"Out of the crooked timber..."

There is a global debate going on concerning why the global financial crisis erupted. The technical debate is what it is; so far there is far more heat than light. But in addition to the technical debate is a debate about how certain underlying assumptions about human nature entertained by economists and even famous central bankers have turned out to be incorrect. It turns out that human beings - as consumers, investors, bankers, stock traders - have not behaved in precisely the ways "rigorous" economic theories predicted that they would. Even Alan Greenspan, former Chairman of the Federal Reserve, showed his surprise at human nature at a congressional hearing late last year: "I made a mistake in presuming that the self-interests of organizations, specifically banks and others, were such as that they were best capable of protecting their own shareholders and their equity in the firms." For a recent analysis written by one of the deepest writer/contributors associated with the Financial Times, please see John Kay's 'How economics lost sight of the real world' (FT  Wednesday April 22 2009 page 11). Kay makes the case superbly.

The debate about the fundamental role of human nature in determining economic outcomes reminds me of a dictum of Sir Isaiah Berlin's. Berlin's work remains a masterly take on the history of political thought. He teaches us that at the basis of any theory of how to organize human society is a theory of human nature. Each theory makes assumptions about what human beings are like. It follows that if you put the theory into practice its fortunes will depend on whether or not its underlying assumptions about human beings turn out to be correct.  On this score, Berlin is with Immanuel Kant who famously said: "Out of the crooked timber of humanity nothing straight was ever made".

Human beings are, on this view, unchangeably complex and unpredictable. That is why technocratic assumptions don't work under real-world conditions. The idea of using models to predict human behavior and then betting fantastic sums of money on the outcome is ludicrous. But it also happens in the field of international development. John Kay's main point applies with equal force to efforts in international development. He says:

"That people respond rationally to incentives, and that market prices incorporate information about the world, are not terrible assumptions. But they are not universal truths either. Much of what creates profit opportunities and causes instability in the global economy results from the failure of these assumptions. Herd behaviour, asset mispricing and grossly imperfect information have led us to where we are today."

One can only hope that once the global system comes out of the current crisis so-called experts will learn to take human beings more seriously ... warts, unpredictability, frailty and all.

Photo credit: Flickr User shwe