Thursday, August 16, 2007

Respecting Caplan but defending democracy.....

I've seen a few references to Bryan Caplan's book "The Myth Of The Rational Voter" from Chris Dillow and Tim Worstall among others. It has even been hurled against me in the Europe debate on the Economist site. I've now read the pdf supplied by the Cato Institute and here are my amateur thoughts....

Being neither a trained economist nor a trained statistician I can only offer a layman’s challenge to Caplan’s thesis.

Caplan states here that democracy delivers sub optimal policy results but not because the “wisdom of crowds” thesis is untrue.

He accepts that despite a great preponderance of uninformed voters the process of aggregation can provide optimal policy outcomes and that this process of aggregation can be explained and justified statistically.

However he does go on to state and demonstrate that in practice the beneficial mean of aggregate judgment is counterproductively shifted by a strong secondary effect - namely systemic bias.

In other words the process of aggregating the decisions of millions of voters assumes that bias is randomly distributed among them and that the beneficial outcome of the democratic process is that the irrational random biases exhibited by millions of voters effectively cancel one another out so that like the housewives favourite brand of washing powder democracy washes whitest because it cleans all known biases.

However if the bias is systemic (i.e. common to millions of voters) it is not random and it survives this beneficial “washing” process because it can’t be cancelled out and it emerges intact from the aggregate wash at election time to inflict biased and therefore sub optimal outcomes in policy.

Caplan highlights four systemic biases which contaminate democratic effectiveness in this way. He says:

“People do not grasp the "invisible hand" of the market, with its ability to harmonize private greed and the public interest. I call this anti-market bias. They underestimate the benefits of interaction with foreigners. I call this anti-foreign bias. They equate prosperity not with production, but with employment. I call this make-work bias. Finally, they are overly prone to think that economic conditions are bad and getting worse. I call this pessimistic bias.”

His exposition of these biases and their effect on policy is masterful in my opinion. He is particularly strong in his description of the persistent irrationality and inconsistency of these biases.

But he also more or less states that these biases are not only a systemic feature but that they are ineradicable. They are like Edward Said’s magic kingdom of the oriental “other” in that, like Said, he perceives them to be culturally hard wired and immune to either external understanding or correction.

I would humbly suggest therefore that his own exhibited bias is cultural pessimism rather than the economic pessimism he attributes to the “crowd”.

I think that his pessimism is an irrational bias because it takes no account of time. His conclusions and the data set which supports them is a statistical snapshot and a snapshot distorts by suggesting that what it shows is fixed when in reality it is fluid, it misleads precisely because it takes a dynamic and converts it into a constant.

In other words the biases his snapshot identifies may indeed be systemic but that does not mean that they are either permanent or ineradicable. After all history shows an economic progress in democratic societies that simply could not exist if these biases were always operable and everywhere as decisive in their impact as Caplan claims.

Therefore whilst I obviously accept that his identified biases do exist and that they are systemic I don’t think that it necessarily follows that they are always exhibited but that, to the contrary, it is possible that they are only intermittently exhibited.

In addition my optimistic guess would be that over a long timeframe the biases themselves will modify and change and that in a democracy this modification will be in the direction of greater rationality.

In the short term I believe they be overruled entirely. To take one instance - the Thatcher revolution in Britain can be seen as having operated in the teeth of nearly all of the biases Caplan identifies.

The context of pre Thatcher economic failure clearly operated as a powerful suppressant of Caplan’s systemic biases insofar as voters abandoned their default biases and the party that represented them (Labour) because they accepted the emergency was a great one. They were shocked (or terrified) into a temporary rationality. As outgoing Prime Minister James Callaghan noted – something fundamental had shifted in the political landscape and maybe that something was the abolition or at least the suspension of Caplan’s systemic biases. A shift back to the beneficial mean?

So in a shorter timeframe these biases may vary in their effect from decisive to marginal and this variance may owe more to economic context and to the public’s need to concentrate their minds. In other words in comfortable times a tertiary hot house effect could apply which may permit these orchids of irrational bias to flourish as decorative illusions that the “crowd” believes it can afford. The biases will here be decisive in voting outcomes. In times of emergency however, the frost sets in and the hot house effect is gone and more robust considerations are brought to bear which diminishes, suspends or abolishes these biases altogether. Here the biases become marginal to voting outcomes.

Caplan states in his piece that economists now only disagree on the margins. Perhaps the crowd is only “irrational” at the margin (or within as yet not understood tolerances).

Secondly: Tim Worstall (in his Telegraph review) endorses Caplan's proposal "to move decisions from the political realm, where we are irrational, to the market one, where we are rational." But how are markets formed? Particularly markets in second tier demand i.e. luxury markets? Could demand not form around what a snapshot shows to be bias? Could the persistence of these biases not be seen as the pre articulate stage in the formation of a new demand and therefore a new market?

As Lord Salisbury once said of a mid Victorian Indian famine “the market in corn may correct itself in the long run but the Indian peasant starves and dies in the very short run”.

