Supporters of a free market, on the other hand, are caricatured as having a bleak view of mankind while espousing policies that emphasise voluntary co-operation with minimal restraints on human behaviour. This circle can only be squared if we understand that they do not, in fact, believe that people are heartless, self-serving agents. The only group of intellectuals who consistently claim that we are self-serving, consumerism-obsessed materialists are left-wing thinkers such as Oliver James, who rails against ‘selfish capitalists’. As Kenneth Minogue (1989: 23–24) observed, it is the egalitarian who believes that ‘most people are selfish and greedy, but that governments can act morally on their behalf’.
Simply put, economists assume that people are largely driven by self-interest when it comes to financial transactions. This is not an article of faith, rather it is an observation based on the revealed preferences of real people in every society since time immemorial. As Binmore (2007: 4–5) notes, empirical research
only supports the conclusion that for most adequately incentified people in most economic environments in developed societies, the data can be explained without assuming that such an other-regarding component is large. [In any case] it is not axiomatic in mainstream economics that human beings maximise their own income [and economists – neoliberal or otherwise – do not believe that] people have no other-regarding or social component at all in the utility functions that describe their final choices.
No matter how narrowly we define it, self-interest is clearly a very powerful motivation in human interactions. Towards the end of his chapter on self-interest, Chang acknowledges this, saying, ‘Of course, all this is not to deny that self-seeking is one of the most important human motivations’ (Chang 2010: 50). It explains why the baker sold bread in the eighteenth century and it continues to explain the bulk of economic behaviour much better than theories based on ‘benevolence’ or ‘lifestyle choices’. However, nobody seriously suggests that it is mankind’s only impetus. Altruism, charity and generosity flourish in everyday life and can still be found even in the hard-nosed world of business. As Chang rightly says, ‘Self-interest is a most powerful trait in most human beings. However, it’s not our only drive’ (41). That is the simple truth. No free-market economist has ever said otherwise. On this point, at least, there is no disagreement.
Greed is not good and capitalism does not rely on people being greedy. Capitalism is good, however, because it works even when people are greedy.
5 Arthur Laffer is best known for the ‘Laffer Curve’, which shows that tax revenues decline when tax rates are set too high.
2. Economists believe people are perfectly rational
‘Economics is not a science’, writes Suzanne Moore in The Guardian, ‘it’s not even a social science. It is an antisocial theory. It assumes behaviour is rational’ (Moore 2012). In The Courageous State, Richard Murphy (2011: 77) states that economists believe that ‘there is perfect information available in markets to inform decisions which are then made optimally. In other words, they assume that we all know everything we need to know about quite literally everything’.
They do not. Rationality is an important concept in economics and economists have different views about the extent to which people are rational, but as Tyler Cowen notes: ‘Economists accept no single set of assumptions about rationality, nor any one set of assumptions about the role of rationality assumptions in economic theory and practice’ (Cowen 2004: 233). This was highlighted when Eugene Fama and Robert Shiller both won the Nobel Prize in Economics in 2013 despite having starkly different views about the rationality of people and markets. Game theorists tend to assume that people are highly rational, and some theoretical economic models are based on the assumption that individuals are logical and perfectly informed. This does not mean, however, that economists believe that the population is entirely rational, well-informed, intelligent or wise. Nor can the field of economics be demolished with one of the almost infinite number of examples of human foolishness.
Some models are useful
The statistician George E. P. Box once said that ‘all models are wrong, but some are useful’ (Box and Draper 1987: 424). Theoretical economics sometimes describes a world which no one believes exists, nor ever will exist, and yet it can still be useful. For example, economic theory suggests that, if there is perfect competition in a totally free market, prices will drop to the point at which there is no excess profit. In this scenario, a company sells a product with a ten pence profit margin and so another company jumps in and sells the same product with a nine pence profit margin. This undercutting continues until the product is sold for the exact amount it costs to manufacture, distribute and retail, including the salaries of all involved (the marginal cost of production).
This scenario is patently unrealistic, partly because government regulation precludes the possibility of free markets with total competition and no barriers to entry, but also because in a vibrant and creative economy there are always profit margins for entrepreneurs to chase. But, although the model is hypothetical to a large extent, it contains the important truth that greater competition tends to lead to lower prices. Reducing barriers to entry forces down prices and, all other things being equal, reduces profit margins. As Harris and Seldon (1959: 48) write, ‘ ‘‘perfect” competition is a figment of the imagination, although a useful one. It is still true that the less imperfect a market, and the more it approaches the “perfect” model of theory, the better results it might yield in terms of costs and prices.’
It is not necessary for a totally free market to exist for the benefits of competition to be shown empirically, nor does a fantasy world of perfect competition have to be created for the benefits of competition to be felt. And it is emphatically not the case that if one pays more than cost price for a product then ‘the whole edifice of neoliberal economics collapses’, as Richard Murphy claims (Murphy 2011: 45).6 How different this is from state socialism in which the closer a country gets to the ideal of central planning, the worse the outcomes become (and how ironic that those who criticise the free market for its imperfect competition propose government monopoly as the solution).
To take an example from Econ 101, a model which assumes that lower prices will lead to more sales is useful, not because the outcome invariably follows the intervention, but because it will tend to do so, has been shown to do so and there are common sense reasons why it should do so. Similarly, a model which assumes that people make rational, self-interested decisions is useful, not because people invariably do so, but because most people try to do so, and frequently succeed in doing so, most of the time. Rational man, or homo economicus, ‘is not only a simplification of man, as all models will be, but he is also a caricature for he epitomises to an extreme degree the essential characteristics of economic behaviour’ (Morgan 1996: 20). So long as the caricature represents a fundamental truth about how people tend to behave, the model is useful.
6 Economists ‘assume that every business sells every product it makes at what is called the marginal cost of production. That means all they want back for the product they sell is the precise cost they incur for making the precise item they have sold. So if they sold you, for example, an MP3 download then they not only should but must, if this model of utopia described by neoliberal economists is to work, charge you just exactly what it cost them to make the MP3 download they sold to you. I kid you not: the whole edifice of neoliberal economics and the mantra so often repeated that business is more efficient than government is based on this type of logic.’ (Murphy 2011: 44–45).
Rational choice and behavioural economics
A fair degree of rationality can be expected from human beings. As P. J. O’Rourke says, it would be