Tuesday, March 29, 2011

Yes, economists are influenced by incentives, but that doesn’t mean they’re amoral, intellectual guns-for-hire

Recently saw “Inside Job,” the 2010 documentary about the financial crisis. The director, Charles Ferguson, raises a valid point about the financial ties between some of the deregulation-happy economists and the financial sector (see Ferguson’s written piece on the topic here) – but he seems to imply at times that the economists have simply been paid to take (and argue for) the policy positions they have. In his written piece, he comments on

John Campbell, chairman of Harvard's economics department, who finds it very difficult to explain why conflicts of interest in economics should not concern us.

But could he be right? Are these professors simply being paid to say what they would otherwise say anyway? Unlikely. Mishkin and Portes showed no interest whatever in Iceland until they were paid to do so, and they got it totally wrong. Nor do all these professors seem to make policy statements contrary to the financial interests of their clients. Even more telling, they uniformly oppose disclosure of their financial relationships.

My point is not that the guys he discusses in the film (and the written piece) are blameless, but I think these things probably work in less explicit terms. They’re not intellectual prostitutes with a clear price-tag for taking the position you want to see them in. If you proposed explicit payment for their services they would feel horrified. However, they have a crush-at-a-distance to begin with, and as you wine and dine them, shower them with gifts and praise their opinions of you, they feel valued and vindicated and ever-more-certain that their view of you was correct.

This is not really rocket science: You have an economist who writes on the financial sector and regulation. He is positive to deregulated, free markets. You invite him to your financial firm, pay him well, and he meets lots of intelligent, smart, well-dressed and hard-nosed business men who tell him that he’s “spot on,” he’s “really understood things,” and who tell him anecdotes and stories that support and strengthen his views. Of course he’ll end up feeling even more strongly that he was correct (“Heck, I’m the guy who’s so insightful on reality that the guys on the ground want to hear my perspectives and pay handsomely for it!”), and of course you’ll enjoy his company and invite him around again, (“Heck, he’s the guy who sees our value and understands our potential!”)  and of course you’ll both feel that you have found a supportive and understanding and clear-sighted partner.

Now, economists are frequently happy to talk about how everyone is influenced by incentives – and if people disagree, economists will explain how this may be a “hidden motivation,” or how it may nudge us in un-noticed ways. Same here. There is no need to make it into a story of evil-doers wringing their hands and counting their cash as they cynically concoct models to support things they don’t believe in. Reciprocity, vanity, social proof… this is the sort of thing that happens every day.