The Great Transformation of Economic Theory

In the Origins of Central Banking, we discussed how the Bank of England was created in 1694 to provide funding for a war with France. The success of this institution was noted, and it was replicated across Europe, so that Central Banks came into existence to finance the nearly continuous wars between European powers that characterized the 18th Century. The 19th Century was unusual in that European powers set aside differences to create a Hundred Years of Peace (1814 to 1914), in order to go on a spree of global colonization and conquest. The transition from war to peace also created a transformation in economic theories from Mercantilism to Free Trade. Some aspects of this transition are discussed below.

The Root of All Evil

An essential aspect of the Great Transformation from traditional, paternalistic societies to market societies involves re-engineering human motivations. The lust for money does not normally rank high as a driver of human behavior. When a capitalist society makes markets the central mechanism for production and distribution of essential commodities to the society, then the money motive must be strengthened. Capitalism cannot risk the baker taking a day off for fishing, or laborers deciding to take a break from monotony, disturbing the supply of essential commodities to the populace. Many mechanisms are used by capitalist societies to make the love of money enter the hearts of all members of the society. Max Weber noted that “In fact, the summum bonum of this ethic, the strict earning of more and more money, combined with the strict avoidance of all spontaneous enjoyment of life, … is thought of … purely as an end in itself,  … .  Man is dominated by the making of money, by acquisition as the ultimate purpose of his life. Economic acquisition is no longer subordinated to man as the means for the satisfaction of his material needs.  This reversal of what we should call the natural relationship, so irrational from a naïve point of view, is evidently as definitely a leading principle of capitalism as it is foreign to all peoples not under capitalistic influence.” The Great Transformation changes the Biblical “Love of money” to the Shavian “Lack of money” as the root of all evil. These changes are reflected in politics, trade, and in economic theories, as we discuss below.

Finance for Wars:

There is a close connection between wars and finance. Central Banks were created for the purpose of financing wars, and for most of 18^th Century, the main function of Central Bank was to provide financing for wars. The evolution towards modern monetary functions occurred in the 19^th Century, where European powers avoided wars with each other, and concentrated on colonizing the globe. During this century, arranging finance for investment for ventures in the colonies across the globe became the main function of finance. Wars on European continent were avoided because of the influence of haute finance on political decisions. Similarly, the evolution of money in the 20^th Century has been strongly influenced by War. The gold standard collapsed due to World War 1. Attempts to re-instate the gold standard failed due to World War 2, at which point the Bretton-Woods agreement of 1944 created an alternative. This was a dollar-based system of international trade, called a gold-exchange standard since dollars could be exchanged for gold, at least theoretically. When all currencies are tied to gold through dollars, even notionally, this leads naturally to fixed exchange rates based on gold-equivalence. Financing expenses of the Vietnam War led to massive overprinting of dollars, making it impossible for the USA to redeem them in gold. In 1971, Nixon announced that dollars would no longer be redeemable for gold. This “Nixon shock” removed the anchor which had tied all currencies to a fixed gold value, and set them all adrift. The natural consequence was the world of floating exchange rates which we now live in.

The Unusual Nineteenth Century

Given the close connection between finance and war, Mercantilism is based on the acquisition of gold from foreigners to enhance domestic ability to make war, and also to weaken foreigners’ ability to finance their war efforts. This is perfectly natural in a world of constant warfare. The exceptional 19^th Century occurred because the process of colonization of the globe temporarily made available vast resources of the entire globe to the colonizing European powers. The conquest of colonies raised standards of living among peoples of European descent at an astonishingly rapid pace, while impoverishing the colonies and the entire planet to a far greater extent. Vast numbers of books have been written to explain the MYSTERY of the ascent of Europe, and the corresponding failure of the rest of the globe. James Blaut in “Eight Eurocentric Historians“ and “The Colonizers Model of the World” has listed and debunked over thirty of these myths. Meanwhile, no one has mentioned the elephant in room (except to dismiss it): massive expropriation of global resources created by conquest of 85% of the planet enriched Europe and impoverished the globe. In fact, Lefken Stavrianos in “Global Rift: the Third World Comes of Age“ has put forth and documented precisely this thesis. Unfortunately, this book has been out of print for some time. The 19th Century was unusual in that vast non-monetary resources available in the colonies – men and minerals – were exploited, so that trade was carried out for enrichment of mother countries in terms of commodities, as well as gold and silver. This change in orientation from Mercantilism was reflected in classical economic theories of the 19th Century.

