The title of Benjamin M. Friedman's latest piece for The New York Review, "Two Roads to Our Financial Catastrophe," refers to his examination of two recent books analyzing the economic crisis. One is by John Lanchester, who is not known for his work in economics and is described by Friedman as "a British writer better known for his fiction and criticism;" but that background would justify the rhetorical flair of his book's title: I.O.U.: Why Everyone Owes Everyone and No One Can Pay. The other is by John Cassidy, a journalist specializing in economics and finance. His title is less flamboyant but more fascinating for its substance: How Markets Fail: The Logic of Economic Calamities.
Friedman provides an excellent précis of Cassidy's "logical analysis" that bears consideration:
… Cassidy is interested in the people behind what he calls "the triumph of utopian economics," and how their ideas came to be so dominant. As he rightly points out, "the notion of financial markets as rational and self-correcting mechanisms is an invention of the last forty years." Such advocates of market efficiency as the Austrian economist Friedrich von Hayek, the University of Chicago's Milton Friedman, and contemporary economists like Eugene Fama and Robert Lucas (both also at Chicago) all receive careful attention. So do the political figures who championed their ideas, most prominently Ronald Regan and Margaret Thatcher. Alan Greenspan, with his bizarre devotion to the Russian-born ideologue Ayn Rand, stands out as the chief villain in Cassidy's telling, guilty of not just flawed ideas and sinister influence but "much prevarication" as well.
Cassidy contrasts the "utopian economics" that each of these people helped to propagate with "reality-based economics," which suffers not only from the inevitable intellectual messiness that comes with attempts to analyze the world as it is, but also from failing to line up with the interests of the economy' self-aggrandizing elites. The centerpiece of Cassidy's analysis of the difference between the two economic worldviews is the prevalence and potentially damaging consequences of what he calls "rational irrationality"—a situation in which each influential actor does only what makes perfect sense from an individual perspective, but the combined effect of everyone's acting in this way leads to outcomes that make sense for no one.
Ironically, the logic of rational irrationality can be deduced from the very principles of game theory that lie at the heart of utopian economics; and game theorists are at least willing to acknowledge it as a dilemma, more specifically the "prisoner's dilemma." If utopian economics is all about building the right models against which one seeks to optimize payoff, then the prisoner's dilemma is the classic example in which optimization of the group cannot be achieved by each individual seeking his/her own individual optimization.
Beyond such counterexamples, however, is the question of whether or not reasoning grounded in a philosophy of positivism can deal adequately (never mind effectively) with that "inevitable" messiness of reality. This goes back to whether or not one can build those "right models" in the first place; and I have previous observed that all positivism can tell us is whether or not a model is internally consistent. The problem is that consistency offers nothing when it comes to recognizing that inevitable messiness:
Consistency is thus worse than Ralph Waldo Emerson's "hobgoblin of little minds;" it is a pragmatically unattainable goal that distracts us from more realistic goals concerned with "living with the mess" (otherwise known as being-in-the-world).
This emphasis on verbs like "living" and "being" emphasize a further problem with utopian economics, which is that the mathematics of game theory equates optimization with finding an equilibrium point in a complex multidimensional landscape. In other words game theory is, from a grammatical point of view, noun-based and thus totally at odds with verbs like "living." This, again, is a point I have previously discussed invoking one of my favorite twentieth-century thinkers:
Put another way, the worst thing that can happen to an economy is that it achieves a state of equilibrium, because, in the spirit of Isaiah Berlin's approach to the history of ideas, that "state," by its very name, is fundamentally static; and the only time a "living system" achieves stasis is in death!
I would therefore suggest that what makes "rational irrationality" so irrational is its analytic foundation based on the concept of state. That foundation basically clouds any vision of what we have now come to call "gaming the system," which is basically the search of loopholes through which the system may be abused for the sake of personal gain.
This, in turn, provides a lens through which we can think about getting out of the mess in which we are still bemired. If Greenspan has become "chief villain," then his primary act of villainy has been deregulation, which is why so much of the current talk about economic reform concentrates on establishing a new regulatory system. I do not object to such reform, but I think we need to be careful about where it takes us. By their very nature, regulations can only live in that noun-based world, which, in the spirit of gaming the system, can always be subjected to verb-based abuses. Regulations can be useful, but they can only go so far. We would do better to think of the "health and well-being" of economic activities in terms of "Udi Manber's metaphor for safeguarding against abusive and criminal practices on the Internet as an arms race." As I previously wrote, "the safety of the Internet will never be strictly a matter of technology;" and, by the same reasoning, economic health will never be strictly a matter of establishing and enforcing the right regulations. That is just part of the nature of the messiness of reality, which is why being-in-the-world is ultimately a matter of how we act to live with the mess.