Among the winners of the Economics Nobel [1] two of the most interesting are George Akerlof and Robert Shiller. Their book Animal Spirits provided me with much of the intellectual stimulus to write my own Zombie Economics. Their latest has the intriguing title Phishing for Phools: The Economics of Manipulation and Deception.
The central theme is simple. We are all prone to errors in reasoning. Given the complexity of the world, and the finiteness of our reasoning capacity, it could scarcely be otherwise. This obviously leads to decisions that differ from the perfect optimality assumed in simplistic versions of economics.
More importantly, markets create opportunities for others to exploit and amplify our errors in reasoning. Advertising uses all sorts of device to encourage us to make decisions that we would not make if we gave careful and rational consideration to our choices. The entire credit card industry relies for its profitability on the fact that cardholders don’t (as is almost always sensible) pay off their balances every month. And so on.
As Akerlof and Shiller observe, the fact that markets systematically amplify reasoning failures undermines the standard claims about the optimality of market processes.
The proposed policy responses are a bit limited, focusing mainly on regulation and consumer protection. Still, the book is well worth reading.
An interesting side point is an argument that the harms of alcohol, a notorious source of suboptimal decisions, have been greatly underestimated.
A couple of other new books:
The Rise and Fall of Classical Greece by Josiah Ober Is fascinating, combining careful use of quantitative data with a compelling story of how the Greek city-state system grew, survived the imperial conquests of Alexander and influenced the Romans enough to pass on a legacy of democratic exceptionalism.
Also, Andrew Leigh has continued to produce books regularly despite the work of being an MP and Shadow Assistant Treasurer. His latest Luck in Politics covers a bunch of themes I’ve been keen on.
One is the obvious, but often ignored, point that the role of luck in political outcomes is generally underestimated, particularly by pundits who want to assume that whatever happens must have had deep causes. For example, if the electoral boundaries had been drwan a little differently in 1998, John Howard would have been a one-term PM and serial failure.
More significantly, thinking about luck in general ought to incline us to a more egalitarian view of policy. We do well or badly in life as much because of luck as because of our own efforts. In particular, particular talents (say, picking stocks or kicking balls) lead to fame and riches in some social contexts and are valueless in others.
[fn1] If you’re thinking of making a point about the name, please don’t. I’ve already covered it .
John Quiggin 
Senator David Leyonhjelm published an article in The Australian Financial Review last week argue against the nanny state’s intrusion into personal choices and spruiking the agenda of the current Senate Economics Committee’s inquiry into personal choices and regulation. He argued that self-inflicted conditions like obesity incur primarily private costs so the underlying choices such as the food we eat should be left for private decisions. I should send him a copy of Akerlof and Shiller. The nanny state argument is comprehensively undermined by the evidence of systemic non-rationality.
The capacity of adults to make prudent decisions is influenced by biological and deterministic forces such as drinking alcohol and smoking even before they were born . The ABC carried a news item yesterday that exposure to nicotine prior to birth doubled the incidents of misbehaviour amongst a sample of 5000 10-year-olds. And foetal alcohol syndrome has a lot of explanatory power for the dysfunction in remote communities. Some ndividuals’ lives are irreversibly ruined before they are born. To leave people to manage their own lives without some kind of collective intervention is plain cruel.
(This doesn’t necessarily mean nanny state regulation. Contrary to the neoliberals’ conviction that regulation is the first resort of empire-building bureaucrats, it is often the last resort because the more thorough non-coercive methods of state or community involvement can’t get funding through Treasury).
The current crop of television ads for cars certainly illustrates the economics of manipulation and deception. Given that a car is the second or third largest purchase most head(s) of households make (after houses and maybe big holidays), the ads encapsulate some fascinating assumptions about what induces people to buy cars. Car ads are long on emotion and emotive triggers and very short on logic, facts, specifications etc. It might be argued that the TV ad is the hedonic hook and then people will go looking for utilitarian facts though I doubt the latter occurs much beyond a count of seats.
Marshall McLuhan wrote “… the car has become an article of dress without which we feel uncertain, unclad, and incomplete in the urban compound.” It is any wonder that car styling (fashion) and “hedonic placement” have become so all-important?
