Comments on "Critical Thinking about Economics"

My friend K.S. and my Mom left thoughtful comments on my prior blog on “Critical Thinking about Economics.” I started replying in as comments, but found my replies were getting rather long, so here’s a new blog instead.

First, K.S. suggests that shocking events like 9-11 and the economic meltdown are required to enable Americans to accept changes that they wouldn’t have otherwise, even though critical thinking might have unveiled the desirability of such changes. While I agree that shock makes such changes more popularly acceptable, there are other ways to change opinion. Most importantly: Leadership. Whether such leadership is charismatic or visionary, the kind of leadership that can change public opinion goes beyond what Bergen Evans observed in 1954: “For the most part, our leaders are merely following out front: They do but marshal us the way that we are going.”

On this 40th anniversary of Apollo 11’s moon landing, we’re reminded of a young American president who led us to do things we wouldn’t have otherwise. One might observe that Pres. Kennedy’s vision was built on the shock of the Russians beating America into space. Maybe so. Or maybe Kennedy led us in a chosen new direction; he could just as easily have led us into ignoring Russian scientific advances and have Americans continue to focus inwardly, cutting taxes instead of investing in creating an entire generation of scientists, thinkers, and innovators.

Mom noted the challenge of having the masses understand vision and future greatness. She further noted that to counter greed, families and schools must develop ethical behavior and character in their kids. I totally agree. As I noted, developing critical thinking abilities and dispositions in more Americans is one way to increase openness to new visions and the possibilities of the future. And focusing on the development of virtuous character traits is so sorely needed in this country and world.

In his recent book Five Minds for the Future, Harvard Professor Howard Gardner wrote of the vital importance today of educating our kids not only in the academic disciplines, but also so they can synthesize (connect) information, create new ideas, respect the ideas of others, and behave ethically – beyond self-interest – to improve the quality of life for all.

We all see the impact of the lack of such ethical understanding and behavior in the excesses of greed in our society today. Our families, communities, and schools share the responsibility for this failure. I believe we can and must change this situation and each of us has the opportunity to improve the character of kids, ourselves, and our neighbors within our own communities. Like Ronald Reagan’s “thousand points of light,” by working on character development one community at a time, we can create a brighter America. The City of Pleasanton, California is a wonderful example of a community that is accomplishing this objective.

Finally, K.S. cited a Guardian article in which experts explained the current financial crisis to Queen Elizabeth. He asked for my comments on that article.

I agree with the points reported in the article. I think the underlying problem goes deeper, however, than the lack of jurisdiction, failure to understand collective risks of the system, the “psychology of denial,” and personal incentives that differ from society’s interests.

The basic question they didn’t address is: What is the purpose of financial markets, from society’s perspective? In business school, I was taught that the financial markets provide capital for investment, and ultimately, the purpose of investment is to create wealth.

Even while taking the course on stock markets, however, it seemed to me that the stock market is an inefficient means of providing investment capital. While IPOs provide initial capital for company formation, the continued trading of the stock doesn’t provide any additional capital to that company for investment. Trading of already issued stock is merely gambling that the company will pay off more in dividends or the share price will appreciate. But that appreciation is based on gambling that someone will pay more for those shares, expecting more in dividends or capital appreciation. I also learned a term describing a principle in this secondary trading: “The greater fool theory.” It’s a theory that’s hundreds of years old, going at least as far back as the Dutch tulip bubble of 1624, in which speculators bid up prices of single tulip bulbs to today’s equivalent of $100,000 before the bubble burst.

Of course, continued trading of a stock can provide additional capital to a company that issues more stock or trade in their own already issued shares. But fundamentally, how much of the money that is traded in stock ultimately ends up as capital usable by companies to create wealth versus money that is just bet on future share prices? With all the concern about legalizing casino gambling, we seem to be oblivious to the fact that the stock market has made gambling legal and socially acceptable – even admired – for centuries!

We have accepted significant changes in the financial markets during the past few decades – notably the creation of increasingly exotic derivatives and increasing deregulation of the markets – during a period of unprecedentedly long market expansion. These changes have helped a relative few make fortunes in personal income for awhile. But these changes haven’t created much inherent wealth or wealth-creating investment. Rather, they’ve created a huge casino enabling a few to make fortunes on other peoples’ money and risk.

These changes have worked to lull the world into complacency and also to ignore fundamental truths and lessons of the past. For example, a basic economics lesson is that a company that is too big to fail – a monopoly – needs to be highly regulated in order to protect society’s interests.

My answer to Queen Elizabeth’s question “How come nobody could foresee it?” is that many people could and did foresee the economic crisis. However, most of us just didn’t like the pronouncements of the critical-thinking, ethical Cassandras. Instead, we hoped the easy money would continue to come along with the easy answers. Well, most of us are paying for that misplaced hope.

