Economics is often presented as a hard science, dealing with objective truths and cold, hard numbers. But is this really the case? In "Licence to be Bad," Jonathan Aldred challenges this notion and explores how many economic concepts and theories that underpin our society are far from objective truths. Instead, they are often based on flawed assumptions and can lead to harmful consequences when applied to real-world situations.
This book takes readers on a journey through various economic ideas and theories that have gained prominence in recent decades. It examines their origins, their implications, and the ways in which they have shaped our thinking about society, markets, and human behavior. By unpacking these concepts, Aldred reveals the human element behind economic theories and shows how they are not as infallible as many economists would have us believe.
The Rise of Free-Market Economics
The Mont Pèlerin Society and the Chicago School
In 1947, just two years after the end of World War II, a small group of economists led by Friedrich Hayek gathered in Mont Pèlerin, Switzerland. This meeting marked the beginning of a movement that would eventually come to dominate economic thinking in the Western world.
At the time, the prevailing economic wisdom was represented by John Maynard Keynes, who advocated for increased public spending to stimulate economic growth in post-war Europe. However, Hayek and his followers disagreed with this approach. They believed that governments should stay out of the economy as much as possible and let the free market decide where money should be made and spent.
This group of economists would go on to form the Chicago School of economics, which provided the theoretical foundation for the free-market policies of Ronald Reagan in the United States and Margaret Thatcher in the United Kingdom during the 1980s. The ideas of the Chicago School have remained influential ever since, shaping economic policy and public discourse around the world.
The 2007 Financial Crisis and Climate Change
The impact of free-market economic thinking can be seen in how we interpret major events and challenges. For example, in the aftermath of the 2007 global financial crisis, many people blamed financial regulators and governments rather than the banks themselves. This perspective aligns with the Chicago School's belief in minimal government intervention.
Similarly, economic theory has influenced how we think about climate change. The concept of "free-rider thinking," which suggests that individual actions are insignificant in the face of global challenges, has gained traction. This pessimistic worldview, given economic legitimacy by American economist Mancur Olson in the 1960s, has contributed to inaction on climate change.
Game Theory and Its Consequences
The Prisoner's Dilemma
Game theory, a way of predicting behavior based on rational decision-making, rose to prominence in the post-war years. One of its most famous examples is the Prisoner's Dilemma, which illustrates how individual self-interest can lead to suboptimal outcomes for all parties involved.
In the Prisoner's Dilemma scenario, two criminals are arrested and held in separate cells. The police offer each prisoner a deal: if they confess and implicate their partner, they'll go free while their partner serves ten years. If both confess, they each get eight years. If neither confesses, they both get two years.
According to game theory, the rational choice for each prisoner is to confess, regardless of what the other does. However, this leads to a worse outcome (eight years each) than if they had both stayed silent (two years each). This paradox illustrates how individual rationality can lead to collective irrationality.
The Selfish Worldview
Game theory, particularly as developed by John Nash, emphasizes the role of self-interest in decision-making. Nash believed that people always act selfishly, and any apparent cooperation is merely a temporary alignment of self-interests.
This perspective has had far-reaching consequences. By assuming that others are always acting selfishly, people are more likely to act selfishly themselves, creating a self-fulfilling prophecy. This has led to a more cynical view of human nature and social interactions.
However, real-world examples often contradict this purely selfish model. International cooperation on issues like carbon emissions and nuclear disarmament shows that humans are capable of collaborating for the greater good, even when it may not be in their immediate self-interest.
The Coase Theorem and Its Misinterpretations
Ronald Coase's Original Insight
Ronald Coase, a British economist, made an important observation about how economic actors might resolve conflicts. He used the example of two farmers: one whose cows eat the other's crops. Coase noted that the farmers would weigh the cost of damage against the cost of putting up a fence, making a decision based on economic efficiency rather than legal rights.
Coase's key point was that transaction costs – the time, effort, and money spent on negotiating and enforcing agreements – affect decision-making. He argued that in a world without transaction costs, the initial distribution of legal rights wouldn't matter for economic efficiency, as parties would bargain to the most efficient outcome.
Misinterpretation and Consequences
However, Coase's ideas were often misinterpreted, particularly by the Chicago School economists. They took Coase's theorem to mean that transaction costs should be minimized, leading to less government intervention and more emphasis on private dealmaking.
