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Thursday, May 21, 2009

Fortune Tellers and Planners, Public and Private

Throughout history, as far back as we have records, there have been fortune tellers and magicians. That is, there have been people who claimed to have a means of knowing the future and others who purported to know how to manipulate or control the course of events by rituals or other means. All kinds of methods were used to divine the future, from the flight of birds to the shape of the livers of sacrificed oxen.

It would seem that thinking of this kind has a deep appeal to human beings, that we may even be hardwired by evolution to be attracted to it. Seemingly the idea of a future that is somehow knowable and determinable eases anxiety and makes the world seem safer and tamer. (This also explains the persisting appeal of conspiracy-based theories of history and current affairs. Apparently many people would rather believe that the world is run by incredibly cunning and evil people than admit that no one is “in charge.”)

No One Knows

The claim to be able to predict or direct the future is wrong, and to the extent we believe it, we will do incredibly dangerous things. In some ways we can make predictions about what will happen—if we couldn’t, life would simply be impossible. Thus on the basis of what has happened already, we can predict fairly confidently that the sun will rise in the east tomorrow. We can be almost as confident that the Chicago Cubs will not win the World Series—or can we? The problem with the second kind of prediction is that it works on the basis of past regularities or statistical aggregates involving human interaction. Most of the time these predictions pan out, but not always.

One major problem is unforeseen and (more importantly) unforeseeable events, which completely change what can reasonably be anticipated and make nonsense of what looked like sound expectations. Another problem is that people will change their behavior on the basis of what they confidently expect to happen. Sometimes this makes the anticipated event even more likely, but occasionally it has the opposite effect and confounds all the confident prognostications. In reality, while we can guess at bits of it and have reasonable expectations in some areas, the human future is ultimately radically unknowable merely on the basis of past experience, on both a micro and a macro level.

It is also true that all of us seek to influence the course of future events. Simply by living and acting we have an influence to some degree. This, however, is largely not a matter of definite purpose on our part. We influence the future in ways we do not anticipate or intend. Beyond that we often consciously try by acting in certain ways to make particular outcomes more likely and others less so. In other words, we make plans assuming that our actions will have the results we anticipate and desire. Sometimes things work out, but often they do not. The more elaborate and longer-term the plans, the greater the likelihood that things will not work out as expected. This applies to both individual and collective action.

All of this has an obvious bearing on economic thinking and on what we can reasonably expect from public policy. Essentially, we should have modest and humble expectations of what it can achieve. We should be prepared to accept that most policies will fail; that is, they will not bring about their anticipated outcomes. We should also expect that in many cases public policy will have consequences that were not only unforeseen by those advocating them, but could not have been foreseen—even by critics.

Above all, this means that the idea of using political power to plan or guide the course of events is ultimately a fantasy, one that can only end in disappointment. Sometimes government policies will work out the way they were intended to, but more often something will derail them or they will produce unexpected and often unwelcome results. This is of course one of the central arguments made against government planning by the Austrian school of economists, most notably Mises and Hayek. The solution for them is to use the outcome of the interactions of individuals in markets and other social institutions to generate signals, such as prices, that correct errors and provide some degree of guidance as to what course of action one should follow to achieve a desired result. One of the most important aspects of this process is insurance, essentially a series of transactions (bets, effectively) that provide a rough guide to the chances of certain undesirable events happening.

The Austrian analysis, moreover, does not only apply to government. It also applies to private institutions. Thus much of the planning by large private firms or churches or charities fails in the same way that government planning does. It is less dangerous or apparent because firms and other private organizations, while organized on a nonmarket basis internally, are embedded in a wider system of market relations that swiftly reveal when plans are not working out. Therefore they are corrected more swiftly.

However, this self-correcting mechanism can break down. One problem is the one I touched on in a previous column (“The Recurring Crisis,” the distorting effects of the government monopoly of money. As money is the medium in which prices are expressed, distortion of its supply will have systemic effects and delay corrections from taking place, making the problems more severe than they need be. This is exacerbated by another phenomenon that is purely private in origin and reflects the human weakness for certainty alluded to earlier. Just like the Romans, our own society has its class of augurs and fortune tellers, but now they appear as economic forecasters and academics. Individuals who take their omens and prophecies seriously will believe that they can know and control the future and act on that basis. This is bad enough, but it’s made worse by another flaw in human psychology: our propensity for crowd manias. The combination of these traits with the government monopoly of money is what has produced a global financial crisis.

In the last ten to fifteen years a curious form of intellectual hubris came to possess the professions of economics and finance. Many participants came to believe that complicated mathematical modeling made it possible to estimate risks so accurately that the future was truly knowable in the sense that any possible outcome was somehow taken account of. The result was a misplaced confidence that led people to make highly risky bets on the basis of an assumed knowledge of the future returns on investment and growth in the value of various classes of assets. When combined with the mistaken monetary policy of the Fed, the result was disaster once things did not work out as expected.

What should we take from this? Mainly that we need to be more humble and aware of the limitations of human knowledge. Above all we should remember that government is no wiser and in many ways less well informed than private actors.

  • Stephen Davies is a program officer at the Institute for Humane Studies and the education director at the Institute for Economics Affairs in London.