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Why the People Running Our Economy are Clueless

Update.  Still working on the book.  Getting really close.

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The US is in so much trouble is because most of the people at the top, don’t understand the role the American Dream plays in the success of our economic system.  Due to this ignorance, they are continually surprised when nothing works the way it is theoretically supposed to work.

Here’s a classic example from the testimony of Alan Greenspan to Congress in relation to the 2008 financial crisis.   Alan was, arguably, the person with the most power over the economic system in the world, for over a decade.  Yet as you will see in the testimony, he’s completely clueless.  In it, he professes that he didn’t understand why so many bankers, acting out of rational self interest, didn’t do the right thing.

Alan Greenspan: “Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity, myself included, are in a state of shocked disbelief.”
Congressman: “Do you feel that your ideology pushed you to make decisions that you wish you had not made?”
Alan Greenspan: “Yes, I’ve found a flaw. I don’t know how significant or permanent it is. But I’ve been very distressed by that fact.”

Of course, it is understandable why Alan is confused.  His entire life is built on the study of economics.  Economics is a soft academic science that is predicated on the idea that people act solely on the basis of rational self interest, and that the economy produces wealth only because people act in this manner.  Of course, as this book has proven again and again, this assumption is a terrible error.   A falsehood and a lie we’ve been told again and again until people think its true.

Capitalism doesn’t produce wealth because people are greedy or selfish to a fault.  Capitalism does it because people are building a better life for themselves by following the structure and discipline of the American Dream.   Economic independence is one indicator this pursuit is working, but so is the ability to build a produce or deliver a service that makes it possible for other people to improve their lives too.

This is so important I need to walk you through this step by step.  I’m doing this partly because I think you will see why it is so valuable and party to undo some of damage this lie has done to our understanding of how things work.

When Adam Smith penned his famous book, The Wealth of Nations, the Protestant Ethic was the basis of most economic and social life.   Not long after that, Ben Franklin articulated this ethic as the American Dream.   It was, for all intents and purposes, the commonly held wisdom at the time and Adam Smith recognized this.  He did this by reducung the American Dream to something he called “enlightened” self-interest.   Here’s what this means.

Rational self-interest is simply selfishness. It’s purely the desire of an individual to advance his or her interests to the exclusion of all else.  It’s the type of behavior we chastise in our kids for, due to problems it creates in later life.  IN contrast, enlightened self-interest requires the intelligence to see beyond yourself, to the greater context.  Additionally, it’s the belief, that if an action improves both your life as well as the lives of others, the value of the action is better than if it improves only your or others.  This truth should be self-evident and obvious to everyone reading this, particularly since we are living in a world that was built on the idea enlightened self interest. It should be proof enough that an United States with many prosperous people is much more prosperous than one with a few very prosperous people.   In a world of widespread prosperity, even the most prosperous are more prosperous than in a world with few winners.

This truth should also be self-evident on the personal level too.

When I act solely based on my self-interest, I operate without internal or external restraint.  This means that contrary to the thinking of the many economists who believe in petty self-interest, I am also free of the restraints imposed by rules, regulations, and laws.   In fact, self interest dictates that these rules are either weapons to use against others or dictates to be ignored to the extent punishment can be avoided.  In short, self-interest dictates that these rules and laws are only followed when the potential of being caught and the punishment that may result exceeds the value of the action — which due to the imperfections and corruptibility of legal and rational rule sets is very easy to do. It gets worse.  Rational self-interest can even be used to justify acts that damage the prosperity of everyone.  This implies that if a sufficient number of people act in the same fashion, the entire system becomes a dysfunction cesspool.  A place where every scam, fraud, and theft imaginable is dreamed up and acted upon.

In contrast, enlightened self-interest requires maturity. A mind that isn’t hamstrung by the myopia of childish ambition.  A mind that can see a world beyond.  This does NOT mean that enlightened self-interest means that we should put the needs of others above the needs of the individual.  Far from it.   A decision making system based solely on altruistic is as completely dysfunctional as one based solely on selfish action.  Selfless altruism is the basis of Communism and National Socialism, with their complete disregard for self-interest.  This  is why these systems are always heavily bureaucratic and machine-like in the way they operate.  This denial of nature also why they often become ruthlessly authoritarian.

 

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Discussion — 12 Responses

  • Michael J. Lotus March 19, 2014 on 3:52 pm

    This distinction also occurs in Tocqueville, who referred to “self-interest rightly understood” — which is what you are calling enlightened self-interest.