Life and money are both short and a rational long term decision may not only be irrational but also immoral (letting the Indian Peasant die)in the short term. Perhaps an understanding of this immorality provides a clue as to how these biases become systemic.

All of Mr. Caplans identified Biases could fairly be described as Biases of trust. People do not trust the rich to make their money honestly. People do not trust foreigners. People do not trust that “the invisible hand” of the market will provide a better job after they lose their current “make work” job. People do not trust the future.

Whilst in the aggregate this distrust is irrational in the particular it certainly is not. The broad river of market progress is full of such eddies in which altered local conditions apply to those which apply to the river as a whole.

However since those caught (and thereby disadvantaged) by these eddies are relatively few in number their bias against beneficial economic change should not affect the aggregate “wash” at election time. However if millions feel an empathy or solidarity with the plight of the disadvantaged minority then this solidarity acts as a multiplier and it will deliver the systemic bias that Caplan describes.

But might not this solidarity be better seen as a contract payment – the necessary consideration paid in return for the maintenance of the general culture of trust without which markets could not operate at all?

Trust formation in markets is not covered in Caplan’s survey. What makes us trust one another and therefore operate dependently but remotely from others for the same economic object? Without this trust surely the zero sum (lose lose) model of economic relations remains the default option?

Mostly it is experience, our own and that inculcated by family, that enables us to trust others. Trust is therefore learned behaviour and it may be counterintuitive in that our instincts may prompt us to be less trustful then we have in fact learned to become.

Creating solidarity with those outside the family has been the incremental achievement of centuries. So if widespread trust provides a fundamental economic benefit what is its premium? Could the motivation behind these irrational voter biases be a rational attempt to signal the price of trust itself? Could the voter’s systemic bias not be the first steps towards forming and growing a market in trust?

If the outcomes are economically sub optimal it may be because the rational demand for solidarity is expressed in the irrational language of bias by the “crowd”. As a consequence of this bad communication the “crowd” politically rewards supply failure.

The policy outcomes are therefore damaging to the general economic health and often even directly damaging to the interests of those they are intended to help but they still meet the minimum criteria of the solidarity demand i.e. they prevent Lord Salisbury’s Indian peasant from starving to death.

If so might this moral minimum not provide sufficient (though not efficient) incentive for the crowd to persistently renew its badly articulated demand for solidarity?

Might this not be an immature, even embryonic market, in which demand signals are strong but confused and supply solutions are consequently clumsy and expensive?

Perhaps the systemic bias Caplan has identified is only a prelude – baby talk for what will ultimately become a mature market that efficiently prices trust and solidarity into the economic equation?

If we assume that the basic market drivers of economic prosperity are now understood and that, as Caplan states economics is now only controversial at the margin then what value does the current consensus place on this trust? Is this an understood but negligible factor or is it not yet understood and therefore still outside the authoritative statements of the consensus?

Even if, as Caplan says, the economic consensus around markets is final - the knowledge of markets themselves is still far from complete. To paraphrase the satanic Donald Rumsfeld maybe what is an unknown to the consensus is a “known unknown” to the crowd and, with these biases, they are only performing their historical role of developing the signals & information necessary for the consensus to later integrate into formal knowledge.

Certainly it may not be irrational in times of plenty to select sub optimal economic solutions (reducing the profit in the national P&L account) in order to extend or repair this solidarity (rebuild the national balance sheet). In prosperity a strategy of income discount that optimises underlying capital assets may be an optimal economic outcome and it could certainly be described as a rational decision.

Thirdly: Even in the (likely) event that my speculations above can all be adequately addressed by those with greater expertise, I would still argue that in a tiny historical time span democratic societies have in fact developed a form of mass solidarity or trust which is unparalleled in any other system. So even if these voter biases are only an expression of irrational recidivism towards a more primitive economic logic, this is not necessarily surprising given the shortness of the period in which the current economic consensus has been fully established. Caplan’s study may therefore be demonstrating a “lag effect” or a “long tail” rather than (as he suggests) a permanent condition.

Fourthly: In addition Caplan’s new consensus does not enjoy a monopoly hold over either the media or the message that is necessary to transform it from being the consensus of economists into being the consensus of the public at large. After all it is only 20 years since the Marxist challenge was finally and absolutely discredited within the economics faculties of the academy. Meanwhile, down the corridor, in those conservative outposts of the humanities and social studies departments, the Marxist critique is actually still dominant. Caplan’s economic consensus is therefore daily denied in the scripts of plays, documentaries and soap operas written for the mass audience by the products of this unreconstructed Marxism.

Caplan has made a fascinating case but, in my opinion, his indictment of democracy has failed to demonstrate that his identified biases always operate decisively rather than conditionally, or that they might be an embryonic market of the type he calls for, or that they are always and necessarily irrational or that they are a permanent or “hard wired” feature rather than a ‘lag effect” distortion which will diminish over time.

But in the end all of the above may simply reflect my own irrational bias & belief that the building of public trust around the economic consensus is the job of democracy. To use the consensus as a lever to overthrow democracy is just way too counterintuitive for me.

1 comment:

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