Book Report: The Logic of Life

I just finished reading The Logic of Life by Tim Harford. The overall point of the book is to show that, in general, people are rational. It is a response, although a moderate one, to critics of the assumption of the rational economic actor.

For a long time, economic theory assumed that all economic actors are perfectly rational - they have full information and can accurately value their preferences. More recently, experiments have questioned that assumption. This is particularly important since the rational actor assumption is necessary to support a pure free market philosophy.

The experiments have shown that people are not always rational. People will sometimes penalize other people, even if it hurts themselves, and sometimes for irrational reasons like team affiliation. Also, people often value two equal things differently if they are presented in a different way. People are also far more charitable than a rational actor theory would expect.

Harford's book seeks to debunk some of these experiments - showing that they are the result of lab experiment conditions that are different from the real world. And he also shows many examples where people are behaving rationally even if at first glance their behavior looks irrational.

While his book does a good job of showing rational behavior, he does not actually show that the rational actor model is accurate. In fact, that is far from his goal. It is clear that what he wants to do is show readers that people do respond rationally to incentives. This is something that liberals and conservatives desperately need to be reminded of.

Liberals tend to dismiss the rational actor model outright and conclude therefore that we need government intervention. Behavior by Wall Street provides a good basis for this - as people tent to undervalue risk the farther away from a market crash we get.

Conservatives on the other hand have an oversimplified view of the rational actor, believing that without government, the rational actor makes perfect decisions and creates a free market utopia.

In truth, the underlying assumption of economics, and Harford makes this point very well, is that people do in fact respond to incentives. This is the invisible hand that Adam Smith talked about. However, when people respond to incentives, they don't always behave in the way we expect because we don't always fully understand the incentives.

A great example of this, to my mind, is the current recession. While part of the problem may have been psychological and irrational, there were also incentives that encouraged much of the worst behavior. For example, Wall Street compensation rewards quick, even if fleeting, profits instead of long term sustained growth. This can incentivize risky behavior. Also, home loan originators were able to sell their new loans quickly, giving them no reason to care if the loans would be paid off in the long term.

I do have to say, Harford's book does not actually cover the financial crisis. His examples instead include smokers and drinkers changing behavior in response to taxes and the ability to quit, or people choosing more oral sex as other forms of sex become more risky. I have taken his general theme and extended it to cover our recession and the bubble that caused it.

One example that Harford uses that I wish he spent more time on was voting. He tries to show how choosing not to vote is a rational decision. His logic, strictly applied to what I just wrote, is hard to deny when looking at someone who wants their vote to make a difference. If someone will vote only if there is a chance their vote will make a difference, then it is rational not to vote since it is extremely rare that an election is decided by one vote.

Unfortunately, Harford spends almost no time discussing why voting might be rational. He gives a few reasons, but moves on quickly. In doing so, he gives the impression that not only can choosing not to vote be rational, but that voting is irrational. I don't think that is his intention, but that is how it comes off. I think that if Harford used his incredible logic skills, and his command of statistics, he could point out many reasons that voting is rational.

I finished the book a few weeks ago, so I don't remember all of the examples and data he used. In general though it is a pretty convincing book. And the topics covered in the book (money in politics, crime, social issues, segregation) made it far more useful than Freakonomics and Super Freakonomics (more on that in another post). And it is written to be just as accessible as those books are. In other words, it is poppy, but pretty useful.