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The Story of Economics 'Monsters'
00:28:10
In this three-part series Michael Blastland lays out the history of economic ideas to...
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- [00:01]
A
Thanks for downloading this podcast from the BBC. Though it might not be what you expect, some of the people behind More or Less have been busy making another series, the Story of Economics, presented by Michael Blasland and broadcast in three parts from Wednesday 16th March. Since more or Less is off air, we thought you might like this. Instead, you can find out more about this series@BBC.co.uk.
- [00:31]
B
Allow me to introduce myself. I am Economic man, or Homo economica. Straight from the economics textbook and out for a spot of shopping. So I have what economists call my very own scale of preferences. Here's to the list. And given the price, in light of my resources, I aim to maximize my utility. And since I'm rational, really I am, I calculate that'll be 47x minus percent. My individual self interest is best served by that one packet of cheese and onion.
- [01:16]
A
Thank you.
- [01:16]
B
Thank you. Now that's a bit of a caricature of what it means to be economic man, and it's hotly debated. It's in fact, like Shakespeare's Hamlet, economics is riven by two views of what it is to be human. Noble in reason or at the mercy of unruly human impulse. Gluttonous lack of self control. For example, In this series we heard first about economics as a story of morality. Then we heard the story of economics as science. This week it's economics as the story of people, how they think and behave. And we'll do this with a set of intriguing questions about whether you and I are all that Homo economicus describes. Here goes. First, is my or your economic judgment as sound as we probably both like to think? Earlier in the series, we met the economist Paul Seabright at the zoo to compare people with other primates. Time for a return visit.
- [02:24]
C
The modern financial system was built by large brained apes that evolved on the African woodland savanna somewhere between 7 million years ago and today. If you think about how those apes lived for almost all of their life, they lived in small bands. They were very suspicious of strangers. They didn't have anything to do with large towns, villages, cities. Certainly none of them would have known how to react to Wall Street. Yet these apes, at the very, very latest part of their social life, decided to build modern civilizations, and in particular to build spectacularly complex financial systems. It's not surprising that the psychology which those apes brought to the task was not quite up to the job of managing a system as complex as the financial system we now have. So if you want to take a concrete example, we know that social primates in general and human beings in particular are good at what you might call strategic reasoning. That's to say, when I think of you not just as an arbitrary blob in my environment that sort of moves in certain ways and that might or might not be threatening to me, but as somebody rather like me with intentions and preferences and desires and fears whose behavior I can therefore anticipate by modeling you as a conscious, thinking, willing agent. Now that's strategic reasoning. But of course, when we're not just friends but rivals for something, it becomes important to anticipate what you're doing and to anticipate it better than you anticipate what I'm doing. Now human beings are very good at that, but we're not as good as we like to think we are. And the modern financial system depended to a terrible extent on individuals thinking that they could out reason others. So how many people did you know bought houses in London and the Home Counties in the last few years and thought very cleverly that even if prices couldn't go on rising forever, they would be able to sell the houses and get out of the bubble before the bubble burst?
- [04:26]
B
Feel flattered by that? Me neither. There we go, priding ourselves on our judgment. And Paul says we're deluded. Were you? Which brings our next behavioural question. When I buy, is it really between me, the price and the product or am I heavily steered by you, by envy maybe of your new phone because everyone has one, or fear buying this, doing that because everyone else does. Think of the best selling Christmas toy, which it will be is a tough call. But then one edges ahead and is named the must have. At which point, well, they sell out because the manufacturer didn't see the rush coming either. People decide their wants when they see what others want. So who really sets my preferences? Me? You? All of us. Paul Seabright watches monkeys. Another economist, Alan Kirman, tries to understand what some call our herd like behaviour by studying a smaller beast.
