'The Sceptical Economist'

The Skeptical Economist Jonathan Aldred 2009 The Sovereign Consumer The sovereign consumer represents the first stage in a process of economic abstraction which leads to the so-called 'homo economicus' model of motivations for human behaviour. It is in essence a simplified model of how the average human might shop. When extended, it becomes a view of the rational cost-benefit analysis which the average human applies to many quasi-economic decision making situations. The consumer is sovereign in the sense that his primary motivations are internally generated. The would contrast, for example, with a Hegelian analysis, which looks to see how cultural influences determine human economic (and other) choice. A typical story there would be the influence of advertising. A second way in which they're sovereign is more internal. The model for human shopping first advocated by the early economists (Smith) claimed that rationality was sovereign over emotion, whim, brainwashing, etc. This is the so-called rational economic decision maker. Notice the strong enlightenment influence of rationalism here but the absense of an ought/is distinction - these people reasoned (perhaps wrongly - see Rorty, etc) that reason ought to be how we shop and by implication (wrongly) that it is a good model for how we actually shop. Think Descartes, who applied a process of stripping away that which he could doubt, only to leave him with a power to cogitate. A similar move is made by the early economists. They found a rational homunculus at the centre too, just like Descartes and the other rationalists. The philosophical influence of this stripping away coincides with the scientific approach which was gaining ground in enlightenment times - namely the model building approach of the astronomer. Think Gauss, Bernoulli, Laplace, De Moivre, Pascal, Fermat and the foundations of probability and statistics. One element of what they were doing was building a (simple) mathematical model. In that realm phenomena to be explained were based on normal distributions, unlike economic/financial data, which seems to be based on Levy probability - with fat tails. But still, I should be very clear that we shouldn't criticise the desire to simplify using models - it is a great thing, but you must always remember the simplifying assumptions you made in your head at the start. This book is all about going back to those simplifying assumptions and re-examining them and re-describing them as now too simplistic. There's clearly a political agenda in his book, which again, is fine, but when reading it, it is best to keep this in mind. So think of the sovereign consumer as the Cartesian 'Cogito'; on a trip to the local market. What are the basic elements of the myth of the autonomous shopper? I have (sovereign) preferences. (When it breaks down and you introduce Hegel or behavioural finance, you still have preferences, but biased/non-sovereign ones). I have choice - there's more than one thing I can buy (extended, more than one thing I can chose to do); I.e. I have something to do, a decision to make. Next, I have information about the choices available to me. Think of knowledge of the existence of choice as a kind of level 0 information. You have information that there are 3 products which can satisfy your preference. Finally there's a cost constraint - usually expressed as a budget. Just thinking in general about these four tenets of the automous shopper. Two of them are already general purpose enough - information and choice. The model doesn't go in for simplifying the arrival of information or the possibility of enormous choice. And thinking about it from a political economy point of view, there aren't any vested interests in allowing any kind of simplifications to go through here. The other two - a cost constraint and a model of preferences which are boundaried at the individual - both of these have been put to political use and both been recently criticised. Actually, I could well imaging that you could have an infinite set of cost constraints and the classical model could still go through. But since we usually have a single unit of account (money, regardless of the currency), they probably can be all 'translated' into a 'dollar value'. But this book spends time criticising this 'cash out to cash' moralism, so there's definitely a critique there. Finally, the idea that you draw you boundary of influence on preferences to the individual human, this is the strong enlightenment position. Our whole western legal and political system is predicated on a 'responsible' autonomous individual - the criminal justice system doesn't make much sense without it, property rights, protestantism, reward structures, etc. It is deeply ingrained into our western culture, so to see it pop up as a simplifying assumption in the core classical economic model is bound to be no surprise. How does all this hang together ? Well you can imagine that the simplistic model of 'maximum finding' on a well-defined mathematical function could be a simulacrum for 'chosing'. The optimisation process is on the function of the user's happiness. Picking one choice from among many in the presence of information (even if the information is incomplete) is kind of like finding a maximum in a mathematical function. You're constrained by your budget. You can see first of all how things like Lagrangian Multipliers are going to be useful to the mathematical economist with this kind of setup. This happiness function is usually called the utility function. As you could imagine yourself, this is probably a function of a lot of variables. It must be time-varying, surely. And it is probably a function of how wealthy you are (as per Daniel Bernoulli and the marginal utility of rich and poor people being different). It must also be a function of what information is available to you at that time. This is your filtration, in stochastic processes terminology - your information set. By saying this is a function of a lot of variables (or perhaps some of them are parameters), then what you're saying is that you are faced with a family of possible utility functions, predicated on the choice