As part of the rollout of his coming administration, Joe Biden announced his intention to nominate Janet Yellen as his treasury secretary. As with all such announcements, people tried to anticipate what that would mean for future policy.
One of the most interesting versions of that crystal-ball-gazing came from John Tamny. His American Institute for Economic Research article, The Biggest Janet Yellen Red Flag is George Akerlof, connected Yellen to her husband George Akerlof, because they reportedly seldom disagree, and then used Akerlof and Robert J. Shiller’s “Phishing for Phools” to show how questionable such reasoning could be.
Since I did an extensive review of “Phishing for Phools” in the Summer 2016 Independent Review, and it deals with important misunderstandings and criticisms of free markets, Issues & Insights readers might find it an appropriate extension of his insights. So, with the Independent Review’s permission, consider the following:
In ‘Phishing for Phools: The Economics of Manipulation and Deception,’ Nobel Prize-winning economists George Akerlof and Robert Shiller argue that free markets are less benign than generally understood, because ‘our free-market system tends to spawn manipulation and deception’ (p. vii). The phishing of the book’s title is not internet fraud to trick personal information out of people. The authors use it as a broad metaphor for ‘getting people to do things that are in the interest of the phisherman, but not in the interest of the target’ (p. xi). Those targets are phools; psychological phools who let ’emotions … override the dictates of common sense’ or let ‘cognitive biases … lead him to misinterpret reality’ (p. xi) and informational phools subject to manipulation and deception due to a lack of relevant knowledge. ‘Phishing for Phools’ insists such phools become prey, because free markets inevitably create more phishermen whenever profitable phishing opportunities remain unexploited.
‘Phishing for Phools’ claims to be ‘a very serious book’ (p. 11) and it makes sweeping claims of omnipresent phishing (though it backs away from some of its apocalyptic rhetoric later in the book), including ‘Insofar as we have any weakness in knowing what we really want, and insofar as such a weakness can be profitably generated and primed, markets will seize the opportunity to take us on in those weaknesses’ (p. x) and ‘Civil society and social norms do place some brakes on such phishing, but in the resulting market equilibrium, if there is an opportunity to phish, even firms guided by those with real moral integrity will usually have to do so in order to compete and survive’ (p. xii).
Unfortunately, the book’s analysis and the dire picture it paints are seriously flawed. Even applications intended to illustrate it actually contradict it.
‘Phishing for Phools’ starts from assertions that people ‘do not do what is really good for them; they do not choose what they really want’ (p. 1) and that we follow ‘monkey-on-our-shoulder tastes’ which are ‘not good for us’ (p. 4). However, it never makes clear what those statements mean. Is ‘what is good for us’ the same as ‘what we really want?’ Does every choice the authors believe is not good justify added government regulations? Would ‘beneficiaries’ really be grateful? And with regard to the volume’s opening illustration, is every Cinnabon customer phished into a self-deluded choice? Such lack of clarity provides one reason its sweeping conclusions are insufficiently supported.
‘Phishing for Phools’ also errs in personifying markets as causing phishing, as when it asserts ‘The free-market system exploits our weaknesses automatically’ (p. 3). Markets don’t cause phishing. Self-interest and the willingness of some to take advantage of others spawn manipulation and deception, not free markets. In fact, the argument has causation reversed. The important issue is not that markets make people more ethical (though they do reward many types of such behavior), but that the more people find ways to reduce unethical behavior (the more people tell the truth, live up to agreements, etc.), the more efficient and beneficial markets become (as illustrated in economics textbook discussions of the superiority of legal markets over black markets). If the authors had studied, say, Avner Greif’s work on the Maghribi traders (see ‘Contract Enforceability and Economic Institutions in Early Trade: The Maghribi Traders’ Coalition,’ American Economic Review, Vol. 83, No. 3 (Jun., 1993), pp. 525-548), who made great strides in those areas, including against government depredations, they could have found both theoretical and empirical reasons to recognize this error.
Further, one cannot blame markets for enabling bad behavior because voluntary arrangements haven’t eliminated all bad behavior. Every form of social organization must deal with such hard facts about humanity. The relevant issue is whether other arrangements, such as those imposed by government (the primary institutional alternative to voluntary agreements) will produce less harm.
