Andrei Shleifer is a professor of economics at Harvard University. Nicola Gennaioli is a professor in the Department of Finance at Bocconi University, Milan.
A Crisis of Beliefs is well worth reading as either a treatise on psychology or as an application of a model of psychology to people’s mistaken thinking and acting in certain economic circumstances.
But Gennaioli and Shleifer must ask, How would the human participants act if, instead of being a bundle of desires, fears, cognitive biases, and ignorance regarding the abstract primary relativities of the economic process, they understood the laws of the process and the precepts for adaptation yielded by the laws? That is to ask, Is there a set of laws independent of human psychology and above intellectual ignorance to which human participants would enlightenedly adapt if they understood them? And, if so, is not the primary responsibility of professors of macroeconomics to educate and enlighten participants as to the laws they are violating so as, thus, to curb automatically their irrational psychological tendencies?
We wish to discuss several fundamental issues:
- the distinction between the efficient cause of the economic process vs. the formal cause or immanent intelligibility of the economic process
- the distinction between psyche and intelligence; between, on one hand, being ruled by blind desires, fears, and psychological or cognitive biases, and on the other hand, achieving the intelligent and insightful grasp of the immanent intelligibility of the laws of the dynamic economic process,
- the distinction between description vs. explanation
- the likely difference between people’s actions with respect to the prospect of boom or slump if their actions are based upon understanding of the systematics of the objective economic process rather than upon blind ignorance regarding the objective process
- the “Mistaken Expectations” of CWL 15, 80-82 vs G&S’s mistaken expectations in their model of psychology
- the presentations of the Bureau of Economic Analysis and the Federal Reserve Board as non-explanatory
- the task of educating participants out of the darkness of instinct into the light of intelligence regarding the systematics of the economic process
Under several different headings we have distinguished between the notions of efficient cause vs. formal cause, AKA immanent intelligibility. We have emphasized that Functional Macroeconomic Dynamics is a field theory of the immanent intelligibility of the objective process. This theory is more fundamental than, prior to, and independent of the psychology of the participants.
… Special Relativity is primarily a field theory, that is, it is concerned not with efficient, instrumental, material, or final causes of events, but with the intelligibility immanent in data; but Newtonian dynamics seems primarily a theory of efficient causes, of forces, their action, and the reaction evoked by action. [3, 43/ ]
Ought there not to be introduced a technical term to denote this type of intelligibility? … the intelligibility that is neither final nor material nor instrumental nor efficient causality is, of course, formal causality…what we have called the intelligibility immanent in sensible data and residing in the relations of things to one another, might be named more briefly formal causality… [CWL Insight, 78; x/x]
Paraphrasing:
Ought there not to be introduced a technical term to denote this type of intelligibility in the macroeconomic process? … the intelligibility that is neither final nor material nor instrumental nor efficient causality is, of course, formal causality…what we have called the field theory or the intelligibility immanent in sensible data of the dynamic economic process and residing in the relations of functional flows to one another, might be named more briefly the formal causality of the economic process…
Lonergan discovered a field theory of macroeconomics.
again, as to the notion of cause, Newton conceived of his forces as efficient causes, and the modern mechanics drops the notion of force; it gets along perfectly well without it. It thinks in terms of a field theory, the set of relationships between nobjects. The field theory is a set of intelligible relations linking what is implicitly defined by the relations themselves; it is a set of relational forms. The form of any element is known through its relations to all other elements. What is a mass? A mass is anything that satisfies the fundamental equations that regard masses. Consequently, when you add a new fundamental equation about mass, as Einstein did when he equated mass with energy, you get a new idea of mass. Field theory is a matter of the immanent intelligibility of the object. [CWL 10, 154]
Paraphrasing
again, as to the notion of cause, macroeconomists mistakenly conceive of subjective preferences as formal causes. Functional Macroeconomic Dynamics drops the notion of subjective preferences; it gets along perfectly well without it. It thinks in terms of a field theory, the set of relationships between ninterdependent, implicitly defined functional activities. The field theory of Functional Macroeconomic Dynamics is a set of intelligible functional relations linking functionings which are implicitly defined by the relations themselves; it is a set of relational forms. The form of any functioning is known through its relations to all other elements. …. Field theory is a matter of the immanent intelligibility of the object.
Paraphrasing[CWL 21, 6-7]
Lonergan moved macroeconomics back to premises more remote than Walrasian statics, microeconomic price theory, neoclassical macroeconomics and Keynesian macroeconomics; he developed explanatory formulae quite unlike others’, and though he did not impugn them, neither was he very interested in them; casually and incidentally combinations of prices and quantities turn up as particular coincidental cases in an enlarged and radically different field. … Lonergan employed a new field-theory dynamics to make aggregate, mutually-defining, velocitous functionings the basic interdependent variables; and as Newton transformed the formulation and interpretation of Kepler’s laws, so Lonergan transforms the neoclassical and Keynesian laws of how the economy actually functions. … He achieved a scientific generalization of the old political economy and of modern economics that yields the new political economy which we need. … Plainly the way to settle disputes about the intelligibility of the economic process is through a sublating, more general, dynamics of implicitly defined, interdependent functionings.
