Clash of Ideas

Browse through the bad news about journalism, news organizations, newspapers, television and radio stations, magazines and the publishing business, the movie business, and the advertising business and you can find hints of the promise the future holds for 4th Estate, the press.

The promise lies in what we can call a 5th Estatea press that is made up of journalists, the mass media, communications and “the people formerly known as the audience.” No longer one-to-many, global communications is increasingly conversational, and many-t0-many.. Though it may seem more like a raucous party than a sit down dinner, it is evolving. You don’t need to become an economist or a hacker to be able to follow the forces and trends behind the news, good and bad, about the future of journalism and media (mass and niche) today.

Economics For the rest of us: Then

Economic theories are subject to change.  Economics is not a science, though it can rely on theories, models, mathematics, and trends. Economists often strive to base their economic ideas on science, but economics is not a “hard science.”  A quick tour of the major theories and ideas behind our global economy will make it simpler to put the upheavals in mass media industries, journalism businesses, and the way we communicate today into a human perspective.

This is the briefest look at economic theory that begins at about the same time the U.S.A. does. There are links/references to give you more context as we do a flyover of economic history so that we can explore what’s happening to news today.

In 1776, Adam Smith’s, The Wealth of Nations, was published. Smith figured out that land, labor, and capital were the three factors of production and the major contributors to a nation’s wealth. An ideal economy was a self-regulating market system that automatically satisfied the economic needs of the populace.

That ideal self-regulating market was kept in balance by the  “invisible hand.” That is an assumption that individuals and markets, in pursuit of their own self-interest, will act rationally, and that the free-market will produce the greatest benefit for society as a whole.

In a simpler society than ours, this might have been true, but since individuals and societies are always in transforming and changing laws and regulations, it isn’t true nowadays. Economists adjust their theories to reflect changes in society.

Economists saw that despite their assumptions and belief in a self-regulating market, there existed an unequal distribution of income among landowners, workers, and capitalists. They set out to explain why some folks are rich, and some are poor. Thomas Malthus and David Ricardo were noted economic thinkers who attempted to explain persistent poverty and low living standards through the idea of [footnote]diminishing returns[/footnote]. That theory explains why you can’t just keep adding workers to a factory to increase production and profit. Dimishing returns theory says that at some point, bigger is no longer better, and production and profit don’t increase to keep pace with investments in factors like workers, machines, or raw materials.

To get the U.S. out of the Clutch Plague of the 1930’s and later,  policymakers turned to economist John Maynard Keynes. Keynes’  said that  government spending and taxing was a way to stabilize a failing economy. Similar ideas were applied during the recession of 2009 in the American Recovery and Reinvestment Act of 2009. By increasing government spending and decreasing taxes on the working public, at a time when private spending is insufficient and pushes us to a recession or reducing spending and increasing taxes on the public, when private spending is too great and threatens inflation, policy-makers attempt to keep the economy under their control.

Until the 1960s, economist Keynes’  focus on the factors that determine total spending, were the core of modern macroeconomic analysis. But in the 1970s,  inflation and lagging productivity led to new ideas and theories about economics. One of these, monetarism, reemphasizes the critical role of monetary growth in determining inflation.

The rational expectations theory says the market has the ability to anticipate government policy and that would limit the effectiveness of government action. This increased the importance of the Federal Reserve Bank or Fed, the central bank of the United States, which is a government appointed but independent agency. It is the Fed that is active in efforts to stabilize the banking industry and our economy though monetary policy.

Supply-side economics, pushed by President Reagan, identified economic growth as a fundamental prerequisite for improving society’s material well-being.  However,  supply-side economics counts on the public to save and invest if the nation’s economy is to grow. A focus of government policies during the late 20th century  focused solely on de-regulation of industries, financial institutions, and most economic entities yielded mixed results. The economy hit a brick wall in 2009, when another world-wide depression threatened the economic and political stability of most nations.

Alan Greenspan, former chairman of the Board o...

Alan Greenspan, former chairman of the Board of Governors, The Federal Reserve Board, USA. (Photo credit: Wikipedia)

Speaking for economists and business people, Alan Greenspan, former chair of the Federal Reserve Board, said, “those of us who looked to the self-interest of lending institutions to protect shareholder’s equity, myself especially, are in a state of shocked disbelief,” in 2009.

Something about economic policy and the theories it had been based on, was no longer explaining how things worked in the real world. Economists began to explore some new ideas, outside the theories of Classical Economics, with its “invisible hand” and assumptions of rationality because our markets were failing as the economy tanked.

Economics for the rest of us: Now

“Classic” economics is based on the idea that consumers and employers act rationally. This means that everyone is a uniformly good judges of the value of goods.

Is this true? In “Here Comes Everybody,” Clay Shirky describes the way we think as “economically irrational but socially useful,” and that “contrary to classical economic theory…we have a willingness to punish those who treat us unfairly, even at a personal cost.” Is Shirky on to something?

