self-interest and the financial meltdown, part 1

It is with considerable embarrassment that I offer some thoughts related to the financial meltdown.  The main reason for this sheepishness is that I’m afraid that analysis isn’t worth much right now.  The real task is to offer a way forward, one that staves off economic catastrophe and hopefully doesn’t reward the miscreants (who, it should be stressed, can not only be found in Washington and on Wall Street, but on Main Street as well: while some borrowers were undoubtedly tricked by fraudulent lending practices, the main story seems to be one where borrowers were overwhelmingly unable to turn down deals that common sense should have told them were too good to be true).  But I have no solutions to offer.  Given that I spent a good deal of my career analyzing financial markets, one might think that I should feel guilty about this.  What saves me from such feelings is that, as a sociologist, no one is looking to me for solutions.  And certainly no one can blame me or my disciplinary kin for having provided any aid or succor to those who got us in this mess.  To the contrary, anyone who knows me knows that I have long been a bear.  But this is an occasion where having been right really sucks.  I am deeply concerned that family and friends will soon be in dire economic straits, and so I wish I knew of a way out.

My avowed concern for others is a useful segue into one of the key themes that this crisis has evoked for me: what is myth and what is fact about the premise that human beings are motivated by self-interest.  A related topic came up recently on this blog (the discussion Teppo flagged today seems relevant too) and this discussion was helpful to me, at least in part because it led me to read Dale Miller’s essay “The Norm of Self-Interest”.

This essay develops the very interesting and compelling thesis that we should be skeptical about the premise that human beings are motivated by self-interest because much apparent evidence supporting this premise may be an artifact of its self-fulfilling features. The last paragraph of the essay summarizes the argument very well:

Evidence that material self-interest is powerful, therefore, may speak more to the power of social norms than to the power of innate proclivities. Interpreting the presence of self-interested behavior to suggest that self-interest is inevitable and universal rather than historically and culturally contingent only serves to strengthen the layperson’s belief that pursuing self-interest is normatively appropriate, rational, and enlightened. The result of this is a positive feedback loop: The more powerful the norm of self- interest, the more evidence there is for the theory of self- interest, which, in turn, increases the power of the self-interest norm ( Schwartz, 1997 ). None of this is to say that self-interest, even narrowly defined, is an insubstantial force in human affairs. But, however strong the disposition to pursue material self- interest may be, it is likely not as strong as the prevalence of self-interested behavior in everyday life suggests. Homo economicus, it should not be forgotten, inhabits a social world.

As I said, I think Miller’s essay is compelling.  And it dovetails nicely with Swidler’s observations in Talk of Love, about “individualist/voluntarist American culture, wherein individuals can only justify their decisions by framing them as the result of autonomous, voluntary action” (p.176).” But I think it is limited in at least two critical ways (that don’t apply as much to Swidler).

To quickly get to the heart of these two issues, it is instructive to consider this quote from Friday’s NYT from James Cox of Duke Law School, who apparently supported the SEC’s disastrous 2004 decision to roll-back capital controls on investment banks:

We foolishly believed that the firms had a strong culture of self-preservation and responsibility, and would have the discipline not to be excessively borrowing… Letting the firms police themselves made sense to me because … I foolishly thought the market would impose its own-self discipline. We’ve all learned a terrible lesson.” (emphasis added)

I like this quote because his admission of past foolishness and culpability is a breath of fresh air right now. I also like it because: (a) he points to two different mechanisms that promote the pursuit of self-interest—organizational culture and market discipline, only the first of which is related to the mechanism highlighted by Miller; and (b) he reminds us that while there are indeed positive feedback loops which reinforce the tendency to act on the basis of self-interest, there are also negative feedback loops, by which the pursuit of self-interest tragically leads to self-defeating actions. In a sense, there is both more and less basis for expecting self-interested action than Miller supposes.

 

Since this post has become ridiculously long already, I’ll say a word about the implications of point a (the basis for expecting of self-interestedness), and develop point b (why the pursuit of self-interest can be self-defeating) in an upcoming post.

 

Why should we expect self-interested action, in the first instance?  Miller suggests that the alternative to his norm-based account is one rooted in human nature, and he suggests that this alternative is weak because we appear to have other, non-self-interested inclinations. So for the moment, let us turn off that mechanism by assuming that there is no natural inclination towards self-interestedness. But let us also assume that the norms promoting self-interest often do not have much teeth behind them, as Miller admits may be the case (see his section on “Why Does Self-Interest Predict Behavior Better Than Attitudes?”). Would we then have a world of altruists, as Miller’s argument seems to imply?

 

No. The reason is straightforward (and suggested by Cox’s invoking of market discipline): competition. Like all organisms, human beings need resources to survive, and such resources are typically under the control of other human beings who could provide those resources to others instead of to us. In highly competitive environments, we are forced “to look out for no.1” regardless of whether this might have been our natural inclination and regardless of whether norms promote this behavior. (In fact, we have many norms that limit self-interested behavior, but Miller ignores these in his essay). In short, homo economicus does not just “inhabit a social world,” as Miller would have it (where such inhabiting implies the need to adhere to society’s norms), he is a creature of highly competitive social worlds. Remove the competition, and you remove the structural underpinning for self-interestedness.

 

We need to find no better example of such self-interestedness than the current liquidity trap, where banks– and everyone else for that matter– hoard capital in a bid to save themselves, thereby digging a deeper hole. Meanwhile, Zimbabweans are suffering even more than we can imagine, not from deflation but from hyperinflation (on top of everything else they have suffered recently), which has created a “Darwinian” struggle for survival, according to the NYT. One does not need human nature or norms to explain self-interested behavior in conditions like these.

 

There seem to be two potential objections to this (I’m sure you will raise others!). One is that, especially insofar as we are trying to account for American individualism, it seems awkward to attribute it to the fact that America is a resource-scarce environment. The short answer to this is that the culture of individualism reflects the intense status competition of American life; and as a positional good (see Fred Hirsch’s excellent book The Social Limits to Growth), status is an inherently limited (zero-sum) resource. (Put differently, Miller misfires when he focuses on material interest as the locus of individualism). Of course, one might argue that nothing is forcing Americans to engage in status competition, and so our tendency to pursue status must be due, either to natural proclivities or to the kinds of norms that Miller describes. I don’t have the space to develop the point here (I will try to do it in a book I’m slowly writing), but I would argue that this is wrong, and that in fact, the pursuit of status should be seen, in the first instance, as a defensive move, which is necessitated whenever we find ourselves in an environment where resources are allocated on the basis of status, and especially where the failure to attain some status brings about social death (i.e., elimination from certain interactions/contexts). To quickly make the point: while I am willing to believe that most sociologists have no natural need for status, this has little effect on the behavior we see at the ASA (or in the job market, citation patterns, etc.). Such an environment effectively demands status-seeking.

The second objection will be addressed in my upcoming post: Why do people– and financial market participants in particular– engage in self-defeating behavior even when environmental factors would seem to discipline them to act self-interestedly? Put differently, why was Cox wrong when he (reasonably, and consistently with Chicago-style economic theory about how regulation is unnecessary) presumed that both market discipline and norms of self-preservation would prevent the investment banks from taking suicidal actions?