Ideology and Rationality: An Irrational Relationship

Ezra Klein has a great interview up with Robert Shiller today, who was just awarded the Nobel Prize for his work on the inefficiencies of financial markets and valuation.  The whole thing is good, but there’s this wonderful quote in particular:

When I look around, I see a great deal of foolishness, and I can’t believe it’s not important economically.

Shiller is referencing Larry Summer’s famously brusque maxim:

“THERE ARE IDIOTS. Look around.”

The point of this is to rebuke the idea that markets are “efficient”.  The word “efficient” is tossed around a lot in popular discussion, but it has a specific meaning here, which is the Efficient Market Hypothesis.  This is the idea that the price of a financial asset accurately reflects the best possible guess at the discounted future value of the asset.  In weak form, it encompasses all publicly available information – in the strong form, it encompasses all information (in other words, assume that insider trading is rampant and informative).  The upshot of this is that one cannot consistently achieve “alpha”, which is an edge over the market as a whole.  It has turned out to be true enough to be a very useful guide for investors (avoid active investing!) and false enough to be a very poor guide for policymakers (bubbles are impossible).

In the United States in 2013, these opposing views have clear ideological flavors.  The focus on people’s irrationality is strongly entrenched on the left wing, whereas the focus on people’s ability to make rational self-interested decisions is integral to right-wing policy.  For example, Bush’s Social Security privatization initiative hinged on the idea that individual investors would be able to manage their portfolios better than the central managers of the Social Security trust fund…and liberal opposition was focused on disputing that exact point (as well as the benefit cuts, but that’s beside the point).

This ideological valence isn’t inherent to the nature of leftism and rightism.  Early liberals (think Adam Smith, not Karl Marx) were very focused on man’s often-irrational behaviors. the root of their emphasis on constitutionalism and rule of law.  As Madison wrote, “If men were angels we should have no need of government”.  And Marx built his entire model of society based on the concept that people were rational maximizing economic agents and thus there exist immutable economic “laws of motion”.  20th-century leftism was absolutely fixated on the idea that people’s behavior was comprehensible (read James Scott’s Seeing Like a State sometime, it’s focused on this very question).

The question of whether people’s behavior is rational or not is very frequently a key dividing question between left and right…but the position of both on the question is not stable and never has been!

About these ads

Tags: , , , , , , , , ,

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

Follow

Get every new post delivered to your Inbox.

Join 123 other followers

%d bloggers like this: