While reading Michael Shermer's The Mind of the Market: Compassionate Apes, Competitive Humans, and Other Tales from Evolutionary Economics, I suddenly realized that the terms Shermer was teaching readers about in chapter five were mostly familiar terms from psychology and probability.
Some of them I learned at MIT, but I also read about many of these terms in a book this year or last year -- and I can't remember what book and it's driving me crazy! Maybe it was Tim Harford's The Logic of Life: The Rational Economics of an Irrational World? Or Michael Mauboussin's More Than You Know: Finding Financial Wisdom in Unconventional Places? Or Marshall Goldsmith's What Got You Here Won’t Get You There: Discover the 20 Workplace Habits You Need to Break?
I just don't know, so I thought I would write a bit about each chapter of The Mind of the Market -- since the whole purpose of starting this blog is to help me remember what I've read and what I've learned from reading.
So here we go...
I've already summarized the prologue, Economics for Everyone, and chapter one, The Great Leap Forward, so let's start with chapter two, Our Folk Economics. Chapter two feels like a book report on the history of free market economics. The books mentioned through chapter two include:
- On the Origin of Species: By Means of Natural Selection by Charles Darwin
- Atlas Shrugged by Ayn Rand
- Human Action: A Treatise on Economics by Ludwig von Mises
- The Origin of Wealth: Evolution, Complexity, and the Radical Remaking of Economics by Eric Beinhocker
- Socialism by Ludwig von Mises
- The Wealth of Nations by Adam Smith
- Mutual Aid: A Factor of Evolution by Pyotr Kropotkin
I'm not complaining -- I didn't know much about the free market theory and I've only taken a handful of economics courses between high school and college so I found it very educational.
Still, chapters one and two feel like a two part introduction to the book (three parts if you include the prologue) and sets up Shermer's argument that economies are "complex adaptive systems" (CAS) -- "systems in which individual particles, parts, or agents interact, process information, learn, and adapt their behavior to changing conditions" -- and that we all owe our faulty economics instincts to our species' rapid evolution.
Chapter three, Bottom-Up Capitalism, continues with the book report -- William Paley's Natural Theology, Adam Smith's The Theory of Moral Sentiments and Frederic Bastiat's The Petition of the Candlemakers -- and again I'm thankful for the education on the history of free market theory. Shermer teaches us that Charles Darwin (Origin of Species) was arguing with William Paley (Natural Theology), who was arguing against Adam Smith (The Wealth of Nations), who was arguing against the mercantilists ("the belief that nations compete for a fixed amount of wealth in a zero-sum game"). This reminded me that I'd like to read Robert Wright's Nonzero: The Logic of Human Destiny (click here to view the table of contents and excerpts).
Anyway, the mercantilists of Smith's time believed in reducing or eliminating competition from foreign producers. Today we call that "fair trade" or the "favorable balance of trade" add the government uses a myriad of ways to intervene in the economy:
- tax favors for businesses
- tax subsidies for corporations
- regulations: to control prices, imports, exports, production, distribution, and sales
- licensing: to control wages and protect jobs
- taxes: through terms like "duties," "imposts," "excises," "tariffs," "protective tariffs," "import quotas," "export quotas," "most-favored nation agreements," "bilateral agreements," and "multilateral agreements"
Chapter three also discusses the Sherman Antitrust Act of 1890 -- which I hadn't thought about since taking AP US History as a high school junior -- which allows the government to indict individuals and companies on one or more of four crimes:
- price gouging: charging more than the competition
- cutthroat competition: charging less than the competition
- price collusion: charging the same as the competition
- monopoly: having no competition
The story of Charles Martin Hall's Aluminum Company of America (founded as the Pittsburgh Reduction Company and now known as Alcoa), which produced aluminum through a process far cheaper than otherwise available at the time. Hall found that aluminum was produced as byproduct of passing an electric current through a bath of cryolite and aluminum oxide. The Justice Department charged the company's directors with 140 criminal counts, including excessive prices when Alcoa in fact lowered prices dramatically.
