Failed Economics: Tyranny of Mathematics and Enslaved by the Wrong Theory

The strange world of modern economics

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By David Sloan Wilson

When it comes to my economics training, I’m a late bloomer. My primary training is in evolutionary theory, which I have used as a navigational guide to study many human-related topics, such as religion. But I didn’t tackle economics until 2008. I had just helped to start the Evolution Institute, the first think tank to formulate public policy from a modern evolutionary perspective, and one of our benefactors asked me what evolution might have to say about the financial crisis that had broken upon the world.

At the time I had no way to answer this question. Economic jargon mystified me—an embarrassing confession, since I am fully at home with mathematical and computer simulation models. Economists were very smart, very powerful, and they spoke a language that I didn’t understand. They won Nobel Prizes.

Nevertheless, I had faith that evolution could say something important about the regulatory systems that economists preside over, even if I did not yet know the details. After all, financial markets and other regulatory systems are products of cultural evolution, based on psychological processes that evolved by genetic evolution. That’s my area of expertise. If I can’t connect the dots between my area of expertise and economic theory, then something’s wrong—and it might be on their end, not mine. I therefore took up the challenge of answering our benefactor’s question, although I must admit that I felt like the gentle hobbit Frodo making his way toward Mordor.

Fortunately, I had a Fellowship of the Ring to rely upon. The study of human genetic and cultural evolution has become a wonderful blend of scientists from all disciplines, including economics. Some of my closest colleagues are highly respected economists, Herbert Gintis, Samuel Bowles, and Ernst Fehr, who have acquired an advanced knowledge of evolution, publishing widely in the best scientific journals in addition to the best economic journals.

I already knew from their work that the main body of modern economics, called neoclassical economics, was being challenged by a new school of thought called experimental and behavioral economics. Proponents of the new school had captured the public imagination with books such as Nudge: Improving Decisions About Health, Wealth, and Happiness, by Richard Thaler and Cass Sunstein, Predictably Irrational: The Hidden Forces That Shape Our Decisions, by Dan Ariely, and Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism, by Nobel laureates George Akerlof and Robert Shiller. Sunstein had recently been appointed President Obama’s regulatory czar, so the new school of thought was having an impact on public policy.

According to the new school, neoclassical economic theory is based on a false conception of human nature and must be replaced with a more realistic conception. As Thaler and Sunstein put it in Nudge, economic theory and policy needs to be based on “Humans”, not “Econs.” I cheered when I first read these lines and looked forward to learning about the new improved conception of human nature, which presumably would be informed by evolutionary theory. I was disappointed. My colleagues such as Herb, Sam, and Ernst confirmed my own impression: They appreciated the relevance of evolution but were a tiny minority among behavioral and experimental economists, who in turn were a tiny minority among neoclassical economists. Modern evolutionary theory was having virtually no impact on currently economic theory and policy.

The more I learned about economics, the more I discovered a landscape that is surpassingly strange. Like the land of Mordor, it is dominated by a single theoretical edifice that arose like a volcano early in the 20th century and still dominates the landscape. The edifice is based upon a conception of human nature that is profoundly false, defying the dictates of common sense, before we even get to the more refined dictates of psychology and evolutionary theory. Yet, efforts to move the theory in the direction of common sense are stubbornly resisted.

There is plenty of dissent among economists, and some of the best are working the hardest for change. The folks who award the Nobel Prize in economics don’t like the edifice that much either, and often add their weight by awarding the prize to the contrarians. Yet, even with all that talent, effort, and the prestige associated with the Nobel Prize, the edifice remains standing in one spot like a volcano adding to its own height and spewing out toxic policies. Why does it resist change? One reason is ideological, as we shall see, but another reason involves path dependence. Neoclassical economics provides an outstanding example of the “you can’t get there from here” principle in academic cultural evolution. It will never move if we try to change it incrementally. It must be replaced wholesale with a more realistic conception of human nature.

Economists were much more closely attuned to common sense and evolutionary theory before the volcano erupted. Adam Smith (1723-1790) observed that people following their narrow concerns somehow combine to make the economy work well, as if guided by an invisible hand. Today we use terms such as emergence and self organization to describe this phenomenon. It is spectacularly demonstrated by social insect colonies. The fabled honeybees and ants definitely don’t have the welfare of their whole colony in mind. They’re just responding to local environmental cues in ways that makes their colonies work well as a whole. They could respond in an infinite variety of ways, most of which would not contribute to the success of their colony, but natural selection has winnowed the responses that work at the colony level.

