Economists Need More Sympathy

Check out my latest post at Novel Stance about how economists need to incorporate sympathy more into their models. Here’s a bit:

Economic models’ overreliance on rational self-interest as the basis of human nature made their conclusions appear selfish and out of touch with reality. By not embracing a more nuanced view of human nature, economists lack a full understanding of how people behave and risk losing more credibility with the general public.

Read the whole thing here.

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Pin Factory

What follows is the sixth installment in a series explaining the context and deeper meaning of all eight songs on my band’s album all about Adam Smith “Silent Revolution.”  Listen to the entire album with audio commentary/explanation here. This song is inspired by text found in Section 1, Chapter 1 of Wealth of Nations.

The reason why certain nations get rich and others don’t is from a country’s ability to utilize the gains from specialization and division of labor. If we are all left to independently grow our own food, tend to our own wounds, or build our own airplanes, we’d all have a material standard of living dramatically less than what we have by participating in a commercial society. The “Robinson Crusoe” scenario is an extreme example showing how much we gain by having people focus on fewer tasks and work together to produce more with this same amount of inputs.

Smith was inspired by this picture in Denis Diderot’s Encyclopedie that showed the different stages of pin production.

Even in such a seemingly trifling trade, the tasks are split up between all the workers in a pin factory to significantly increase input.

One man draws out the wire; another straightens it…it is even a trade by itself to put them into paper; and the important business of making a pin is, in this manner, divided into about eighteen distinct operation, which, in some manufactories, are all performed by distinct hands…

Within a firm, division of labor increases output. Twenty people trying on their own and separately to do all tasks needed in pin production will surely turn out fewer pins in a given day than when they work together.

…But if they had all wrought separately and independently, and without any of them having been educated to this peculiar business, they certainly could not each of them, have made twenty, perhaps not one pin in a day; that is, certainly, not the…what they are at present capable of performing, in consequence of a proper division and combination of their different operations.

And within a society, specializing and utilizing division of labor increases output even more. A brain surgeon’s time is too valuable to force him or her to grow their own food and learn to program their computer. Instead, the brain surgeon goes to the supermarket where specialists in food production sell their services and resources. Or buys the iPhone that was programmed by the people who studied computer science.

It is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than to buy.

The complete lyrics to Pin Factory:

From wire drawn until the straightening, pass through eighteen distinct hands
Ten people now could make more in a day than if left to do on their own
Cut then before put into paper, the pin comes out in completion
What seemed at first to be a trifling trade is revealed to greatly improve

And the master of a family knows this truth
That you don’t make at home what it costs less to buy

And the master of a family knows this truth
That you don’t make at home what it costs less to buy

 

The Ethics and Culture of Corporations

Two oft-repeated assumptions about big companies in market economies:

1. Corporations pursue profit by all means without regard to concerns for ethics, the environment, diversity (racial/gender/socioeconomic), and community externalities.
2. Corporations consistently underpay minorities and women for doing the same work that white men do.

I see these as contradictory. A vast amount of literature shows that diversity at a company is good for its bottom line. Having more women and people of color in an office is good for everyone’s productivity and increases the likelihood of good ideas that are essential for keeping a company strong. Furthermore, if a company was only concerned about its bottom line, it’d only employ women and minorities (much cheaper!). The obvious reality is that companies do pursue profit, they do discriminate against women and minorities, but they engage in behavior that is not always profit-maximizing.

Consider an alternate proposition:

• Corporations pursue profits in an environment that is constrained by the prevailing culture and ethical norms; sometimes that culture leads to discriminatory behavior and sometimes it means putting ethics over profits.

This means that if the higher-ups at a corporation come from a culture that gives them implicit bias towards men, white people, or those that went to their alma mater, hiring decisions will be made that reflect those biases even when it is against the self-interest of the company. At the same time, culture can also influence business decisions that put ethics over profits. Price-gouging during a natural disaster, for example, might not happen (even if profit-maximizing) because cultural norms shun such behavior.

Essentially, prudence is not the only thing guiding human behavior, even if economic models often suggest so. What’s interesting to me is the overlap of people who a) attack the utility-maximizing framework of mainstream economics as being oversimplified; and b) say that people in a “capitalist” economy are purely self-interested.

 

 

 

Economists and Over-Reliance on Prudence

I’m currently reading Bourgeois Equality, Deirde McCloskey’s final installment in a trilogy. I have a lot of thoughts that will be for another day, but for now a quick observation…

Among the many ideas and arguments brought up in the trilogy, McCloskey criticizes modern-day economic thought as relying only on one of the seven principal virtues: prudence. Ethical philosophers and psychologists throughout time have recognized that human behavior is (and should be) guided not just by prudence (“rational self-interest”) but also by temperance, justice, courage, love, faith, and hope. Adam Smith, in Theory of Moral Sentiments, argued wonderfully about how human behavior guided only by any one of the four cardinal virtues (the first three plus prudence) was unreasonable and unethical. More to the point, mainstream economic analysis today is both incomplete and unreasonable to reduce all human behavior down to a rational utility maximization.

What dawned on me is how the economics discipline today is full of people worshipping this prudence-only mindset. I think the causation works both ways. On the one hand, individuals who themselves see problem-solving and behavior as largely rational calculated decisions will be disproportionately drawn to economics…because the framework they are going to be working with jives better with their own approach to life. On the other hand, students who study economics often start to shape their approach to life problems and policy decisions as if human behavior is only understood through prudence. After studying economics for a couple years, I recognize that I started to oversimplify behavioral analysis and ethics as “well, yeah, it’s in their self-interest.”

To non-economists the following parable may seem absurd, but to me at the time it sounded oddly sensical: the girlfriend of a roommate was visiting for the weekend; the roommate without the girlfriend felt this was a burden on his space and lifestyle, so he did some Coasean bargaining to allow this roommate’s girlfriend to visit and stay with them. They worked out some monetary deal to make the visit an agreeable event. Since they were sharing a room, the girlfriend visit meant the single roommate would have to sleep on the couch. What a drag! (For the record: I was not directly involved in this situation)

Another quick bit of evidence can be seen in experimental economics. Some experiments, like the dictator game or ultimatum game, are meant to isolate how altruistic humans can be in different scenarios when money is involved. Non-economists demonstrate more charity and altruism, even when the experiments are anonymous and no “self-interest” can be ascertained from their behavior. Undergraduate economics students, on the other hand, follow more closely to what “maximize utility” models would predict. Basically, they know the models. They know how they’re “supposed” to act. In a sense, they have shifted their decisions to emphasize prudence more than the other virtues. Like I said, the causation can work both ways, but I doubt that roommate would have engaged in some Coasean bargaining absent learning about the concept in economics classes. No society that I know of imposes a norm of private bargaining in such a household situation.

This reality unfortunately reinforces itself. Prudence-driven individuals are more likely to go into economics, economics is more likely to draw people towards a more prudence-based approach, and the discipline ends up staying focused on prudence only. People who are so aghast at the idea of rational self-interest being the sole driver of human behavior stop after Intro to Micro and go into other disciplines. In addition, the credibility of the subject to outsiders diminishes. On some levels, this is a fair decrease in credibility. In others, it means non-economists wrongly dismiss economic realities of scarcity and the laws of supply and demand when they shouldn’t.