General Equilibrium (C-M-C’) Versus Karl Marx (M-C-M’)

The transition from constant warfare in the 18^th Century to the Hundred Years Peace in the 19^th was accompanied by the transition from Mercantilism to the free trade theories of Adam Smith and Ricardo. To understand the difference, we must look at the purpose of trade. When trade is carried out for the purpose of making money, the M-C-M’ paradigm applies. That is, traders use money to produce commodities, and sell them to make more money. Trade is adversarial in this paradigm – either I will make money or you will make money, both parties cannot get more money given a fixed and finite supply of gold. Using unbacked currencies, MMT accounting identities show that if exports are greater than imports, domestic profits and savings must increase by the amount of the difference. Conversely, if imports are greater in value than exports the difference reduces net profits and savings in domestic economy. Thus, trade is a zero-sum game when played for money. The win-win solution at the heart of General Equilibrium models of trade is based on trade for commodities, or the C-M-C’ model, as explained below.

Modern economic theory has its roots in the peace of the 19^th Century, where economic activity produced commodities to raise standards of living, and money was an intermediate good; the C-M-C’ paradigm. The theory of comparative advantage argues that both nations can get both of more goods if the colonies specialize in raw materials while the center specialize in manufacture and industry. The theory assumes that the goal of trade is to get more commodities C-M-C’, and not to earn more money. Similarly, general equilibrium theory of Walras is also focused on the acquisition of commodities as the final outcome of trade. These theories are not compatible with a world where trade is for the purpose of acquiring gold and the financial power to make wars. They emerged and became powerful and widely accepted because of sudden change in the interests of haute finance, represented by Central Banks, from war to peace.

Finance for Peace:

Karl Polanyi writes about the sudden shift from war to peace that occurred at the beginning of the 19^th Century as follows – (parenthetical expressions are mine; for full original quote, see Polanyi Quote)

The “balance of power” ensures that three or more units capable of exerting power will always behave in such a way as to combine the power of the weaker units against any increase in power of the strongest.  (BOP) attained this end only by continuous war between changing partners. The fact that in the nineteenth century the same mechanism resulted in peace rather than war is a problem to challenge the historian. The entirely new factor (which explains how BOP produced peace instead of war) was the emergence of an acute peace interest. (The State, the Church and the Public were strong advocates of war as a means of protecting the national interest.) Few things were regarded as more detrimental to a community than the existence of an organized peace interest in its midst. As late as the second half of the eighteenth century, J. J. Rousseau arraigned trades people for their lack of patriotism because they were suspected of pre­ferring peace to liberty.

After 1815 the change is sudden and complete. The backwash of the French Revolution reinforced the rising tide of the Industrial Revolution in establishing peaceful business as a universal interest. Metternich proclaimed that what the people of Europe wanted was not liberty but peace. Gentz called patriots the new barbarians. Church and throne started out on the denationalization of Europe. Their argu­ments found support both in the ferocity of the recent popular forms of warfare and in the tremendously enhanced value of peace under the nascent economies.

When the interests of haute finance (central banks, and the transnational financiers behind these banks) became aligned with peace, then the public minds were aligned with peace, instead of war. The vast proportion of Colonial trade in the early 19^th Century was between mother country and colonies, and not across colonies. The colonies were generally poor in gold but rich in resources. So, the Mercantilist model of acquiring gold for making war became obsolete. Instead, theories were developed which were aligned with acquiring resources for the mother country by exploiting the colonies. This process was hugely successful as massive amounts of global resources were transferred to nations of European origin, enriching them while impoverishing the rest of world. Stavrianos provides historical details in “Global Rift: The Third World Comes of Age“.

