The Frontal Cortex

Milton Friedman and Rational Agents

Milton Friedman was a magnificent economist, and I’ll defer to other economists to sing his praises. But it’s worth noting that, besides being an evangelical for free-markets, he was also a proponent of the rational-agent model. Those two facts aren’t a coincidence. Friedman firmly believed that, when left alone, people will intelligently act in their own best interest, and that the market will coordinate their actions to produce outcomes beneficial for all. The wisdom of crowds depends upon the rational wisdom of the individual.

Of course, prospect theory, behavioral economics, neuroscience, and neuroeconomics have dismantled many of the naive psychological assumptions that Friedman subscribed to. The more we know about the brain the less rational we seem. Herbert Simon was prophetic.

But Friedman wasn’t interested in our irrationality. He repeatedly argued that, because economists can make reasonably accurate predictions about the value of the dollar, or the rate of unemployment, the erroneous assumption of rationality is irrelevant. The powerful calculus of economics cancels out the bewildering psychology of its subjects. (Friedman summarized this philosophy in his famous “F-twist” argument for “positive economics,” which consisted of two separate claims: 1. Theories should be judged by the accuracy of their predictions; 2. Theories should not be judged by the accuracy of their assumptions.)

Tyler Cowen defends Friedman’s positivism by referencing Quine, since Quine also didn’t think much of theoretical assumptions. (See “The Two Dogmas of Empiricism“.) But Quine’s model of knowledge depended upon the interconnectivity of our facts. When Quine famously wrote that “the unit of empirical significance is the whole of science” he was pointing out that without the web of related knowledge, all empirical statements are pretty meaningless.

This was Friedman’s mistake: he wasn’t enough of a Quinean. If he was, then he would have wanted to draw connections between economics and psychology. He would have wanted to see how the facts of economics could be entangled with our neural anatomy. Quine isn’t an excuse for not testing your assumptions, or turning your assumptions into an unfalsifiable dogma; Quine simply reminds us that whenever possible we should try to connect our empirical observations together. This means that economists should always be trying to ground their mathematical predictions in an accurate biological model of human decision-making. Of course, when they do that, the assumption of rationality that Friedman believed in is no longer valid.

Comments

  1. #1 quitter
    November 17, 2006

    So, was he brilliant or fundamentally mistaken about human behavior and fully discredited?

    I’d argue for the latter. Friedman is a man the world would have been better without. Just think, no Reaganomics, no Bushonomics, these supply-side morons would never have gained primacy, and maybe we wouldn’t be 9 trillion dollars in debt while simultaneously screwing people.

    The other problem with Friedman and this rational actor crap, is that it’s so obviously false. The problem I have with libertarians, first and formost, is their belief in this Chuck Norris-like consumer, who can do anything and everything. In order for a market to be “fair” and to be completely free of racism or discrimination, consumers need to be on equal footing with corporations. Most consumers are not very intelligent, most are not rational, many as a result, are taken advantage of and there are any number of irrational economic decisions that are the basis for whole industries. How about checks cashed stores? How about credit cards and predatory lending? How about data aggregation and redlining of the poor? All of these things existed in Friedman’s time, all are created by a free market, and all are examples of why government regulation is absolutely necessary to curb the excesses of the market.

    Further, his arguments for why the great depression occurred are the biggest load of denialist BS I’ve ever heard of and the ultimate proof of his complete illegitimacy and that his writing was ideologically driven drivel. The fed apparently caused the great depression, yes, the big evil government.

    It wasn’t people investing in the market on credit, or the fact that there was no FDIC insurance on banks, or that there was no SEC to make sure trade practices were above board, it was interest rate mismanagement. Bull Shit. Good riddance to Friedman (who lived in San Franscisco, ha!)

  2. #2 Richard
    November 18, 2006

    You describe Friedman as “evangelical for free-markets” and I think that phrase is apt. There is more than a whiff of religiosity around the free-market ideologues. They are often as utopian as the old Marxists were.

The site is undergoing maintenance presently. Commenting has been disabled. Please check back later!