By Insula Qui
I would like to apologize for the lack of articles these last weeks, but I needed to spend time on putting out the second edition of “Libertarian Reaction”, which you can buy here.
As most of you would assume, I subscribe to the Austrian school of economics, but this last month I have been posting quite a lot about behavioural economics, a wholly disparate school of thought. And since many Austrians deny the fundamental usefulness of behavioural economics, I think it is my duty to show how there can be a complete synthesis between these perspectives. Keep in mind that I’m not an economist, but rather just commenting on the field from my perspective of political philosophy, if I make any errors in fundamental theory, then that is my own fault.
The first criticism that Austrians are quick to make about the entire school of behavioural economics is that it asks: “Why do people act?”. But Austrians supposedly only analyze the results of people acting. But this is patently false. For example, we can look at Hayek’s work and find that it mainly focuses on why people act but does not factor in human biases. His work instead analyzes the distribution of knowledge. So why reject the analysis of bias while integrating knowledge into Austrian theory? The answer to this question is fairly simple, behavioural economics directly challenges any notion that human action can be assumed to be rational to any degree. And although Austrians nominally deny that they expect humans to act rationally, a lot of Austrian theory revolves around the notion that humans act according to their own interests. However, for humans to act according to their own interests, they have to act somewhat rationally. But behavioural economics does away with the last degree of rational human action as it demonstrates why humans can act contrary to their own interests.
Austrians are also quick to respond to this by asking what does acting against your own interest mean? And to answer this, we have to go back to the knowledge problem and integrate it to the personal level. For those who are not familiar with the fairly overplayed concept, when it’s harder to distribute knowledge, it is harder to make good decisions. This can apply to many things, large corporations need to trade within themselves, so they cannot rationally allocate resources. States have no profit motive, so they do not know where to properly allocate resources. Socialism removes market signals, causing it to be impossible to know how resources should be allocated. But there is no reason for why the knowledge problem cannot apply to individuals. Thus, the core purpose of our synthesis will be applying various issues of knowledge to individuals.
This is because there are two different ways people make decisions, they do so either by using their fast thinking or their slow thinking. The fast form of thinking is passionate, biased, and well tuned to make quick decisions without any particular concern for the future. This is the field of thinking to which most mundane actions should be relegated to. This is also the field of thinking that forgets keys at home and makes bad spontaneous decisions. The slow form of thinking is calculating, deliberate, and tends to use more logic and reasoning than the fast form of thinking does. If a person was given an infinite timeframe in which he could think as slow as he could, going through every single factor, he would be fully rational within the constraints of his knowledge. But due to the fact that it is impossible to think perfectly slow in the real world, all actions are irrational to a degree.
Thus, instead of the rationality in classical economics, we find ourselves with the simple fact that humans act irrationally to achieve their perceived goals. This in itself fixes every faulty assumption in Austrian economics theory. People do not act rationally to any degree, and it is useless to think of plain exchange without any fundamental value judgements. This is because there will never be plain exchange. This means that prices will always be distorted to some degree, the market will never be perfectly adjusted, and there will always be mistakes. But this is something the Austrians should rejoice over, it means that those who can think slowly, the entrepreneurs, can always capitalize on what is currently missing. They can adjust the market, charge proper prices, and deal with the fundamental mistakes people always make by nature. Entrepreneurship is only possible when there are systematic errors within the market.
But a critic could now claim that individuals make mistakes, but large groups would not do so. This is also false, individual valuations do not tend to contradict, but rather tend to go with the trend. Individuals usually have elastic demand curves and will make exchanges in that range, individuals are also influenced by what others think. For example, a man could value getting engaged more than two months’ pay, and if it is commonly accepted that engagement rings have to be worth that much, the man would be willing to commit simply because it is expected of him. It doesn’t matter how wise or unwise spending this much is from a financial standpoint, but only that the individual valuations are influenced by social norms.
Furthermore, the behavioural theory of bias perfectly explains the one error in the Austrian business cycle theory. The Austrians assume that when people can not have the information they need about the monetary system and the money supply increases, they will be so biased towards positivity that they do not account for inflation. But the Austrian theory itself does not provide the relevant metric that ensures that people are biased towards positivity. If all people were biased towards negativity, inflation would mean that business owners properly adjusted their profits according to the yearly average of monetary inflation and would not rely on price inflation to adjust their spending. However, behavioural economics demonstrates that people have a tendency to be biased towards positivity, which is why they expand their businesses during the inflationary boom and buy into stocks that have been growing exponentially.
By applying behavioural economics, we can draw conclusions that help with Austrian economics. However, we should now see what Austrian theory can add to beheavioural economics and if Austrian insights about human action can complete the theory of human behaviour. The example where we can use Austrian economics (alongside a bit of public choice theory) is in regards to choice architecture. The behavioural economists trust the state in designing choices for the population, but we have to see how this conflicts with the fundamental nature of human action. The people who are involved in the state look out for their own profit, and are not held accountable by market incentives, this means that choice architecture devised by the state will more often than not result in the state profiting the most.
This can be done in two ways, first, by reducing the amount of state expenses without reducing state taxation. Or choice architecutre could also give the state more money without providing additional services. In essence, all choice architecture done by the state will be characterized by two features. It will be profit maximizing and service minimizing. This can be contrasted with private companies that want to maximize both profit and service due to them being tied together. There are also agencies that are profit minimizing and service maximizing, but these are usually relegated to the realm of decentralized charities. Furthermore, a completely socialist economy would have all agencies as both profit and service minimizing, as all profit is illegal and all service is not tied to the benefit the workers get. This also lets us conclude that all agencies in a libertarian society would have to be service maximizing.
However, the state will try to engineer decisions whenever it creates choice architecture and as far as it will do so, it will only engineer decisions that are profitable to the state. Thus, all state choice architecture will ultimately be focused around the question of how to tax more and spend less. The final answer to this would be to outsource basically everything done by the state, while retaining the harshest grip on power by the state. This means that every company and industry will be as regulated as possible, while the state will hold onto the minimum possible industry to maintain its role.
The state will still try to collect revenue and allocate most of that revenue to state employees who do not perform productive efforts. This means that the state will want people to make decisions that benefit the banks, large corporations, and so on, and we can see this best illustrated in the American system. The state in America itself is seemingly relatively laissez-faire when compared to some less advanced democratic systems. However, the American government has complete control over entertainment, the media, banking, large industries, unions, private associations, and so on. This means that the power of the state increases perpetually without providing any additional services.
Here we can contrast this with the choice architecture that is created by decentralized charities and private companies. Decentralized charities are the epitome of good choice architecture, their goal is to help people make the best decisions possible, and so they will present the choices that are expected to help the most in the best light. Decentralized charities provide productive options as solutions to various problems. Private companies will also try to provide the most service, but for them it is important that they are the ones providing that service. Thus, private companies will try to incentivize people to consume the greatest quantity of their product, which also involves raising the quality of their product while lowering the price. This means that state choice architecture is fundamentally uneconomic and will lead to people working against their interests as much as possible.