- [05:28]
D
Okay, let's start out with ants. I went to, I used to run a little foundation in the south of France and some well known entomologists from Brussels came there and they were talking about how ants recruited other ants to get to food. And what they found was that even if there were two paths of equal length to go to the food, wherever it was, once an ant finds it, he recruits other ants. And so you might expect after a while, when they'd found both paths, both paths are equal, they would sort of split themselves. Half would go down one path and half would go down the other path. And what you actually observe is that they all concentrate on one path and if you wait long enough they'll suddenly switch to the other path. So with a friend, Hans Felmer, a mathematician, we built a little model of that and then applied it to financial markets. Same idea they all heard in one direction and they all heard back. And it's not irrational, that's the point. You know, if the market's going up and, and everybody thinks it's going up, it's absolutely rational to believe it will go up.
- [06:26]
B
It creates this problem that when you look at what individuals, what might be sensible for an individual, you do get on the big scale that we're talking about whole economies, things can go completely contrary to what you think any individual might choose to do, right?
- [06:40]
D
That's why you get these huge movements in the overall economy. It's the fact that they're doing these things together and looking at each other that makes a difference, you know. Originally, the efficient Marcus hypothesis started out with a man called Bachelier and when he defended his thesis, the man who wrote the report was Henri Pincher, who was a famous French mathematician and said this is very interesting, very nice mathematics and so forth, but this is not what markets are about. What markets are about are people who are constantly being influenced by other people. They don't do things independently. That's what you should try and model and not your independent people making the decisions on their own. The market just doesn't work like that. But modern finance is built on the assumption that it does.
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B
Are we swept along by the mob and the moment in finance or elsewhere? And are we wise or mad to be so? A lot hangs on this. If our mood is herd like and fickle, it might make sense for the government to correct it, if that is government is any more capable. These questions raise another, more fundamental how rational are our choices really? Have you, for example, ever bought something you didn't really want, changed your mind, changed it back? So it's hard to say what your choices really are. The psychologist Nick Chaytor, who we met in our first program, says a simple game makes you wonder.
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E
So we're here again in the psychology department at Warwick University with Julie and I'm going to try another game with her now and this is a very simple one, a hypothetical choice. So if I were to offer you £5 right here and now versus £6 next week, what would you prefer?
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A
£5 now.
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E
Very good. And you're not alone, most of us would say that. Now I've got an Alternative pair of options for you. If I said you can have £5 in exactly a year's time, this time next year, at this exact time of day, you can have your five pounds, or you can wait an extra week and get six pounds, which would you prefer then?
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A
Extra week and get the six pounds.
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E
Very good. And again, everyone says the same thing. Now, it's perhaps worth saying there's something a little strange about that. So let me just imagine, put you into the mindset of the person who's just played the second game. So you've said, I prefer to have six pounds and wait a little bit longer, wait that extra week. And a year goes by and you're back in the lab, and I say, oh, just a week to go for your six pounds, but if you like, you can have five pounds right here and now. What would you want to do then?
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A
£5 here and there.
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E
So you're telling me that if I give you two choices, A and B, you say, I'll have B, please, and. And then a little time goes by and I say, same choices, A or B, and now you say, oh, I'll have A. Is there something a little strange about that?
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A
Sounds completely illogical, but I guess it goes back to the original decision. Bird in the hand is worth two in the bush. So it's the immediacy of it. You've got your money in your hand now, or wait a week and you might not come back.
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E
Yeah, I might not.
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B
Standing gazing at King's College in Cambridge, you have to gaze at King's College. You can't just look at it. Gazing at the college in the way these wonderful Gothic windows and spires reach heavenward, this wonderful symbol of human aspiration, the advancement of learning, the application of rationality. And it just happens to be the place where an economist, John Maynard Keynes, suggested that there was something profoundly beastly about our economic behavior and coined this notion of animal spirits.
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F
The term animal spirits goes back to ancient times. Spiritus animalis in Latin.
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B
That's Robert Schiller, who you might even call spiritual heir to Keynes. His last book was titled Animal Spirits.
