Thursday, August 16, 2012

How Economists Corrupted Economics and Then Corrupted Law and Society

Economists like to think of their profession as a "science." One can call any field of study a science if one chooses, but a true science involves researchers putting forth hypotheses that are then confirmed or rejected based on experimental evidence. In economics the evolution of an hypothesis seems to follow this path: if a majority of economists can be convinced of an hypothesis’s correctness, then it becomes a fundamental law.

At present, most academic economists are enthralled by two assumptions: the efficient-markets hypothesis that states that markets are perfectly efficient at determining prices, and the rational-investor hypothesis that concludes that people will properly balance risk versus reward in making decisions that support their self-interest. Observers who do not have a vested interest in the correctness of these conclusions will look around and find plenty of evidence to support the notion that these beliefs are utter nonsense. Yet they persist.

The allure of these hypotheses arises from the great simplification they provide to help explain what would otherwise be a messy world. With these approximations in hand, one can produce strings of academic studies replete with equations and charts and all the other trappings of science. The fact that these hypotheses were fundamentally incorrect does not mean that they are useless. After all, one can live a long and profitable life laboring under the assumption that the earth is flat. Eventually, however, people wander into situations in which this flat-earth assumption breaks down and they are forced to change their assumptions.

For economists, the eye-opening moments should be the continual recessions that befall the economy. According to their theories, these things are not supposed to happen. Unfortunately, when economists’ reputations and livelihoods depend on the correctness of an assumption, the assumption becomes dogma that must be defended with religious zeal. So if economic catastrophe strikes, the explanation has to be that something has temporarily perturbed the perfect system and normalcy will return if we just wait long enough. It follows that any attempt to "help," such as government intervention, will be counterproductive and must be avoided at all costs. Thus if the government does step in and save their bacon, it can be claimed that the assistance actually delayed the inevitable. They have created an intellectual construct in which nothing can be proven, but in which everything can be explained.

Given this firm "scientific" foundation, these people looked around for another discipline that they could rescue from success. Given their belief in man as a rational actor, the legal professions seemed like ideal prey.

Lynn Stout spends a good deal of time in her book, Cultivating Conscience: How Good Laws Make Good People, describing and discussing the impact of economic thinking on the legal system. It has been wildly—and frighteningly—successful. The merger of the two disciplines is generally referred to as "law and economics."

Law and economics views humans thusly.
"’Economic Man’ does not worry about morality, ethics, or other people. He worries only about himself, calculatingly, and opportunistically pursuing the course of action that brings him the greatest material advantage."

What has this assumption led to in practice?
"In the nations law schools, students are routinely instructed in ‘law and economics,’ an approach that treats law as a kind of pricing system that requires people to pay damages for negligence or breach of contract in order to increase the ‘price’ of bad behavior."

"A generation weaned on the idea of rational selfishness has graduated from our nation’s universities and moved into leadership positions in the worlds of law, business, government, and higher education. They have brought with them an unquestioned belief in the power of material ‘incentives’ that undergirds almost every policy discussion. Are people cheating on their taxes? Increase the penalty for tax fraud. Are CEOs taking dangerous risks with their firms? ‘Incentivize’ them with deferred stock grants. Are America’s children failing to learn their ABCs? Tie teachers’ salaries to their students’ test scores."

It is easy to see why such a legal approach would take hold. It promises to take complex and uncertain issues and render them simple and quantifiable. It provides certainty where before there was intellectual churning. But nevertheless, it is based on a false premise, and it produces incentives that tend to encourage people to behave as if they actually were "economic man."

Does anyone of us actually believe that we act in the manner described by the economists? Would a family of such people survive? Would friendships survive? And most importantly of all, would a society survive? The answer to all is no!

Stout spends the first section of her book providing evidence that people are actually predisposed to "prosocial" behavior. They are willing to share and collaborate with others even if it means a lesser reward personally. This type of behavior is demonstrated universally in psychological gaming experiments, for example.

It is also consistent with evolutionary theory in which it appears humans were not the vicious, territorial beasts, "red of tooth and claw" who would gladly kill to protect territory, mates, or esteem. Humans seem to have survived the rigors of evolution by learning how to collaborate and form social attachments in order to obtain support in times of need. Why fight with a neighboring band when you can exchange gifts, breeding-age males and females, and become an extended family with social obligations?

What Stout’s study of gaming experiments showed, is that it is easy to modify a person’s social response if it appears that they are in an environment where selfish behavior is actually being encouraged or rewarded. Her fear is that laws and regulations are being created that provide incentives that undermine prosocial behavior. Given that it is prosocial behavior that holds a society together, there is reason for concern.

Consider this example provided by Stout. A school has adults who look after working parents’ children until they pick them up at the end of the day. A time for pickup is specified in hope that parents will be on time, and the caretakers can then go home and tend to their own families. The number of parents who were picking up their child late was deemed unacceptable, so a system was initiated in which a fine was levied on the parent who was late. This is good law and economics thinking. But the result was that the number of late arriving parents increased when the fine was levied. Concern for the welfare of others was a stronger source of motivation than a monetary fine. Transforming the transaction from a personal one into an economic one encouraged antisocial behavior.

One can argue that it would merely be necessary to raise the fine to a sufficient level that tardiness would be inhibited, but that entirely misses the point. Putting a monetary value on an interaction changes the very nature of the interaction. To the extent that laws, regulations, and schools encourage people to think in terms of material risk or gain for themselves, they are incentivized to think selfishly. Healthcare legislation is found to be unpopular. Providing benefits for 30 million people in great need is irrelevant if it is thought to impose a minor cost on all others. Is it any longer possible to pass legislation that requires sacrifice on the part of all? Are we becoming a nation of "economic men?" The very fabric of society seems to be coming unraveled.

Consider Tony Judt’s quote on the subject from Ill Fares the Land.
"There is nothing mysterious about this process: it was well described by Edmund Burke in his critique of the French Revolution. Any society, he wrote in Reflections on the Revolution in France, which destroys the fabric of its state, must soon be ‘disconnected into the dust and powder of individuality’....As for the dust and powder of individuality: it resembles nothing so much as Hobbes’s war of all against all, in which life for many people has once again become solitary, poor and more than a little nasty."

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