The current economic meltdown is providing “a teachable moment.” Will we learn or will we continue to keep our heads in the sand? I guess the answer will depend on our families, teachers, and the leaders we elect.


Critical Thinking about Economics

I was delighted when the Ohio Board of Regents hired me as Chancellor to help them and the state “think out-of-the-box.” That’s what my education and management consulting career had trained me to do. So I’ve been especially pleased when I find others who do so and help others stretch their thinking.

Dan Ariely’s book Predictably Irrational introduced me to a new field – behavioral economics – and it challenged my previous thinking.

The only economics courses I took in college were in my MBA curriculum. While taking those courses – which I enjoyed – I thought I would have enjoyed taking economics as my undergraduate major (instead of the mathematics and physics which I took), and I have advised others interested in studying business as an undergraduate major to major in economics instead. With my math background, I quickly understood the economics principles from the models on which they were built. My understanding of the simple principles of supply and demand and economic efficiency became the basis for my self-described moniker of “free-marketeer.”

From Prof. Ariely’s book – and then a couple of sessions by Cornell University professors in Ithaca last year for the Trustee/Council Annual Meeting entitled “Why Trial Judges Make Mistakes” and “Using Psychology to Create a Better Economics” – I learned that the economics models that have been developed to describe decision making are perhaps too simplistic to reflect decisions that are actually made.

The notion that models don’t perfectly predict performance isn’t surprising to me. All models necessarily simplify the real world and hence must be produce somewhat inaccurate depictions of reality. The research done by Prof. Ariely at Duke and Profs. Jeffrey Rachlinski, Thomas Gilovich, and Edward O’Donoghue at Cornell, though, leads to real questions on how useful many of the fundamental economic theories are in depicting the real world, since their research shows that people behave so differently from what those basic theories predict.

This issue is not one of mere “academic” interest. The world has experienced an economic meltdown that has affected hundreds of millions of people – a meltdown that, at its core, was enabled by notions based on those basic economic theories. Alan Greenspan, for example, has testified that his lifetime of free-market thinking and economic policies were based on the mistaken belief that financial institutions would do what was necessary to protect their shareholders and institutions.

For over 20 years, I have questioned whether CEOs really would act in the long-term interests of their companies and shareholders. While I was certainly trained in my MBA studies to act with such interests, I remember first questioning that objective the year Michael Eisner earned what I recall was $104 million in his first year as CEO at Disney. I asked if any CEO who could make more money in one year than he or his heirs could ever spend in their lifetimes would be concerned about the future earnings, let alone survival, of their institutions. Wall Street earnings and bonuses have since made that $104 million look like chicken feed.

I cite the difference between Greenspan’s and my thinking not to in any way to suggest that I’m smarter than he is. Rather, I do so to note the crucial importance of challenging old thinking. Trillions of dollars in net worth have evaporated because a basic old thought wasn’t sufficiently challenged by those with the authority – and responsibility – to do so.

Developing “critical thinking” in its students is the professed objective of virtually every college and university in America. How these institutions accomplish this objective is a largely unexplored mystery. Certainly, some students have mastered the required disciplinary knowledge to think deeply about questions and are able to synthesize their knowledge to apply it to questions other than those they have studied. But how has their education systematically developed these abilities? Further, to be applied in the appropriate situations, critical thinking must also be a personal disposition, for unless a Greenspan challenges his own thinking, the mere possession of the knowledge and the ability to think critically will be woefully wasted.

As demonstrated by this new work in behavioral economics, one way academe gets its scholars and students to think out-of-the-disciplinary-box is to encourage interdisciplinary studies – in this case, the interaction of psychology and economics. Looking between the cracks in organizations has been a fundamental strategy I learned in my management consulting career. However, such exploration is a very unnatural act in academe, in which scholars’ academic careers have been built on being experts in precisely small fields within single academic disciplines. As it’s been said, a Ph.D. learns more and more about less and less. Then gaining tenure has required a slavish dedication to one’s chosen discipline, if only as an act of career self-interest (for if you don’t gain tenure in one institution, you’ll need to look to your colleagues in your discipline to help you secure a position in another institution to try again).

So how do we actually get students to develop the knowledge, ability, and disposition to think critically? As I’ve noted, this is a crucially important question and it is one that transcends individual academic disciplines. The answer must not be sloughed off with simplistic replies like “Well, that’s what liberal education is all about.” After all, our current economic and political situation is one that has been developed by public officials, leaders, and voters who are largely products of that liberal education system.

We need to do better. Challenging our old ways of thinking is a way to start.