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F
For Keynes, animal spirits refers now to the driving force that gets us going in the economy. It's broader, I think, than confidence. It's something about what makes the economy rebound from recessions or what causes it to fall into them in the first place. You know, think of the recent financial crisis. Well, it seemed to have been started by a stock market boom and a housing bubble. People seemed to be enthusiastic and positive and optimistic, and then it seemed to switch to a mood of despair. There's a question for economic theory. Are those moods just the consequence of the economy's changes? Or maybe they're fundamental to what happens in the economy. And that was the new idea that Keynes put forth and launched the whole field of what's now called Keynesian economics.
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B
So can animal spirits fluctuate almost regardless of what some people might call the real factors within the economy?
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F
Populations of people change their thinking. And a beautiful example just came in the last few months when we've seen all these changes in the Middle east. Why did they happen? Is it because some central banker changed the rate of interest? Absolutely not.
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B
Robert upsets the meaning of economics. For him, not numbers, but behavior comes first. People getting and spending, investing and borrowing. Yes, but more than that, people with bad backs and hot dates. Optimistic, pessimistic people. People who switch behaviour because of what? Something in the air or water. If you heard last week's program, you'll have caught us in front of the Phillips machine, this remarkable mechanical representation of the economy. When we were talking about the way in which the economy is or has been represented as a machine. Cog like. Well, we've come back because, incredibly, this machine has something which is strangely not mechanical. It's very human. It's what Keynes himself called animal spirits. And down at the bottom of the Phillips machine is a vat of water which essentially represents optimism and pessimism. And I think this is wonderful. It makes machine like human emotion to some extent. The wheel comes full circle. Invented in 1959, the Phillips machine represents the flows of money through the economy with water through pipes. Its unofficial curator is Alan McRobie. Alan, can you reproduce for us a boom and bust? Yes, you can do that quite easily.
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G
You'll just leave the government valves completely, completely stationary.
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B
So the government does nothing. So we've got a balanced budget from the government, as much flowing in as flowing out.
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G
That's right. What I will do is connect the animal spirits part of the machine, the model of optimism and pessimism at the bottom.
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B
So the idea is we're going to make everybody a bit pessimistic or optimistic.
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G
They're basically going to go with what the market's doing.
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B
And this is going to create a boom because they're all going to start throwing money at investment or a bus if it's the other way around.
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A
That's right.
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B
Animal spirits flowing through a bucket. Is this what drives us and the system, all this psychology? Must we think of economics, economics of all things, as Touchy feely, where what matters is soft, like confidence or trust and perhaps beyond calculation. I decided to seek help from. From the economist John Kaye, over that fine British institution, a pint at the pub, only to discover another whole set of influences over my economic behaviour, of which I'm barely aware.
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G
Our economic behaviour is embedded in so many social institutions and conventions that we just take for granted and we don't understand how they're part of our economic life. First of all, we were able to walk in here without charge, right? Then we went to the bar and we ordered a pint of beer, or we ordered a glass of beer, but what we were actually paying for was the beer, not the glass.
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B
I mean, fortunately there was a table, but I'm not quite sure what Right, we have to sit here again. We didn't pay for it.
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G
Yeah, well, it appears in this pub we can sit at the table without paying any extra. Now, if we were in Italy, there would be one price for having something at the bar and another price for sitting down at a table.
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B
Although there are rules. Again, I mean, if somebody else is sitting at the table.
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G
You can't sit at a table if someone else is sitting at it, unless you ask them.
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B
But it's not their table.
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G
It's not their table, Right. But somehow it's as though they rented the table for the evening, even if they hadn't.
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B
Clearly this is a pretty absurd way to talk about going to the pub for a drink.
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G
Of course it is, because we both lived in Britain for most of our lives and we know what the rules are. But if we came here, if we were doing an anthropological study and came here from New guinea in the way British anthropologists go out to New guinea, we'd have to ascertain what these rules
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B
are and why Is that relevant to economics?
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G
It's relevant to economics because it's the rules like these that determine the structure and the quality of the institutions in which we operate.
