Ostrich Economics

ostrich.jpgGreg Mankiw believes he has revealed an obvious flaw in Robert Frank‘s account of “relative deprivation” (which I’ve praised here.) According to Mankiw,

Market prices should reflect the externalities imposed by neighbors. . . . [C]onventional wisdom is that houses surrounded by bigger, more expensive homes sell for more, other things equal, than houses surrounded by smaller dwellings. This suggests that the rich convey positive, not negative, externalities.

Two responses:

1) Maybe people are sacrificing a lot to be among the rich–but many are not exactly comfortable with their relative position:

When chief executives are routinely paid tens of millions of dollars a year and a hedge fund manager can collect $1 billion annually, those with a few million dollars often see their accumulated wealth as puny, a reflection of their modest status in the new Gilded Age, when hundreds of thousands of people have accumulated much vaster fortunes.

Of course, I laughed at one Silicon Valley mini-mogul’s “earnest” assurance that “You’re nobody here at $10 million.” That kind of subjective “discomfort” is not something anyone should be lamenting. But there is a deeper problem with Mankiw’s drive-by dismissal of Frank’s argument–an extreme version of methodological individualism.

2. One of the key chapters of Frank’s Falling Behind is entitled “Smart for One, Dumb For All.” There he discusses an anecdote about evolution relevant to today’s competitions for status and wealth:

In the contests for access to mates, it’s the relative size of an animal’s antlers that counts, not how big

they are in absolute terms. But when fleeing from predators in densely wooded areas, greater absolute antler width is a serious handicap. It might seem that this is a problem that would solve itself, since a mutant elk with smaller antlers would enjoy relative immunity from predators. True enough, but such an animal also wouldn’t leave any offspring, and in the Darwinian contest, that’s the only payoff that counts.

Oversized antlers belong to a class of traits and behaviors that I have described as smart for one, dumb for all. They are a simple consequence of a positional arms race.

Mankiw’s methodological individualism appears to blind him to the ways in which a given decision can be eminently rational for a family (and those in its immediate vicinity) and yet be part of a process that is collectively self-destructive. Frank does take individual motivations as his starting point, but he follows this wise advice of James S. Coleman (in Foundations of Social Theory):

The interaction among individuals is seen to result in emergent phenomena at the system level, that is, phenomena that were neither intended nor predicted by the individuals. Furthermore, there is no implication that for a given purpose an explanation must be taken all the way to the individual level to be satisfactory. . . . [We] require an explanation that goes below the level of the system as a whole, but not necessarily one grounded in individual actions and orientations.

For Robert Frank, the key variation on classic economic methodology is realizing the importance of context to decisions: your perception of your house’s (car’s, tv’s, etc) adequacy depends on how well it compares to those in your reference group. Rather than contradicting Frank’s point, Mankiw’s insistence on the “positive externalities” of the rich reinforces it: because people generally realize it, they compete all the harder for residences in the “good” neighborhoods and flee the “bad” ones.

Like Frank, I am puzzled by how “the reigning economic models of consumer behavior . . . ignore context completely[, assuming ] that each person’s consumption spending is completely independent of the spending of others.” Frank predicts that:

Future intellectual historians will find this more puzzling than the fact that physicians once prescribed leeches to treat fever. Eighteenth-century doctors, after all, had no way of knowing about the germ theory of disease. But ignorance cannot explain the absence of context from economic models. Even those economists who have not studied the relevant social science literature surely know from their own experience how much context matters. [emphasis added]

So why the struthious approach to context? I’ll make a few stabs at solving that puzzle:

1) Consider that institutions like Harvard (where Mankiw teaches) are themselves great beneficiaries of rising inequality. They are engaged in a positional arms race for donor gifts, and have outdistanced the “pack” to an extent that suggests the general inequality of wealth in the U.S. As Steve O. Michael notes,

[I]n the past 10 years, donors have parted with vast sums of money in donations to colleges and universities that truly do not need them. When a university is richer than several countries put together, when a university can comfortably live off the returns on its billions of dollars in endowment, and when a university can no longer convincingly demonstrate how new money will make a concrete difference in the academic experience of faculty members and students, additional donations to the university are not only mindless but outright wasteful.

In a world of lower income inequality, we might see such gifts spread around among a wider group of almas matres.

On the other hand, it’s a stretch to call the Harvard faculty as a whole fans of inequality. And even if the economics department is pretty orthodox, it still has some members who’d easily recognize the wisdom of Frank’s approach.

2) A sociologist of knowledge might then conclude that the problem isn’t Harvard…so might it be economics in general? In The Black Swan: The Impact of the Highly Improbable, polymath Nassim Taleb argues:

Economic is the most insular of fields; it is the one that quotes least from outside itself! Economics is perhaps the subject that currently has the highest number of philistine scholars–scholarship without erudition and natural curiosity can close your mind and lead to the fragmentation of the disciplines. (155-56).

But I don’t think there is some disciplinarily monolithic “economics” one can dismiss so easily. The changing face of economics evidences an openness to influences from evolutionary biology, computer science, psychology, and philosophy. Mankiw himself recognizes the value of the “big questions.”

3) So that leaves another possibility: is there a political reason for Mankiw’s rather careless dismissal of Frank’s work? Well, Mankiw was an advisor to the current president. And here’s Frank’s account of Bush policies:

[The] George W. Bush administration . . . has enacted the largest ever cuts in our income taxes, most of it targeted to families with the highest earnings. Facing enormous federal budget deficits at a time when we are not paying teachers enough, not repairing our roads, bridges, and municipal water supply systems, and not inspecting the meat we eat, can multi-trillion-dollar tax cuts really be a sensible policy?

At a time when top earners have been reaping virtually all the fruits of the nation’s economic growth, can targeting more than 50 percent of the benefits of these tax cuts to the top 5 percent of earners really be a sensible step?

My guess is that Mankiw says: absolutely yes.

Photo Credit: Creative Commons Licensed Ostrich Image.

You may also like...