you're about to make. The process of selecting that utility function is the process of solving for (finding the variable or parameter; or vector of variables and parameters) a maximum of U(). Side note: is there one single utility function for a person, or one for each choice they need to make. I guess there's a correlated set of individual utility functions which can all roll up into one major individual-level utility function. This could even be considered to roll up to one for a community. This introduces a stochastic element - your U() has a t-subscript, meaning that at any t in the past you solved back then to maximise your utility and this leaves you now in the current state, looking to make the choice you are currently faced wth. Aldred's first point here is that this decision isn't sovereign. Making the assumption that it is allows you to have a simpler utility function than it might otherwise be, so it is certainly fine as a first step in the process of properly modelling all of this. His criticisms:-
• preferences are hazy and hesitant
• getting all the information on the options costs time and effort and people usually only do it to a certain degree
• the choice you make may be fallible - you don't get the arg max of the function - we all make mistakes [this is similar to the performance errors in linguistics; note the existence of performance errors didn't ruin 'transformational grammar' for Chomsky]
The first two of these can be considered two sides of the same coin - namely where to look to blame for the lack of processing capacity. The third in a way is just noise on the channel. It doesn't invalidate anything about the theory, so I consider it the weakest of the three criticisms. Now, as for the first two criticisms - from an information theory point of view, it is like saying that there is inherent uncertainty in the formation of the message in the first place. This is kind of Platonic in its criticism of the non-philosopher king/ordinary man approach to thinking. But if there really is uncertainty in what we want when we set out at the start of a process of choosing, then it is right to model this rather than to assume the origin of preferences to be clearer and more certain than it actually is. From an information theory point of view, it is almost as if the sender of the message doesn't know what they're sending until it has been generated. So clearly a simple information sender type of metaphor isn't quite catching the essence of what really might be going on. But what actually is going on? Can the information theoretic model be elaborated to recover this missing part of the model of the autonomous shopper? I guess it must be that the message you're generating inside yourself is a bitmask, or incomplete message which through iteration and discovery of 'responses' you refine further until a choice is made. The other side of the coin of criticising the brainpower of the shopper - which has the clear Platonic elitism associated with it - is a version of the same argument, which suggests that there's a cost to assembling all the various peices of information together to arrive at a properly informed choice is a costly exercvise. So whereas the Philosopher Kings criticise the capacity for shoppers to know what they want, the economist's own critique of this tenet of the classical model is that 'geting to be informed' about a choice turns out to have costs associated with it. Again, this is the sort of criticism which I could well imagine could be integrated back in to essentially the same model. In fact, I'm sure several Nobel prizes have already been awarded for trying to do this kind of integration. If you think about it, where are you if you are faced with a budget constraint on the act of accessing your preferences? What's going to drive your preferences Critique of equi-available options in the standard model (p14) Evaluating the options open to you definitely is a problem. The whole of behavioural finance can be seen as an examination of the fact that framing of options (how they're presented to you, expressed, contextualised, etc) can lead to different choices being made by you, all other things being equal. Framing shouldn't be observed with the classical 'sovereign consumer' model. Aldred gives some examples from behavioural economics to illustrate framing effects:-
• when you frame an option as the default option, it is more likely to be chosen. (the nudge effect)
• theatre tickets, lose cash equivalent on way to theatre; versus, lose ticket on way to theatre
• availability effect - how 'ready to hand' the information is. This iunfluences the likelihood of choice of an option. What makes a choice ready to hand? Well, it is like asking what makes it memorable - you heard it recently, it is vivid, striking and distinctive. This explains why we worry about striking ways of dying rather than the ones which are more likely to kill us. So, we're more likely to buy the more 'available' choices. The essence of advertising and 'brand awareness' is an exploitation of this availability effect. Think of an actual market - if you're looking for a particular brand of toothpaste there and 90% of the shops have brand #2, then the chances of brand #2 being chosen by you even though you'd rationally prefer brand #1 (e.g. it is cheaper) go up. This perhaps could be modelled by Bayesian prior / posterior modelling. Advertising/branding is a whole section of our economy based on exploiting the availability effect
• current emotional state framing effect - how we're feeling now effects our decision