Power and Knowledge

The popular picture of economic theory as a body of knowledge created by neutral searchers for truth is dramatically wrong. From Adam Smith onwards, the ascendant economic theories have been closely linked to the interests of the wealthy capitalists. Free trade suited the interests of England, which had a fifty-year lead over Europe in the Industrial Revolution. It is no coincidence that free trade theories were strongly advocated by England. At the same time, theories of protection were developed by  German economist Friedrich List, and other European and US economists in the early 19^th Century. After the US and Europe caught up to England using protectionist policies, the West collectively imposed free trade on the rest of the world. Wars with China and Japan were carried out with the only objective of opening these economies up to free traders of the West. For this history see Ahmad & Zaman “Free Trade and Development“. For a more general view of how economic theories are devised to favor the rich and powerful, see ET1%: Blindfolds Created by Economic Theory of the top 1%. Analysing the links between power and knowledge opens the door to deep insights. As Foucault said, “My job is making windows where there were once walls”.  More transparently, “The history of the struggle for power, and consequently the real conditions of its exercise and maintenance, is still almost totally hidden. Knowledge is not a part of this: that should not be known.”   In order to create people who are ready to die for their country, the truth that the war is about control of resources like oil, must be concealed — see “The Business of War” for a detailed discussion. Even more important, our entire educational system is designed to create human resources for the labor market essential to the survival of capitalism. Knowledge about the potential for excellence contained within every human being must be concealed for this purpose. The journey of life begins when we remove the blindfolds created by our education, and make the strenuous efforts required to discover our true identities — see “Learn Who You Are!“

Advertisements

History of Money

An Islamic WorldView

[bit.do/azhom] Radio Islam, South Africa 14m Interview of Dr. Asad Zaman by Mufti Yusuf Moosagie on Tuesday, 8 Oct 2018, at 9:30am South Africa time and 12:30am Pakistan Time

Q1: What is Money? 0:20 to 2:22

This is a deep and difficult Question. BUT WHY is it so complex?
50 people own more than half planetary wealth. They cannot exploit us WITHOUT our consent. Our consent is creating by feeding us FALSE theories about the nature of money. Today, Ph.D.’s from Harvard learn and propagate false theories which make it impossible for us to understand how the current monetary financial systems are used to exploit us.
The KEY question to ask, to unravel the mystery, is “Who has the power to CREATE Money?” We must ‘follow the money’ to find the answer. For more details see The Battle for the Control of Money.

Q2: How has the nature of…

View original post 868 more words

Central Bank History (3/5) 1914-1980

This series of posts is based on a single lecture (Lecture 13 of Advanced Macro II) exploring the evolving functions of Central Banks through time. It goes through a vast amount of material in a very short time, and hence is a very sketchy treatment. This is the 3rd post,  which deals with the period from WW! to the 1980s. The 15m segment of Lecture 13 dealing with this time period is linked below. The writeup below is a somewhat edited and abbreviated version of: Monetary Policy from 1914 to 1980s

Background: Central Banks were created to provide funding for wars, and were extremely successful at this function. When wealth is measured in gold, then Mercantilism is the natural economic theory – we use trade to get gold from foreigners. If this fails, wars can be used to acquire the gold by force. European history is marked by nearly constant warfare, even after the end of religious wars (Peace of Westphalia 1648). The Gold Standard is inherently a zero-sum, adversarial system of trade.  Polanyi (The Great Transformation) writes that “The nineteenth century produced a phenomenon unheard of in the annals of Western civilization, namely, a hundred years’ peace—1815-1914”.  The main explanation for this is the transnational character of the Central Banks. The 19^th Century was devoted to the colonization of the globe by Europe. In this effort, the Lords of Finance found transnational cooperation useful, and wars inconvenient. Polanyi describes the “sudden change” when patriotism went from being a great virtue to a barbaric relic of the past – this change in public sentiment was created by the interest in maintaining peace in Europe by haute finance. Wars among the European powers did not make sense when financial and material power could be used to capture the resources of the entire planet. By the early 20^th Century, about 85% of the globe had fallen under the influence of European powers. The internal dynamics of capitalism seek continuous expansion, and exhaustion of global frontiers led naturally to World War 1 in 1914. What is worth noting is that it was high finance that created the wars of the 18^th Century, and the same force which produced the peace of the 19^th.

