Sunday, May 26, 2019

"Review Essay: Phishing for Phools: The Economics of Manipulation and Deception by George A. Akerlof and Robert J. Shiller"

The book itself seems a bit lightweight, especially considering both the authors have that Nobel hardware to hang around their necks.
The review essay starts out as off-putting (the Austrians can be like that) but then gets into some interesting observations.
For the record we aren't as enthusiastic about Akerlof as we are re: Professor Shiller.

Professor Akerlof's 'Lemons' paper is fascinating, here's the version hosted at MIT (14 page PDF) but for market practitioners a lot of his other stuff just isn't actionable.

On the other hand, like Ricardo, Doc Shiller understands the game well enough to be able to make accurate predictions, and though his predictions aren't of the same magnitude of insight as say, Mendeleev, who forecast the chemical and physical properties of elements that hadn't yet been discovered, Shiller's thinking has been of great use to market professionals.

Plus he is the keeper of the Cowles Foundation records at Yale which makes him jake in my book.


Review essay
Phishing for Phools: The economics of manipulation and deception
George A. Akerlof and Robert J. Shiller 
Princeton, N.J.: Princeton University Press, 2015, 272 PP. T

This book tells its readers a great deal about the inner workings of mainstream economics, particularly behavioral economics. This review details just how far the profession has drifted from reality. My general impression is that the authors are simply putting forth their opinions or perceptions of how the world should be, and then constructing a theory to justify those opinions. The theory is then supported by a selective construction of events.

The authors are both Nobel laureates and in 2009 wrote Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism. Here they argued that because of emotions and psychology, the government’s response to the financial crisis must be decisive and overwhelming. The government’s response, particularly the Federal Reserve’s, gives the impression that the book was influential among policymakers.

George Akerlof, a retired Berkley professor, was trained at Yale and MIT. He was awarded the Nobel Prize in 2001 for his paper, “The Market for Lemons: Quality Uncertainty and the Market Mechanism.” Akerlof was also the President of the Federal Reserve Bank of San Francisco and Chair of the President’s Council of Economic Advisors during the Clinton Administration. He is also the husband of Janet Yellen, the current Chair of the Federal Reserve.

Robert Shiller, a Yale professor who also earned his PhD at MIT, was awarded the Nobel Prize in 2013 for his empirical analysis of asset prices. He is noteworthy as a contributor to the development of behavioral finance and as an opponent of the efficient market hypothesis. Unlike most mainstream economists, Shiller has made several correct forecasts of economic bubbles, including the dotcom bubble and the housing bubble. 

Their general theory of markets involves a three step process. First, they begin with the notion that the free market is great at producing goods and services and rising standards of living. The coauthors claim to be “admirers of the free market system” (p. vii). The problem with this foundational assumption is that they think it applies to the real world. 

To the contrary, the US and other leading economies of the world are not true free market economies in any sense. The US economy is riddled with high and distortive taxes, large and often hidden subsidies, price controls, and multiple, often overlapping regu-latory agencies, to name just a few interventions. Government-granted monopolies permeate much of the US economy, and the US government has created pervasive moral hazards that distort our decision making. Thus, the current US economy is highly distorted and somewhat unstable because all of these interventions are subject to change. For example, no one would argue that farming would be exactly the same as farming without any government interventions in farming and related industries. 

Also, the U.S. interventionist state apparatus did not just recently materialize, but has been around for a very long time. That means  there is a long history of intervention; including irregular cycles of wars, inflations, tax reforms, public enterprises and monopolies, to name a few. Therefore, the current economy is not only a product of current conditions, but is also influenced by a history of interventions. An example of the effects of interventionism would be that children who grew up during the Great Depression are systematically more frugal and more likely to be “pack rats.” Another example is the lifelong negative psychological, physical, and economic consequences that soldiers often experience after working in traumatic wartime conditions. It would be hard to argue that these two features of reality can be easily ignored, but such features of policy and historical context are ignored throughout the book. This ignorance is the basis of many of the authors’ errors.  

The second step in their general theory of markets is the notion that markets have systemic problems of trickery. In most instances people trade in such a way that both parties benefit, but the authors argue that there are many cases where competition creates problems. These problems typically consist of instances where someone is sold something they didn’t want, or need, or that the authors have concluded they should not want. This type of problem is spawned by the nature of the “free market” economic system:
Many of our problems come from the nature of the economic system itself. If business people behave in the purely selfish and self-serving way that economic theory assumes, our free-market system tends to spawn manipulation and deception. The problem is not that there are a lot of evil people. Most people play by the rules and are just trying to make a good living. But, inevitably, the competitive pressure for businessmen to practice deception and manipulation in free markets lead [sic] us to buy, and to pay too much for, products that we do not need; to work at jobs that give us little sense of purpose; and to wonder why our lives have gone amiss (p. vii, emphasis added).
The third step in their general theory of markets is that when some deception or manipulation is established, it becomes embedded in the market. Market competition cannot overcome such problems. In the authors’ words, free market competition results in a “phishing equilibrium.” For example, the authors believe that cat owners who buy cans of cat food named “roast beef pâté” are caught in a phishing equilibrium. In other words, when a phishing for phools situation is established, it continues to exist, until perhaps government intervention is introduced to stop it. It would seem that the authors have been confined throughout their careers inside the ivory tower without access to the Internet. In contrast to the authors, everyone knows that there is some manipulation, deception, and trickery in the economy, whether it is fraud or the ordinary kind. Cat owners need not taste for the authenticity of the cat food manufacturers claims. Fluffy can render her own verdict. 

The economic questions are 1. What causes this behavior and 2. What tends to control or diminish this type of behavior? The first question will be a focus of much of this review....
....MUCH MORE (16 page PDF)