Of course the example we all know of is the Microsoft Internet Explorer antitrust suit (bundling Internet Explorer with Windows and partnering with AOL, IBM, Intel, Compaq and others which "compelled Netscape to stop charging for Navigator).
The Wal-Mart tidbits from chapter three were also interesting:
By employing 1.3 million people (about as many as the military), and keeping retail prices low through quantity purchasing, a McKinsey & Company study estimated that Wal-Mart alone accounted for a whopping 13 percent of U.S. productivity gains in the second half of the 1990s. As the savvy social commentator and political analyst George Will noted, for every fifty retail jobs that Wal-Mart caused to be lost among its competitors, it created a hundred new jobs at Wal-Mart, making it "about as important as the Federal Reserve in holding down inflation."
I still haven't figured how I feel about Wal-Mart (especially after learning about the massive subsidies Wal-Mart receives from local and state governments) but I'd like to learn more about the economics of Wal-Mart.
Also in chapter three, Shermer quotes Nobel laureate economist Edward C. Prescott that the government's job is "to provide the opportunity for people to seek their livelihood on their own terms, in open international markets, with as little interference from government as possible" and not "to protect U.S. industry, employment, and wealth against the forces of foreign competition." Prescott's research found that "those countries that open their borders to international competition are those countries with the highest per capita income" and that open economic borders are "the key to bringing developing nations up to the standard of living enjoyed by citizens of wealthier countries" (the Treaty of Rome -- originally France, Italy, Belgium, West Germany, Luxembourg and the Netherlands -- and the subsequent increase in productivity compared with Denmark, Ireland and the United Kingdom).
Chapter three closes with the thought that anarcho-capitalism (the belief that political systems will eventually fall into disuse) and other free-market extremists are impractical as:
we need political states based on the rule of law, with property rights, a secure and trustworthy banking and monetary system, economic stability, a reliable infrastructure, protection of civil liberties, a clean and safe environment, and various freedoms . . . a robust military for protection of our liberties from attacks by other states . . . a potent police force for protection of our freedoms from attacks by other people within the state . . . a viable legislative system for establishing fair and just laws . . . and an effective judicial system for the equitable enforcement of those fair and just laws.
The best politico-economic system to date is a liberal democracy and free market capitalism, or democratic-capitalism. In a system of democratic-capitalism, social liberalism and fiscal conservatism is a synergistic marriage that leads to the greatest prosperity, the greatest liberty, and the greatest happiness for the greatest number.
In case you couldn't tell, I liked chapter three -- I'm not sure I agree with Shermer on all his points but I still found it educational.
Chapter four, Of Pandas, Products, and People, starts out with Shermer's ode to cycling -- Shermer uses the massive changes in cycling technology during the mid-1980s through today to discuss how markets change. Also in this chapter Shermer explains many economics and evolutionary terms:
- path dependency: "where markets become dependent on the paths they are already in"
- historical lock-in: where markets "become locked into the channels in which they are operating"
- bandwagon effect: where customers "gravitate toward products that they think will most likely become readily available"
- network effect: "when producers and retailers, anticipating the bandwagon effect, produce and stock up on the products that they think will be most in demand by consumers"
- Nash equilibrium: where "two or more players reach an equilibrium where neither one has anything to gain by unilaterally changing strategies"
- Pareto efficient: allocation of resources is Pareto efficient when markets reach an equilibrium where an optimum level of win-win and win-no-lose trades (versus win-lose and no-lose-lose trades) is reached (where no further trades could be made without someone losing)
- Evolutionary Stable Strategies: a strategy that when adopted by a population of individuals consistently outcompetes alternative strategies
- exaptation: "a feature that originally evolved for one purpose is later co-opted for a different purpose"
- continuities:"a contiguous and constant connection to the past, as change occurs gradually over time"
- discontinuities:"breaks from the past as change occurs suddenly and dramatically over time"
Shermer's discussion of the QWERTY keyboard is fascinating. We've all been told that QWERTY was designed to slow down 19th century typists (who would jam the typewriters if they typed too fast). And (according the Shermer), more than 70% of English words can be produced with the letters DHIATENSOR but most of these letters are not in a "strong striking position" (home row struck by the strong first two fingers of each hand) and all vowels are removed from the strongest striking positions. Only about 100 words can be typed exclusively on th home row and the (typically weaker) left hand is required to type over 3,000 words alone (without use of the right hand). And the home row includes the alphabetic sequence DFGHJKL (minus the vowel I).