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B
I think of this as the fish question. How aware is a fish that it swims in water? Not very. Am I too, a prisoner of my time and place whose choices aren't calculated but absorbed from culture? Oh, dear. The simplest economic transactions in institutions, from pubs to banks, in firms and stock markets, all mixed into a cultural soup of things we do because these are things we do rather than the result of rational, independent calculation. I'd like to know more about Homo economicus. Let's hear from the historians who've accompanied us in this series. Roger Backhausen. First, Mary Morgan.
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A
By the early part of the 20th century, we don't have much of an account of individuals. They act out of self interest and it's a rational self interest until you get to the point, famously with Frank Knight, who had this account of man as a slot machine. You know, he doesn't think, he doesn't need to think, he just behaves in this Pavlovian dog mode of you put a coin in and you get something out. It's a rational, self interested person and there's nothing else to say. And I think at that point it's sort of a low point, if you like, of the count of the individual, because we've now got much richer again on the individual front. A lot of economic models do incorporate random behaviour because it's accepted. You can't explain behaviour completely. Now the problem with that, of course, is those random elements, for this approach to make sense, need to obey certain sort of statistical laws, otherwise it doesn't really make sense to, to pursue this. In recent years, economists have turned a lot more than they ever used to to experiments. I mean, this is behavioral economics.
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B
I suspect some people feel there's just a bit of a ghost in the whole machine. You know, economics, which is very often characterised as a sort of mechanistic discipline, is never going to get at whatever it is. That's. You might call it soulful, you might call it artistic, you might call it willful or capricious or whatever.
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A
But then if you take that view to its extreme, do you end up saying we can't explain behavior at all? If you say we can't explain behaviour, then what do we do?
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B
Well, you might say that you can explain 9/10 of behaviour, but there's this little bit that occasionally comes along, throws a spanner in the works and then we get a crisis.
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A
Yes, well, I think that's what most sensible economists would say, and most economists would have said that for very many decades that we can't explain everything. We are just trying to explain as much as we can. And the crucial thing is to try to find out which are the bits we can explain and which are the bits we can't.
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B
I've come just around the corner from Broadcasting House in London to see a bit of life in all its messy, disorganised, weird street variety. And I'm sitting outside a cafe with the economist and journalist Tim Harford of Radio 4's More or Less and the Financial Times, but also particularly for our purposes today, author of a book called the Logic of Life. We're going to see how much logic we can observe, Tim, can we find rational, logical explanations for some of the odder characteristics in people's economic existence?
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H
Well, we can try, and economists have tried with growing confidence over the decades. So I suppose you would start with Gary Becker, Nobel Laureate at the University of Chicago, who's produced theories of rational discrimination, rational drug addiction and rational crime. So Becker is a theorist. So he would start by saying, let's think about the incentives that a criminal faces. What are the career options available to him or her? What are the benefits of committing a crime? What is the likelihood of being caught? What is the cost of punishment? And Becker puts all this down in a theoretical model. Very, very interesting thinker. When I met him at Chicago a few years ago, he parked his car illegally before we went to lunch. I looked at him and he said, well, you know, I don't think they check that carefully. I'll be fine. So I said, well, was that a rational crime? And he said, well, yes, it was. So that's the, that's the Becker school of thought.
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B
I can see your. You're tucking heartily into your second coffee there, Tim. Are you addicted and is that rational?
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H
I'm addicted and it's perfectly rational, at least according to Gary Becker. All kinds of things happen to you when you're addicted. You build up a tolerance, you get withdrawal symptoms if you stop. Well, there are also presumably benefits to being addicted. Various drugs feel good, caffeine feels great. And so the rational addict weighs up the costs and benefits and may well decide to become addicted.
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B
Tim and others write compellingly about how much human behaviour we can make sense of if only we figure out the incentives. And it makes perfect sense to push this as far as possible. Maybe you've seen the latest fashionable twist, nicknamed the nudge unit, set up to advise David Cameron on policy to encourage ours to do the right thing and said to be highly influential in the nudge unit. They don't always rate our logical powers to choose for our own good, but they do think they can change us with better incentives. The nudge theory comes from economist Richard Thaler.