This misinterpretation has led to some questionable policy decisions. For example, in 1983, Illinois implemented a scheme to reduce unemployment by offering employers a $500 reward for hiring and retaining unemployed individuals. This attempt to encourage simple dealmaking along Coasean lines largely failed, with many employers and potential employees feeling uncomfortable with the arrangement.
The influence of the Coase Theorem can also be seen in the development of carbon markets, where countries and companies can buy and sell rights to emit carbon. While intended to create an efficient market solution to pollution, this system often encourages short-term thinking and downplays the actual environmental damage caused by emissions.
Public Choice Theory and Its Impact on Government Perception
James M. Buchanan's Public Choice Theory
In the 1970s, American economist James M. Buchanan developed public choice theory, which applies economic thinking to political decision-making. The core idea of public choice theory is that everyone in politics – politicians, civil servants, and even voters – acts primarily out of self-interest.
According to this theory, political decisions are not made based on what's best for society as a whole, but rather on what benefits the decision-makers personally. For example, politicians are seen as motivated mainly by their desire to get re-elected rather than to serve the public good.
Consequences of Public Choice Theory
Public choice theory has had a significant impact on how we view government and politics. It has contributed to the widespread belief that there's too much government regulation and that voters are poorly informed and focused on short-term gains.
However, this theory contains several contradictions. For instance, while it claims that voters are easily fooled, it also inspired Ronald Reagan's successful presidential campaign on a platform of reducing public spending – suggesting that voters can indeed make decisions based on long-term considerations.
Moreover, public choice theory can become a self-fulfilling prophecy. When public sector workers are told that everyone acts selfishly, they're more likely to adopt such behavior themselves. The same goes for voters and politicians. This demonstrates how economic theories can shape behavior rather than merely describing it.
Free-Rider Thinking and Its Devastating Consequences
The Origins and Spread of Free-Rider Thinking
Free-rider thinking is the idea that individual contributions to collective efforts are insignificant and therefore not worth making. While this concept has ancient roots, it was revived in the 20th century by economist Mancur Olson.
Olson argued that in large groups, rational individuals would choose to "free ride" on the efforts of others rather than contribute themselves. He used the example of a single person trying to hold back a flood with a bucket – an effort that's not just ineffective but not even praiseworthy.
The Impact of Free-Rider Thinking
This way of thinking has had far-reaching consequences in various areas of modern life:
Tax Evasion: Since the 1980s, it's become increasingly common for corporations to aggressively minimize their tax bills, exploiting every possible loophole. The justification often given is that there's no point in paying more tax if competitors are paying less.
Climate Change: Many individuals argue that their personal efforts to reduce carbon emissions are insignificant compared to what big businesses and governments could achieve. This leads to inaction and a sense of helplessness in the face of a global crisis.
Civic Engagement: Free-rider thinking can discourage people from participating in community efforts or political processes, as they may feel their individual contribution won't make a difference.
However, this perspective overlooks the power of collective action. When many individuals contribute, it can lead to significant changes and even inspire broader action. The author argues that we should move away from free-rider thinking and recognize the importance of individual contributions to collective efforts.
The Expansion of Economic Thinking into Everyday Life
Gary Becker's Economic Approach to Human Behavior
Since the 1980s, there's been a movement to apply economic thinking to a wide range of social and personal issues beyond traditional economic concerns. This approach was pioneered by American economist Gary Becker, who sought to explain various aspects of human behavior through an economic lens.
Becker's ideas have had a profound impact on how we view many aspects of life:
Immigration: Becker suggested that immigration should be decided based on wealth, an idea that was initially controversial but has since been adopted in various forms by many countries, including the U.S. and several European nations.
Criminal Justice: In the 1970s and 80s, Becker argued that longer prison sentences would deter crime and allow for reduced spending on law enforcement. However, this approach failed when implemented, as crime rates actually increased with fewer officers on the streets.
Personal Choices: Becker attempted to explain seemingly irrational behaviors, like smoking, through economic reasoning. He argued that smokers were making a conscious choice to trade longevity for the pleasure of smoking.
Family Life: Becker provided economic explanations for traditional family structures, arguing that a division of labor between a working husband and a housewife was the most efficient arrangement.
The Limitations of Economic Reasoning in Personal Life
While Becker's ideas have been influential, they also demonstrate the limitations of applying strict economic reasoning to all aspects of life. Viewing the world solely through the lens of economic rationality can lead to oversimplification of complex human behaviors and motivations.