Understanding Statistical Distributions

In line with the pedagogical mission of this blog, I will be writing up a sequence of posts which explain the concept of a statistical distribution. As has been pointed out by numerous authors, a fundamental mistake in understanding concepts of uncertainty and probability was made in the early 20th Century, when views of Keynes and Knight were rejected, and ideas of Ramsey, De-Finetti, and other subjectivists were accepted. To set things right, we have start from scratch, and build up the concept of probability on new foundations. These posts are an attempt at the first steps in this direction. I am reproducing this post from the original posting on WEA Pakistan Chapter

In his Guide to Econometrics, Peter Kennedy writes that, even though the concept of distribution of random variables is the most basic and the most important concept at the foundation of all of statistics and econometrics, very few students actually understand what this means. My own teaching experience with students who have taken statistics and econometrics courses confirm this observation – despite its fundamental importance, very few understand it.  The goal of this sequence of posts is to explain this concept in the simplest cases, and in the simplest way, in the hope of fixing this problem. A Very Important reason for the confusion is that there are actually FOUR different concepts of distribution. The FIRST concept refers to the distribution of characteristics within a parent population. This is the only REAL distribution – that is, this distribution exists in external reality, and is objective and concrete, and the same for all. The SECOND concept refers to a THEORETICAL distribution, which can be used to provide mathematically convenient APPROXIMATIONS to real distributions. These theoretical distributions DO NOT EXIST in external reality. These are convenient simplifications and idealizations which exist in our minds, but not in the real world. The example is that of a Euclidean line which is perfectly straight from minus infinity to plus infinity. It is so infinitely long that it cannot fit in our finite universe, and can only exist in our imagination.  The theoretical distributions are exactly of this nature – idealizations which exist in our imagination, but not in the real world. The THIRD and FOURTH concepts are statistical and relate to repeated independent random draws from parent populations. These create random variables which have two types of distributions. The problem of understanding for students arises from the problem that Teachers fail to differentiate between different concepts, and fail to build up the complex concept from the basic and elementary parts. This FIRST deals with the simplest case of a REAL DISTRIBUTION of characteristics within a REAL population, which does not involve any concepts of randomness or probability.

Real Distributions

The first type of distribution, which is very easy to understand, is the only one which actually exists in the Real World. All the other three concepts are imaginary – they exist in a world of theory, which exists only within our imagination, and does not have a counterpart in reality. Our planned course in Real Statistics (see also RSIA 1, RSIA 2, RSIA 3, and RSIA 4) will differentiate strongly between real world concepts and imaginary concepts. In order to understand “real distributions” we start with the concept of a PARENT POPULATION. This is the target of our statistical inference procedures. That is, the goal of our statistical efforts is to learn about the parent population. It is convenient to think of “population” in literal terms as a population of human beings, although it can any collection of real world objects. We are interested in studying the characteristics of the members of the population

Central Bank History (2/5) 1814-1914 Hundred Years Peace

In previous post on the founding of the Bank of England, we have explained that Central Banks were created to provide financing for wars. In fulfilling this role, they had several advantages over the state, enabling them to get credit, and get it at low interest rates. For a number of reasons, this was not possible for sovereign states. See  Origins of Central Banking  for historical details about the creation of the Bank of England. Accompanying post on  Monetization, Maturity Transformation, and MMT  explains the dramatic differences between appearances and reality about exactly how banks function.  That the main function of Central Banks was financing of wars, and that they succeeded at this function very well, is empirically established by Paul Poast in “ Central Banks at War ”. One of the unique features of this virtually constant fighting between the “great powers” of Europe was that no one party could dominate the others, although many attempts were made. This was due to the Balance of Power mechanism, whereby when any one power seemed to be acquiring too much control, the others would combine against it, to prevent this from happening. A consequence of this continuous fighting with no single victor was a “Military Revolution”, which was not just in weapons and battle tactics, but in finding ways of financing the enormously expensive methods of modern warfare that were invented in the process. For a detailed historical discussion, see Paul Kennedy “ Rise and Fall of Great Powers ”.  Central Banks are an important part of this story, in terms of creation of modern methods of financing warfare. This post provides a detailed explanation of concepts covered briefly in the 15m video lecture:

The last of the major wars between the Great Powers ended in 1814 with the defeat of Napolean at Waterloo. After this, a century of peace between the Great Powers ensued, until the outbreak of the first World War in 1914. See  Hundred Years’ Peace . Karl Polanyi writes that this was due to the emergence of a peace interest – haute finance. The Central Banks, established to give loans to states to fund wars, were globally connected. They found it more profitable to maintain peace, and benefit from global trade and investment, rather than provide funding for wars. In particular, avoidance of direct conflicts, and investments in the colonies became a larger priority. Over the hundred years of peace, the functions of Central Banks evolved and changed. As this happened, the theory of Central Banking was also developed in the light of accumulating experience.     

Game Theory for Humans with Hearts

The following is a slightly revised excerpt of Section 1.2 from my paper on “Empirical Evidence Against Utility Theory“ – Game theorists rule out Humans with hearts by assumption. The excerpt provides some empirical evidence (not needed by anyone except economists) that human actually do have hearts, and this actually affects their behavior! surprise, surprise!

The “Goeree-Holt Humans with Hearts” (GHHwH) Game: Conventional game theory operates under the assumption that both players (A-player labelled Aleena, and B-player labelled Babar) are heartless human beings. They have no emotions; rather, they are disembodied brains floating in vats. For more explanation and discussion, see “Homo Economics: Cold, Calculating, and Callous“. Below we discuss a game described in Goeree, Jacob K. and Charles A. Holt (2001). “Ten Little Treasures of Game Theory and Ten Intuitive Contradictions,” American Economic Review, vol. 91(5): 1402-1422. They do not provide a name for this game, so we will call it the GH Humans with Hearts game; it is a convenient way to prove the human beings do not behave like homo economicus. Furthermore, this assertion is not a surprise to anyone except economists, who are trained to “think like economists”. This means deep training in learning to model human behaviour as heartless, which blinds them to the complex realities of human behaviour.

At the initial node, Aleena has the choice to PLAY or to OPT-OUT. If she opts out she receives AOP < $10, and Babar received BOP – Aleena and Babar’s Opt-Out Payoff.  If Aleena chooses to PLAY, then Babar has a choice between High, which gives him $5 and Aleena $10, or Low which gives him some payoff  BLO < $5, while Aleena gets ALO.

Game-theoretic analysis of this game is simple and straightforward. We work by backwards induction. Given that BLO < $5, Babar will always play High. So Aleena can count on receiving $10, which she gets in this case. This is higher than her opt-out payoff of AOP (by assumption), so she will choose to play.

The standard game theoretic analysis of this game provides us with the following insights:

1. The value of ALO does not matter, since Babar will always play High.
2. The value of BLO does not matter, as long as it is strictly less than $5.
3. If Aleena chooses PLAY, she can count on receiving $10
4. The value of AOP does not matter, as long as AOP<$10

All four of these insights, which come from game theory for humans without hearts,  are wrong. Furthermore, ordinary untrained subjects who play this game behave in ways which show deeper understanding of human behavior.  Thus game theory systematically handicaps the understanding of actual observed behavior in this game.

Experimental evidence provided in Goeree and Holt (2010) reveals the following patterns of behavior:

1. When the difference between $5 and $BLO is small, Aleena cannot rely on Babar choosing High. Suppose BLO = $4.75, which is only a bit smaller than $5. In one experiment, 15% of the B-players choose Low, which gives them a quarter less than the optimal move High.
2. As a consequence of possible “mistakes” by Babar, Aleena will compare ALO to AOP, to decide between Opt-Out and Play. If her optout payoff is $7, while BLO is $0, then Aleena makes a large loss when Babar does not make the right choice of High. In this situation, experimental evidence shows that A-players often opt-out.
3. As the difference between $5 and BOP increases, the chances of B-player playing High increase. In experiments, A-Player anticipates this and chooses to PLAY more often. None of these phenomena is predicted by game theory, showing the theory is blind to aspects of the game which untrained observers are aware off.
4. A high value of BOP can create resentment in B-player . For example if BOP=$10, then PLAY move by player Aleena reduces the maximum payoff of B-player to $5. This could easily motivate B-player to take revenge for being deprived of $10. Babar can do this playing Low, accepting a lower payoff for himself, and punishing Aleena by giving her $0=ALO. Anticipating this, A-player takes the secure option of Opt-Out very often in this situation. Again this behavior shows greater wisdom than game theory.

