Tuesday, September 18, 2007

More on Alan Greenspan

Here are excerpts from an article in Slate about Alan Greenspans's growing recognition of the irrationality of human economic behavior. When will economists in general catch on and do a better job of factoring this irrationality into their economic models?

Greenspan seems to argue that since the case for capitalism is so overwhelmingly rational, the opposition to it must surely stem from very deep-seated, immutable characteristics. "And that carries me to the general conclusion that if you're going to model an economy, you have to do far better in understanding how the unit of the economy functions—i.e., the human being"...

Looking to human nature also helped Greenspan solve a perplexing economic mystery. Over the last 150 years, it seems that the maximum productivity growth the economy could achieve over a long period of time was 3 percent annually—despite a series of productivity-enhancing innovations, from the steam engine to the Internet. His conclusion? "What ultimately looks to be the case is that's the pace at which human beings operate," he said. People simply can't process new ideas more quickly. "The answer is that the human race, no matter how one defines it, is not smart enough to do better."

The ultimate rationalist seems to have concluded that fear, resistance to change, exuberance, and human limitations play a bigger role than expected in economic development. And he recognized that economists have proven so human—i.e., fallible—in their forecasting because the force actually driving the economy is humans who are prone to act on emotion rather than reason. The inability to account for exuberance and fear—"huge unknown variables"—is one reason why economists do poorly forecasting recessions and other economic reversals. "I've been forecasting for 50 years and I have not seen any improvement in our capability of forecasting," he said.

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