The Economic Naturalist’s Field Guide: Common Sense Principles for Troubled Times
Economics attempts to understand how societies solve a very basic problem. Because our resources are limited, people cannot have everything that they desire. Given that reality, how do we decide what to produce, how to produce it, and how to distribute the output? Economics strives to understand how societies and individuals make choices about how to allocate their scarce resources over the nearly unlimited wants of individuals within the society.
The Economic Naturalist’s Field Guide, written by Robert Frank of Cornell University, a well-regarded economist, author, and New York Times columnist with a knack for asking interesting questions, argues persuasively that traditional economic models do not properly capture the choices that people make in many common situations. One of the main points of the book — a series of columns from the New York Times and elsewhere spliced together almost seamlessly into a series of thematic chapters — is that social context matters when people make decisions. This is a very basic and important insight, but it’s also one that the economics profession has largely ignored. To use an example from the book, if someone is interviewing for a job, it may be in their best interest to buy clothes that are better quality than average to improve their chances of success. But if everybody does this, nobody gains an advantage over anyone else, all that happens is that everyone spends more money on clothes than before leaving them all less to spend on things they might enjoy more. Thus, they are all worse off.
Why is this important? In traditional economic models, people are assumed to maximize their self-interest, and the market process regulates this behavior in a way that results in the best possible outcome for society as a whole. This is the idea of the invisible hand. However, as this example shows, this result does not hold when the social context surrounding choices is important.
Notice too that this can lead to an “arms race.” If others do something, and it gives them an advantage, you must do it too just to stay even. And as the examples in the book make clear, this can explain why we have been living in larger and larger houses, working longer and longer hours, buying bigger and bigger cars, even why financial firms take on too much risk.
Can this arms race be stopped? The answer is yes, the key is to regulate behavior in a way that stops the relative status leap-frogging that drives everyone to a suboptimal outcome, and there are many examples in the book illustrating how this can be accomplished.
The book’s explanation of how traditional economic models come up short does not stop there. Traditional economic models assume that people make rational choices as they pursue their self interest. That is, the model assumes people implement the best strategy they can come up with to maximize their own happiness. But there are two things wrong with this. People do not always behave rationally, and they do not always exhibit self-interested behavior.
This observation, coupled with what we have learned from new research in behavioral economics allows us to explain things that traditional economic models have trouble with. For example, behavioral economics tells us that people tend to overvalue immediate benefits and undervalue future costs, and that this can cause them to make irrational decisions. They consume too much and save too little for retirement, they drop health insurance on the belief that it won’t happen to them, and they make other choices that do not take sufficient account of problems they might encounter in the future. The traditional model says these behaviors shouldn’t exist, and hence it is not very helpful in formulating policies that help people attain the levels of insurance, saving, environmental protection, and so on that they need.
The same is true for self-interest, the traditional model says that behavior inconsistent with a narrow interpretation of self-interest shouldn’t exist, yet we donate anonymously to causes to help people we will never meet, and we make other sacrifices of various sorts to help people with no expectation of personal gain. If we want to fully understand the choices people make, our model of human motivation must be richer than the behavior assumed in standard economic models, and the book gives many interesting examples of how this might be accomplished.
I fear, at this point, that I have not done the book justice. It is a very well written, non-technical, and easy to understand presentation of important economic concepts. Reading it will definitely give great insight into how economists think and how, in some cases, their models have led them astray.
And I haven’t even gotten to one of the best features of the book, the many, many interesting questions used to illustrate important economic concepts, questions such as:
Do tax cuts really help the rich?
Are ethical people at a disadvantage?
Does money makes us happy?
Did greed on Wall Street cause the recession?
Why do we need mandatory headgear rules in sports?
Can anti-government crusades make us poorer?
Was Milton Friedman really a bleeding heart?
Why are economics teachers so bad?
Why is herding behavior in humans important?
Why has inequality been growing?
What are “winner take all markets” and why they are important?
Does competition eliminate discrimination?
Should people who borrowed too much during the housing boom be given a break?
I hope we can get to at least some of these questions during the discussion.
Economists have been under fire recently for failing to predict the breakdown in the financial system and the subsequent recession. For anyone interested in understanding some of the ways in which traditional economic models have failed, this book is a great place to start.