Yet the Dvorak Simplified Keyboard (DSK), which is supposedly much better, has never quite caught on. Historical research (according to Shermer) says that the inventor of QWERTY (Christopher Latham Sholes) designed his typewriter to separate keys whose type-bar letters (frequent letter pairs like T and H) were close to each other underneath the typewriter carriage. Shermer argues that "QWERTY may be suboptimal, but it is no less so than its erstwhile competitors."
Chapter five, Minding Our Money, is all about psychology and probability terms.
- cognitive dissonance: "mental tension created when a person holds two conflicting thoughts simultaneously" (Shermer uses the example of rationalizations that doomsday cults make when their prophecies don't come true)
- inattentional blindness: when attending to one task, many of us become blind to dynamic events (the gorilla suit during a basketball game is the typical example used and Shermer uses it)
- blind spot bias: when people recognize the existence and influence of biases in others but fail to see those same biases in themselves
- introspection illusion: how "people trust themselves to employ the subjective process of introspection but do not believe that others can be trusted to do the same"
- self-serving bias: "we tend to see ourselves in a more positive light than others see us"
- attribution bias: the tendency to accept credit for good behavior but to allow the situation to account for bad behaviors
- framing: that whether choices are "framed" as penalties or rewards affects one's decisions
- representative fallacy: "an event is judged probable to the extend that it represents the essential features of its parent population or generating process"
- availability fallacy: "we assign probabilities of potential outcomes based on examples that are immediately available to us, which are then generalized into conclusions upon which choices are based"
- anchoring fallacy: how once an initial value is set, we are biased toward that value (so don't be afraid to be the first to throw out a number during a negotiation)
- hindsight bias: "the tendency to reconstruct the past to fit the present knowledge"
- law of small numbers: "we tend to believe that small sample sizes are representative of the larger population"
- law of large numbers: "if the numbers are large enough, the probability is that something weird is likely to happen"
- Monty Hall problem: Whether you should change your choice on the classic television game show Let's Make a Deal (three doors with a brand new car behind one door and goats behind the other two doors) after Monty Hall opens one of the doors you did not choose and unveils a goat -- you should but most people would not
- mental accounting: where we put monies into different categories depending on the frame or context
- Wason Selection Test: thought experiment "designed to test symbolic reasoning" (four cards, each with a letter of the alphabet on one side and a number on the other side, with two cards showing numbers and two showing letters such as M 4 E 7; test the rule "if there is a vowel on one side, there must be an even number on the other side" by turning over just two cards -- the answer is E and 7 but most people choose E and 4)
- endowment effect: bias toward the status quo (what you already have and must give up in order to change) versus what you might have once you choose
- sunk-cost fallacy: how "we hang on to losing stocks, unprofitable investments, failing businesses, and unsuccessful relationships" based on our past costs and not wanting to sacrifice our sunk costs
- confirmation bias: "where we seek and find confirmatory evidence in support of already existing beliefs and ignore or reinterpret disconfirmatory evidence)"
- loss aversion effect: "shows that people tend to fear losses about twice as much as they desire gains"
Whew, that took longer than I expected . . .
I will write more about the other chapters later . . .
Happy Halloween!
