Tuesday, May 17, 2011

DiCarlo Coaching: Pandora's Box


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Sunday, May 8, 2011

Blacklisted Economics Professor Found Dead: NC Publishes His Last Letter


Professor Outis Philalithopoulos was found dead in his home three days ago; the coroner's report cited natural causes that were left unspecified. Unfortunately, all of the professor's academic work has disappeared; the only trace left appears to be the following letter, which he sent to an admirer shortly before his death. The understandably concerned recipient of the letter has shared its contents with Naked Capitalism, and has insisted that her identity be protected.
Dear * * *,
Reading your generous letter was an unexpectedly encouraging experience. I rarely feel that others truly understand the purport of my theories, but when I see a high school student such as yourself navigate her way through the vilifications that surrounds my work, it makes me want to redouble my efforts to explain my ideas to a larger audience.
How did you become the most courageous economics professor of our time?Really, you are far too kind. I never thought of myself as anyone out of the ordinary while working as a young PhD on technical questions in Public Choice theory. As you probably know, Public Choice is the pathbreaking theory that demystified the decisions of politicians, showing that they act rationally in order to maximize their own economic benefits.
Soon after receiving tenure, it occurred to me that we were being profoundly inconsistent. While we had correctly criticized the previous mainstream view that politics involved benevolent efforts to serve the common good, we had failed to apply the same rigor to the community of academic economists. As a result, we were modeling both economic and political actors as self-interested utility-maximizing agents, while continuing to see economics professors as idealistic pursuers of truth. I decided to correct this oversight by developing my theory of Academic Choice, in which economists are theorized as rational agents who continually seek to maximize their future earnings potential.
The way I would describe Academic Choice theory is that it is "the sociology of economists, without romance." Is this right? What an insightful comment. As you say, Academic Choice theory is a descriptive project, with no normative orientation. We apply a critical approach in order to counterbalance pervasive earlier notions of economists as scientific heroes struggling against popular ignorance in order to serve the common good.
What would you identify as the central insights of Academic Choice theory?The theory begins by identifying three principal ways in which economists try to maximize their utility. First, they receive salaries from universities, which can be increased if their course enrollment increases. Course enrollment is primarily driven by students with future careers in business and the financial sector, so an economist has an incentive to propound theories that CEOs and financial institutions find attractive. Even if adoption of these theories leads to substantial public costs, these costs will not be shouldered by the economist personally. Second, by developing such theories an economist can open the door to future wealth as a lobbyist or consultant. Third, the support of economists is critical to creating and maintaining special privileges for thefinancial services industry and for top corporate officers. By threatening to withdraw this support, economists can engage in rent-seeking. I call this last practice academic entrepreneurship.
Is it really plausible that economists threaten top banks that in the absence of some kind of payoff, they will change the theories they teach in a direction that is less favorable to the banks? There are certainly cases in history of the following sequence:
. Economist E espouses views that are less favorable to certain special interest groups S. Doing so threatens the ability of S to extract rent from the public.
b. Later, E changes his view, thereby withdrawing the prior threat.
c. Still later, E is paid large amounts of money by representatives of S in exchange for services that do not appear particularly onerous.
For example, let E = Larry Summers and let S = the financial services industry. In 1989 E was (a) a supporter of the Tobin tax, which threatened to reduce the rent extracted by S. This threat was apparently later withdrawn (b), and in 2008 E was paid $5.2 million (c) in exchange for working at the hedge fund D. E. Shaw (an element of S) for one day a week.
However, it is naturally more difficult to witness the negotiations in which specific threats were appeased with specific future payouts. This is a problem that also bedevils Public Choice theory, in which it is likewise difficult to show exactly how a particular politician is remunerated in exchange for threatening businesses with anti-business legislation. The theory assures us that such negotiations occur, although they are difficult to observe directly. Perhaps further theoretical advances will help us to close this gap.
Isn't it offensive to assume that economists, for motives of personal gain, shade their theoretical allegiances in the directions preferred by powerful interest groups? How could it ever be offensive to assume that a person acts rationally in pursuit of maximizing his or her own utility? I'm afraid I don't understand this question.