We are not going to discuss wealth or value, supply and demand, price levels and price patterns, capital and labor, interest and profits, production, distribution, and consumption. Because we are not, it certainly will be objected that our discussion has nothing to do with economic science, for economics is precisely the study of wealth and value, supply and demand, and so on. The answer is as follows. The discussion moves on a more general plane to terminate in a more general conclusion. Because the general includes the particular, a generalized economics cannot but include the particular economics. [CWL 21, 8]
Unlike Gennaioli and Shleifer’s model of psychology, Lonergan’s Functional Macroeconomic Dynamics prescinds from psychology or a vaguely defined psychological situation. It insists rather on the adoption of the correct psychological attitude to the requirements of the process; it does not take psychological attitude as primary in the objective process. Unlike Gennaioli and Shleifer, Lonergan does not take man as he is or as he may be thought to be and from that deducing what economic phenomena are going to be. He takes the exchange process in its greatest generality and attempts to deduce the human adaptations necessary for survival.
our inquiry differs radically from traditional economics, in which the ultimate premises are not production and exchange but rather exchange and self-interest, or later, exchange and a vaguely defined psychological situation. Our aim is to prescind from human psychology that, in the first place, we may define the objective situation with which man has to deal, and, in the second place, define the psychological attitude that has to be adopted if man is to deal successfully with economic problems. Thus something of a Copernican revolution is attempted: instead of taking man as he is or as he may be thought to be and from that deducing what economic phenomena are going to be, we take the exchange process in its greatest generality and attempt to deduce the human adaptations necessary for survival. [CWL 21,42- 43]
We have also distinguished between description and explanation; and we have called on the Bureau of Economic Analysis to provide, in addition to its descriptive arrangements of the National Income and Product Accounts, a scientific, explanatory arrangement of the National Income and Product Accounts.
A distinction has been drawn between description and explanation. Description deals with things as related to us. Explanation deals with the same things as related among themselves. The two are not totally independent, for they deal with the same things and, as we have seen, description supplies, as it were, the tweezers by which we hold things while explanations are being discovered or verified, applied or revised. … it remains that description and explanation envisage things in fundamentally different manners. The relations of things among themselves are, in general, a different field from the relations of things to us. … The scientist selects the relations of things to us that lead more directly to knowledge of the relations of things among themselves. Ordinary description is free from this ulterior preoccupation. [CWL 3, 291-92/316-17]
We have found functional flows – not Gennaioli and Shleifer’s representativeness and extrapolation based on a “kernel of truth” – to be the basic terms and foundational elements of a systematics of the objective process.
“Functional” is for Lonergan a technical term pertaining to the realm of explanation, analysis, theory; it does not mean “who does what” in come commonsense realm of activity. … Lonergan illustrates his basic meaning of ‘explanation’ by referring to D. Hilbert’s method of implicit definition: Let us say, then, that for every basic insight there is a circle of terms and relations, such that the terms fix the relations, the relations fix the terms, and the insight fixes both. ‘Thus the meaning of both point and straight line is fixed by the relation that two and only two points determine a straight line. … Lonergan went on to identify the contemporary notion of a “function” as one of the most basic kinds of explanatory, implicit definition – one that specifies “things in their relations to one another” (CWL 3, 37-38/61-62)…In Lonergan’s circulation analysis, the basic terms are rates – rates of productive activities and rates of payments. The objective of the analysis is to discover the underlying intelligible and dynamic (accelerative) network of functional, mutually conditioning, and interdependent relationships of these rates to one another. [CWL 15, 26-27 ftnt 27]
The whole structure is relational: one cannot conceive the terms without the relations nor the relations without the terms. Both terms and relations constitute a basic framework to be filled out, first by the advance of the sciences and, secondly, by full information on concrete situations. [CWL 3, 492/516] (In addition, read in the entirety [CWL 3, 490-96/514-520]
A Crisis of Beliefs posits economics as a science of human psychology, a science of the psychology of participants, a science of detection of irrationality. But the psychological human participants are, as it were, outside the process. They are the efficient causes in the implementation of the process, not the formal cause or immanent intelligibility of the process. To be sure, human actions cause the flows to be what they happen to be. But human actions effecting the booms, slumps and associated human misery do not constitute the normative, immanent intelligibility to which humans must adapt. Compare the driver of the automobile driving the auto into a ditch with the participants in the economic process driving the process off course.
A study of the mechanics of motor-cars yields premises for a criticism of drivers, precisely because the motor-cars, as distinct from the drivers, have laws of their own which drivers must respect. But if the mechanics of motors included, in a single piece, the anthropology of drivers, criticism could be no more than haphazard. [CWL 21, 109]
It is not a matter primarily of psychology, sociology, or anthropology. The science of macroeconomics is, first of all, a matter of understanding the laws of the mechanism. But if the mechanism of macroeconomics included, in a single piece, the psychology, sociology, and anthropology of drivers, criticism could be no more than haphazard.