The claim that capitalism and capitalist markets are “efficient” always bemuses me. The question is efficient at what? Is the roughly 100 year triumph of the modern automobile in any way a story of efficiency as in efficient use of resources? Clearly it is not. It would have been far more efficient to develop mass transit, to use bicycles for short trips, to emphasise rail (or air) for long trips, to use land allocated for roads for other purposes, to have small passenger vehicles where they are absolutely necessary supplied by hire services and taxi services and so on.
The story of the automobile is the quintessential morality tale of capitalism; costly, unsafe and an irrational and wasteful use of human and natural resources. The triumph of the automobile on its own refutes any and all claims that capitalism and capitalist markets are in any way efficient.
Capitalism is an absurdly wasteful system; absurdly wasteful of resources and highly inimical to humans and nature. Capitalism is efficient only at encouraging greed, hedonism and vanity and then failing to satisfy these very same induced desires.
If economics is indeed about efficient allocation of scarce resources as J.Q. claims then economics must reject capitalism as a most horrendously inefficient system. The triumph of the automobile alone proves the case against capitalism.
Interesting that you recommend Akerloff and Shiller. The only review I had seen was not very complimentary:
http://newramblerreview.com/book-reviews/economics/a-phool-and-his-money
Did Howard win in 1998 because of unfair electoral boundaries? It’s true the LNP won with <50% of the TPP, but it 's possible to win that way even with exactly equal numbers in electorate. You could say that Howard was unlucky in 1998 because he had to deal with Pauline Hansen, who really ate into his primary vote and to a lesser extent into his 2PP vote, though you could also say that she was a creature of his making.
Howard was< lucky, but for different reasons. In 2001 he had the election delivered to him by Osama bin Laden, and in 2004 he had the exceptional good fortune of going up against Mark Latham. Now thatwas good luck.
@Ikonoclast
You’re over analysing this. People find cars a useful way of getting from point A to point B.
The books sound interesting and its themes.
i.e. The market is not optimal, not always self correcting, and prone to nasty positive feedbacks which bring the house down.
Sounds like ‘systems thinking’ and maybe even ecological economics are trying to emerge again so that equilibrium economics will be seen for what it really is – a short term, unstable lull/special case rather than a reflection of universal norms.
Steve Keen should be happy.
But the troubles with reasoning arent just about erroneous reasoning. At the risk of being boring as I’ve said some of these things before Bayes Nets attempt to formalize reasoning now in many sciences to an extent not possible in economics and address error. But this has also yielded the following conundra:
a. Bayesian reasoning – inference if you prefer – still leaves only best estimates with associated probabilities and uncertainties – so error and uncertainty are built in and mistakes in hindsight arent necessarily what we think of a failure to pick the right answer because there never was a perfectly right answer in the first place from the perspective of the decision make – though not recognizing that may be part of the problem with some economists and business types and yes engineers and scientists – i.e. hubris – that we know THE answer – may make things worse and build in mistakes into future decisions.
b. The diverse paradoxes that pervade the world make it interesting but make ‘perfection’ unachievable or unachievable. Simpson’s paradox is a really nice one that seems particularly relevant to economists with their equilibrium cost curve obsession. We are blinded by positive trends but miss the underlying negative trends that are implied.
c. The exploration of causality that Bayes has openned up has not addressed a plethora of other complications with causal reasoning highlighted by Nancy Cartwright for example e..g CARTWRIGHT, N. 2007. Hunting Causes and Using Them: Approaches in Philosophy and Economics. History of Economic Ideas, 15, 179. CARTWRIGHT, N. 2001. What Is Wrong with Bayes Nets? The Monist, 84, 242-264.
The Bayes net system though proving very and powerful for solving small system problems like disease diagnosis – shows also that with increasingly complexity the noise of uncertainties rapidly overwhelms our ability to predict the future or reason about the present. Also at least in Pearls framing of Bayes Nets, one has to bring in concepts like belief and faith which some athiests though they had jettisoned. This is to address what is the initial cause – where do you start reasoning from given all starting points themselves have causes.
@Ikonoclast
I sympathize with your frustration and anger against capitalism as well as its destructiveness.
But we have to ask what were the alternatives once civilization with its capacity to defeat/surpass the more in harmony with nature hunter gatherer societies (who were no saints either as illustrated by NZ and possibly the loss of the Pleistocene megafauna).
Could we have developed our current understanding of the natural world and the need to conserve it without the research structures that emerged in capitalist societies?