Framing effects - an idea How are these framing effects related? There's a basic model here. (i) A chooser in a certain state. (ii) The reality of how frequent and 'ready to hand' instances of actual choice are there before us, including as a specific sub-case (ii-a) the initial/first/most frequent/least cost 'default' option. So Bayes theorem could explain a lot of this as likelihood of choice ready to hand. And the emotional state angle could really be incorporated into the utility function, in theory. Perhaps the rational function optimizer isn't optimising a deterministic function but one with a stochastic component. Maybe emotional demands, preferences, etc, could be modelled as stochastic processes? This would allow for the model to cope with the same user making a different decision based on the internal stochastic/emotional state in his head. And the model deals with the 'cost' of finding out in a bayesian / sampling way. (A bit like the idea of demes in genetics). I.e. you sample your immediate environment up to a maximum of your cost budget for discovering choices, elaborating choices. Then this is sensitive to the Bayesian priors, frequencies of discovery. You then chose based on this sampling. What's the real message about framing effects from the book here - that the so-called objective options - the things 'out there' which you get information on, these are actually subjective. Them being subject to internal motivations and drives doesn't make it impossible to model them, though, I think. But it may make it more complex to model. Side note: this kind of reminds me of the objectivist/anglo-saxon versus subjectivist/european philosophical debates.. Husserl, Bergson, Merleau-Ponty might be pleased. But not too pleased cos there is science in behavioural economics - theories are tested, invalidated, etc. This criticism of the uniformity and neutrality of objective options doesn't strike me as fatal. It is kind of like the difference between an equi-probable prior probability distribution and one where the priors are unevenly distributed, where there are a bunch of conditional probabilities, etc. In essence you can still imagine a model being built of a 'slightly less than sovereign consumer' which retains a lot of the characteristics (mathematical rigour, for one) being maintained. Isn't this just what's really going to happen in this domain? I imagine so. Critique of definable preferences in the standard model (p16) Aldred continues on the theme of criticising the illusion of clear preferences. We're bad at working out just how satisfied a choice will make us in the future. And in particular, we tend to over-estimate our level of happiness in the future as the result of selecting any given choice which is at hand. Not only are we bad at projecting/measuring how happy a choice will make us in the future, we're also bad at remembering how happy a choice made us in the past - we tend to remember the more extreme (bad or good) moments, and we have a tendency to over-weight the more recent memories. This is called Peak-End Evaluation. The author then talks about the interesting colonoscopy experiment. If you leave a colonoscope inserted for an extra minute once the procedure is over, the patient gives more weight to this experience (which is relatively speaking, less painful, though still uncomfortable). This makes a difference to their later appreciation of the whole experience. Both these forward looking and backward looking failures are accompanied by a third, our own concept of what is in our own self-interest may itself be confused. This is, to my mind, a philosophical criticism about the possibility of coming to know your own preferences and in working out what is in your own self interest. This to me sounds like it has its origins in Plato and the later Wittgenstein, to pick just two examples. To make the case he tells us to consider the problem of self-control in consumption decisions. I know lack of control is a big philosophical area in itself, but the author concentrates on the consumer angle. Things we do to help ourselves cope with the reality of self control - we put our alarm clock out of reach, we sign up to regular pension contributions. Examples of loss of self-control - we go to a restaurant determined not to have a pudding, but change our mind. We aren't rushed, or lacking information. We often seem to have competing preferences all the time. Significant uses of the myth of the sovereign consumer (1) In Advertising Advertisers like to 'explain away' the apparent success of advertising by saying that it isn't 'persuasion' based but 'informational' - ie they aren't looking to change your mind, just to tell you what choices you have. This preserves the illusion of the sovereign consumer. But wait, most advertising isn't informational at all. The economic cheerleaders of advertising come back with a seemingly more nuanced defence: our underlying preferences don't apply to products at all - the properly concern the underlying characteristics of products. A product (consumable item) is just a bundle of characteristics. This is a pretty straightforward dereferencing move. The 'economically useful' point of advertising is that it gives you information about this bundle of characteristics. It additionally tries to persuade you on this product. Hence your preferences remain sovereign in theory. This is the 'service' which advertising applies to advertising - information about characteristics - and these feed into your sovereign preferences about characteristics, without changing them. Yeah, right. This does sound like an argumentative sleight of hand. Still, this is how models develop. Doesn't sound like a revolutionary move. Apparently this line of reasoning is brought out by the advertising lobby when defending the right to target 'vulnerable' groups. (2) In Revealed preference theory This is a Paul Samuelson idea (1938). Basically, you can find out the best option to chose from by looking at what consumers actually purchased. (In general, their purchasing habits). It is a move which is very common in finance, where you imply a fact from the state of (some) market variables at a certain time. It was an attempt to replace utility theory, since this was (is) considered not operationally defined, hence not very much use. Think about how wonderful and straightforward everything would be if revealed preference theory turned out to be true. You'd be able to chart a course for better decisions simply by crunching a bunch of market time series. Where does the idea of the sovereign consumer come from? So far he hasn't said too much about that. It is a fundamental core of economics. So it probably dates back a few hundred years, in some form or other. ie Revealed preference theory isn't