Economic Theory Is a Pathological Lie Carefully Constructed to Normalize Evil

Earlier today I was pushed by a regular correspondent and reader of my blog to explain my position regarding malinvestment more fully.  I always appreciate this person's insights and probing, and this time it is no different.

From the first e-mail:

You have written a few times, regarding malinvestment. From its common usage, I think malinvestment is thought to mean investment outside a competitive dynamic, where price discovery should be allowed to match supply with demand and malinvestment inhibits that process.

I incorporated my initial response as the update to this post from earlier today.  This prompted another email asking for further clarification and providing what I think is fair (and constructive) criticism.  Here are the two most important paragraphs, which have prompted this more open discussion:

If inclined, you might consider a post, with strong references, supporting your claim, the contents in the last email. This has been a central tenet of yours, I have noticed. Before, I was not sure how to understand it, because of the use of "malinvestment" throws a monkey-wrench into the equation, for me. You should understand that this view and some (some) of your views, although nuanced, complex and perhaps correct, I believe, are somewhat esoteric, eclectic, if not inaccessible or technical.

. . .

Your email reply, as it is written is clear. It is just the thesis is unusual. Perhaps that is what you might think legitimizes the position. However, without context or without some corroborating analysis, its form is un-integrable, I believe; or, it has a myriad of problems for various people.

I think the title of this post nicely brings my thesis "right down to earth in a language that everybody here can easily understand," as Malcom X once said. 

A Quick Disclaimer

Before I get rolling, I want to make clear that I don't believe that economic theory must always be a pathological lie.  I believe it is possible, in theory, to develop a mathematical model that accurately reflects how the economy really works.  Indeed, some have argued that people like John Maynard Keynes and Hyman Minsky have already done so, and Steve Keen and other Post Keynesians continue to build on their work, the bulk of which has been ignored by the Chicago and Austrian schools, among others.

Unfortunately, as a practical matter, I believe it is impossible to overcome the underlying political nature of economics (which used to be called "political economics") and the interests that economic discipline serves (i.e., the "rentiers" that were disappeared from economic discussion by the creation of neoclassical economics as an answer to Henry George's criticism of classical economics).  What history has shown us is that the fallacious mathematical models of economic theory are never replaced with accurate models.  At best, additional fallacious mathematical models of economic theory are layered onto the old ones, often while claiming that the new models incorporate the theory of a critic while not doing so at all (e.g., the so-called Keynesian-neoclassical synthesis and the later Neo-Keynesians and New Keynesianism).  At worst, criticism of the fallacious mathematical models of economic theory are used elsewhere in the socio-political arena to persuade the masses that the mathematical models are not, in fact, fallacious but sound (e.g., applying Gunnar Myrdall's insights to form neoliberal social institutions that turn citizens into sociopaths). ** Due to the political forces at work, economic theory will always be a set of  clothes tailored for a non-existent emperor. 

Explaining My Thesis By Breaking It Into Its Constituent Parts

Now, let's break the title of this post into its constituent parts:  economic theory is (1) a pathological lie (2) carefully constructed to normalize "evil."  As to the fallaciousness of mathematical models in economics, people like Steve Keen have done a great job of explaining how the math of orthodox (and related heterodox) economic theory doesn't work.  See here, here and here.  The first link is to a blog post that links to complete set of lectures and video/audio of a course he taught in behavioral finance.  Highly recommended.  The second link is to his book at mobi.com (superior PC-based reader to Kindle's), and the final link is to supplementary material for the book and includes additional lectures. 

Of course, the fact that the mathematical underpinnings of economic theory are provably false does not make economic theory a "pathological lie."  No, what does that is the fact that economists persist in perpetuating the falsehoods while knowing that they are, in fact, a falsehoods.  This one place where I break from Keen, who views his fellow economists' behavior as irrational and "mad", primarily because he incorrectly believes that his profession exists to explain the world as it really is when, in fact, it exists as a propaganda arm of rentier interests to rationalize their behavior as just the magical market doing its work.  In this sense, as I've noted elsewhere (and here, too, I believe), economics codifies-- in very different terms-- a modern version of feudalism's "divine right of kings": the wealthy are wealthy because the market chose them as winners.   The recasting of the divine right of kings in "free market" terms is particularly evident in Hayek's conception of the market, which forms the cornerstone of neoliberal economics and policy in both the Chicago and Austrian schools of economics.

