Friday, October 23, 2009

A Psychologist Invites Modern Economists to His Couch

Jim Taylor, Ph.D. writes in Psychology Today HERE:

Economics: Economists are Irrational!”

What are free-market economists thinking?

“I recently read an article by the Nobel Prize-winning economist Paul Krugman in which he described the renewed battle between so-called freshwater economists (so named because they are largely based at the University of Chicago and other Midwestern universities) and saltwater economists (based primarily at Princeton, MIT, Berkeley and other coastal universities). The freshwater economists are disciples of Adam Smith and espouse the free-market and rational actor models. The saltwater economists align with John Maynard Keynes and his belief in the need for regulation in financial markets and that people aren't rational actors.
The past 50 years have been dominated by freshwater economists who had a reverential faith in the power of free markets (Smith's "invisible hand") and the rationality of people in their financial decisions. Given what has happened to our economy in the last decade, noted for its multiple bubbles (e.g., Internet, housing, mortgage), it's hard to believe that any of these "efficient market" adherents still have jobs, much less credibility in how the economy actually works

You should read Jim Taylor’s article. It’s a great knock-about piece of popular journalism, much of which I enjoyed, some of which I thought not quite fair in its populism, and on occasion some elements of which he is wrong. This last is not Jim’s fault: he takes the claims of modern economists at face value and responds to them to his light-hearted rant.

Lost Legacy has never been slow in criticizing the ‘Chicago Adam Smith’, a person with ideas that are far from the ideas of the Adam Smith born in Kirkcaldy in 1723.

George Stigler’s boast that “Adam Smith is alive and well and lives in Chicago” (1976) reflects to invention of the Adam Smith of the “invisible hand” (a mere metaphor for Adam Smith whose single use of it in Wealth Of Nations referred to the unintended consequences of the risk-avoidance of some, but not all merchants – foreign trade with Europe, India, and the North American colonies, was a major contributor to the British economy – who preferred the home trade), and had nothing to do, at least in Adam Smith’s mind, with how markets worked, how banks should be regulated (yes, he favoured government regulations in banking!: WN II.ii.94: 324), or how the price system worked.

The belief that the “invisible hand” was a significant ‘idea’, ‘concept’, ‘theory’, or ‘paradigm’ was wholly invented in the 1950s by neo-classical economists on the back of general equilibrium mathematics (which interestingly did not include a term for the “hand”) and in support of a worthy criticism of Cold War, Soviet central planning. It is now taught in every economics 101 class as if it had historical validity, mainly by people who have never bothered to read Wealth Of Nations.

However, Adam Smith did not espouse a vision of ‘perfect competition’, of ‘Homo economicus’, or ‘rational actor models’. On this assertion Jim betrays a lack of appreciation of Adam Smith’s works.

Even when discussing price changes in a market, he spoke of ‘neighbourhood’ markets, not an economy (Book I, Wealth Of Nations). I don’t expect Jim to be familiar with the Kirkcaldy Adam Smith, or with economics generally (his three degrees are in psychology), but he might appreciate a glance through Lost Legacy to see how much he traduces Smith’s reputation by making light of the differences between what he as responsible for (“Theory Of Moral Sentiments”, 1759 and “Wealth Of Nations”, 1776) and what modern epigones invented in his name.

Jim says he “would love to put these economists on the couch and explore what is going on in their heads” (I assume no Freudian motives here!); I would rather that Jim sat in a library and read some Smith and Keynes for himself. As it is, he gives offence to the valid notion that inter-disciplinary familiarity is good for scholarship.

Jim and I can agree that modern “economists” who dominate the profession presently, invented a mathematical world devoid of human beings. Adam Smith, incidentally, a talented mathematical scholar by 18th century standards, is totally innocent of such a charge. Those ‘guilty’ as charged can defend themselves and Jim should direct his ire, undergraduate humour, and psychological "explorations of their heads" to them.

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