Re: People who think that "rational economic man" is sociopathic might find this a bit humorous

[Julio Huato <juliohuato@xxxxxxxxx>]

Jim,

> Economists play a bait and switch game.

Totally agree.  Only Marxists stick to our definitions and assumptions
with absolute consistency, even if needs and circumstances change.  On
the other hand, we don't like to play golf.

> sure, people have conscious purposes, but that's very different from
> the neoclassical conception, in which those purposes are typically
> seen as individualistic and almost always seen as arising somehow from
> outside of society (dropping from the sky or determined by genes).

Jokes apart, I'll repeat this: there is no point in criticizing a
theory by simply opposing a more complex premise to the simpler one on
which the theory is based.  The assumption of "rational" individuals
is neither necessary, nor sufficient to characterize their method. 
Standard economic theorists are *not* committed to a single and fixed
definition of "rationality."  Why would they?  Their specific
definition of rationality is contingent upon the problem they're
addressing and their ability to derive clear (testable) conclusions
from it.

Other things equal, standard economic theorists prefer to base their
reasoning on assumptions that are more -- rather than less --
"realistic."  For the most part, their choice of definition is a
compromise that trades off "realism" for analytical tractability or
vice versa.  If they can get away with more complex definitions of
rationality and still get clear results, they'll tend to use them.

We need to understand the role of behavioral economics in today's
economics.  Behavioralism doesn't substitute the results of standard
theory.  Not for the time being.  To the extent the patterns
established in those experiments can be formalized, they will only
modify the abstract results of the standard theory.  Or -- to put it
in more Hegelian terms -- they will only "transfigure" or "transform"
those results.

We may not like the analogy, but this is not very different from
saying: "Assume all production industries have an average capital
composition.  Then, the production prices are equal to the direct
prices and the gross profits are the surplus exchange values. 
However, in reality, only by chance will an industry's capital
composition coincide with the average.  Then, production prices
systematically deviate from the direct prices and the gross profits
from the surplus exchange values."

In behavioral finance, this is clear.  The argument (say, Shiller's)
is that the results derived from nonarbitrage or equilibrium arguments
are not consistent with observable patterns.  *Still* the benchmark
continues to be general equilibria!  All behavioral finance does is
show that there are a host of "heuristics" (anchoring, affect, etc.)
"biases" (overconfidence, excessive optimism, etc.), and "framing
effects" (loss aversion, aversion to sure loss, etc.) that account for
systematic deviations from market efficiency, mean-variance optimal
portfolio, Modigliani-Miller's equity-debt irrelevance, Coase's
irrelevance of ownership rights allocation, etc. -- in a phrase:
general equilibria!

The behavioral finance argument is not that -- say -- maximization of
the expected NPV is useless, but that there are systematic reasons why
the observed behavior of individuals deviates from NPV maximization. 
The normative part of the story is that people *should* use certain
tricks to correct as much as possible the distortions introduced by
their emotions, genetic predisposition, etc. and get closer to
maximizing the NPV of their assets.  Were not for these distortions
(and others, such as agency costs, taxation, informational
asymmetries, etc.), general equilibrium would be an apt description of
reality.

There are precedents in the history of economics.  Just as an example,
Vernon Smith's famous market experiment, reported in his 1962 JPE
paper, showed that with private and imperfect information regular
folks could generate prices leading to Pareto efficiency and all that.
 In a sense, Smith's experiment seemed to provide an argument in favor
of free markets stronger than Arrow and Debreu's.  Yet nobody thought
of discarding general equilibrium.  GE remained as the gold standard
in theory.  Why?  Forget the fact that experiments with small groups
may not be relevant to the behavior of entire societies.  The fact is
that social and economic experiments, no matter how "controlled" they
may seem, always leave us uneasy about *causes*.  We never know where
chance or measurement problems may sneak in, because the precise
causal mechanism is in a black box.  Abstract deduction has its
drawbacks, but in deductive structures conclusions can be established
mathematically or logically.  And math (which nowadays effectively
contains logic as a subset) -- as E. Wigner put it -- is "unreasonably
effective in science," not to mention industry.

The reason why behavioral economics is rising as of late is not only
because it is demonstrating that, carefully looked at, the predictions
of the theory deviate from observable facts, but *mainly* because it
has been able to show that those deviations are systematic -- hence,
amenable to theoretical formalization.  This much is clear if we make
an attempt to look at the evolution of theoretical economics as a
whole.

Julio

PS: Ted's summary of Keynes' views on capitalism is excellent.  May I
just add that, in the Keynesian long run, the economic problem will be
solved, detestable money making will be superseded, but also -- why
bother -- "we will all be dead."







> The basic idea concerning human choice _is_ tautological: people do
> what they want to do. (How can you tell what someone's preferences
> are? simple, revealed preference, i.e., what they do.)

Two things are mixed up here:  In theory, the preferences are simply
assumed.  They're axiomatic.  On the other hand, the point of revealed
preferences is to *integrate* -- i.e., to infer from given shocks,
say, a demand curve or consumer surplus or whatever.  And *that* is an
*empirical* exercise. The problem with revealed preferences is *the
inductive leap*, but that problem is common to all inductive
reasoning, which is to say, to all empirical work!!