Is there a "behavioral" version of Academic Choice theory, in which the basic premises are enriched by the possibility that economists sometimes act irrationally? Great question. One of my students developed just such a theory – he postulated that economists sometimes do act benevolently, but they have access to limited information and are subject to cognitive biases. Under these assumptions, he proved that economists would produce theories that are flawed in similar ways to what is independently predicted by Academic Choice.
However, while his dissertation was unquestionably a valuable contribution to the literature, I am personally convinced that the original Academic Choice theory is more empirically realistic. Studies have shown that many people do act irrationally, but not economists – to the extent possible, their decision-making conforms to the model of Homo economicus.
If the theories of economists are harmful to the general welfare, why doesn't someone try to persuade the public that these theories are mistaken?Collective action in this sense is infeasible. If we instead consider the efforts of a single individual, the cost in terms of time and effort of discrediting an economic theory is substantial, while the benefits are dispersed over many people and so are comparatively small. In any case, the efforts of one person are unlikely to be decisive in swinging the consensus of economists away from a given erroneous theory. It follows logically that the rational decision for an intellectual consumer is to be inactive on this front, and even to be ignorant of the flaws in economic theory.
It might be thought that when economic theories are marred by particularly glaring problems, the public would notice. However, the consequence may simply be to select for economic theories that are particularly difficult for the public to evaluate, without implying any increase in the aggregate accuracy of such theories.
Do you simply assume based on the theory that people are generally ignorant about mistakes in economic theories, or are there other reasons why you would think this?Public Choice scholar Bryan Caplan was able to prove empirically that democracy subsidizes irrational beliefs. He looked at one political issue after another and found that the views of voters are very different from the mainstream views of economists and are therefore obviously irrational. I would love to be able to prove that intellectual consumers are ignorant of biases in economic theories with an equal degree of rigor, but so far have not thought of a way. See, however, the response to your next question.
The core claim of Academic Choice is that valid economic theories are an underprovided public good, due to a combination of academic entrepreneurship and rational public ignorance. Is this merely a prediction of the mathematical models, or is there real world evidence of this claim? Originally I did arrive at this result as a logical consequence of the theoretical model; however, the prediction has since been corroborated through empirical investigations.
Consider the following seven propositions. All of them have been effectively promoted and publicized by academic economists:
1. (e.g. Greenspan) It is unnecessary to worry about deception in financial markets since market discipline will make sure that dishonest agents are permanently ostracized.
P2. (Clarke) A person whose income is 100 times as large as that of another person has contributed exactly 100 times as much to the general welfare.
P3. (First Welfare Theorem) Corporations, if left to themselves, will always provide employment to everyone and produce an economy featuring constant recession-free growth.
P4. (Arrow-Debreu) A necessary condition for this ideal economy is the availability of arbitrarily complicated securities that reference cash flows in all times, in all places, and in all ways imaginable.
P5. (Borrowing at the Risk-Free Rate) Economic institutions should be designed under the assumption that whenever a firm or bank tries to obtain a low interest loan, it succeeds.
P6. (1997/2008) If a Third World country has a banking crisis, bedrock principles of economics dictate that its largest banks should be allowed to fail and be acquired by U.S. and European banks. However, if the U.S. has a banking crisis, bedrock principles of economics dictate that its largest banks should be saved through massive subsidies from the public.
P7. (EMH, etc.) It is impossible for investment funds to beat the market. However, the current capital market system centered around funds trying to beat the market is this most perfect system conceivable by human beings.
As a bright high school student like yourself can clearly see, the list consists entirely of statements that are obviously wrong, and several of them are internally inconsistent. If economists were simply confused, we would expect to find no pattern in these statements. Instead, as predicted by Academic Choice, statements P1-P7 all directly enable rent-seeking by certain influential minorities (financial sector employees and corporate executives). Moreover, P1-P7 have also helped to generate market discontinuities with significant public costs, among which the recent global financial crisis.