really the start of this idea. Ultimately it has philosophical origins (Plato) but I can also see the influence of early political economy too - Hobbes. It is a model. A simplification, and one which creates a whole range of subjects to investigate, so it is a productive simplification. And, again like all models, just because it contains some simplifications, doesn't mean you should abandon it - all models are in essence like that. The sovereign consumer is the 'enlightenment' rational agent - either the undecieved Cartesian 'Ego' or perhaps the Hobbesean before he surrenders his rights to the sovereign. Just while I'm on the subject of definitions, rational expectations is the theory that people guess the future correctly, on average (Begg). This more clearly has a rationalism origin. In fact it is just the idea of rationalism applied to economic questions. Again, you can see it as a model, where you model the decision maker as someone who is rational and can cast that rationality forward into the future to build his own model of the future based on what he currently knows. And his decisions are based on this act of rational foresight. The use all the available information. Rational expectations theory answers the (important) question: how do people form expectations of what will happen in the future (e.g. inflation expectations). The answer this theory gives is: fully rationally! So if the rational way to come to an opinion about inflation - i.e. in order to have an opinion, this theory says we take in history of inflation, government policy, likely policy changes in the relevant future, just about anything which is humanly knowable about the situation. In this context, you can think of revealed preference theory as rational expectations + efficient market hypothesis. That's a neat way of summarising it. If you can afford a set of options A, B, ..Z right now (within your budget), and you picked A, then the fact you could afford B, C, ..Z means that your revealed preference is for A over, B, A over C, ... A over Z. The theory states you'd never ever chose B, C, ...Z in any set of options available to you in the future (ceteris paribus) if you can afford any of them, since your revealed preference is for A. It is almost like: you're in a current state at time t such that you picked A. Well, if you're currently building out a tree of possibilities of choice out into the future, with a filtration I_t - ie knowing only what you know now - in any future occasion faced with some other set which includes A, B, ...Z (and possibly other things), then you'd pick A over B,...Z again. (It is agnostic on whether your new choices had available to you something which was even more desirable than A (and affordable). The criticism is that it is in fact impossible in a real world to say what options were eliminated to make you pick A that first time. Hence the full set of preferences weren't revealed. But unless I knew more details about it, I don't know if this criticism is just a misunderstanding about infinite sets. Isn't it a relationship between a distinct choice and a (perhaps finite, perhaps infinite) set of choices which you could have made, Does it need to be defined over all possible affordable alternatives? That seems not necessary. Not sure. But if it doesn't have to be over all affordable alternatives - a circumscribed revealed preference, then perhaps it can survive that criticism. (3) Later in the book, he'll give the example of 'discounting the cost of future lives' which is a move often taken in everything from road planning to global climate control debates. To work out the cost of a sickness or death they sometimes 'back out' the cost of working in an industry as a way of putting a price on illness and death. To do this, there's an impicit use of the revealed preference theory again - the worker is assumed to be fully rational, with a range of choices open to him and so you can imply the full cost of his likely early death by the premium he gets paid from doing this job. The author later separately criticises this argumentative move. He states "Real people don't choose jobs as sovereign consumers chose washing powder"(p21)
(i) growth is good because it leads to more consumption
(4) In justifying economic growth (the proper subject of chapter 2, so read this as a prelim) The classical argument:




(ii) consumption is good because it leads to more preference satisfaction [this is the step which relies on revealed preference theory & the myth of the sovereign consumer]

(iii) preference satisfaction is good becasue it makes people better off.



If consumption is so unjustified, why do we do it then?(p22)
He's just taken away a couple of the intellectual underpinnings of the myth of economic growth being good for us. This is what's he's aiming at in the whole book. But now he gives an essentially psychological explanation for why it happens. Well, there's 'why is it happening now' and there's 'why did it happen historically'. And there is probably a political reason for why it happened back then. Also, back when the developed world was developing, then growth was a good thing, but not any longer. It is worth remembering this distinction.#
Because it is addictive and competitive (remember, these are psychological explanations - they were always true, even during that time of the West's development where 'going for growth' was a good thing to do. Purchases are addictive - you accomodate to the ownership of it and the purchasing of more and more gives you the pleasure you require. This kind of backs on to Daniel Bernoulli's claim that a marginal extra dollar isn't as beneficial to a wealthy person as to a poor person. (Which itself is an idea which leads to progressive policy decisions from governments - the best use of a dollar goes not to the person who can afford it, but to the person who'll receive the most benefit from it). The happiness treadmill is a phrase which sums up this element of consumption. Evidence for this 'happiness accomodation' (i) lottery winners only temporarily elevate their happiness level (ii) newly paraplegic people eventually return to their normal level of happiness. Conclusion