Economic Theory for the Socially Perplexed By Bryan Caplan

Why is getting along with other people so complicated? Shows like Seinfeld and Curb Your Enthusiasm have explored this question with hilarious results. But last week Rick Harbaugh of Indiana University came to speak at GMU, and convinced me that economic theory has at least as much insight to offer the socially perplexed.

Harbaugh is a technically sophisticated signaling theorist, but his models begin with Tolstoyan insight into the human condition. Case in point: the paper Harbaugh presented was “False Modesty: When Disclosing Good News Looks Bad” (co-authored with Ted To). Other signaling theorists have assumed that if you can brag about yourself, you will. But in fact, inappropriate (but TRUE) bragging often lowers one’s social standing:

If you have good news should you disclose it? The standard answer is yes because otherwise people will skeptically assume that you have nothing favorable to report… [T]alented students are often reluctant to brag about their grades, highly educated people do not always list their degrees, donors sometimes make anonymous donations, overachievers often engage in understatement, advertisers of high quality products frequently use a “soft sell” approach, and people accused of an offense sometimes withhold mitigating information rather than “protest too much” or “make excuses.”

The paper then explains with great clarity what assumptions you need to make this story fly. It’s beautiful.

In another paper, Harbaugh turns prospect theory on its head. The key building block of the paper: “skill signaling.” Harbaugh explains:

Most risky decisions involve both skill and chance. Success is therefore doubly fortunate in that it brings both material gain and an enhanced reputation for skill, while failure is doubly unfortunate… For instance, the manager of a successful project wins the confidence of superiors to oversee more projects, while the manager of a failed project is viewed as incompetent and loses future opportunities… [A]n investor who picks a successful stock enjoys the esteem of friends and family, while an investor who chooses poorly looks like a foolish loser.

We’ve all been there.

Bottom line: Harbaugh’s the first high-level theorist in years that made me see the social world in a new light. Unless economic theorists want Levitt-style empiricists to confine them to an irrelevant ghetto of economics, they’re going to need to read between the lines of Harbaugh’s research program and learn his underlying moral: Theorists should draw their inspiration from life, not from “the literature.”

P.S. Still craving more Harbaugh? Check out “Too Cool for School.”