    This is a good distinction to make. Modern thinkers, using reductionist ideas derived from Economics, depict a hyper-simplified and non-existent world where a narrow conception of rational self interest is universal, and efficient. But real markets, real communities, real businesses don’t actually look like the pristine, mathematicized model. Further, if you dig down more deeply, you can find that there is a “second order rationality” which pushes toward enlightened self-interest. A classic recent case, and an intellectual milestone which had bad consequences, is Richard Posner’s discussion of “rational breach” in his influential Law and Economics textbook. Posner dispenses with any irrational moral baggage, in his view, and says, that if you make a contract and it is cheaper to breach it than keep it, you should breach it, and the court is there simply to reduce transaction costs and not to moralize as if there was anything bad about breaching a contract per se. This is a brutally oversimplified analysis of an extremely complex social phenomenon. Later analysts, even within an economistic framework, showed that game theory is applicable, and that reputational issues matter in getting others to bargain with you and to reduce transaction costs by raising trust. So, to the surprise of few people outside of the field of professional economics, the moral assessment of breaching, which is older than literacy, is consistent with personal and collective efficiency.

    I disagree about the primacy of the Protestant ethic. The English (and lowland Scots, and the Dutch) had been individualistic and market-oriented, with a robust civil society including business ventures, for many centuries before Protestantism. We talk a lot about this in America 3.0. So, Smith’s enlightened self-interest is a phenomenon which was empirically observable, but which was not widespread. For most communities it could be an aspirational goal, but it was not currently in existence. In other countries even as close by as France, there was a zero sum mentality, with business being either very small scale or being regulated monopolies granted by the state. There was small scope for voluntary behavior on a large scale allowing the exercise of enlightened self-interest.

    You are onto something valuable — reestablishing a moral foundation for voluntary cooperative action, including very large scale action, which requires trust, and requires participants to bring a shared moral understanding to their participation in the collective activity. There have always been thieves, but today we have gone from shameless thieves, to people who cannot even conceive of the meaning of the word “thief” or that it can apply to them, or that they should care if it does, as long as they have as much money as they can get and not go to prison. That is too low a standard to sustain an immensely complex extended order such as we have indefinitely. This means people have to be formed, one by one, by upbringing, example and expectations to have an inner moral compass that actually works, at least some of the time, when it is to the person’s own immediate detriment to go where the compass points.

    Standing by for the prescription of how to make this restoration. I would say a religious revival is the only proven way, but you may have other ideas!

    This is a good post. Hence a long comment … .

    Reply
    • G Michael J. Lotus March 23, 2014 on 11:20 pm

      We’ve already had the religious revival, and it has not worked. Something else is needed, about which more below.

      Evangelical Christianity (as distinct from mainline Protestant denominations) rose as a political force beginning in the mid 1970s. Self-professed Evangelical, Jimmy Carter, was elected President in 1976 in part due to the then-newly-noted turnout of Evangelical vote. Ronald Reagan campaigned directly to this constituency, which played a significant role in his election in 1980 and again in 1984.

      Throughout the 80s, 90s, and 00s, the general pattern was that Evangelical Christianity played an increasing role in election outcomes and broader cultural dialogues, offset only in periods of economic downturn or crisis. During this period, Evangelicalism increasingly became politically and culturally conflated with Fundamentalism (they are not the same thing) in the form of the Religious Right.

      With the aid of vast influxes of funding from rationally self-interested actors, the Religious Right became a dominant cultural force right up to the point of the economic crash of 2008. Since that time, the Religious Right has lost power on the national level but retained it in various states and regions.

      If Fundamentalist-Evangelical Christianity had the necessary ingredients for producing and sustaining a moral society as we’re describing it here, it failed utterly. Instead, its moral agenda was an obsession with other peoples’ sex lives. Its secondary cultural agenda was opposition to science, which fueled a backlash in the form of the rise of “New Atheism.”

      The risk of religious revivals in general, is that they are predicated on a type of enthusiasm (“en theos”, filled with the spirit of the divine) that has little room for critical thinking or other limiting feedbacks. Thus they tend to move toward absolutisms, as we have seen with both the Religious Right in American Christianity, and with the Taliban in Islam.

      Religion, philosophy, and the arts, have historically been the source of individuals’ and societies’ sense of _values_. At one time they were also the source of the sense of _factual truths_, but in this role they have been replaced by the sciences, and no sane person would wish to return to the prescientific era (cholera, anyone?). Though science is the most comprehensively capable means of elucidating the facts of the natural world, from the subatomic to the astrophysical level, it necessarily can’t make judgements of value.

      The fatal flaw of fundamentalism (in any tradition or denomination) is its inherent fragility: if any part is shown to be false, the entire thing collapses. Thus we see efforts to shore up young-Earth creationism (“YEC”) with the ridiculous and diagnostically paranoiac assertion that God planted fossils and created the cosmic red-shift _in order to tempt humans and test their faith_. This fragility gives rise to shrillness and extremism in the attempt to prop up the belief system, until the point where it is overwhelmed by contradictions and collapses into a fringe minority position.

