Cleveland or the Federal Reserve System.)Even if people behave randomly, if something cost more, on average people must must buy less, since their income won't go as far. A reflection assuming a bit more rationality is:
- Gary Becker, Irrational behavior and economic theory, Journal of Political Economy 70, 1962, 1-13.
If $500 bills are on the sidewalk, people will pick them up. For an analysis of different psychological assumptions still retaining this basic notion of arbitrage, look at this Nobel Prize winner's book:
- Donald N. McCloskey, The limits of expertise, The American Scholar, Summer 1988.
Finally, for more on the financial end, I recommend:
- George Akerlof, An Economic Theorist's Book of Tales: Essays that Entertain the Consequences of New Assumptions in Economic Theory, Cambridge U. Press, Cambridge, 1984.
At a minimum, I hope this list shows that the psychological assumptions behind economics have been part of the economics discusssion for quite some time.
- Nassim N. Taleb, Fooled by Randomness: the Hidden Role of Chance in Markets and in Life , Texere, New York, 2001.
© 2003 John Baez
baez@math.removethis.ucr.andthis.edu