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Economic Mindset

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This month features two books on economics, the theory of how humans make decisions to deploy the limited resources available to them to achieve their goals. It assumes that every person makes every resource decision rationally and is sufficiently knowledgeable to do so. This thinking has guided economic policy for many decades—and has led to less than acceptable results. About 50 years ago, some economists start- ed questioning that assumption. They could see many instances when it appeared that people did not behave rationally, so they turned to the field of psychology to reconcile the anomalies they observed between projected rational behavior and actual behavior. Thus began the field of be- behavioral economics.

Richard Thaler is one of the pioneers for this marriage of psychology to economics. He won the Nobel Prize in Economic Sciences in 2017 for his work in this field. His book, Misbehaving, chronicles the development of behavioral economics over the last 50 years and gives testament to the intransigent nature of people who have invested a significant portion of their lives in a discipline. Despite overwhelming evidence to the contrary, there are still many economists today who hold to the rational person assumption and refuse to incorporate behavioral economics into their models.

There is a chapter in this book regarding sunk costs—investments that have been made and are unrecoverable, such as copper telephone wires in the cell phone age. Economic theory states that sunk costs must be ignored when making decisions for the future. There is a valuable lesson here for all of us. Have you ever decided not to do something you would prefer to do because you had bought tickets for something else? You fell victim to the sunk cost trap. Economists who have invested their lives in the rational person theory have not been able to take their own advice. They can’t ignore the sunk cost they have invested in their years of work in their discipline. This is the reason that almost all breakthroughs in any discipline come from young people. Misbehaving is a very insightful book that will help any person understand why they do things that are less than optimal. Reading it will help you know yourself better, and that is well worth the investment of your time.

James R. Otteson is one of my favorite authors. He has the distinction of being the only author featured twice in this column; you may recall his book Honorable Business featured in the January 2021 column. His new book, Seven Deadly Economic Sins, does a masterful job of discrediting counterproductive beliefs people harbor regarding economics. There is an old saying: “It ain’t what you don’t know that gets you in trouble, it’s what you know for sure that just ain’t so.” Otteson states in his preface that economists agree on some basic principles that “can not only be readily expressed and understood but would benefit humanity if more widely appreciated.” He devotes one chapter each to seven misconceptions, and then ends the book with an implementation guide for individuals.

The first fallacy is that we live in a zero-sum world, that if someone gains wealth, it comes at the expense of someone else. Otteson gives convincing proof that wealth is positive-sum since the advent of specialization and capitalism. Almost every person in the world has been lifted out of extreme poverty due to the creation of wealth.

He warns us, too, against the “great mind” theory, another fallacy. There is a persistent, pernicious belief for many in government that they are capable of deciding what is best for people and it is their job to enact laws that force people to comply with their judgments. This thinking ignores the opportunity cost of these laws. What else might that money have been used for? Do you want to be governed by people who are arrogant enough to believe that they know better than you what is best for you?

These examples are mentioned to whet your appetite for the wisdom contained in this short, easy-to-read book. This is essential reading that will fill in what they didn’t teach you in school. Read it and then give a copy to your children and grandchildren.

 

RALPH STAYER, an avid reader and former CEO of Johnsonville Sausage, leads a book club in Naples with about a dozen other high-power friends. The group only reads non-fiction as a way to keep learning and sharpening the mind. Every month, Stayer shares the latest page-turners earning a permanent spot on his ever-expanding bookshelves.

 

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