Some of your critics have insinuated that the true aim of your research is to restore faith in the possibilities of democracy. How do you respond? I confess feeling rather hurt by this accusation. Let me explain to you, though, the reasons for this misunderstanding. A generation of Public Choice economists had proposed guidance by economic theories as an efficient alternative to the mistakes inherent in democratic processes, or in other words, to political market imperfections. Academic Choice suggests, however, that once one introduces "academic" market imperfections, we may need to confront the possibility that far from correcting political failures, the authority of economists may actually prove to be a source of further distortions in the economy, leading to what I call the "academic dissipation of value."
This much is correct. However, to make the leap to assuming that I intentionally created Academic Choice theory in order to favor democracy is malicious and unfair – it is just like claiming that the main goal of the founders of Public Choice was to discredit politics.
What kinds of proposals could help to minimize value destruction by academic economists? You are quite right that from the point of view of the public this issue looms large. Even in most Western democracies, more than half of the total GDP is allocated according to principles promoted by agents subject to Academic Choice dynamics, i.e. economists. One simple remedy to the large negative externalities generated through their academic entrepreneurship could be to shrink the size of the sector of academic economists.
Another approach is indicated by the game theoretic insight that winning strategies in competitive games usually involve a random element. Following this principle, ever since antiquity trials have been decided by juries who are chosen by lot. We should therefore strongly consider periodically repopulating economics departments with people selected at random.
How are your personal relations with your economist colleagues? When I began to develop Academic Choice theory, I fully expected resistance from historians of science, since I knew they would see me as trespassing on their terrain. But I was heartbroken when I realized that colleagues in my own departments now regarded me with something akin to hatred. I tried to help them to see the elegance of my mathematical models and proofs, but their hostility continued unabated: no one would publish my articles, and even my most promising graduate students were refused jobs everywhere. I could not understand how my attempt to extend the reach of economic theory had led to this rancor, and my only solace was to remind myself that Howard Roark in The Fountainhead had also been misunderstood by colleagues who did not understand his individualistic dream of creating beauty.
But nonetheless, I persevered, and one day it dawned on me that the reactions of my colleagues were actually a startling confirmation of Academic Choice theory. After all, economists are very familiar with the free rider problem, whereby individuals take advantage of group benefits without contributing anything. In order to guard against free riders, economists had instituted the tenure process and the journal review process. And since my theories could conceivably weaken the ability of economists to extract rent in the future, they had classed me as a free rider and were attempting to impose costs on me!
Now that I have realized this, even the most malevolent stares of my colleagues are unable to disturb my sense of inner peace – for I realize that every attempt to disincentivize me from my chosen career path is yet another vindication of the explanatory potential of economic models.
If economists are generally self-interested utility maximizers, how can one explain your own passion to pursue the truth at all costs? I confess that your question has forced me to reconsider many things. Indeed, after thinking about the financial outcomes associated with my career, it seems hard for me to avoid the conclusion that I myself constitute a refutation to Academic Choice!
Trying to address this paradox has led to the humbling realization that I am a flawed example of Homo economicus. In fact, I suffer from a cognitive bias known as harmonization bias – i.e., my personal utility function is distorted by virtue of ascribing positive value to harmony between the real world and my economic theories.
My initial reaction to this disturbing discovery was fear that the validity of Academic Choice could be compromised – what if other economists also suffer from harmonization bias? Thankfully, the disorder appears to be rare in the community, and so Academic Choice theory remains applicable to the real world.
Would you recommend a research career in Academic Choice theory? There are certainly a few obstacles. You would have to resolutely conceal your interest in Academic Choice during your entire educational career, at least until you receive tenure. Once you reveal your true passion, you would have to accept both relative poverty and ceaseless acrimony on the part of your colleagues.
Academic Choice is certainly not for everyone –at the very least, it is necessary to suffer from harmonization bias. In light of these considerations, I had begun to accept that the chances of ever finding another student willing to study Academic Choice were slim. Still, your brilliant and lively letter has led me to question my pessimism.
Wouldn't it be marvelous to see new faces in Academic Choice! The theory is full of beautiful unsolved problems that doubtless stand only in need of a fresh examination. Maybe harmonization bias is not as rare among people in general as it is among economists. Maybe I should try to offer a scholarship for younger students. What do you think?
Good luck with your senior research report and all the best,