Smith from A to V; or The Fallacy of the Ipso Facto Leap

There is an interesting paper to call your attention to in the new issue of The B.E. Journal of Economic Analysis & Policy.  In "The Market: Catalyst for Rationality and Filter of Irrationality" by John A. List Daniel L. Millimet, they conclude (emphasis mine):

An important issue facing behavioral and experimental economics today is the role of the market in shaping and influencing behavior. Yet, the extent to which experience in naturally-occurring markets influences rational choice behavior has heretofore been unexplored empirically. This study begins by presenting evidence from a set of experimental treatments that exogenously induce market participation by individuals, finding that the market is more powerful than most surmise: using one straightforward test for rationality relying on the theory of revealed preference, we find that the market is a catalyst for this type of rationality. This result is surprising in that our experimental design constitutes a particularly demanding test of learning, as our exploration measures participation in one particular market and rational choice behavior in a separate, quite distinct, “market.” Insights gained from these treatments suggest that economic rationality is a social, not an individual construct.

These findings naturally lead to an examination of market outcomes in multi-lateral decentralized markets that are populated by irrational and rational buying agents. Such an analysis lends insights into whether rationality influences rent allocation and whether equilibrating properties of markets are affected by the presence of a significant number of irrational agents. Our findings suggest that even in markets populated entirely by irrational actors, several fundamental features of markets, such as price and quantity realizations, meet neoclassical predictions after a few rounds of market experience. In light of recent findings of individual irrationality, this empirical result should have significance to scholars interested in both positive and normative economic modeling and aggregate market outcomes.

I haven't read the whole thing, but it seems like a clever experiment and result that is very Smithian (of the Vernon variety). 

As interesting as I find the results from modern experimental and behavioral economics, the leap that many make from "actors are irrational" to "therefore markets fail" is one that Austrians should be responding to.  Too many in the discipline believe that the argument for the efficacy of markets is premised on the rationality of actors.  To the contrary, the Austrian argument has long been that "rationality" is not in the actors but in the ways in which market institutions filter in and out certain types of behavior. 

What Vernon Smith calls "ecological rationality" is the way we should be thinking about this. It is also the legacy of good economic thinking from A. Smith to V. Smith, not to mention Mises, Hayek, Alchian and others in between.  This perspective puts the emphasis in economics not on the degree of rationality of the actors but on the ways in which institutions emerge and then succeed or fail at channeling individual action to social benefit.  That requires, in my view, that we understand the human mind and how we choose (thus experimental and behavioral economics has its role), but what we must avoid is what I would term the "Ipso Facto Leap" from individual irrationality to "market failure."  In a way, it's parallel to how public choice economics had to undermine the "Ipso Facto Leap" from market failure to "government intervention is superior."  Vernon gets this and we should be making more use of his work, and the disciplinary prestige that goes with it, to hammer home the Fallcy of the Ipso Facto Leap.

It's nice to see an article in a mainstream journal that makes this point and uses the language of "catalyst" and "filter" in the title in the way this one does.

(Note for Pete B:  Yes, both "Smith from A to V" and "The Fallacy of the Ipso Facto Leap" would make great paper titles for you to steal from me.  You could at least do me the favor of a co-authorship on one or the other. ;) )

Comments

[Dave Prychitko]

I'd just call it the Ipso Facto Fallacy.

[Roger Koppl]

This looks like a great article, Steve. Thanks for that. I share your enthusiasm for V. Smith. He's got Hayek, evolutionary psychology, and experimental methods all working together. What's not to love? :-)

List and Millimet cite Gode & Sunder as well as Becker's 1962 JPE paper to which Kirzner responded. But they don't cite Hirschman's "The Passions and the Interests." As Hirschman documents, one of the oldest arguments for the market is that it tames the passions. Hume made an argument along these lines in his History and, as you say, it's in A. Smith too. It's also in Max Weber and Hayek. It looks like L&M have an impressive innovation by testing the idea in the lab. Very nice.

[Grant]

Thanks for the post; I'd always assumed that markets were just better at selecting more-rational actors than the alternatives.

It would be interesting to repeat this sort of experiment in environments that some believe causes macro-irrationality: implicit "bailouts", credit expansion/contraction, uncertain "regulatory" environments, etc.

[Steve Miller]

1) Great post on a very important topic. So what if people are loss averse, have intransitive preferences, etc.? How does that mean markets will necessarily fail, or that government intervention would improve things?

2) Why are you people acting like you haven't heard of John List? Bad, bad Austrians! He is to economic research as Albert Pujols is to hitting.

[mortgages]

Great post on a very important topic. Why are you people acting like you haven't heard of John List?