Unfortunately, rather than overcoming people’s self-interested willingness to bend others to their purposes, government often provides the means for them to impose greater harm. Government’s comparative advantage is in coercion, which is both the most powerful form of manipulation and an incentive for greater deception, by raising the payoff to controlling it. Further, transferring owners’ decisions to government moves them to people with less productive information and worse incentives, selected through a political process that similarly attenuates voters’ information and incentives (as the authors admit, ‘politics is vulnerable to the simplest phish’ (p. xvi)). And the understanding of even such basic issues of price controls, trade restrictions, and barriers to entry offers reason for industrial-strength skepticism of claims that government interventions will benefit citizens.
The authors also generate their dire pronouncements from the assertion that economic theory assumes businessmen’s behavior is ‘purely selfish and self-serving’ (p. vii). That is not true. Economists assume people are self-interested, rather than selfish (see Gary Galles, ‘Self Interested, Not Selfish,’ Mises Daily, https://mises.org/library/self-interest-not-selfishness). That is, we all desire command over more resources to advance things we care about, but there is no assumption of selfishness (e.g., actions such as Mother Teresa building a leprosarium with her Nobel Prize money are not ruled out). Economics assumes that our other-directed ‘tastes’ are given, not non-existent. Here, ‘Phishing for Phools’ is channeling game theorists who assume selfishness to make their models tractable, not because economics postulates it.
The book’s selfishness assumption is combined with the assertion that the ‘fundamental concept of economics’ is ‘the notion of market equilibrium’ (p. 1). That pairing is taken to imply that if one party did not phish you, ‘someone else would,’ so that ‘The free-market system exploits our weaknesses automatically’ (p. 3). In other words, ‘The free-market equilibrium generates a supply of phishes for any human weakness’ (p. 22), a phishing equilibrium ‘in which every chance for profit more than the ordinary will be taken up’ (p. 2).
This misstates economics’ actual foundation, which is scarcity. Scarcity implies individuals face incentives to alter choices so long as their expected marginal benefits exceed their expected marginal costs (an inequality indicating a person is not in equilibrium). Equilibrium is just a shorthand means to describe the direction market arrangements will adjust, expressed as a ‘stopping rule’ when incentives to change behavior (disequilibrium) would cease, but in a world of uncertainty, change and frictions, people cannot be assumed in equilibrium. (Students of Austrian economics, in particular, will be sensitive to this confusion. As Peter Boettke has written [The Austrians on Equilibrium: Some Divergent Views, austrianomnibus.blogspot.com/2011/03/austrians-on-equilibrium-some-divergent.html], ‘For Mises, however, equilibrium signifies the destruction of the science of economics (i.e. human action).’
In addition, when individuals have moral beliefs and ethical commitments (i.e., they aren’t ‘purely selfish’), as is true of virtually every individual, it destroys the implication that equilibrium requires that every profitable phish will be undertaken. That is because people are not indifferent to how profits are earned. Many are willing to accept lower returns, when they consider the means ethical, over a normal rate of return earned unethically, which would include phishing, so there is no necessary zero-profit result to force markets into a phishing equilibrium.
Further, the book’s extension of the assumption that market equilibrium requires that every profitable opportunity be exploited to phishing ignores another implication of its logic that undermines its conclusions. If phishing is recognized as harmful, then providing anti-phishing protection will also be a profit opportunity for entrepreneurs. That would mean that every phish we can discover how to stop at a cost less than the benefit of stopping it will be stopped. And many of those means are yet to be discovered, so a successful phishing expedition today may soon become an unsuccessful one, solved by entrepreneurs. Consequently, the authors’ phishing tales that ignore anti-phishing profit incentives vastly overstate the harms involved.
After ‘Phishing for Phools’ ‘ many alarming pronouncements, Chapter 11, ‘The Resistance and Its Heroes,’ backs away from them because of ‘individuals who step back from the profit incentive,’ who demonstrate that ‘in fact we live in a community of people who care about one another’ (p. 136). In stark contrast to the book’s previous presentation, ‘Businessmen of conscience with good products have both moral and economic reasons to out the phishermen’ (p. 140), implying that the ‘phishing is everywhere’ warnings were dramatically and misleadingly overstated. And getting to this ‘it’s not so bad’ point by first misstating economic theory’s assumptions, then undoing the strawman several chapters later, will justifiably make many readers feel phished by the book, which is only made worse when it does another u-turn and returns to assertions of the ‘inevitability of phishing’ (p. 170).