Today, the research of biologists and neurologists, informs the thinking of  behavioral economists, who study the role of psychology and brain function on economic decision-making. By studying the ways the human brain perceives gains and losses in general, we are discovering that humans do not always act in a rational way.

Instead, humans act  in ways that are “predictably irrational” when it comes to  decisions about money, and gains and losses. Behavioral economists can use their findings to help policymakers craft an economic system with built in safeguards against this predictably irrational bias in human behavior. An economic system designed to compensate for human nature, might help us avoid bubbles, panics, collapses, and near-catastrophic breakdowns better than systems from the past.

Basing policy on way people actually think and act might work better than setting policy based on assumptions that aren’t borne out in the real world.

“The rational investor should not care whether she had $10 million and then loses $8 million or, alternatively, whether she has nothing and ends up with $2 million.” People and primates hate a loss more than they love a gain. Autistic people do not perceive a loss differently than a gain, and their behavior is characterized as abnormal.
For behavioral economists, the “efficient market hypothesis,” is a problem. because it is based on the assumption that all past and  current info about a  product or good is reflected in its price. That just doesn’t account for the way real humans think and act. People ignore obvious information about how inflation distorts the relative worth  of a purchase. We believe something is worth more than it really is, buying on a whim.

For scientists who study the brain, this is a function of the brain’s ventromedial prefrontal cortex (VMPFC.) This is a part of every human brain, hard-wired into how we think about things. The VMPFC is the central location of what economists call the “money illusion.” Behavioral economists say that “predictable irrationality” derives from this brain function. This is the thinking that lies behind the prices on collectors’ items on E-Bay.

An item with little intrinsic value can sell for hundreds of dollars because someone decides it is worth that and will pay. Following the efficient-market hypothesis, the only thing that can distort the rational equilibrium between supply and demand, is outside shock, like an oil embargo or the failure of a crop. But in our real world markets, there are unaccountable booms and busts. Anyone alive in the late 2000s knows this from experience. Humans make decisions using rules of thumb or heuristics, as a guide. Relying on rules of thumb is a mental legacy from our ancestors, as biologists and neurologists are demonstrating in their current research.  It is useful to rely on wired-in rules when a predator attacks, but it can introduce cognitive bias and errors in reasoning that can mean our “gut” isn’t giving us such good advice when we exist in a complex world where threats to our way of life aren’t predator beasts, but bad money decisions.

The business cycle depends on trust between business and consumers. Poor investment logic, based on collective irrational “gut feelings,” instead of rational decision-making, leads to booms and busts. The recent spectacular rise in housing prices, followed by the catastrophic failure of the real estate market, and other economic ills, are an example of this. The value of a condo or home didn’t correspond to its actual value. Prices were based on how much a people felt a property would appreciate, and how much profit a buyer might make from the sale. Homeowners borrowed against an imaginary value often set based on “gut feelings,” not the physical and geographic features of the property.

Economist John Maynard Keynes explained bubbles by calling our collective irrational impulses, “animal spirits.”  Today, we are more likely to call them “gut feelings,” and the actions taken based on these irrational impulses, are the cause of bubbles. Steven Colbert’s explanation of the irrational but attractive condition he called “truthiness” explains animal spirits and the basic irrationality of humans facing real world conditions.Truthiness comic

The behavioral economists and brain researchers have pinpointed this bit of irrationality in the VMPFC. When we give more weight to info that confirms our own viewpoint, than to critical information, we exhibit a gut feeling called the bias of rule of thumb reasoning, or the confirmation bias.   Salesmen who want us to buy before we’ve had time to “sleep on the decision,” are taking advantage of the availability bias which prompts decisions based on the most recent information.

Hindsight bias – the feeling we knew something all along –  comes after the fact, but operates to make us feel like we possessed knowledge that we only came to after the fact. Just thinking about money can trigger “reward and regret” centers in the brain. Therefore, whether we hear good or bad news, will  bias a decision we make after the trigger is set off. Behavioral economics provides a framework for policy making (and for investing) to help us avoid emotion-based, ill-conceived investments.

Authors Richard Thaler and Cass Sunstein write in Nudge about “Liberal paternalism,” or government regulations based on a rule of thumb, called anchoring, which set up a point from which people can begin to make a decision. Chosen correctly, a good anchor nudges people away from an inclination to make bad decisions. Choice architecture – clear information on choices, for example, a map of options for complex financial decisions, can help individuals make better decisions.

Take a look at the small print on any credit card bill today for an example of very poor choice architecture. New laws are redefining how credit information must be presented in an attempt create better choice architecture for consumers. Economics is a human endeavor, not “hard science.” Andrew Lo who is working on a theory that is a synthesis of evolutionary theory with classical and behavioral economics, says that we need to understand competition, mutation, and natural selection as they play out in economics. Lo’s model helps identify “herding” behavior in consumers, so regulations can be put in place that will adapt to market conditions to avoid bubbles and busts. Keep these ideas in mind as we go on to consider how traditional media business models and new models work and what ideas they are based upon. Any new models are going to need to account for our innate biases and our predictable irrationality.

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