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|Grand Illusion - Page 6|
Back to Earth
Now we're being forced (maybe "challenged" is a nicer, more therapeutic word) to rethink our long love affair with money and the fond belief that through some magic formula—real estate, derivatives, The Secret—we can go on piling it up forever. The awakening is a rude shock. What's happened over the last year—what's happened since last September!—isn't the way it was supposed to be, according to the principles of free market economics, a matter of almost religious zeal in America probably ever since Adam Smith's The Wealth of Nations was published in 1776.
According to the holy canon of the true faith of the unimpeded free market, if people are allowed to individually pursue what they regard as their own enlightened self-interest, their collective behavior will result in a general state of robust, healthy economic equilibrium overall. The market is by definition "perfect." Most people will generally make rational choices about how to make and spend money, if given their druthers. Even the personal failings of individuals—greed, ignorance, dishonesty, fear, "irrational exuberance"—will cancel themselves out and the system will act "as if" every person were a perfectly rational, responsible Homo economicus.
Since everybody in the market is, in effect, a paragon of economic virtue and propriety, the free operations of the marketplace will be perfectly transparent, automatically and naturally providing access for all to the information people need to make prudent, well-informed decisions: buyers and sellers will have equal power and opportunity to settle on a fair, mutually-agreed-upon price. Self-interest will lead every person to act wisely, ethically, and with nice concern for the other players in the game.
This almost comically na•ve view of human behavior and how real human economies actually work has been the foundational dogma of academic economics and a linchpin of capitalist ideology for much of the past century. Given today's ongoing financial train wreck, it now seems amazing that so many big economic brains held beliefs that are such an assault on ordinary common sense. Many of these experts are now walking around shell-shocked.
You almost had to feel sorry for Alan Greenspan, Federal Reserve chair and official White House financial oracle for the last 20 years—our own Yoda—as he sat almost quivering in the hot seat of Congressional hearings, admitting that he was as dumbfounded by the "tsunami" smashing the beatific free market vision as anybody else. He admitted that there was a "flaw" in his beloved model. He felt "shocked disbelief" that the "self-interest" of the people running banks and investment firms didn't automatically lead them to be wise, honest, and protective of their clients' interests. He seemed startled that the incredibly complex mathematical risk-management formulas that were supposed to remove any trace of disorder from the perfect economy had failed so miserably: economics was supposed to be as predictable in action as Newtonian laws of physics. Then Greenspan, the guy who never saw a government regulation of the market he liked, called for more government regulation of the market!
A Different Kind of Vision
It seems clear that the current economic debacle didn't occur as a result of too much rationality in the market or because people making financial decisions—from housekeepers and store clerks taking out massive loans they couldn't afford to Wall Street colossi taking out massive loans they couldn't afford—were acting in the wise and thoughtful fashion you'd expect from Homo oeconomicus. In fact, they were acting just the way anyone who's ever taken a Psych 101 course was taught—with the same mix of emotion, impulsiveness, sometimes solid, sometimes flaky reasoning, and normal craziness that lies behind pretty much everything we do.
And at last, today there are some genuine, card-carrying economists who've actually recognized these truths. A group of psychologically informed behavioral economists are getting their place in the sun now (after being long ignored) for doing what orthodox, mathematically minded economists never did: conduct empirical research on how flesh-and-blood humans make economic decisions in the real world. Their most famous proponent is Daniel Kahneman, a psychologist who won the 2002 Nobel Prize in economics for pioneering just this kind of work. Kahneman himself devised a variety of novel experiments revealing the many ways people are inclined to make decisions on the basis of fast, spontaneous, intuitive, uncontrolled reactions and subjective experience, rather than on objective facts and slow, strenuous deliberation. What he and other behavioral economists have discovered, incredible as it seems, is that people are often irrational, emotional, unable to discern their own genuine self-interest, prone to major cognitive distortions, bias, and overconfidence, and dependably driven by blind herd instinct to make bad situations worse. Imagine that!
Kahneman and others are now making a huge public splash because of their insights, apparently deeply shocking to the economic establishment, that Homo oeconomicus—the person who decides how to spend, save, invest, and constantly thinks about getting richer—is the very same as Homo affectus—the person usually awash in emotions (you know: love, fear, grief, greed, envy, anger, desire, need to be accepted, etc.) In short, these researchers are bringing back home to economics the whole psychological panoply of thought, feeling, and even ethics loosely referred to by Adam Smith in his first book as the "moral sentiments."