He who can, does; he who cannot, teaches.
~George Bernard Shaw
Name as many billionaires as you can. Now some millionaires. Who are the richest people you know personally?
Aside from being rich, what do they all have in common? Very few of them are economists.
Most of the world’s billionaires are businessmen or inventors—they’re people with big ideas. Many studied engineering in university, and many more don’t even have degrees.
What about the millionaires? I bet you named famous performers (athletes, actors), local entrepreneurs, or people with “boring but safe” jobs like lawyers, doctors, or architects—people with professional degrees.
How many economists did you name? Not many.
You’d think knowing how the economy works would be a big advantage—it’s not. The proof’s in the pudding: most economists work for the government. Many are cubical-dwelling corporate drones. A lucky few teach. Why? Because they can’t do.
Listening to economists is a sure-fire way to ruin your restaurant, bankrupt your business, and implode your investment portfolio. Why? Economics is abstract while reality is complicated, thus what works in theory rarely works in practice.
The best way to learn economics is to start a business and read books that will give you the intellectual tools to figure things out for yourself—books on history, statistics, and psychology.
Or, you could play Settlers of Catan.
No, I’m not being facetious: you’ll learn more about economics playing Catan than you would in a university economics class. Don’t believe me? Read on.
Killing Homo Economicus
It’s getting late. You’ve been playing Settlers of Catan for hours. And Joe is pissing you off.
He keeps moving the “knight” piece onto your tiles and stealing your resource cards. Not only that, but he’s been turning everyone else against you with his snide remarks.
Suddenly Joe presents you with a proposition: “trade me some clay and I’ll give you wheat”. It’s a good deal: you need clay just as much as Joe needs wheat, and trading will get both of you one step closer to winning the game. Trading with Joe is the rational decision—it makes economic sense.
What do you do?
If you’re anything like me, you’ll tell Joe to take a hike: there’s no way you’re trading with a lowlife like him. You’d rather lose the game than trade with your nemesis!
Your response may not be all that rational, but it’s real. People aren’t computers that constantly weigh their options rationally, and then make the most reasonable choice based on the available evidence.
People are animals. We’re emotional. We have instincts—or more accurately, we have decision-making heuristics (mental shortcuts) that are hardwired into our brain’s architecture. Basically, people aren’t rational.
Classical economic theory is based on the assumption that people behave rationally: we are rational consumers who weigh the relative utility of products before buying them. For example, economists assume that when presented with two different, but identical, items, people will invariably buy the cheaper one. Although this makes perfect sense in an abstract, theoretical sense, reality is messy.
People make irrational decisions all the time. In fact, behavioral psychologists like Daniel Kahneman (who won the Nobel Prize in economics for establishing “behavioral economics” as a field of study) thinks irrationality is the norm in the marketplace.
For example, Kahneman has shown that people are willing to pay more for a product if they are psychologically primed with completely unrelated high numbers than with low numbers (that is, if they were shown a sheet of paper with either high or low numbers on it a few minutes prior). This is because of something called the anchoring and adjustment heuristic, which is how the human brain interprets numbers.
Essentially, the brain will anchor to the last number with which it was primed, and then adjust down or up from that to arrive at a price. Say you ask ten people to estimate a price for a product—one that is fairly valued at $500. If they are primed with the number 1,000, their guesses will likely average around $550. However, if you primed a different group of people with the number 10, their guesses will likely average around $450.
There’s nothing rational about that, is there?
Behavioral psychologists have discovered many other heuristics that have big economic consequences, but the fact that even one exists is enough to undermine the foundation of classical economics. People just aren’t that rational.
Complexity & Emergent Properties
Economists often retort that that while individuals are irrational, the law of averages smooths this out in the population as a whole. Unfortunately, the relatively new interdisciplinary field of emergent properties and complex systems puts the kaibosh on this.
Simply put: groups follow different rules than individuals, these rules often differ according to the size of said group, and these rules could not be predicted given the individual characteristics. Given this, there is no reason to expect that purely rational consumers would make rational choices in the aggregate—never mind irrational consumers.
Groups have to be investigated on their own terms.
And of course, there is a large body of empirical evidence that shows aggregating people doesn’t magically make them rational—groups are just irrational in different ways.
For example, in his book The Hour Between Dog and Wolf, John Coates explains how stock markets vacillate between periods of irrational exuberance and panic across all time-horizons, be it minute-by-minute, hour-by-hour, or year-by-year. Emotions like hope and fear govern the market, not rational expectations.
Economic theory is based on the presumption that people are rational. This is a lie. There is no homo economicus—no rational consumer. There are just homo sapiens, and they’re irrational.
If you’ve played Settlers of Catan then you already know this, and you’re miles ahead of everyone currently enrolled in Economics 101. Catan has more to teach us about economics, but in the interests of brevity I only included the first lesson in this article. The other two economic lessons can be found here.