Again,
Our aim is to prescind from human psychology that, in the first place, we may define the objective situation with which man has to deal, and, in the second place, define the psychological attitude that has to be adopted if man is to deal successfully with economic problems. Thus something of a Copernican revolution is attempted: instead of taking man as he is or as he may be thought to be and from that deducing what economic phenomena are going to be, we take the exchange process in its greatest generality and attempt to deduce the human adaptations necessary for survival. [CWL 21,42- 43]
So again, Gennaioli and Shleifer must ask, How would the human participants act if, instead of being a bundle of desires, fears, cognitive biases, ignorant of the laws of the process, they understood the laws and the precepts for adaptation yielded by the laws? That is to ask, Is there a set of laws independent of human psychology and above intellectual ignorance to which human participants would enlightenedly adapt if they understood them. And, if so, is not the primary responsibility of professors of macroeconomics to educate and enlighten participants as to the laws of the process rather than to correct their irrational psychological tendencies?
Macroeconomists won’t make any major progress in properly counseling re booms and slumps by taking the distorted psyche of participants and making its subjective psychology the intelligibility of the objective process. Rather we make progress by establishing scientifically significant foundations and then educating the participants as to the laws of the process prior to their desires, fears, and their cognitive biases towards representativeness and silly extrapolation based on some “kernel of truth” about past and present situations.
Gennaioli and Shleifer, in particular, have applied psychology to a particular phase in the economic process which Lonergan clearly recognized – the transformation of what should be an orderly pure-cycle expansion of the process into the disorderly sequence of boom, slump, and crash. Gennaioli and Shleifer’s treatise can be very helpful; if there is validity to their psychological model, it helps us understand why and how the driver of the economic mechanism, ignorant of the laws of the mechanism, drives it off course.
the rising prices of the surplus expansion are not real and relative but only monetary and absolute rising prices; to allow them to stimulate production is to convert the surplus expansion (of the ideal pure cycle) into a (trade cycle of) boom (which must be followed out of systematic necessity by a correlative and devastating slump). This I believe is the fundamental lack of adaptation to the productive cycle that our economies have to overcome. [CWL15, 139-140]
More fully:
Previously I have suggested a lack of adaptation in the free economies to the requirements of the pure cycle. What that lack is can now be stated. It is an inability to distinguish between the significance of a relative and an absolute rise or fall of monetary prices. A relative (i.e. “real”) rise or fall is, indeed, a signal for a relatively increased or reduced production (of one product relative to another) … Inversely, the rising prices of the surplus expansion are not real and relative but only monetary and absolute rising prices; to allow them to stimulate production is to convert the surplus expansion (of the ideal pure cycle) into a (trade cycle of) boom (which must be followed out of systematic necessity by a correlative and devastating slump). This I believe is the fundamental lack of adaptation to the productive cycle that our economies have to overcome. [CWL15, 139-140]
Now in any expansion it is inevitable that quantities under production run ahead of quantities sold. Current production is with reference to future sales, and if there is an expansion, then future sales are going to be greater than current sales. But in the free economies the acceleration factors are not held down to the minimum that results from this consideration. During the surplus expansion the basic price-spread ratio J will increase from an increase of R, of a”, and also of a’. The advance of the price-spread ratio will work out through a rise of the basic price level, and selling prices generally will mount. Now, when prices are rising and due to rise further, the thing to be done is to buy now when prices are low and sell later when they are high. There results a large amount of liquid investment. Each producer orders more materials, more semifinished goods, more finished goods, than he would otherwise. Moreover, he makes this speculative addition to a future demand estimated upon current orders received, so that the further back in the production series any producer is, the greater [will be] the speculative element contained in the objective evidence of current orders received, the more rosy the estimate of future demand, and the greater the speculative element he adds to this estimate when he places orders with a producer still further back in the series. Thus an initial rise in prices sets going a speculative expansion that makes the acceleration factors quite notable, expands the price spread still more, and stimulates a pace of further acceleration that it will be quite impossible to maintain. Etc. [CWL 15, 160]
At the root of the depression lies a misinterpretation of the significance of pure surplus income. In fact it is the monetary equivalent of the new fixed investment of an expansion…..our culture can not be accused of mistaken ideas on pure surplus income as it has been defined…; for on that precise topic it has no ideas whatever………However the phenomena referred to by …”pure surplus income” are well known. … pure surplus income may be identified best by calling it net aggregate savings and viewing them as functionally related to the rate of new fixed investment [CWL 15 152-53]
Elsewhere we have treated Why and How the Basic Expansion Fails to be Implemented.
So finally, let us bring this section to a close by referring the reader to CWL 15, 80-82 for Lonergan’s explanation of decline based on misunderstanding of the objective process by efficiently causal, and ignorant, humans. The trade cycle is not primarily the result of entrepreneurial greed but of a failure to understand what is going on in an economic expansion
One is led immediately to the significance of the basic price spread and the concrete possibility of the business cycle and to the important conclusion that the business cycle is not primarily the result of entrepreneurial greed but of a failure to understand what is going on in an economic expansion…. ]Michael Gibbons, Economic Theorizing in Lonergan and Keynes p. 313]