If you can agree that the repetition of a known falsehood as the truth is, in fact, a lie, then I don't need to prove that the lie is, in fact, pathological.  Indeed, my assertion as a whole is that "economic theory is a pathological lie carefully constructed to normalize evil," but the definition of "pathological" implies that the lie is involuntary or compulsory.  The fact is that I chose the term "pathological" to refer to the effect of economic theory on society as a whole rather than to describe the mental state of economists and others who repeat the lie, many of whom do so earnestly and honestly.  As I've stated here and elsewhere, I believe a direct consequence of neoliberal economics and policy is a society of sociopaths, i.e., individuals without a conscience.  This was the entire point of mangling Smith's Invisible Hand.

Turning to the assertion that the pathological lie was carefully constructed to normalize evil, I have several posts that discuss the history of the neoliberal political movement, including who was behind it, how it was initially constructed and how it morphed over time.  Generally, you can find these posts by looking for the "Neoliberalism" label, but good examples can be found here, here and here.  You can also see Robert Vienneaus's thoughts on Milton Friedman, the Austrians, and some of the problems with certain aspects of economic theory.  Robert is a non-economist economist who earnestly and in his own way is marching on the same path as Steve Keen trying answer bad math with good math.  I cannot say that I agree with everything he says, but that's because I have not read everything he has said.  I believe he is a computer scientist by profession, which probably explains why he and I (trained in CS/EE) arrived at many of the same conclusions regarding neoliberal (like everybody else, he calls it neoclassical) economic theory.

I cannot expect anyone to merely accept my conclusion that economic theory is a purposeful lie, but I think a careful reading of history, on the one hand, and the huge known disparity between economic theory and the reality it supposedly describes will convince everyone of good conscience that this didn't happen by accident.  Neoclassical economics was created to avoid the valid criticisms of Henry George, who first identified debt-financed speculation as the true cause of industrial depressions in the late 19th century.  The neoclassical-Keynesian synthesis, New Keynesianism and Neo-Keynesianism all purported to adopt and follow Keynes when, in fact, all of them disappeared the part of Keynes' General Theory that would euthanize the debt-financed speculator (i.e., the "rentier").  Neoliberal Chicago School economics were on hand and at the ready to take over when "Keynesianism failed," as it did when, according to Hyman Minsky, debt-financed speculators created the "stagflation" phenomonen, something that had only been theorized by a Chicago School economist shortly before the theory, which made no sense on its face, became reality.  And then there's the Chicago School's theories of finance, the effect of which was to financialize the real economy in its entirety, allowing the debt-financed speculators to blow bubbles in all asset classes, not just in land, as was the case in Henry George's day.

My conclusions regarding the true nature and purpose of economic theory are based in part on my professional experience in negotiating complex and difficult deals, which often devolved into litigation.  These negotiations had an average duration of 18-24 months, typically involving a lot of travel and many meetings internally and with the other side.  In several cases, hundreds of millions of dollars were at stake.  One of the things the experience taught me was to pay careful attention to what the other side actually did and compare it to what they claimed they were going to do.  Trust but verify.  I discovered that whenever there was a significant difference between the two, the other side was lying.  Plain and simple.

Turning Back to the Correspondence that Prompted This Attempted Response.

Recapping:

You have written a few times, regarding malinvestment. From its common usage, I think malinvestment is thought to mean investment outside a competitive dynamic, where price discovery should be allowed to match supply with demand and malinvestment inhibits that process.

I've highlighted the phrase "competitive dynamic" because that's a term that applies to capitalism, but what we currently practice-- thanks to neoliberal economics and its neoclassical foundations-- is not capitalism but what I've started calling "financialism."  As I stated previously here:

If competition were good for the economy, we'd have it.  We don't.  The reality is that competition is BAD for a financialized economy because real competition disrupts the illusion of perpetual growth that makes the FIRE sector a lot of money.  J.P. Morgan realized in the late 19th century that competition is bad for business, if you're an investment banker.   Monopoly is a feature of neoliberal policy.

What did I mean by this?  As I explain here, although not in precisely the same terms, finance drives economic decisionmaking by firms because firms are managed to meet the expectations of CAPM financial models that express the stock price of a company in terms of its future cash flow according to its balance sheet.   That is, corporate executives don't manage their businesses to maximize profits, they manage their balance sheets to simulate a financial instrument that, on a quarterly basis, demonstrates an exponential and perpetual increase in value at a rate faster than inflation. Yet another way of putting it is that corporations are managed to maintain the illusion of a bond having infinite duration that perpetually compounds interest at a rate faster than the rate of inflation.  Why?  Because of the incentive structures provided to executives, CAPM is not merely descriptive but is actually normative.

Steve Keen's lectures on behavioral finance explain the economic hierarchy quite well: microeconomic theory supposedly models the behavior of consumers, individual firms and their respective aggregating industries; macroeconomic theory supposedly models how these various industries and consumers interact in the larger economy building, of course, on microeconomic foundations; and finance supposedly models the value of firms by building on macroeconomic foundations.  If microeconomic theory fails, so does the entire edifice of economics fails as the hierarchy is flattened down into finance.