The religous city state does not seen a likely candidate. Socialism seems to have evolved as an idea as a reaction to capitalism so is not much chop.
As to other civilizations with high resource levels and longevity, China withdrew from the world while India seems to have been a collection of states like Medieval Europe who might just have easily gone down the capitalist road … in hindsight both may have taken to capitalism eventually – heavens they have now taken to it like ducks to water unlike Africa which suggests capitalism is an outgrowth of increasing civilization given human behavioural patterns.
Meanwhile all these older civilizations were destroying ecosystems with even less thought.
Perhaps the human race is destined by its biology to be capitalist as its last phase. I have to say I love this question and its extension in the search for answers to the Fermi Paradox.
Companies should not use manipulation and deception because if they do they could be taken to court under the law of unjust enrichment.
I went to an interesting talk on this law by a Cambridge law professor last year. There was a recent high court case that is important as it is a precedent for the use of case law from other common law jurisdictions in Australian court cases.
It is quite interesting – if there is deception or even an accident like accidentally transferring the title of an expensive painting to someone meaning that one party is unjustly enriched, then a trust is created between the beneficiary of the unjust enrichment and the benefactor of the unjust enrichment.
Apparently the law of unjust enrichment complicated Australian common law – which in the 1980s was being dominated by contract law.
“The belated recognition of the law of unjust enrichment in Australia and England was one of those embarrassing things of the 1980s and early 1990s, like pop music or mullet hairstyles.”
Indeed an eminent but unnamed judge remarked “We don’t need a law of restitution. It is no more than a neo-Marxist conspiracy to upset law that has always been perfectly well understood under the familiar headings of the common courts.”
However the law of unjust enrichment is another very old law adopted by the English from Roman law
Liability for unjust enrichment arises when
1. The defendant is enriched
2. The defendant’s enrichment is at the expense of the plaintiff
3. The defendant’s enrichment is caused by an unjust factor
The fundamental legal principle is “that no one ought to unjustly enrich himself at the expense of another”
So you can see manipulation and deception that led to the enrichment of one party would be unjust enrichment and make the party liable
Future generations would have a case about present generations enriching themselves at the expense of future generations – but I don’t know how you could go to court for future generations unless maybe if you were a trustee of a inter-generational trust. Or you tried to get standing as a public interest case?
@Uncle Milton
I’ve fixed “fairer”.
For the rest I agree. In an improved version of what I said to Andrew Leigh when I launched the book, Howard is an illustration of the Law of Large Numbers. He had good luck early on, when Phil Lynch ran into trouble, then appalling luck for a decade or more, and great luck from 1995 until the end of his career (where he made the standard mistake of hanging on too long).
@John Quiggin
Menzies is another to whom the law of large numbers applies. Very bad luck in his first time as PM, including the Canberra air disaster that killed three of his ministers and destablisised his government. The second time around, he was sustained by Petrov, the Labor split, going up against three times each against Evatt and Calwell, and winning the 1961 election by one seat, where that one seat was won on Communist Party preferences.
@Uncle Milton
I believe the claim about CPA preferences is apocryphal Also, Jim Killen later admitted making up the claim that Menzies (who hated him) had called to say “Killen, you’re magnificent!”. But the one-seat win on preferences part is right.
This reminds me of a great word I found to use in launching Andrew’s book. “Apophany” is a portmanteau of apocryphal and epiphany, referring to the detection of spurious meaning/pattern in random data.
@John Quiggin
Wikipedia says Killen won 130 votes of which 93 were CPA. So its semi-apocryphal.
When we talk about good luck or bad luck we are often referring to Emergence in a Complex System. There are a lot of interacting agents. Perhaps we would make better decisions if this were better understood. Our three eldest grandchildren are now at University doing courses that involve complexity, and, to the best of my knowledge, the only person badgering them about this is me. Yet we live in an enormously complex environment and surely we would make better decisions about it if we tried harder to understand in general terms about complexity. In-depth understanding is difficult and the fractal nature of some outcomes and the accompanying mathematics soon become well beyond me (peripheral involvement in 2 studies using Bayesian Networks notwithstanding) but the general ideas are not too difficult (see e.g. Sargut and McGrath Harvard Business Review September 2011). I think Einstein’s observation about insanity is doing the same thing over and over and expecting different results, something that many people do not appear to comprehend. Perhaps it depends on how our amygdala are programmed. (I would prefer he used another word than insanity that can have a specific clinical meaning but the observation is otherwise apposite). The Law of Large Numbers is described in several of the comments. Perhaps as data are collected they converge to a mean but the individual values and their frequency are more likely to have a very skewed distribution, even a Power Law distribution, with the mean being meaningless and the distribution important. I do not understand how it applies to the politicians illustrated. Is there a graph available of the number of failures on one axis and the number of politicians on the other?