The same point can be made for the cells in our bodies. They don’t have the welfare of our whole body in mind; they don’t even have a mind. They’re just responding to local environmental conditions by switching genes on and off in a way that leads to the welfare of the collective. There is an infinite variety of ways that cells might respond to local environmental conditions, but natural selection has winnowed the ones that work at the level of the whole organism. When Adam Smith invented the metaphor of the invisible hand, he was saying that human economies are like bodies and beehives in this regard.

Smith did not say that people are entirely self-interested. That would come later, from his followers and disciples. He had a sophisticated and nuanced conception of human nature that he described most fully in his book The Theory of Moral Sentiments. According to Smith, people have genuine concern for others in addition to themselves. They have a sense of right and wrong that leads to the establishment of norms enforced by punishment. They are interested in their reputation as much as their monetary income, and so on. Shakespeare would have felt comfortable with Smith’s conception of human nature. People still responded primarily to their local social environment, so the invisible hand metaphor remained apt, but their preferences couldn’t be collapsed into a single generic concept of self-interest.

Charles Darwin and Alfred Russell Wallace were influenced by Smith and other economists, most famously Thomas Malthus (1766-1834), in their formulation of evolutionary theory. Economists, in turn, were influenced by the new theory of evolution. Thorstein Veblen (1857-1929) even wrote a paper in 1898 titled “Why is Economics not an Evolutionary Science?” At the dawn of the 20th century, economics was both closely attuned to common sense views of human nature and receptive to the new theory of evolution that it had influenced. Then the volcano erupted.

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The volcano was the laudable attempt to place economics on a mathematical foundation using physics, not biology, as the inspiration. There was nothing sinister or self-interested about this effort. It made perfect sense at the time. Physicists such as Isaac Newton (1642-1727) had succeeded in describing the laws of physical motion in the precise language of mathematics. Wouldn’t it be magnificent to do the same thing for the laws of human society? That became the goal of Leon Walras (1834-1910) and other economists, as recounted by Eric Beinhocker in his excellent book The Origin of Wealth: The Radical Remaking of Economics and What it Means for Business and Society. Here is how Eric describes the zeitgeist of the times:

Following Newton’s monumental discoveries in the seventeenth century, a series of scientists and mathematicians, including Leibniz, Lagrange, Euler, and Hamilton, developed a new mathematical language using differential equations to describe a staggeringly broad range of natural phenomena. Problems that had baffled humankind since the ancient Greeks, from the motions of planets to the vibrations of violin strings, were suddenly mastered. The success of these theories gave scientists a boundless optimism that they could describe any aspect of nature in their equations. Walras and his compatriots were convinced that if the equations of differential calculus could capture the motions of planets and atoms in the universe, these same mathematical techniques could also capture the motion of human minds in the economy.

It’s easy to imagine the allure of this goal. If economics could be placed on a mathematical foundation comparable to physics, it would achieve a status greater than any other human-related discipline such as sociology, anthropology, psychology, or philosophy. Biology held no appeal as a source of insight because it wasn’t mathematical. Walras appeared to achieve this goal in his masterwork titled Elements of Pure Economics published in 1872.

Walras’s main challenge was to provide a mathematical demonstration of the invisible hand. If individuals maximizing their local concerns really do self-organize into well-functioning economies, then top-down regulation by government leaders is unnecessary. The government merely needs to stop meddling and the economy will run itself. Walras succeeded in providing a mathematical proof of this possibility, but only by making certain assumptions–lots of them.

Anyone who builds theoretical models, as I do, knows how many simplifying assumptions must be made for a model to be mathematically tractable. The world described by the mathematics becomes detached from the real world, not because of any ideological bias, but just so that you can grind through the equations. It was at this point that economists began to rely upon a conception of human nature that defies the dictates of common sense, even before we get to the more refined dictates of psychology and evolutionary theory.

The people who inhabit the economic models, often referred to as Homo economicus, are driven purely by self-regarding preferences. Mathematically, this means that they care only about maximizing their own interests without reference to anyone else’s interests. What I want cannot depend upon what you want. Exactly what I want can be broadly interpreted but operationally it is usually assumed to be my monetary economic interests. The single assumption of self-regarding preferences banishes a large fraction of real-world human preferences from the mathematical kingdom.

Next, people who inhabit the mathematical kingdom are infinitely wise in pursuit of their self-regarding preferences. Lest you think that I am creating a straw man, here is how Richard Thaler and Cass Sunstein, two economic insiders, describe it in Nudge: “If you look at economics textbooks, you will learn that Homo economicus can think like Albert Einstein, store as much memory as IBM’s Big Blue, and exercise the willpower of Mahatma Gandhi. Really.”

