Tuesday, April 8, 2014

Really, A Rational Economy? 

Since the 2007 financial crisis, bookstores have been flush with information about finance, money, banking, democracy, government and other critical analyses of the state of our economy. Michael Lewis has covered The Big Short and Neil Barofsky has reported on TARP's corruption in Bailout. Lawrence Lessig takes on finance reform in Republic, Lost while Jeffrey D. Sachs examines The Price of Civilization, to name just a few standouts. 
How we structure our economy, the expectations we have of it, and what it actually delivers to support democratic principles is something citizens should understand on a basic level, if only for their own improved economic station. Economics is called "the dull science" but it's not a science - it's a set of theoretical assumptions accompanied by theory-justifying graphs. The above writers address the reasons for, the power of, and the handling of money in the real context of human behavior. Here are a few of their salient points.     

The dominant U.S. economic theory for the past half century has asserted an "efficient market theory." This theory says that money in a free-market economy flows to its most productive uses because human beings, with access to full information, will rationally choose to use their money in ways that are beneficial to them. There will be winners and losers spread randomly throughout the economy, but the market is always “efficient,” i.e. no one individual can always win. 

But is this well-founded theory? Does it sound reasonable to you on the practical face of it. Might the theory be too abstract? Do you see possible problems?  Are the assumptions based on common sense and how people actually behave?   Consider this Q&A about the theory's claims:

Q. Do we all have access to complete information in our financial dealings? 

A.  No. Even in the financial markets, most investors don’t know or understand what is going on. Information is often overly complex or only benefits insiders.  The false hopes and market manipulations of the recession prove that. On a simpler level, consider your monthly bank statement, carefully written in arcane, circular, legalistic language offered as “information” to fulfill your “right to know.”

Q.  Are we all always rational in our behavior? 

A.  No. You and I know that from the get-go. We have seen and perhaps participated in herd-like thinking and mass emotional responses ranging from paralyzed fear to Greenspan's "irrational exuberance." But economists are only beginning to understand this phenomenon. Led by MIT's Amos Tversky and Daniel Kahneman, the field of behavioral economics takes on the vast complexities of human nature and responses to economic issues. 

Q.  Do human beings act out of altruism (my benefits = your benefits) or out of a more narrow self-interest?

A.  The human race tends toward narrow self-interest. This is not just a Darwinian notion, i.e. humans are genetically programmed to protect only themselves and their kin when push comes to shove. It is also a cultural fact in the way our society permits the pursuit of selfish power and greed over justice, honesty, and fairness. 

While the efficient markets theory made sense to the Chicago School of Economics that developed it, we all know a rigid and simplistic view of the world can befall professors committed over the years to an idea. In fact, it is the “quants,” (academic numbers gurus) who largely facilitated the U.S. fall into a 3-year-and-counting recession, producing market algorithms that investors didn’t bother to, or couldn’t, fathom.

Niall Ferguson shows in his book, “The Ascent of Money,” that financial history never has been, and never will be smooth. Instead, he describes it as a “roller-coaster ride of ups and downs, bubbles and busts, manias and panics, shocks and crashes.” We can calculate and work with risk, looking back at the frequency of known, recurring events, but we cannot measure, predict, and bet on the unknown future. It lies before us, preparing mysteriously to unfold in who-knows-what directions.   

Finally, from Ferguson, “(F)inancial markets are like the mirror of mankind, revealing every hour of every working day the way we value ourselves and the resources of the world around us.”  Do we like what we see in that mirror or is it time for a facelift?

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