How buying a round shows the limits of economics

Economics has limits. Its narrow focus cannot explain social phenomena. To understand this, John Kay in the Financial Times asks us to consider Christmas gift-giving or buying a round of drinks at the pub by comparing how anthropologists and economists interpret these social rituals:

For the anthropologists, the custom of standing a round represented ritual gift exchange. They drew an analogy with Native American potlatch festivals, where tribes would gather to eat, sing, dance and confer lavish presents – sometimes treasured or essential possessions – on each other. The economists preferred a more hard-nosed explanation. Buying drinks in rounds rather than individually was a means of reducing transaction costs. The number of dealings between the customers and the bar was reduced, and the need for small change diminished.

I proposed an empirical test between the competing hypotheses. Did you feel successful or unsuccessful if you had bought more drinks than had been bought for you? Unfortunately, the result was inconclusive. The anthropologists believed their generosity enhanced their status. The economists sought to maximise the difference between the number of drinks they had consumed and the number they had bought. They computed appropriate strategies for finite games and even for extended evenings of indeterminate length. The lesson is that if you want a good time at a bar, go with an anthropologist rather than an economist.

We can also see the limits of economics when we consider the act of starting a family:

The economists who argue that the rationale of the family is found in cost savings have a point. Two together can live more cheaply than two separately, if not as cheaply as one. But anyone who thinks the quest for scale economies is the primary explanation of the human desire for family life is strangely deficient in observational capacity, as well as common sense.

The ‘economics of the family’ is a prime example of an economic imperialism that seeks to account for all behaviour through a distorted concept of rationality, an extreme example of economists’ notorious physics envy. Some models developed in physics demonstrate a combination of simplicity and wide explanatory power so remarkable that it makes no sense to think about the world in any other way.

But such powerful explanations are rarely available in other natural sciences, and almost never in social sciences. Even the visit to the bar is governed by a complex and tacit collection of social conventions. How do you know that you have bought the beer but only rented the glass?

The point is not that economics has no value but that, by itself, it can neither fully explain nor provide a rounded understanding of human needs and human behaviour. The specific problem here is economism, the reductionist idea that all social phenomena can be reduced to economic dimensions. This reductionism enables believers in neoclassical economics to argue that the market outstrips or permits ignoring ethical, social, political or cultural values. It is why the orthodox economic ideology of the past three decades has, amongst other things, led to so much social corrosion.

Following the banking crisis of 2007/8, this orthodoxy is, in Adair Turner’s famous phrase, “a fairly complete train wreck of a predominant theory of economics and finance”. It is now only a matter of time before that predominance ends. But it would be a mistake, and ironically an economistic one, to view the old orthodoxy purely as a practical failure. It is also a moral failure, precisely because it is economistic.

The Liberal Democrats need to move on and develop radical alternatives (The Theory and Practice of Community Economics by David Boyle and Bernard Greaves is a good place to start). This is a vital element in any recovery strategy for the Liberal Democrats because the party will be doomed if it fights the other parties for the right to cling to the wreckage of TINA (‘There Is No Alternative’). Moving on, however, requires not just a Plan B, C or D but also an ethical and human dimension. This means a decisive rejection of economism, and an insistence that human welfare and human values come before ideological constructs.