The Science Of Human Nature Is Proving Classical Economics False. What Comes Next?

In a previous post, I wrote about the emerging view of human nature as fundamentally cooperative and group-oriented rather than simply self-interested as most conservatives believe.  I noted that this paradigm shift has important implications for progressives in a political sense.  We should not shy away from appeals to cooperative instincts and the common good because they are “fuzzy” and “soft”.  Instead they should be front and center because they touch something deep within our basic nature.

But that’s not all the implications of these new findings.  There are also very important implications for economic policy.  Start with middle class economics.  This school of thought, associated with progressive economists like Robert Reich, Joseph Stiglitz, Paul Krugman and progressive institutions like (ahem) the Center for American Progress, ties progressive policy proposals directly to the interests and capabilities of the middle class. Since the middle class as a group embraces a huge swathe of American society, this is a very promising framework for a group-oriented appeal.

The new theory of human nature also casts considerable doubt on the standard model of economics, based around neoclassical assumptions that people are solely motivated by self-interested concerns.  As we have just seen, they aren’t, which poses a rather fundamental problem for mainstream economics.  The problem deepens when the other key part of the standard economic model is recalled: people rationally, efficiently and effectively pursue that self-interest at all times, carefully calculating probabilities and assessing costs and benefits so they can get the best possible deal for themselves—like a sort of self-interested Mr. Spock.  People aren’t like that either, as the evolving science of behavioral economics has clearly established.

Behavioral economics has found, based on observation of actual people making decisions, that people don’t understand probability, under- and over-estimate risk, respond heavily to how choices are framed and generally fail, in a wide variety of contexts, to “rationally” pursue their goals.  These results, now widely accepted even within mainstream economics, have been well-summarized by Cass Sustein and Richard Thaler in their book Nudge and by Daniel Kahneman in his book Thinking Fast and Slow.

So we’re not purely self-interested and we do a spotty job of pursuing that self-interest when we try.  What does this say about standard models of the economy based on aggregating the assumed efficient, self-interested actions of millions and “proving” that everything works out for the best if those efficient, self-interested individuals are left alone?  Nothing good.

And indeed nothing good has come out of applying that model for three decades.  There has been no growth boom and no rapid rise in living standards.  In fact, both overall economic growth and, especially, living standards growth have been relatively slow by historical standards.  And instead of unleashing a frenzy of creative solutions to long-standing economic problems, deregulated economies have just made most of them worse: more speculative bubbles; more risky investments; more inequality; more unemployment; more bad jobs; and so on.  Finally, risky economic behavior got completely out of control and the resulting financial meltdown sent the economy into the biggest nose-dive since the Great Depression.

It’s fair to say the mainstream economic model now lies in ruins.  Its core assumptions have been tested and found wanting.  Unleashing purely rational, purely self-interested individuals to do whatever they want has proved to be a recipe for stagnation at best and utter disaster at worst.  And the reason is simple: these individuals don’t exist and never will.  Therefore, the market will never work as the current standard economic model says it should.  Instead, an effective economics should accept the preferences and inclinations of actually-existing people and reject the limits that imaginary perfect markets supposedly put on economic objectives.

These points have been made and made forcefully by very prominent progressive economists like Krugman, Stiglitz, George Akerlof and Robert Shiller among many others.   But, as noted recently by economic journalist John Cassidy, we have yet to see the emergence of a “new Keynes” with a positive theory of how the economy works that can replace the standard model.  That is not to say there are not at least the beginnings of such a theory.  Again, the emerging middle class economics school of thought is starting to generate both the theoretical and empirical work that could lead to a true alternative paradigm to neoclassical economics.

But as yet there is no worked-out theory that connects the microfoundations of actual human behavior to the macro outcomes that economic policy is concerned with.  The microfoundations of the standard model—completely self-interested homo economicus—however unrealistic are mathematically tractable in a way that lends itself to macro analysis.  The same is not true for our new, more accurate, but complicated, understanding of human motivation.   But the micro-macro connection will have to be bridged if our new Keynes is to emerge and consolidate a theory to guide a new era of capitalist growth.