The popularity of books like "Freakonomics," which applies economic reasoning to various scenarios, shows the ongoing influence of this approach. However, the author argues that seeing everything through the cold, rational eyes of homo economicus (the idealized rational economic actor) is not a healthy or accurate way to understand human behavior and society.
The Complexities of Incentives and Human Motivation
Unexpected Responses to Incentives
Economic theory often assumes that people will respond rationally to incentives, particularly financial ones. However, real-world examples show that human behavior is far more complex:
The Haifa Day Care Centers: When several day care centers in Haifa, Israel, introduced fines for parents who were late picking up their children, the number of late pickups actually increased. Parents viewed the fine as a fee they could choose to pay, which reduced their guilt about being late.
UK Plastic Bag Tax: In contrast, when the UK government introduced a small charge for single-use plastic bags, usage fell by 80%. The success of this initiative was largely due to the accompanying public awareness campaign that explained the environmental reasons behind the charge.
The Importance of Messaging and Non-Financial Motivations
These examples highlight the crucial role of messaging and non-financial motivations in shaping behavior. People don't always respond to incentives in the way economists expect because their decisions are influenced by a complex mix of factors, including social norms, personal values, and how the incentive is presented.
Richard Titmuss's study on blood donation, described in his 1970 book "The Gift Relationship," provides another compelling example. When some U.S. states experimented with paying people for blood donations, the quality of donated blood decreased, and some regular donors stopped giving altogether. For many people, the act of donating blood was motivated by altruism rather than financial gain.
Ethical Considerations of Incentives
The author also raises important ethical questions about the use of incentives:
Moral Boundaries: Some incentives, such as bribing a judge, are clearly immoral and undermine the integrity of important social institutions.
Coercion vs. Incentivization: Under extreme circumstances, such as the offer of an enormous sum of money or the threat of torture, people might be forced into actions they would never normally consider. This raises the question of whether such extreme "incentives" are actually forms of coercion rather than free choice.
The Limits of Choice: As philosopher Isaiah Berlin pointed out, the mere existence of alternatives doesn't necessarily make an action free. Context and circumstances play a crucial role in determining the true freedom of choice.
The Flaws in Probability Models and Risk Assessment
The Limitations of Normal Distribution
Many economic and financial models rely on the normal distribution (the bell curve) to calculate probabilities. However, real-world events often don't follow this pattern, leading to severe underestimation of the likelihood of extreme events.
This became glaringly apparent during the 2007 financial crisis. David Viniar, then CFO of Goldman Sachs, described market events as "25-standard deviation moves" happening "several days in a row." According to normal distribution models, such events should occur less than once in the history of the universe. The fact that they were happening repeatedly indicates a fundamental flaw in the models.
Fractal Distributions and Scale Invariance
The stock market, like many natural phenomena, follows a fractal distribution rather than a normal distribution. Fractal distributions are scale-invariant, meaning they show similar patterns whether you zoom in or out.
In a fractal distribution, the likelihood of extreme events falls more gradually than in a normal distribution. This means that while events like financial crashes are still unlikely, they're not so rare that they can be completely discounted.
The Challenges of Calculating Probabilities
Calculating probabilities using fractal distributions requires a large amount of data, which is often not available for rare events like financial crashes. This highlights a broader truth about probability: some things are truly uncertain, and we need to be more honest about the limits of our ability to predict them.
Implications for Climate Change Modeling
The author draws a parallel to climate change projections, which often rely on problematic assumptions and vague, broad estimates. Many models assume that the lives of future generations are worth less than our lives today, a questionable ethical stance that significantly impacts the calculations.
The author argues that we need to be more upfront about the limitations of probability models, especially when dealing with complex, long-term issues like climate change. Sometimes, admitting that there are things we don't know is more valuable than providing false certainty.
The Problem of Inequality and Economic Justifications
The Fractal Nature of Inequality
Inequality in modern societies follows a fractal distribution, similar to the stock market and other complex systems. This means that the pattern of inequality is similar at different scales. For example, if the richest 1% of a population receives 20% of the total income, then within that top 1%, the richest 1% (i.e., the top 0.01% overall) will receive about 20% of the income going to the top 1%.