      Thus what we actually need is a synthesis, based on facts as elucidated by science, and values as elucidated in the common ground of a wide range of traditions. This was the basis of the 18th century Enlightenment, and it can form the foundation of an emerging 21st century “new Enlightenment.”

      Reply
  • Cavolonero March 19, 2014 on 6:28 pm

    I remember watching Greenspan’s testimonry and Waxman’s questions. The thing was – he didn’t say what this terrible flaw actually was. Waxman wanted him to say ‘ this whole ‘ free market ‘ idea has been entirely wrong from the start, but, what ‘ the terrible flaw ‘ actually was to Greenspan was that invariably, The State will always interveen in the end and screw it all up – ‘ because if you just let the markets operate see … ‘

    Reply
  • James Bowery March 20, 2014 on 6:06 am

    It boils down to the incentives.

    If you want to have a cohesive society in which the poor are rooting for the rich to become richer through creativity, and the rich are not terrified of competition from upwardly mobile middle class, you must align their interests:

    Treat the government as a mutual property insurance corporation with a citizen’s dividend paid out equally to all citizens from the property insurance premiums.

    Reply
  • Chris S. March 21, 2014 on 10:46 am

    “Economics … is predicated on the idea that people act solely on the basis of rational self interest….”

    People, being human, often act on rationalized self interest. They act, then later they rationalize their actions as consistent with who they are. As in, “it seemed like a good idea at the time.”

    Reply
  • AC March 22, 2014 on 8:31 pm

    John,
    You can sum up everything we are fighting against with one word: Aristocracy.
    Have you ever read the book “The Killer Angels” by Michael Shaara? One of the central themes of the story is that the union and confederates were fighting over different dreams for America. The Confederate dream was one of cementing the aristocratic, plantation culture in the South while the Union dream was one of preserving the American Dream for the nation as a whole. We are essentially fighting that battle again between the Aristocracy and aristocratic thinking (Who you are matters more than what you do) and the American Dream (What you do matters more than who you are).

    Reply
    • Ryan AC May 8, 2014 on 5:02 pm

      Thanks for the rec. AC, just purchased a copy for myself. The story looks very timely. Have you read “The Fourth Turning” by Strauss and Howe? What I’ve found as a good lens with which to view our current situation.

      Reply
  • AC March 22, 2014 on 8:59 pm

    You are correct about enlightened self-interest. You could also call this acting in a community minded manner(ie: A rising tide favors all boats) . We as Americans have forgotten how to work as a team towards a common goal for the good of all. The tricky part comes when we have to establish what is a good balance between the rights of the community and the individual. Right now, the problems we face are too big for any one individual to solve (Snowden put a light on privacy abuses by the gov’t, but it will take collective action to curb both corporate and gov’t abuses of privacy). Collectively, most of the current problems can be overcome. What we have to find out is if there are enough people with enlightened self-interest out there to come together to do the work.

    Reply
  • Dustin April 8, 2014 on 4:30 pm

    In understand we are all screwed. What can I do to help my kids?
    How can I help divert them into situations that will help them in the future?
    How I can I retool when I’m so heavily invested in the debt hamster wheel (cars, mortgage, credit cards) , even though I have a pretty good income?

    Reply
    • John Robb Dustin April 9, 2014 on 10:52 am

      Invest everything into reducing your burn rate and increasing the number of actively managed income streams you have access to. Don’t invest in passive wealth. Invest in active wealth. More on this later.

      Reply
  • Clark Landwehr May 6, 2014 on 7:45 pm

    I have followed JR for a long time and am a big fan. His insights have been a major influence on my thinking. But I find talk of dreams somewhat disheartening. Is investing in dreams and beliefs really the answer??? Did America’s problems really start in the 1970’s???. I think America went wrong in the Civil War when we started borrowing money from private firms to finance the war. Which may be the real tragedy of Lincoln’s assassination. He would have tried to undo that policy.
    And I don’t think we can even define self-interest. That requires some kind of neutral architecture for calibration. The idea of enlightened self-interest may be even worse than plain vanilla self-interest. That is basically saying: “if people only understood what is REALLY in their self-interest, all our problems would be solved.” That was Stalin’s solution.
    Lately I have been taking a hard look at the old pagan idea of virtue. Which is may get us out of the ‘hedonic quagmire”…

    Reply
    • John Robb Clark Landwehr May 7, 2014 on 9:58 am

      Clark. I’ve found something much better. Had to work through the cruft first. JR

      Reply