Chapter 11 also argues that we ‘have reduced phishing by isolating information phishing to an outback of the hard-to-measure/ hard-to-evaluate’ (p. 137). If information phishing is largely contained, why go to all the effort to lump it in with psychological phishing, only to conclude they are not really similar and one of them isn’t really a big problem? Again, readers will feel phished.
‘Phishing for Phools’ reflects other shortcomings, as well. They include an almost total absence of discussion of powerful market capitalization mechanisms (it decries supposed reputation mining but otherwise ignores the crucial role good reputations play in economic arrangements – see W. Bentley MacLeod, Reputations, Relationships, and Contract Enforcement, ‘Journal of Economic Literature,’ Vol. 45, No. 3 (September 2007), pp. 595-628); misrepresenting Adam Smith; frequent use of strawman arguments; and blaming free markets for phishing when ineffective government performance of its ‘protective’ function is actually at fault. Perhaps even more important, though, is that in its eagerness to scapegoat free markets, it simply overlooks the fact that the government protectors it extols as solutions to phishing are actually among its primary causes.
One striking illustration is the book’s discussion of the mortgage meltdown, which it blames on various private actors. However, the mortgage market is not a free market, but a heavily and ineffectively regulated one. The book ignores government barriers to entry protecting existing credit rating firms from competition that would have produced more accurate assessments. It overlooks the role of the Department of Housing and Urban Development’s increasing requirements for loans to lower income homebuyers. It also fails to notice that Fannie Mae and Freddy Mac’s willingness to buy bundles of bad loans as if they were good loans provided reassurance to other buyers because they anticipated they could always sell to a government-sponsored enterprise’s ‘greater fool.’
Perhaps the best illustration of the extent to which ‘Phishing for Phools’ misrepresents reality, however, is its discussion of Social Security (pp. 153-55) as a QED illustration of its analysis – which is preceded by a section lauding the ‘Age of Reform,’ including populism, good-government progressivism and New Deal experimentalism, and a mythical post-WWII consensus that ‘government would be a useful counterweight to the excesses of free markets,’ (p. 151) so that any attempt to argue ‘government is the problem – is itself a phish for phools’ (p. 152).
‘Phishing for Phools’ dismisses individuals’ competence to manage their own retirement because ‘careful planning is psychologically difficult’ (p. 153). Then it lauds the good things Social Security and Medicare have done for certain groups. Unfortunately, it fails to recognize that all those accomplishments came about as the result of history’s largest-ever financial phish. Social Security (including Medicare) has been a series of Ponzi schemes from the beginning (see Gary Galles, The Government Runs the Ultimate Ponzi Scheme, Mises Daily, https://mises.org/library/government-runs-ultimate-racket). Its origin and every expansion provided benefits far in excess of costs to early participants, requiring that later generations had to be forced to bear the burdens. It was promoted by conning voters into believing they had earned their benefits, which were absolutely guaranteed, yet the government argued that the taxes involved were actually available for the general support of government in Helvering v. Davis (1937) and that there were no benefit guarantees in Fleming v. Nestor (1960). The result is unfunded liabilities in Social Security and Medicare that are several times the official national debt (see Michael Tanner, Medicare and Social Security Tabs Coming Due, Reason, March 2015).
Yet ‘Phishing for Phools’ rejects privatization possibilities as ‘to be blunt, daffy'(p. 155), on the basis of a half-page summary of ‘some simulations’ by one of the authors that (as far as I can tell) ignores not only Social Security’s unfunded liabilities, but also the welfare costs and the labor supply effects its taxes impose. However, a great deal of research by Edgar Browning (see, for example, The Anatomy of Social Security and Medicare, The Independent Review, Summer 2008) and others shows that trying to maintain the current unsustainable system is actually the daffy possibility.
In sum, ‘Phishing for Phools’ has many phlaws, ranging from phaulty premises to internal inconsistencies and a blindness to evidence that is hard to see as unintentional. That makes it a poor investment. ‘Phishing for Phools’ provides confusion, but few benefits that go beyond age-old warnings to ‘Be careful, someone might try to take advantage of you.’ Many consumer advocates offer far more practical help. And they won’t undermine your ability to spell for no good reason.The Independent Review: A Journal of Political Economy, Volume 21, Number 1, Summer 2016
Gary M. Galles is a professor of economics at Pepperdine University.