Error is Obvious, Coordination is the Puzzle

|Peter Boettke|

That is the title of a new working paper with Adam Martin and Zachary Caceres.  

Behavioral economics has made its mark by bringing under intense scrutiny the limitations of individuals’ cognitive abilities. The conclusions of such inquiries call into question results from standard economic modeling dependent on assumptions of strong epistemic rationality. Most conspicuously, behavioral economists have introduced a host of new potential causes for market failures. F. A. Hayek likewise famously questioned the cognitive abilities of real world actors, but drew radically different conclusions. We argue that, for Hayek, market institutions rather than individual agents bear the primary cognitive burden in coordinating economic activity. Gaps in individual rationality thus fail to provide adequate grounds for positing market failures. Vernon Smith’s body of work, with its distinction between ecological and constructivist rationality, provides powerful support for the Hayekian position on which it draws its inspiration.

Comments

[Jerry O'Driscoll]

This is surely the central issue of the social sciences. To paraphrase Hayek, before we can explain why people commit mistakes we must explain how they could ever be right.

Hayek's answer had little to do with the "rationality" of individuals, but with the operation of institutions. This distinction touches on many, many of the issues debated here. I'd include Pete's recent posting on market monetarism and Steve's on ABCT.

Too often the debates are fruitless because there is no common understanding of the question at hand. On monetarism, the discussion went off on which rule is optimal. The question posed by both Friedman and Hayek concerned institutions and the incentives they generate.

Hayek's critique of central bankers was not that they made mistakes. It was that they inherently lacked the information needed to set interest rates at levels consistent with intertemporal plan coordination. The critique was not about interest rates, but information.

[Pietro M.]

It is impressive that cognitive biases are considered causes of market failures, when they are more likely to be causes of democratic failures. In fact there are complexity-reducing institutions on the market, but voters are usually as dumb as a monkey when it comes to understand policies.

I think that the only explanation for this evident double standard is that the democratic myth is the religion of our age, and it cannot be critically discussed without being considered somewhat of a jerk.

That is why liberal propagandists such as Amartya Sen have never wanted to take public choice issue seriously (not to mention Hayek's theory of institutions). A realistic institutional analysis would push liberal constructivism into a corner.

[McKinney]

Very interesting paper. I like the Chesterton analogy.

“The hyper-rational models that behavioral economists love to critique are, in fact, the “intellectual heirs” of Lange and Lerner’s models of central planning (De Grauwe 2010).”

That explains a whole lot!

It appears that neoclassical econ has gotten away from subjectivity by trying to formulate an objective definition of welfare.

If efficiency required that no one was made worse off, there would be no progress. Progress always makes someone worse off at least in the short run. Learning requires making mistakes that are painful enough to make sure we avoid them next time.

Hayek: “…the very cast of thinking of the great entrepreneurs would not exist but for the environment in which they develop their gifts.”

That statement reminds of what Andrei Shleifer wrote about not being able to teach the old communist dogs new tricks.

[Troy Camplin]

Indeed, every technological improvement is going to make those whose technology is being replaced worse off -- but at the benefit of many, many, many more people.

It's about tradeoffs.

[Greg Ransom]

Jerry wrote,

"often the debates are fruitless because there is no common understanding of the question at hand"

Kuhn pointed out that this frequently happens in science -- when folks are groping to articulate radically different deep explanatory paradigms, e.g. radically different theory-laden perceptions and problem / explanation structures, intuitions, and exemplars.

[Rafe Champion]

This book looks relevant, fairly hot off the press, found by accident (checking the Popper Web)

http://networkedblogs.com/tYYj4

Blurb.

It’s often claimed that some people—fundamentalists or fanatics—are indeed sealed off from rational criticism. And every month new pop psychology books appear, describing the dumb ways ordinary people make decisions, as revealed by psychological experiments. The conclusion is that all or most people are fundamentally irrational.

Ray Scott Percival sets out to demolish the whole notion of the closed mind and of human irrationality. There is a difference between making mistakes and being irrational. Though humans are prone to mistakes, they remain rational. In fact, making mistakes is a sign of rationality: a totally non-rational entity could not make a mistake.

Rationality does not mean absence of error; it means the possibility of correcting error in the light of criticism. In this sense, all human beliefs are rational: they are all vulnerable to being abandoned when shown to be faulty.

[Josh S]

When you think of the market as a constant process of discovery, adjustment, coordination, and correction, I'm not sure the term "market failure" even means anything.