As Keen discusses in the first few lectures of his course, a fundamental assumption of microeconomics is its theory of the firm in which every firm is managed to maximize profits.  As discussed above, this assumption is false.  (FYI -- Keen uses math to debunk the neoclassical theory of the firm, but his math starts from the same basic starting point as what he is debunking without recognizing that finance is normative).  

How did I reach the conclusion that finance drives corporate decision-making?  I used to be an executive at a public company, and there were several instances during my career working in corporations (starting with Intel) where I was struck by economic decisionmaking that was driven primarily by the balance sheet and not by actual cash flow (i.e., profit maximizeing) concerns.  At the time, I really did not understand why this was the case, but as I taught myself finance and valuation theory in order to contribute to discussions regarding M&A etc., I learned about the models that analysts used to estimate the value of our company.  Still, it took another year of studying economics (and the economic history of the United States) outside of the corporpate environment to understand the implications of CAPM on the real economy and on economic theory, as well.  If you understand net present valuation methodology, you'll quickly recognize that the rules of that methodology (e.g., the selection of the discount rate, growth assumptions, terminal value, etc.) ultimately express the value of the firm as bond of infinite duration that exponentially grows in value over time.  If you accept that providing executives incentive stock options and restricted shares aligns their interests with those of the shareholder, which is to have a financial asset that grows in value infinitely and perpetually at a rate greater than that of inflation, then you should have no problem in accepting my conclusion that financial theory is normative, not merely descriptive.  FYI -- I have recently discovered that there is some literature on this topic.

Recapping the follow-up correspondence:

If inclined, you might consider a post, with strong references, supporting your claim, the contents in the last email. This has been a central tenet of yours, I have noticed. Before, I was not sure how to understand it, because of the use of "malinvestment" throws a monkey-wrench into the equation, for me. You should understand that this view and some (some) of your views, although nuanced, complex and perhaps correct, I believe, are somewhat esoteric, eclectic, if not inaccessible or technical.

. . .

Your email reply, as it is written is clear. It is just the thesis is unusual. Perhaps that is what you might think legitimizes the position. However, without context or without some corroborating analysis, its form is un-integrable, I believe; or, it has a myriad of problems for various people.

I admit that my explanation of my thesis, which can be summarized into a pithy ad hominem attack on economic theory as a whole, is nevertheless difficult to explain without resorting to an explanation of concepts that are foreign to most people.  Here's the problem, and it's something that I learned a long time ago: the person who determines the starting assumptions of a debate usually wins the debate.  To start by assuming that economic theory is right and trying to explain why it is wrong is a losing proposition because economic theory is based on centuries of layered lies, and attacking all of the lies (as people like Keen tend to do) makes you look weak: if you had a killing blow, you'd deliver it and not seek the death of your foe by a thousand cuts. 

I think my insight about finance as normative can be developed into a killing blow, but it still needs further work to persuade the masses who are stuck with iconic words and useful fictions inflicted on them by neoliberal social institutions that sprang into existence to put the insights of the rival institutional economists and neutral cognitive scientists to work to their advantage (e.g., neoliberal think tanks construct their policy messaging by applying Kahneman's Prospect Theory, even as neoliberal economists construct their policy messaging by applying Benthamite Utility Theory; not surprisingly, both reach the same conclusion, even though Prospect Theory is based on empirical evidence that proves Utility Theory to be wrong).

In the meantime, I'll stand on my outright rejection of economic theory as politics, something that categorically cannot be integrated into people's current understanding of how the world works.  I fully understand how people are most persuaded by things that seem to confirm what they already know, but that's not the route I plan to take because cognitive biases tend to smudge important differences out of existence, much as an eraser smudges graphite off a sheet of paper.  Sometimes you need to challenge first, then engage.

Anyway, thanks go once again to my email buddy for prompting me to attempt to explain my thesis in one place, and apologies for probably failing in my first attempt.


**FYI -- I have a working theory that the Nobel Prize in Economics is awarded based primarily on the extent to which a recipient advances rentier interests in applying economics as a control mechanism over the masses, regardless of whether the recipient purposefully set out to do so.  Gunnar Myrdal (an institutional economist and critic of neoclassical theory) and Daniel Kahneman (a cognitive scientist whose Nobel prize-winning work forms the basis of behavioral economics) are two examples of unwitting participants.

Irony Alert: The "Anchoring and Adjustment" of Behavioral Economics

Another reposted post.

One of the books that I've read recently is Scott Plous' The Psychology of Judgment and Decision Making, available here. This book, although expensive, is a wonderfully concise discussion of the cognitive science, the primary foundation of behavioral economics.

