Look, We Get It, People Aren't Always 100% Rational


No offence towards Cornell professor Robert H. Frank, but how many times are we going to have to read some version of this article.

In the column for this Sunday’s NYT, Frank argues that free markets don’t work as beautifully as Alan Greenspan imagined because human being aren’t always totally 100% rational like economists assume they are.

You know, they chase bubbles. They favour short-term pleasures over long-term ones. Our ancient nervous system clouds our rational decision making. We make decisions based on random recent events, like floods! Or terrorist attacks! Yadda yadda, etc..

It’s not that any of this is wrong necessarily, it’s just very-very well-trodden ground. And Frank isn’t too interested in pushing the argument much further. (It is also a strawman, someone needs to write a book, “The myth of the rationality-assuming economist“)

He ends with:

Of course, periodic asset bubbles occurred even when markets were less competitive. But people in earlier times were less aware of the high returns being earned by highly leveraged investors. Relaxed regulation and increased competition now confront investors with temptations that growing numbers of them are ill-equipped to resist.

Alan Greenspan’s erstwhile faith in the invisible hand notwithstanding, it was never reasonable to have expected market forces to protect society from the consequences of this risky behaviour.

Here’s the problem with this argument, and the same argument when it’s made by Robert Shiller and Joe Stiglitz and anyone else. They say humans aren’t rational and thus the free market needs regulation. But why is regulation the proper antidote? Why do we assume regulators to be rational? Remember, regulators pre-bubble were interested in expanding homeownership and the general policy of the United States was to keep price-appreciation going. That’s been built into our law for a while.

Sure, now we might (for some period) adopt a different stance. But over the long run, on what basis are we to believe that the biases and irrationality of government regulation/policy will prove to be the proper antidote to our own actions? The answer’s never given. It’s just assumed.

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