Once again, these absurd assumptions were driven not by ideological bias but by the tyranny of mathematical tractability. The theory couldn’t be pushed in the direction of common sense because it would become impossible to grind through the equations. Yet, the theory commanded enormous prestige because it represented the ideal of a science of economics comparable to the science of classical physics. Abandoning the ideal would knock economics off its pedestal and back among the ranks of the other human-oriented sciences such as sociology, psychology, political science, and anthropology. Heaven forbid!

As I delved deeper into the history of economics, I saw it as a struggle between those who pledged allegiance to the mathematical edifice and those who chafed against its rule, including Thorstein Veblen way back in 1898.

Here is a tale of three Nobel laureates to illustrate what I mean.

Nobel laureate #1 is Maurice Allais, a French economist who received the prize in 1988 and is most famous for a paradox that he discovered in the 1950’s. As an example, imagine that you can choose between getting one million dollars with certainty vs. one million with a 89% chance, nothing with a 1% chance, and five million with a 10% chance. If you’re like most people, you’ll opt for the sure bet. Now you’re given a second choice between nothing with an 89% chance and one million with an 11% chance vs. nothing with a 90% chance and five million with a 10% chance. If you’re like most people, you’ll go for the 5 million, even though you have a slightly higher chance of getting nothing. These decisions reflect the fact that when real people make decisions, they are sensitive to both the average outcome and variation around the average. So are other animals. My evolutionist colleagues have performed dozens of experiments on birds and other creatures showing that they will choose either risky high-payoff options or safe low-payoff options depending upon how well fed they are. Their flexible behavior with respect to risk makes perfect sense from an evolutionary perspective.

If people behave the same way, then where’s the paradox? The mathematical edifice of economic theory needs the assumption of mean expected utility to remain tractable. For those who have pledged allegiance to the mathematical edifice, risk sensitivity becomes a paradox. Never mind that real people behave that way, it seems like common sense, and also makes perfect sense from an evolutionary perspective!

Let’s pause to savor the irony of the situation. A purely fictional world defined by mathematical equations acquires so much authority that it becomes the real world for its adherents. Aspects of the real world that cannot be related to the imaginary world are so dumbfounding that they are labeled paradoxes by the faithful. Here is how Allais described his struggle with the faithful in a 1987 essay:

For nearly forty years the supporters of the neo-Bernoullian [expected utility] formulation have exerted a dogmatic and intolerant, powerful and tyrannical domination over the academic world; only in very recent years has a growing reaction begun to appear….[The Allais paradox] is fundamentally an illustration of the need to take into account not only the mathematical expectation of cardinal utility, but also its distribution as a whole around its average, basic elements characterizing the psychology of risk.

Does this seem a little bit like religion?

Nobel laureate #2 is George A. Akerlof, who received the prize in 2001 and was elected president of the American Economic Association in 2007. His presidential address was titled “The Missing Motivation in Macroeconomics”. The missing motivation was norms. When I first encountered this paper, I rubbed my eyes in disbelief. Norms? Economists have been primary advisors on public policy and they’re only newly discovering a little thing called norms? What planet do they come from?

Norms don’t exist in the mathematical kingdom because they violate the assumption of self-regarding preferences. When you’re Homo economicus, your preferences don’t depend upon anyone else’s. Norms are all about the coordination and enforcement of preferences among members of a group. Adding norms would require a massive restructuring of the edifice.

Here’s Akerlof’s own diagnosis of the problem from his presidential address, starting with John Maynard Keynes (1883-1946), a giant figure in the field of economics who made the mistake of pledging his allegiance to common sense rather than the mathematical edifice.

But a new school of thought, based on classical economics, objected to the casual ways of these folks. New Classical critics of Keynesian economics insisted instead that these relations be derived from fundamentals. They said that macroeconomic relationships should be derived from profit maximizing firms and from utility-maximizing by consumers with economic arguments in their utility functions. The new methodology …overturned aspects of macroeconomics that Keynesians had previously considered incontestable.

In other words, the mathematical kingdom became the new reality, banishing norms along with risk-sensitive behavior from its conception of human nature. Allais expressed hope in his 1987 essay that the edifice was crumbling but Akerlof was still standing outside the ramparts in 2007.

Nobel laureate #3 is Elinor Ostrom, who was awarded the prize in 2009 and was the first woman to be awarded the prize in economics. I was fortunate to attend a workshop with Lin, as she prefers to be called, a few months before she received the prize, and to work with her up until her death in 2012. If anyone deserves to be called the gentle hobbit who saved the world from Sauron, it is Elinor Ostrom.

To be continued… 

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Adapted from The Neighborhood Project: Using Evolution to Improve My City, One Block at a Time, published by Little, Brown.

2016 January 28

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