“insanity is doing the same thing over and over and expecting different results”
This would seem to apply to neoliberal austerity in Europe.
@Newtownian
In turn, I sympathize with your viewpoint without agreeing with it. I mean I can understand what leads you to that viewpoint. The extant has a great advantage over the merely hypothetical. Capitalism is extant. Post-capitalist socialism (in some genuine and worthwhile form) is mostly theory at this stage. There are significant pockets of socialist-like co-operativism in the world economy but they are still mere pockets in the large scheme of things.
Your viewpoint, if I may be a little critical, suffers from what I would term “temporal parochialism” (a parochialism related to one’s position in time or history) and “extantism”. “Extantism” one might characterise as a bias to regard only the existent as possible. There is an also an “end of history” flavour to it. It is always very hard to envisage how history might progress beyond its current stage. It does seem to me that you are engaging in “end of history” thinking; namely that no system is possible beyond this one. Capitalism is implicitly assumed to be the last and highest possible system.
The above is encapsulated when you say; “Perhaps the human race is destined by its biology to be capitalist as its last phase.”
One can imagine a person in medieval times, even a very educated person for the times, being unable to envisage any system beyond feudalism. One can imagine such a person saying, “The human race on earth is destined by God’s laws to be feudalist at its highest phase” although the term “fedualist” would probably be replaced by a phrase that outlined the status quo. Appropriate to the time, the locus of predeterminism would of course be situated in God rather than in the laws of biology.
As part of the advances accruing from the scientific-humanist revolution in the hard sciences and also in comparative studies in the soft sciences and humanities (comparative religion, comparative sociology and anthropology and even comparative ideology) we are more able to theorise that other systems might be possible other than merely our own current or extant system. However, I would argue that while we might be more amenable in theory to the idea that other and new systems are possible, I am not sure our predictive abilities or prescriptive abilities about which system could or should emerge are all that much improved. This is simply because the whole problem is so vast, complex and open-ended.
However, I argue that we should keep trying to envisage and bring about a better system even while patching the current system. In any case, humans will unconsciously, or perhaps even “meta-consciously” with group intelligence, keep seeking better systems. The visual analogy I use is “tunneling the possibility space” and its pretty much like a brute-force, branching path tree-search guided by heuristics which we humans conduct en masse with different humans following different branching paths. Attempts at the impossible are dead ends and beyond each such dead end is an impossibility space. Perpetual motion machines for example “reside” in an impossibility space. Attempts at the possible may lead to large new possibility spaces where a lot can happen and be achieved.
Maybe you should read the book. It’s quite easy to read; I personally found it extremely illuminating. It’s not about which products we should produce as per your New Rambler quote, but about how choice works in the real world and how this invalidates simplistic assumptions about markets and rational choice. Akerloff and Shiller are the first or only people to criticise rational choice or free market ideas as simplistic but they do add some solid evidence-based analysis to what is often a ideological – aka air-headed – debate. The obvious conclusion from A&S is that in at least some microeconomic situations more complex models of economic choices are clearly required.
@Matt
The fact that Alex Tabarrok disliked the book enough to write a hostile review is a positive recommendation.
@Uncle Milton
As Andrew Bartlett points out, it’s true in an absolute sense that Killen would have lost if absolutely zero Communist Party preferences had gone to him. But Bartlett also points out that an absolutely zero flow of preferences is extremely unlikely. Killen only needed 28 CPA preferences out of 676 CPA votes to win. It’s still ironic that he won with any preferences at all that came via a Communist Party voter.
Bartlett also remarks about the bizarre fact that 193 people who voted 1 CPA also voted 2 DLP, an anti-communist party. Go figure.
There is half a chance that irrational decisions are often due to attribution asymmetry fostering slow learning. You can bet that hubris dictates that chance is seen to be a more likely perpetrator when outcomes are bad than when they are good.