sophiaserpentia | Neuro-economics

In college I studied a significant amount of economics: 12 upper-class hours. All of that stuff I learned about -- the curves of supply and demand, economies of scale, the money supply, etc. -- the entire edifice of academic economics -- sounds really great, but it is all based on the assumptions of open information, rational self-interest, and product equivalence. Economists shrug off the gap between these assumptions and reality, saying, "Well, the math is valid for those assumptions, so it should approximate reality to some degree. However:

"Economics has hit the wall," said Andrew Lo, director of MIT's laboratory for financial engineering. "It has explained about as much as it can with the tools it has. There are too many inconsistencies between theory and data."

The problem with economic theory is that it assumes that scarce resources are being handled by robots, not by domesticated primates, with our biological responses to scarcity and our tendencies for stratified culture. The gap between real behavior and assumed behavior is so big, that economic theory is a hollow abstraction so far removed from reality that leads not to better policy, but to inhumane policies and justification for imperialism.

The other day I posted about behavioral finance; today there is a story in the news about neuro-economics, a new field which examines the ways the brain responds to classical resource-scarcity situations.

Economics -- the study of how people react to resource scarcity -- is going to be completely turned on its ear within the next twenty years. There will be a paradigm shift comparable to that inspired by Marx or Keynes. I see considerable opportunity for the development of a more humane socio-economic-political theory.

From the story linked:

In virtually every area of markets, human behavior has economists stumped. "We don't know why stock prices go up and down," said Caltech economist Colin Camerer. "We don't know why savings rates are so dramatically different in different parts of the world. We don't know why there is labor market discrimination." People trust other people when economic theory says they should not. They cooperate when betrayal seems more rational. They gamble foolishly, overestimating risk when they are losing, and underestimating it when they are winning. They spend too much and save too little.

Economists know all this from personal experience, but they don't know how to factor the quirks of human behavior into their mathematical models. This is no small matter. Efforts to set interest rates, revamp health insurance, privatize Social Security, revise pensions, police the sale of securities and alter legal liability rules rely to some degree on economists' ability to make reliable predictions about the choices people will make.

... Pioneers in neuroeconomics believe the key to understanding economic behavior lies deep in the brain, at the level of cells and synapses.

The brain is above all an economic engine forged by evolution through eons of scrounging for scarce resources, they argue. So the ability to trade things of value is the defining characteristic of the brain, the keystone of human character.

"Trade preceded agriculture; it preceded cities; it is a major component in human sociality. More than anything, it explains our success as a species," said Vernon Smith, an economist at George Mason University whose work in experimental economics earned him a Nobel Prize in 2002.

Some experts suggest that stock markets and other financial exchanges, as creations of the human intellect, may mirror the biological networks in the brain.