A good review by Jonathan Knee of the exteremely-sharp Richard Thaler’s truly excellent new book, Misbehaving. The intellectual evolution of the Chicago School is very interesting indeed. Back in 1950 Milton Friedman would argue that economists should reason as if people were rational optimizers as long as such reasoning produce predictions about economic variables–prices and quantities–that fit the the data. He left to one side the consideration even if the prices and quantities were right the assessments of societal well-being would be wrong.
By the time I entered the profession 30 years later, however, the Chicago School–but not Milton Friedman–had evolved so that it no longer cared whether its models actually fit the data or not. The canonical Chicago empirical paper seized the high ground of the null hypothesis for the efficient market thesis and then carefully restricted the range and type of evidence allowed into the room to achieve the goal of failing to reject the null at 0.05 confidence. The canonical Chicago theoretical paper became an explanation of why a population of rational optimizing agents good route around and neutralize the impact of any specified market failure.
Note that Friedman and to a lesser degree Stigler had little patience with these lines of reasoning. Friedman increasingly based his policy recommendations on the moral value of free choice to live one’s life as one thought best–thinking that for people to be told or even nudged what to do–and on the inability of voters to have even a chance of curbing government failures arising out of bureaucracy, machine corruption, plutocratic corruption, and simply the poorly-informed do-gooder “there oughta be a law!” impulse. Stigler tended to focus on the incoherence and complexity of government policy in, for example, antitrust: arising out of a combination of scholastic autonomous legal doctrine development and of legislatures that at different times had sought to curb monopoly, empower small-scale entrepreneurs, protect large-scale intellectual and other property interests, and promote economies of scale. At the intellectual level making the point that the result was incoherent and substantially self-neutralizing policy was easy–but it was not Stigler but rather later generations eager to jump to the unwarranted conclusion that we would be better off with the entire edifice razed to the ground.
As I say often, doing real economics is very very hard. You have to start with how people actually behave, with what the institutions are that curb or amplify their behavioral and calculation successes or failures at choosing rational actions, and with what emergent regularities we see in the aggregates. And I have been often struck by Chicago-School baron Robert Lucas’s declaration that we cannot hope to do real economics–that all we can do is grind out papers on how the economy would behave if institutions were transparent and all humans were rational optimizers, for both actual institutions and actual human psychology remain beyond our grasp:
)Economics tries to… make predictions about the way… 280 million people are going to respond if you change something…. Kahnemann and Tversky… can’t even tell us anything interesting about how a couple that’s been married for ten years splits or makes decisions about what city to live in–let alone 250 million…. We’re not going to build up useful economics… starting from individuals…. Behavioral economics should be on the reading list…. But… as an alternative to what macroeconomics or public finance people are doing… it’s not going to come from behavioral economics… at least in my lifetime…
Yet it is not impossible to do real economics, and thus to be a good economist.
But it does mean that, as John Maynard Keynes wrote in his 1924 obituary for his teacher Alfred Marshall, while:
the study of economics does not seem to require any specialised gifts of an unusually high order…. Is it not… a very easy subject compared with the higher branches of philosophy and pure science? Yet good, or even competent, economists are the rarest of birds.
And Keynes continues:
An easy subject, at which very few excel! The paradox finds its explanation, perhaps, in that the master-economist must possess a rare combination of gifts… mathematician, historian, statesman, philosopher… understand symbols and speak in words… contemplate the particular in terms of the general… touch abstract and concrete in the same flight of thought… study the present in the light of the past for the purposes of the future. No part of man’s nature or his institutions must lie entirely outside his regard…. Much, but not all, of this ideal many-sidedness Marshall possessed…
John Maynard Keynes would see Richard Thaler as a very good economist indeed.
…And Professor Thaler is generally happy to name names when detailing the intellectual deficiencies and petty rivalries of his vocation…. The economics profession that Mr. Thaler entered in the early 1970s was deeply invested in proving that it was more than a mere social science…. Early in his career, Professor Thaler created a list of observed behaviors that were obviously inconsistent with the predictions of established orthodoxy. These found names like ‘the endowment effect,’ which leads individuals to systematically value things they already own much more than the identical item in someone else’s hands. ‘Misbehaving’ charts Mr. Thaler’s journey to document these anomalies in the face of economists’ increasingly desperate, and sometimes comical, efforts to deny their existence or relevance….
Professor Thaler’s narrative ultimately demonstrates that by trying to set itself as somehow above other social sciences, the ‘rationalist’ school of economics actually ended up contributing far less than it could have. The group’s intellectual denial led to not just sloppy social science, but sloppy philosophy…. The ‘misbehaving’ of Professor Thaler’s title is supposed to refer to how human actions are inconsistent with rationalist economic theory. It could just as easily refer to his own professional misbehavior in rejecting the prevalent worldview of academic economists at the time. Although not without serious risk to any aspiring academic, hopefully, his book and his career will inspire more miscreants across a wide range of intellectual specialties.