Phishing for Phools: The Economics of Manipulation & Deception. George A. Akerlof and Robert J. Shiller. 2015.
The authors, both Nobel laureates in economics, argue that the common economic model of a free market with assumed perfect conditions is woefully inadequate for formulating policy in the real world. Although free markets have contributed greatly to prosperity, they have also included many failures such as unfair distribution of income, inadequate social protections, and externalities like pollution that are mitigated by government intervention. Phishing for phools is added to this list of market failures. It is defined as manipulation and deception that are intrinsic to markets and that inexorably arise from the same profit motive that produces prosperity.
In the past four decades, behavioral economics has identified many aspects of human psychology that differ greatly from the rational man of economic models and that are highly vulnerable to phishing. These include many cognitive biases and thinking in terms of narratives onto which marketers can graft other stories. For a much longer time, advertising and marketing in both business and politics have used sophisticated techniques to understand and exploit these same vulnerabilities.
Numerous examples are drawn from all walks of life to show the pervasiveness of phishing for phools. For the financial crisis of 2007, the untoward actions of investment banks, rating agencies, and the trading of derivatives and credit default swaps are discussed. Rip-offs regarding cars, houses, and credit cards are revealed. Phishing in politics is said to undermine democracy, particularly because of the oversize role of money in elections and lobbying. For Pharma and phood, abuses before and after the Food and Drug Act of 1906 are discussed, including the 2006 lobbying victory that barred competitive bidding for Part-D Medicare drug coverage. Bankruptcy for profit by fraudulent bookkeeping in the savings and loan crisis of 1986-95 is described. The rise of Michael Milken’s junk bond industry that enabled the excesses of leveraged buyouts by corporate raiders is reviewed.
The phishing equilibrium is pervasive but not comprehensive. That is because we have individuals who step back from the profit motive and act as leaders of business and government. It is these heroes who make the free-market system work as well as it does, not the unadulterated actions of markets. Some of these individuals work in or have founded organizations that measure and enforce standards, like the Food and Drug Administration, the National Bureau of Standards, and the Better Business Bureau. Other individuals have developed legal protections for consumers or have worked to regulate business and finance in government agencies that may be strikingly underfunded by the enemies of regulation in congress.
The final section of the book discusses the competing stories of the free market. (Remember the importance of narrative in human thinking.) During the Age of Reform from 1890 to 1940, Populism, Progressivism, and the New Deal led to a new, more expansive view of the role of government. The old story is that in the post-World War II years there was a consensus that government met real needs by Social Security, Medicare, securities supervision, deposit insurance, the interstate highway system, aid to the indigent, supervision of food and drugs, environmental protection, auto safety laws, laws against mortgage-gouging, civil rights, and gender equality.
The new story achieved currency in the 1980s when Ronald Regan said, “Government is not the solution to our problem; government is the problem.” This story is derived from an unsophisticated interpretation of standard economics that says free-market economies without government interference yield the best of all possible worlds. Actually, the free market is a double-edged sword that does produce great prosperity but that also produces highly significant harmful effects from which we need protection. The authors provide three examples of important old story protections and new story efforts to end or minimize them by “reform” or defunding.
Social Security: In the old story, for those over 65, Social Security provides more than half of unearned income for the bottom 80% and still provides 31% for the top 20%. Without it, the poverty rate for those over 65 would rise from 9% to 44%. Nevertheless, in the new story, the Bush administration, in 2004, proposed to privatize a significant portion of the program. The plan essentially gave the most vulnerable citizens government loans to be paid back with high interest rates in order to speculate in stocks and bonds. The authors thought that the plan was “to be blunt, daffy.” In addition, the Paul Ryan plan to privatize Medicare that would result in a typical person over 65 paying 68% rather than 25% of health care costs out of pocket.
Securities Regulation: In the old story, securities regulation is one of the most important government functions. In the new story, these functions are to be undone by deregulation and defunding. Both of these likely contributed significantly to the financial crisis of 2007. In 2014, the SEC oversaw close to $50 trillion of assets with a budget of 0.003 cents per dollar of asset. This is 1/400 of mutual funds budget of 1.03 cents per dollar of asset. Quite possibly, this new story defunding of regulators, with workloads and salaries to match, contributed to the eight-year delay between notification of the SEC of suspicions about Madoff’s pyramid scheme and his arrest in 2008.
Citizens United: In the old story, more than a century of campaign law aimed at limiting distortions by moneyed interests in elections. The Tillman Act of 1907 disallowed direct contributions by corporations to political campaigns. New laws in 1974 created the Federal Election Commission and limited campaign contributions and spending. McCain-Feingold of 2002 prohibited PACs, which had arisen to circumvent earlier campaign law, from mentioning candidates in advertising within thirty days of primaries and sixty days of general elections. In the new story, Citizens United, a right wing nonprofit political organization challenged McCain-Feingold in 2007 by paying to release a partisan documentary about Hillary Clinton. With new story thinking, the conservative majority of the Supreme Court denied the distinction between free speech by individuals and free speech by corporations. John Paul Stevens wrote in dissent that this defies common sense. Metaphorically, we must place some limits on those with resources to unleash huge loudspeakers that can drown out the messages of less well-endowed others.
The authors conclude that it is wrong only to picture the healthy (i.e. “efficient”) working of markets because it means that modern economics fails to grapple with deception and trickery that are inherent in competitive markets. Thus phishing for phools is not just an occasional nuisance that should be considered on a case-by-case basis. It is a generality that is an inevitable and inherent part of free markets. Thus phishing for phools should be cast in an Adam Smith-style general equilibrium framework, which is the benchmark for thinking for all economists.
27. Phishing for Phools (deceit in business ignored by right wing economic models)