Many questions about the theory of rational behavior are creating by these empirical observations on human behavior. Among the simplest of this is the question:  “Why does it happen that, 15% of the time, B-players choose the LOW outcome of $4.75 over the HIGH outcome of $5.00?”

There are many possible explanations, from satisficing to computational costs to near-indifference or fuzzy sets. One plausible explanation comes from the concept of Just Noticeable Difference (JND) – If two outcomes are sufficient close, then they are treated as “about the same” by mental decision-making heuristics.

An immediate consequence is that we cannot count on “maximization” of utility. Near-Maximization leads to a host of difficult problems for economic theories. Mankiw (1985) shows that small menu costs – changing prices at a restaurant requires reprinting the menu – can lead to large business cycles.  Similarly, Akerlof and Yellen (1985) show that “near rationality” — or approximate maximization – can have large effects on markets. More than 800 later publications which cite these papers show that approximate instead of exact maximization could be responsible for a wide range of phenomenon, such as sticky wages, the Phillips curve, non-neutrality of money, efficiency wages, and many others. If objective functions to be maximized are nearly flat in a neighbourhood of a unique global maximum, then approximate maxima can range over a very wide set, leaving the approximate equilibria very indeterminate. Virtually no one would seriously argue that people always exactly maximize utilities, but it is widely believed that approximate maximization would lead to approximately the same results as exact maximization. The literature cited above shows that this is not true; bounds on computational ability have serious consequences for economic theory

Some unexplored variants of the GH Humans with Hearts Game are listed below.

1. Building on the idea of the JND, we can assess the attitude of the B-player towards the A-Player. Keeping the B-player payoff at 5 for HIGH and 4.75 for LOW, we can vary the A-Player Payoff and see the effects. For example, suppose ALO is set to $20, double of the $10 that A-player gets when B-player plays HIGH. It is our guess that most human beings would voluntary forego the extra 0.25 cents they would get by playing HIGH, in order to provide a benefit of an additional $10 to the A-player, regardless of whether or not they know who A is. This possibility cannot be contemplated by game-theorists or economists, committed to a model of infinite greed for human behaviour.
2. A negative value of BOP can create gratitude in player A. Suppose that AOP is $15 and BOP is -$10. Aleena should play Opt-Out to get the payoff which is higher than $10 that she will get when Babar plays High. Suppose that ALO is $20, and while BLO is $3. When Babar gets the move, he might return the favour by deliberately making the Low move, choosing $3 instead of $5, in order to reward Aleena with the higher payoff of $20.
3. Many possibilities for altruism and reciprocity along the lines above can be investigated. Would A-player forego Opt-Out in order to provide greater benefits to B? Would B return the favor by choosing the lower payoff, to provide a greater benefit to A? Again, conventional game theory, and economists, are completely blind to these possibilities, which do not arise in their models of heartless humans.

What is the harm of reducing the complexity of human motives to the simple one of greed? We have just seen that understanding human behavior in a very simple game requires taking into account resentment, gratitude, revenge, carelessness and reciprocity. Contrary to the reductionist economic views, a vast number of market transactions are based on motives other than greed. The widely recognized phenomenon of conspicuous consumption creates an externality and hence market failure which should be regulated – however economists fail to acknowledge the phenomenon because it requires motivations other than greed. An additional problem is that highlighting a single motive both legitimizes and encourages it: witness the “Greed is Good” maxim of Wall street.

