“There are idiots, look around.” That was the famously tactless response, in the 1980s, from the veteran economist Larry Summers to the efficient markets hypothesis – the assumption of many financial models that people always make decisions guided by rationality and with perfect information.
Tactless Summers may have been but was he wrong? Irrational crazes are as old as human history. Charles Mackay wrote a book called Extraordinary and Popular Delusions and the Madness of Crowds as far back as 1841.
And we have plenty of modern quantitative evidence that bears out the thesis of mass misconception and confusion. A poll by the Royal Statistical Society in 2013 found that the British public think £24 in every £100 of benefits is claimed fraudulently. The true figure is 70p. Around 30 per cent of the population are perceived to be recent immigrants. The true figure is 13 per cent.
Violence is on the rise, 50 per cent believe, when in fact it has been falling for 20 years. A quarter of people think foreign aid is one of the top three largest items of Government spending when in fact it is less than 3 per cent of the total. And it’s not just Britain where serious misconceptions about the world hold sway.
According to Ipsos Mori, in France the average person believes 31 per cent of the population is Muslim. The reality is 7.5 per cent.
And those are arguably mistakes. Even scarier are the popular conspiracy theories.
A quarter of Americans say they think the US government helped to plan the 9/11 attacks. Around 45 per cent think “millions” of illegal votes were cast in November’s presidential election. The picture of the ivory tower academic economist who assumes perfect rationality and perfect information is something of a caricature, as Summer’s well-known quip itself demonstrates.
Yet there has been a tendency among some economists to continue to assume – sometimes for the sake of convenient modelling, sometimes owing to ideology – that people are well-informed about the world around them.
And Robert Shiller, the Nobel laureate, delivered an important lecture to the American Economic Association earlier this month urging fellow economists to start taking popular delusions much more seriously.
Shiller stressed the economic relevance of powerful “narratives”- plausible but frequently false stories which can suddenly take a hold of the imagination of a large part of the public (and more easily and rapidly than ever in this digital age of ubiquitous social media). He suggested these narratives can drive behaviour, rather than merely being shaped by it, even perhaps causing economic slumps.
“We have to consider the possibility that sometimes the dominant reason why a recession is severe is related to the prevalence and vividness of certain stories,” he suggested.
Shiller feels economists should engage in major quantitative studies of developing popular narratives through textual analysis of internet searches, online mentions, Twitter trends and by mining other sources of “big data”.
Shiller’s challenge is an unsettling one for many economists. This research agenda will doubtless give some (though certainly not all) a feeling of being unmoored from their cherished rules of thumb about the rationality of the so-called “representative agent”. And as Shiller himself acknowledges it is fiendishly hard to disentangle cause and effect when analysing narratives.
Is a popular narrative driving economic fundamentals? Or are the economic fundamentals driving the popular narrative? Did people vote for Brexit because of the power of Vote Leave’s “take back control” narrative and because they became convinced Turkey was about to join the European Union? Did Americans vote for Trump because of the force of the “Make America Great Again” slogan and conspiracy theories about Hillary Clinton’s emails? Or was it because they were economically and socially “left behind”? Narrative economics will never conclusively prove something like this. And it’s hard to see mathematically elegant “microfounded” models emerging from it.
Yet such research may well be able to hint at the right answer. And in this era of online Islamist brainwashing, Trumpian lies and propaganda, the capture of the Labour party by hard-left Corbynites, mindless health scares, fake news, Fox News, the Daily Mail, Twitter bubbles – in this digital epoch of popular delusions and the madness of crowds – the sense that something serious is going on is hard to shake.
Shiller’s challenge to economists feels like a timely one.”
This article appeared in The Independent on 22/01/17