Thursday, December 2, 2010

Homo Economicus (Rational Man?) and the 2007 economic collapse

In this Nova special, economists talk about what led up to the global economic melt down. Two major economic schools of thought are at each other. One school which posits as one of its fundamental principles is that Man is essentially rational and that almost all his decisions behave as if they are rationally calculated based on the evidence given him and for the benefit of his self interests. This school of thought is most prominently associated with the Chicago School. The contending school works on 50 years of behavioral economics posits that much of human behavior and decision making is irrational.

At one point in the film, one of the Chicago School guys tried to defend the thesis in regards to the housing bubble. When that bubble burst, many economists thought that it burst because housing was over valued and it became that way when greed got a hold of individual private investors and banking professionals. There was a hysteria of greed and people bought houses or properties not based on rational deliberation of carefully calculating the risks of buying houses measured against the potential profits of the investment but on motives stemming from competition with other investors and greed.

Well, the Chicago guy basically called the collapse a "shift in value." That is, he thought that the collapse was simply a market regularity that reflected a change in interests/desire of buyers and sellers.

That seems preposterous to me. But it also seems that his justification is based on the idea that value of things like property is market relative. They lack a value outside of the supply and demand of particular markets at particular times. This is a kind of relativism. There's no such thing as being over priced or under priced in the market in such a scheme because the market always determines the proper price. Its value simply is its price as determined by such market forces.

For those like me, it seems that there is such a thing as over/under-valuation of things like houses. What determines their worth or value "objectively" outside of market forces? I think it is their relative contribution to human flourishing. This idea of flourishing is originally Aristotelian but developed also by the economist and philosopher Amartya Sen. Houses are valuable for living in but do they have any value beyond that? Some values are not potentially valuable to flourishing. Some things are desired by society and thus have high market value but do not contribute to human flourishing. Take cocaine. Or maybe IPODs. I don't know.

The basic idea behind flourishing is that human beings are embodied beings which have a natural (thus evolutionary) history. Some circumstances are good for our wellbeing and others not so. Which determines what is largely determined by our physical and psychological constitution which is largely (though not completely since some psychological elements are culturally or individually particular) fixed by our basic human nature.

Things like education has value outside of their worth in the market place. We can imagine a society of philistines who do not value education but does value fancy shoes. In their market, good shoes are very valuable but books are nearly worthless. A Chicago guy might say that books are of little value in that market and thus worth only what they are willing to pay for them which in their case means very little. But it seems to me that these philistines are paying too little for their books. That is, they have under-valued their books, both monetarily and in more familiar senses. Their shoes do not contribute much to their wellbeing but their books has tremendous potential to do so. Moreover, they have made an irrational decision to value their shoes more than their books.

I'm not an economist but it seems to me that this is the way to go but the next part will be how we could obtain a quantitative science of valuation according to the notion of flourishing so that accurate measures of value can be assessed on some flourishing metric (a flourishing dollar standard perhaps). Certainly, psychology, medical science, sociology, economics and anthropology has a thing or two to say about what contributes to human wellbeing but there needs to be something more robust and concrete so that this will be applicable in economics. I don't know how to develop this metric but it's worth thinking about.

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