End of slightly revised Excerpt of Section 1.2 from my paper on “Empirical Evidence Against Utility Theory“

Addendum 1 (Caring for Others): Developing the idea of reciprocity and altruism, I wonder what would happen if player B had an option to sacrifice his gains, in order to create greater gains for A. For example, if HIGH gives B $5 while LOW give B $0=BLO. But, A gets something big, like $100. My guess is that most B-player human beings with hearts would choose to play LOW, sacrificing $5 in order to provide $100 to the other player. A higher order question is – how would player A play in this situation? Suppose that when B-player plays HIGH, A-player gets $0 instead of $10. Then A-players would OPT-OUT and take $7, because they know that a “rational” B-player will go for the HIGH payoff, preferring $5 to $0, and so the A-player will end up with $0 if A-player chooses to PLAY. However, if I was the A-player, and the game was being played in a traditional society with norms of cooperation and generosity, I would be able to COUNT on B-player to sacrifice her $5 in order to allow me to gain $100. In a market society with rampant individualism, where children grow up in broken families and see everyone acting selfishly, and no examples of selfless sacrifice, I would not be so sure, but I may still be willing to take a chance on the B-player. If the game was being playing in a community of professional economists, then I would certainly opt-out, because, being brainwashed by their own theories, professional economists would almost certainly choose to take their $5 and ignore the option to sacrifice this small amount in order to allow me to win $100.

ADDENDUM 2 (Social Versus Market Frames): A very interesting finding of experimenters (see Dan Ariely – Predictably Irrational) is the people behave very differently in SOCIAL situations and in MARKET situations. For example, many people would be very happy to DONATE blood for a good cause, but would not agree to do so for money.  Economists have a REALLY difficult time understanding this — Nobel Laureates argued that adding a money payoff would only strengthen the motivation to donate blood, but experiments show otherwise. Economists also have difficulty understanding FRAMING effects — how the game is described MATTERS – people do not see through to the final payoffs, as game theory predicts they should. According to economists the framing – the words used to describe the game – should be irrelevant. The “rational” homo economicus sees through the empty words and only concerns himself with the payoffs. HOWEVER, human beings with hearts DO NOT behave like this. When playing this ARTIFICIAL game, HOW we described the game is EXTREMELY important. They will translate this decision into EITHER a social frame OR a market frame – and then they will behave very differently. So one important factor to consider in setting up an experimental game is whether the description of the game evokes a social context or a market context.

ADDENDUM 3 (Neutral Description of Games): Standard protocol for experimental game theory holds that we should try to describe the game in neutral language, which does not evoke any emotions. If subjects are used to decision making in adversarial market-contexts (my gain is your loss) and also in social contexts (with cooperation, generosity, and win-win outcomes) then neutral language leaves them clueless. As a result, they will ARBITRARILY translate the game into one of the two frames (my guess). This will introduce a random variation in outcomes. It might be better to explicitly specify one of the two frames, so as to eliminate this source of variation. This would be contrary to standard methodological practice.

ADDENDUM 4 (Poisoning the Well): This game illustrates the argument of Julie Nelson that Economic Theory damages Moral Imagination. A game-theorist B-player may feel happy to give up his measly five bucks in order to give a gift of $100 to the A-player, but training in game-theory tells him that this is  irrational behavior, and so he over-rides his natural impulses towards generously in order to behave like the greedy homo economicus.

Kelvin’s Blunder: Measure Everything

The idea that knowledge is only of observables, and observables can be measured are both important drivers of policies and business and terribly wrong.

An Islamic WorldView

For reasons explained briefly in “The Emergence of Logical Positivism“, the Western intellectual tradition came to the disastrously wrong conclusions that (1) Only science can provide us with valid knowledge, and (2) science is based on observables, unlike religion which is based on unobservables. Furthermore, since qualitative aspects of observables are often subjective, a preference for the objectivity created by measurement was expressed by Lord Kelvin as follows:

When you can measure what you are speaking about, and express it in numbers, you know something about it, when you cannot express it in numbers, your knowledge is of a meager and unsatisfactory kind; it may be the beginning of knowledge, but you have scarcely, in your thoughts, advanced to the stage of science

This idea, that everything worth knowing, can be reduced to numerical measurements, has led Western intellectuals to attempt to measure everything, without concern about whether…

View original post 1,827 more words