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I
One can define any bit of behavior as rational, but I think one has to ask whether that explanation is really credible. There was a survey of in America of participants in retirement plans and they asked them, do you think you're saving too little or too much? Well, three quarters said they were saving too little. Now, rational choice theorist would say, well, that doesn't really mean anything because if they really thought they were saving too little, they would save more. So I devised both a solution to this problem and a kind of a way of showing that the behavioral approach is right. The solution was something that I call Save More Tomorrow, which was to invite people to participate in a program where they automatically increase the contributions to the saving plan every time they get a raise. In a rational model, no one would sign up for that because they're already saving just the right amount. What we find is the program is immensely popular, and in the first plan where we implemented it, we tripled saving rates.
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B
So if you hear that, you can have the rational junkie, for example. I mean, how do you respond to that?
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I
Two of my Chicago colleagues have developed a model of rational addiction. It is possible to write down such a model. I think it's fairly easy to dispense with that model. Consider the drug Antabuse, which some alcoholics take voluntarily. Antabuse has only one effect. It makes you vomit if you have a drink. Now, no rational addict would ever choose to take such a drug. If they're rationally addicted, why would they take a drug that makes them sick every time they enjoy the thing they love? If your favorite food is oysters on the half shell, then you wouldn't take a drug that makes you sick every time you have them.
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B
I can't resist noting how accessible this makes economics. After all, it starts with introspection by any of us asking what? What kind of economic creature am I? If I had to say where this story of economics ends so far, my guess is that it would be here with the search to connect a theory of people with a theory of the system. That is to know ourselves better with all our oddities and reasons, and then to understand how these everyday personal quirks come together to cause global boom and bust. This, for Nobel laureate Joe Stiglitz, is economics holy grail.
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F
If we just took ordinary rational individuals and build up from a microeconomics based on rational individuals, but with imperfect information and credit constraints, what would that look like? That would be a big success in its own now there are two other stages. One to build in now the observable irrationalities and to try to understand those irrationalities. Behavioral economics, what I would say an integration of psychology and economics. Even more ambitious. But there's a third level that I think I'm very excited about. But it's extraordinarily difficult, which is to realize that individual preferences are shaped by our society. So that in in fact the models I described took as given the preferences of individuals. But what we really ought to be thinking about is how we as A society shape those preferences.
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B
So there's a fair bit for economics to do, though not for us. We're nearly done with our story. But before we go, listen to this. See if you can guess what.
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What it is.
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B
It's a chorus of metronomes in Cambridge University's engineering lab. They're standing on a platform, suspended by ropes, then set off unsynchronized. Metronomes keep their own steady time. That's their point. Except that they don't listen. Again, They coordinate. How? By talking to one another. They send vibrations through the platform. These influence the movement of the other metronomes. They're not independent at all. Soon they're in step, like choreographed penguins. It's not a bad analogy for how people with their own rationality can start behaving like a beastly herd, heady with optimism or pessimism. Buy, Buy, buy. No, sell. Sell. But it also symbolises hope. I'll leave you to judge how realistic that hope is, that the way our gossipy complexity moves the whole economy can one day yield to science. I'm in the bank of England. It's grand, solid, not too much opulence, but clearly sitting on a few quid, as you'd hope.
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F
Here.
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B
Once a month, nine people gather to make one of the best, biggest economic decisions there is. Which way to pull one vast lever of control over the economy interest rates. Should the lever go up, down or stay the same? How simple can a decision be? Well, let's think about it. After all, economics, as we now know from all we've discovered in this series, is moral and political and hideously complicated because of that. It's also scientific to technical, statistical and mathematical, and prodigiously difficult because of that. And it's social and psychological about behaviour, attitudes and expectations, with questions about rationality, none of which is exactly a picnic. It's empirical and it's theoretical. It's history. Where was Karl Marx in all this? And culture and institutions and its law and its power. We barely touched on those. Just in case you have a spare moment. Oh, and we haven't talked at all about data and measurement, about whether we even know where we are now, let
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A
alone the story of economics was presented by Michael Blasland and produced by Richard Knight, more or less is back on air from the 1st of April.