One of the things that struck me was the book's discussion of the cognitive "bug" of anchoring and adjustment, which immediately followed its discussion of another cognitive "bug," the inability to accurately assess probability and risk, which it demonstrated through its discussion of the Monty Hall problem, which the books notes can be solved correctly by applying Bayes' Theorem.

If you look at Bayes' Theorem carefully, though, you can view it as little more than a mathematical expression of anchoring and adjustment. Apparently, when you express a bug mathematically, it becomes a feature.

Behavioral Economics as a whole is a study in anchoring and adjustment in that it persists in the fiction that "rational" behavior requires that humans maximize utility by applying precise mathematical formulas while considering only monetary wealth as utility. Behavioral economists do this because they start from the anchor of neoclassical economics, which they are merely trying to adjust to be more accurate. What they should be doing is scrapping the entire edifice as false.

More on Behavioral Economics

Again, a reposted post from the old blog.  This one refers to the fractal nature of human thinking (another reposted post).

In Democracy in America, Alexis de Tocqueville discusses "self-interest, rightly understood," praising the American people for recognizing that it is in their self-interest to help their neighbors, for example. I recently ran across that phrase again in a brand new book from Prof. Ryan Patrick Hanley of Marquette University, entitled Adam Smith and the Character of Virtue. The book is clearly targeted for the academic as it is very dense and heavily footnoted. Thus, even though it only weighs in at a little over 200 pages, the book demands careful reading.

One of the theories that I have been pursuing since I first read the chapter of The Wealth of Nations in which the "invisible hand" aphorism appears is that Smith, too, was discussing self-interest, rightly understood and not selfishness. Prof. Hanley's book identifies more evidence that supports the theory.

Unfortunately, neoclassical economics assumes selfishness, not self-interest rightly understood. This assumption is embedded in the notion that economic value is the sole measure of utility. Indeed, Milton Friedman and others resurrected the invisible hand aphorism in the mid-20th century as rhetorical support that there is no society, only a collection of individuals each pursuing his own self interest. Apparently, the invisible hand aphorism had been ignored by economists until libertarians and their ideological brethren (e.g., objectivists) recognized its value in supporting their views and started putting it to use.

Because behavioral economics starts with the assumption that neoclassical economics is largely correct and seeks only to explain anomalies between what neoclassical theory predicts and what actually occurs, behavioral economists are predisposed to treat reality as the aberration and tend to use perjorative terms to describe real human behavior (e.g., irrational, herd behavior, etc.). Politically, this makes sense: to the extent that behavioral economists are trying to create meaningful and lasting change in the models that neoclassical economics uses to understand human behavior, they must do so incrementally for fear of being marginalized. Your voice cannot be heard if the herd banishes you. Unfortunately, the politics of the situation frame the conclusions of behavioral economists in a way that obscures much of the value of the research and prevents deeper insights.

Describing the tendency of large groups of people to act the same way at the same time as an "economic anomaly" and perjoratively label it "herd behavior," as behavioral economists do, is a tragedy. The problem lies not with reality but with the assumptions underlying the model.

It was actually "herd behavior" that inspired me to start developing the concept that human decision-making is "fractal" in nature. The bottom line is that human beings have a hard-wired decision-making system, the dopamine system, that is involved in every decision they make. Built on top of that hardware is a software system, cognition, that interpets events based on how the hardware system sorted them (e.g., enjoying events flagged as meeting expectations, worrying about events flagged as possibly not meeting expectations, and ignoring those events not flagged). Each of these human systems is part of a human network, i.e. society. Because of specialization, different people know different things, and no one person can be expected to learn everything. So, people watch what other people do to understand what they should do, particularly in making decisions in areas that they don't understand. Viewed in this way, "herd behavior" is really more a form of delegation than it is an example of herding.

The reason that "herd behavior" can lead to violent business cycles is the dopamine system itself. Again, all human decisions are filtered through the dopamine system and the cognitive function. Some decisions, however, are derived from one's perception of others' decisions. One example is the impact of falling or rising prices in the decision to buy or sell a particular stock. It takes time to develop such perceptions, which is why it takes time for people to "jump on the bandwagon." Because of the dopamine system and confirmation bias in the cognitive function, it also takes time to determine that such perceptions are wrong. The more abstract the problem is to a person, the longer it takes that person to make up or change his mind. (This is what I was trying to get at with the concept of a bias error function.) When reality falls far short of expectations, the dopamine system kicks into overdrive and sends signals of fear and dread that can lead to panic. To the extent that one person's decision is based on his perception of another person's decision, and the perception suddenly changes, those signals of fear and dread propagate by virtue of the observer's dopamine system.