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Is That Surprising?

Once in a while an article comes along that makes me wonder whether anybody is paying attention. A friend forwarded me such an article, from Scientific American, describing how surprised we should be that eBay works:

To some economists, this is a borderline miracle, because it contradicts the concept of Homo economicus (economic man) as a rational, selfish person who single-mindedly strives for maximum profit. According to this notion, sellers should pocket buyers' payments and send nothing in return. For their part, buyers should not trust sellers — and the market should collapse. [source]

Sorry, no. Economists are not actually confused by the longevity of eBay. It does not rock the theoretical underpinnings of the science. It is perfectly ordinary — and is in no way a threat to the model of Homo economicus.

Economist Axel Ockenfels of the University of Cologne in Germany and his colleagues have spent the past several years figuring out why this does not happen.

Economists like to study markets. The data they gathered was new, but I assure you that the reasons explaining why eBay is not merely a cesspool of fraud have been long understood. eBay's solution, of course, is its feedback system — which effectively gives every buyer and seller a personal brand. Economists do understand the value of brands.

Because a bad reputation scares off future buyers, even strategic and rational sellers have an incentive to be trustworthy. [Emphasis added]

Wow, that's brazen! The reader is expected to believe that there's no rational reason to be trustworthy except for its effects on reputation — as if fairness is for suckers. I would ridicule that view as completely ridiculous (natch) but for how tragically common it is.

As I read the article I was struck repeatedly by the author's clear belief that rational, selfish behavior ought to lead to fraud and collapse in markets like eBay… and that these markets are saved only by the existence of other (presumably non-rational, non-selfish) factors — indeed, the article's lede declares "social concerns often trump selfishness in financial decision making."

I struggle to find a word to encapsulate how wrong that is. "Bullshit" seems too weak.

It isn't "social concerns" that keep, for example, the market for bread from collapsing when bakers selfishly save money by using tainted ingredients. Rather, the bakers understand that consistent quality is necessary in order to stay in business for the long term… and since they selfishly want to make money over the long term (and not merely for today), they'll use good ingredients. This is not new knowledge! Adam Smith explained over 200 years ago, "It is not from the benevolence of the butcher, the brewer, or the baker, that we can expect our dinner, but from their regard to their own interest."

Rational consideration of your potential actions includes projecting the consequences of those actions. A person who is pursuing their interests (viz., being selfish) will quite rationally consider the future. It's hard to achieve goals of any kind without doing so!

[I]nherent selfishness cannot explain behavior in other settings. Take a child who has been given a bag of jelly beans, which her left-out sibling is eyeing jealously. Many children would voluntarily share the candy just to be fair, even though that would mean fewer jelly beans for them.

Notice the assumed tension between fairness and self-interest, and the assumption that selfishness is bound to range-of-the-moment thinking. I would counter that the desire for fairness here is actually an excellent example of long-range self-interested thinking: You don't want your siblings to resent you because they'll have plenty of opportunities to get even. Or to state it positively, there are many benefits to a good relationship with your siblings — and they're more valuable than half a bag of jelly beans.

Economics has recognized for over 200 years that individuals' pursuits of self-interest do not conflict, but in fact harmonize, and especially so over the long term. This lesson has penetrated very shallowly into common understanding.


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