The Myth of Inevitable Inequality
While some degree of inequality might be unavoidable, the extreme levels seen in countries like the US and UK are not inevitable. Since the 1980s, inequality has risen dramatically in these countries, which have introduced economic policies favoring free markets. Other countries that haven't followed this path haven't seen the same increase in inequality, demonstrating that policy choices can significantly impact wealth distribution.
Questioning Extreme Wealth
The author challenges the common belief that people deserve whatever wealth they accumulate. Using Bill Gates as an example, he points out that while Gates is undoubtedly talented and hardworking, his extreme wealth is also the result of privileged circumstances and building on the work of others. Yet, the financial success of individuals like Gates far outstrips that of others who may have contributed just as much to technological progress.
The Fallacy of Low Tax Rates
One way that modern economics tolerates and even encourages inequality is through relatively low top tax rates, especially in the US. The argument often given is that high taxes discourage economic activity. However, the author points out the flaws in this reasoning:
Motivation: Would you really work harder if your taxes were lower? If anything, a tax cut might make you relax, as you'd get more money for the same amount of work.
Public Services: Taxes fund vital public services. The drive to minimize taxes often overlooks the societal benefits that tax revenue provides.
Historical Perspective: Under President Eisenhower in the 1950s, the top tax rate in the US was 91%, far higher than today's rates. This period saw significant economic growth, challenging the idea that high tax rates necessarily stifle the economy.
The Dangers of Economic "Facts"
The author argues that many economic theories presented as objective facts are actually value judgments, often dangerous ones. The idea that lower taxes motivate people is just one example of flawed reasoning behind many modern economic theories.
These theories rarely reflect how people truly behave. By pretending that they do, we risk creating policies and social norms that are detrimental to society as a whole. The author suggests that we should pay less attention to economists who present their opinions as facts and instead celebrate the complexity and diversity of human behavior and motivations.
Final Thoughts: The Need for a New Economic Perspective
Moving Beyond Homo Economicus
Throughout "Licence to be Bad," Jonathan Aldred has demonstrated how various economic theories and concepts have shaped our thinking about society, markets, and human behavior. From game theory to public choice theory, from the Coase Theorem to free-rider thinking, these ideas have often led to a cynical, overly simplistic view of human nature and social interactions.
The author argues that it's time to move beyond the notion of homo economicus – the idealized, purely rational, and self-interested economic actor. Real human beings are far more complex, driven by a wide range of motivations including altruism, social norms, and personal values, not just narrow self-interest.
Recognizing the Limits of Economic Theory
One of the key takeaways from the book is the importance of recognizing the limitations of economic theories. While these theories can provide useful insights, they should not be treated as infallible laws of nature. Many economic "truths" are actually based on questionable assumptions and value judgments.
The author encourages readers to be more critical of economic claims, especially when they're presented as objective facts. We should be willing to question the underlying assumptions and consider the broader implications of economic policies and ideas.
Embracing Complexity and Uncertainty
Another important theme is the need to embrace complexity and uncertainty. The world is not as predictable or easily modeled as many economic theories suggest. From the limitations of probability models to the unexpected ways people respond to incentives, real-world behavior often defies simple economic explanations.
Instead of trying to force reality into oversimplified models, we should be more comfortable with admitting what we don't know. This is particularly crucial when dealing with complex, long-term challenges like climate change.
Rethinking Our Approach to Inequality
The book also highlights the need to rethink our approach to economic inequality. The extreme levels of inequality seen in many countries today are not inevitable outcomes of a free market, but rather the result of specific policy choices. By questioning the economic justifications for such inequality and recognizing the societal benefits of more equitable wealth distribution, we can work towards creating fairer economic systems.
The Power of Individual and Collective Action
Finally, the author emphasizes the importance of moving away from free-rider thinking and recognizing the power of individual and collective action. While it's easy to feel that our individual efforts don't matter in the face of global challenges, the cumulative effect of many people taking action can lead to significant change.
By rejecting the cynical view that everyone acts only out of self-interest, we can foster a more cooperative, socially responsible approach to addressing societal issues.
In conclusion, "Licence to be Bad" serves as a wake-up call, urging us to critically examine the economic ideas that have shaped our world. By recognizing the human element behind economic theories and embracing a more nuanced understanding of human behavior, we can work towards creating economic systems and policies that better serve society as a whole. It's time to revoke the "licence to be bad" that many economic theories have granted, and instead strive for an economics that recognizes and nurtures the best aspects of human nature.