26 May 2016

By Samuel Bowles

In the aftermath of the stock market crash of 1987, the New York Times headlined an editorial “Ban Greed? No: Harness It,” It continued: “Perhaps the most important idea here is the need to distinguish between motive and consequence. Derivative securities attract the greedy the way raw meat attracts piranhas. But so what? Private greed can lead to public good. The sensible goal for securities regulation is to channel selfish behavior, not thwart it.”

The Times, surely unwittingly, was channeling the 18th century philosopher David Hume: “Political writers have established it as a maxim, that in contriving any system of government . . . every man ought to be supposed to be a knave and to have no other end, in all his actions, than his private interest. By this interest we must govern him, and, by means of it, make him, notwithstanding his insatiable avarice and ambition, cooperate to public good.”

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The idea that base motives could be harnessed for the public good is what I term economic alchemy. And in Hume’s time it was definitely a new way of thinking about how society could be governed.

During the Middle Ages, avarice had been considered to be among the most mortal of the seven deadly sins, a view that became more widespread with the expansion of commercial activity after the twelfth century. So it is surprising that self-interest would eventually be accepted a respectable motive, and even more surprising that this change owed little to the rise of economics, at least at first.

How this came about, you will see, is a remarkable story, one that is finally running its course in light of mounting evidence not only that people are not really all that knavish, but also that treating citizens as if they were knaves may lead them to act is if they really were knaves! But I am getting ahead of the story.

It all began in the sixteenth century with Niccolò Machiavelli. “Anyone who would found a republic and order its laws” he wrote in his Discourses, “must assume that all men are wicked [and] . . . never act well except through necessity . . . It is said that hunger and poverty make them industrious, laws make them good.” Hume, it seems was channeling Machiavelli!

It was the shadow of war and disorder that made self-interest an acceptable basis of good government. During the seventeenth century, wars accounted for a larger share of European mortality than in any century for which we have records, including what Raymond Aron called “the century of total war,” which happily is now finished.

Writing after a decade of warfare between English parliamentarians and royalists, Hobbes (in 1651) sought to determine “the Passions that encline men to Peace” and found them in “Feare of Death; Desire of such things as are necessary to commodious living; and a Hope by their Industry to obtain them.” Knaves might be preferable to saints or at least likely to be more harmless.

The year before Adam Smith wrote in his Wealth of Nations (1776) about how the self-interest of the butcher, the brewer, and the baker would put our dinner on the table, James Boswell’s Dr. Johnson gave Homo economicus a different endorsement: “There are few ways in which a man can be more innocently employed than in getting money.”

Adam Smith showed how a constitution for knaves might actually work at least as far as the economy is concerned. The economic actor, he wrote “intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.”

This is hardly making the case for laissez faire that later generations have attributed to Smith. But it is a milestone in the emerging view that motives other than self-interest could be pernicious. The sentence following one of Smith’s rare references to the invisible hand makes this point: “By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it.”

The Wealth of Nations was still hot off the press when Archdeacon William Paley in his Principles of Moral and Political Philosophy let his readers know that he had no time for the “usual declamation upon … the worthiness, refinement, and delicacy of some satisfactions, and the meanness, grossness, and sensuality of others: because I hold that pleasures differ in nothing but in continuance and intensity.” The economists’ conception of “preferences” was in the making: a ragtag collection of undifferentiated motives including everything from addictions to moral commitments.

The result, remarked John Maynard Keynes in a 1926 pamphlet, The End of Laissez Faire, was that “The political philosopher, could retire in favor of the business man – for the latter could attain the philosopher’s summum bonum [greatest good] by just pursing his own private profit.”

Less than century after Smith’s Wealth of Nations, Lewis Carroll’s Alice had taken the economists’ message to heart. When the Duchess exclaimed, “Oh, ’tis love, ’tis love that makes the world go round,” Alice countered, if only in a whisper: “Somebody said that it’s done by everyone minding their own business.”

From there, it was a short step to thinking that while ethical reasoning and concern for others should inform one’s actions as a family member or friend; the same did not go for shopping or making a living.

And so it came about that since the late eighteenth century, economists, political theorists, and constitutional thinkers have embraced Hume’s maxim and have taken Homo economicus as their working assumption about behavior. Partly for this reason, competitive markets, well-defined property rights, and efficient and (since the twentieth century) democratically accountable states are seen as the critical ingredients of governance. Good institutions displaced good citizens as the sine qua non of good government.

In the economy, prices would do the work of morals.

Neither Hume, nor Smith – author also of The Theory of Moral Sentiments — nor any of the other great classical economists had imagined that people really were knaves in fact. Hume, in the sentence following the passage quoted at the outset added: “it appears somewhat strange, that a maxim should be true in politics , which is false in fact.”

John Stuart Mill played a leading role in restricting what was still called political economy to the study of “such phenomena . . . as take place in consequence of the pursuit of wealth. It makes entire abstraction of every other human passion or motive.” But he immediately termed this “an arbitrary definition of man.”

Unmitigated self interest was always just a handy simplification, one that in the late 20th century greatly simplified the eventual rendering of much of economics in mathematical form. But Homo economicus is now in retreat.

In my recent book I explain why economists have come to have second thoughts about Homo economicus.

First, economic experiments have provided evidence against the “harnessing knaves” approach once favored by the economic alchemists. Motives other than self interest – generosity, reciprocity and ethical commitments – are also important. And explicit economic incentives designed to induce people to act in the public interest some sometimes are counterproductive because they crowd out what Lincoln called “the better angels of our nature.”

Second, Smith’s invisible hand has always needed the helping hand of both public policy and personal morality. Smith’s economy was not the stateless world of sociopaths that so many students of economics encounter in their intro courses. Smith’s insistence that self interest be constrained by elementary morality now resonates in unlikely places.

As the housing bubble burst in 2008 and the financial crisis unfolded, many U.S. homeowners found that their property was worth less than their mortgage obligation to the bank. Some of these “underwater owners” did the math and strategically defaulted on their loans, giving the bank the keys and walking away.

Unlike the New York Times editorial from two decades earlier, the executive vice president of Freddie Mac, the Federal Home Loan Mortgage Corporation, made a distinctly Aristotelian plea for moral behavior in the economy: “While a personal financial strategy might argue for a strategic default, entire communities and future home buyers can be harmed as a result. And that is why our broader social and policy interests will be best served by discouraging strategic defaults.”

Rather than trusting that the market, by getting the prices right, would induce people to internalize the effects of their actions on others, Freddie Mac urged “borrowers considering a strategic default [to] recognize the damaging impact their actions can have on others.”

They were hoping, in short, that morals would do the work of prices.

The greatest challenges now facing the world—including controlling the spread of epidemics and managing climate change and governing the knowledge-based economy–arise from global social interactions that cannot adequately be governed by channeling entirely self-interested citizens to do the right thing by means of incentives and sanctions, whether provided by private contract or by government fiat. With economic inequality increasing in the world’s major economies helped along in many cases by flagrant abuse of legal and moral standards, one may also now doubt Dr. Johnson’s reassurance that “there are few ways in which a man can be more innocently employed than in getting money.”

The novel 18th century idea that economic self interest might under the right institutions sometimes be mobilized for social purposes remains essential to tackling these problems. Markets remain an essential and vast arena of human cooperation (albeit unintended). But the idea of an economy of avaricious knaves waiting to be harnessed for the public good by a discredited economic alchemy now appears to be anything but harmless.