The Fruits of Civilization (29-1) Economics & Psychology

Economics & Psychology

Because economics is the science of how resources are allocated by individuals and by collective institutions like firms and markets, the psychology of individual behavior should underlie and inform economics, much as physics informs chemistry. ~ American economist Colin Camerer

Economic forecasts are regularly way off base, especially when their importance is most critical: in anticipating and curing economic shocks. The unreality of conventional economics models owes to their being based on bogus premises.

Economic theory began with Thomas More and Adam Smith, who examined economic activity in light of man’s moral nature. That holism was lost with the advent of neoclassical economics in the late 19th century, with the atomic calculus that emphasized marginals as the basis of economic decisions.

Psychology and economics both got swept up with the scientific method that had become de rigueur for academic disciplines. Inspired by modeling in physics, economists worked at formalizing economics mathematically. Contrastingly, psychologists became enamored with the experimental tradition, but understandably eschewed mathematical structure to characterize the mind. This divergence in approach broke the natural coupling of psychology and economics.

To a psychologist, a theory is a linguistic construct that organizes regularities in mentation. To an economist, a theory is a body of mathematical models which squirt out predictive variables dependent upon statistical inputs.

Another trend kept the fields apart. In the 1940s, economists took up neopositivism: the philosophical cudgel that crushes, as meaningless, statements not grounded in empirical evidence. While insisting on statistical facts for inputs, economists excused the patently false assumptions behind their models with a special twist, called the F twist, after its vocal proponent, Milton Friedman. The F twist stated that economic models which make accurate predictions are copacetic despite fictional assumptions, such as people being resolutely rational, and being single-mindedly focused on utility or profit. The F twist essentially gave economists license to ignore psychology.

Economists routinely – and proudly – use models that are grossly inconsistent with findings from psychology. ~ Colin Camerer

Many economic theorists worried that relaxing rationality assumptions would inevitably lead to models becoming analytically intractable: that reality would ruin the workability of the equations upon which economists relied. Theoretical leaps optimistically suggested that such conceptual stolidity is unwarranted; whence behavioral economics arose.

Behavioral economics assumes that people are boundedly rational actors with limited cognitive processing power and time, whose choices are influenced by the contexts in which decisions are embedded. ~ American economist Alain Samson

In trying to rationalize the irrationality of conventional economic models, behavioral economics is still in its infancy. Many of the fundamental drivers behind human behavior remain unincorporated.

We need to know much more about when, why, and how much people value control. ~ American legal scholar and behavioral economist Cass Sunstein

Just as in evolutionary biology, altruism and morality are hard to figure, as are other, more picayune peculiarities of the human psyche, such as information avoidance (e.g., the ostrich effect). The conceptual complexity that ensues from accepting that people don’t always look to their own naked self-interest is daunting to model.

Evolutionary psychologists have challenged assumptions about the rationality that underlies behavioral economics. ~ Alain Samson

More tellingly, the false idea of economic dynamics tending toward equilibrium has yet to be brought to heel. Predictive models which are predicated upon any degree of aimlessness (such as changing circumstances) presents a conceptual conundrum.

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The ultimate point of economic behavior is survival. Beyond material needs, people often behave economically to satisfy wants: personal desires, many of which are socially derived. From this view, a successful economic system would be where all people might live in a modicum of comfort. Economists have instead typically looked at economics from a more grandiose perspective: of achieving wealth and prosperity.

While acknowledging finite resources, free-market economists seldom suggest husbanding natural resources so that future generations may live as comfortably. A sensible emphasis on sustainable quality of life is disregarded for promotion of unsustainable growth as an economic dictum. Ignoring limits to growth – both in resource extraction and environmental destruction – has been a consistent blind spot for market-loving economists. Some hand-wave that advancing technology will cover for the losses, but that is just another heaping of fantastic whimsy.

The other dereliction of capitalist thought has been to ignore the breakdown in societal harmony that the market system delivers. The psychological and sociological costs of competitive materialism are asides in the theoretical edifices economists build.

Economists emphasize the benefits of change rather than the injustices and unhappinesses that change brings with it; but even when populations have rising incomes, longer lives, and higher educational standards in total and on average, many individuals within them may be suffering. Critics who emphasize the miseries of dislocation see matters differently from those who emphasize rising GNP. Even those who prosper may be unhappy if they think they should have done even better. ~ English political theorist and historian Alan Ryan

Part of the failure of capitalist thought owes to economic models with a time distortion; instead relying the false assumption that everything continually occurs in equilibrium or is mystically moving toward equilibrium. But equilibrium is nothing more than a mathematical fiction that is never attained. Economic activity is an unceasing gyre based upon the current situation as perceived by its participants.

Economists commonly address the problem of abiding poverty under the maxim that “a rising tide lifts all boats”: growth is the recommended solution. As a modern market system relies upon capital allocation (investment) as its wellspring, this perspective has been properly termed trickle-down economics.

Despite the relatively high average standard of living in the United States, poverty afflicts millions of people. And the particulars of poverty are deeply related to the social structures of class, race, and gender. The vast majority of the poor have always been women and children. ~ American sociologists Margaret Anderson & Howard Taylor

The tragedy of the commons is the economic observation that natural resources will be depleted in the unfettered pursuit of self-interest. Proven time and again throughout history, this tragedy can be taken as axiomatic.

The worst error of all is to suppose that capitalism is simply an economic system. ~ French historian Fernand Braudel

The physical outcome of the commons tragedy – pollution – extends to the basic necessities of life: clean air, pure water, fertile soil. More insidious costs are incurred, most notably societal discord caused by the gross inequities that the market system physiocratically generates. The class struggle that Marx focused on was between the haves and the have-nots that characterizes capitalism; a socioeconomic schism which festers as an economy matures.

Neoclassical economists’ universal prescription for the market system’s inherent flaws, including the inequities, is to impose some limits while not killing the goose laying all the golden eggs. Those less-religious wonder whether the eggs laid are worth the unattributed costs.

An economic system is a commons, as its costs and benefits are shared by all to some extent. The quality of an economic system may be adjudged by the distribution of its outputs. In the case of capitalism, the wealthy reap a disproportionate share of the benefits while the poor are burdened with more of the costs.

Beyond the socioeconomic problems of class stratification, capitalism instills materialism as a metric of the quality of life, fosters a competitive spirit, and strengthens self-interest and a sense of entitlement. In eroding self-esteem, comity, and trust, such social-psychological diseases sicken individual and societal well-being. By succoring suspicion and greed, capitalism is self-defeating, as commerce relies upon confidence in the integrity of strangers.

Capitalism is an ongoing confidence game. Economic cycles are periodic Collective exercises in undue optimism and panic.