Akerlof & Shiller, Phishing for Phools

George A. Akerlof and Robert J. Shiller, who previously collaborated to produce Animal Spirits, have joined forces again. Their new book is Phishing for Phools: The Economics of Manipulation and Deception (Princeton University Press, 2015).

Their thesis is simple but powerful: that “competitive markets by their very nature spawn deception and trickery, as a result of the same profit motives that give us our prosperity.” (p. 165) Economies “have a phishing equilibrium in which every chance for profit more than the ordinary will be taken up.” (p. 2) Free-market equilibrium undermines our plans to eat healthily, it makes us pay too much for our cars and houses, it transforms rotten assets into gold.

We have weaknesses that can be exploited (monkeys on our shoulders), weaknesses that free markets by their very nature exploit. Akerlof and Shiller modestly claim to be making only “a small tweak to the usual economics (by noticing the difference between optimality in terms of our real tastes and optimality in terms of our monkey-on-the-shoulder tastes). But that small tweak for economics makes a great difference to our lives. It’s a major reason why just letting people be Free to Choose—which Milton and Rose Friedman, for example, consider the sine qua non of good public policy—leads to serious economic problems.” (p. 6)

In 1930 John Maynard Keynes projected what life would be like in 2030. In one respect he was pretty close: real income per capita in the U.S. was 5.6 times higher in 2010 than it was in 1930. (He predicted it would be eight times higher by 2030.) But in the other, he was dead wrong. People aren’t worrying about how to use their surfeit of leisure; they’re still worrying about how to pay the bills. “[F]ree markets have … invented many more ‘needs’ for us, and, also, new ways to sell us on those ‘needs.’ All these enticements explain why it is so hard for consumers to make ends meet. … Some say that our predicament is a product of the consumerism of the modern world. … But to our minds, the central problem lies in the equilibrium. The free-market equilibrium generates a supply of phishes for any human weakness. Our real per capita GDP can go up five-and-a-half-fold again, and then do it again; we will still be in the same predicament.” (pp. 21-22)

Akerlof and Shiller devote the bulk of their book to providing examples of phishing. They explain how reputation mining contributed to the financial crisis, why the buyers of the rotten mortgage-backed securities were so gullible, and why the financial system was so vulnerable to the discovery that the securities were rotten. They illustrate how advertisers graft stories of their own onto the mental narratives in our minds. They analyze a study showing that blacks and women are charged more for cars—black men a staggering 9% more. This even when, in the study, the testers were chosen to be as similar as possible in age and education, when “they drove similar rental cars to the dealers; wore similar ‘yuppie’ clothes; indicated no need for financing; and gave the same home address.” (p. 61) The authors describe how credit cards entice us to spend a great deal more than we would if we paid with cash. They give examples from the worlds of pharma, food, and lobbying and explore the S&L crisis and junk bonds.

As the campaign season kicks into gear, it’s perhaps timely to look at one theme in their critique of the Citizens United decision. They write: “Our view of free speech closely mirrors our view of free markets. We view both as critical for economic prosperity; and free speech as especially critical for democracy. But just as phishing for phools yields a downside to free markets, similarly, it yields a downside to free speech. Like markets, free speech also requires rules to filter the functional from the dysfunctional.” (p. 160) The majority opinion, written by Justice Kennedy, “seems to treat speaking solely as conveyance of information, without consideration of its role of persuasion, inevitably with its phish for fools. … Speech is also a way to convince other people to act in our interests.” (p. 161)

Phishing for Phools forswears technical language, making this book accessible not only to economists but to consumers and policymakers. It should make everyone rethink the unfettered free-market model.