Freeing Econ 101: Beyond the Grasp of the Invisible Hand Testing

Three decades before he was head of the Harvard economics department, David Laibson was a high schooler on his way to take his first econ course in that very same department.

It was the summer before his senior year, and Laibson had moved to Cambridge from his home near Philadelphia for a program that prepares precocious kids for college. By night, he would sleep in sweltering, non-air-conditioned dorms on campus. By day, he would take classes that would ignite the fire of a long and bright career.

Laibson is now a celebrated behavioral economist, having pioneered work in how shortsightedness, lack of self-control, and other human foibles can have deep economic consequences. Back then, however, he was just an impressionable kid, not much different from the millions of other students who take Econ 101 each year.

This was 1983, the high-water mark for neoclassical economics, a school of thought that had come to dominate the discipline over the course of the twentieth century. At the center of this school is a model so influential that it’s sometimes known simply as the standard model. All models are cartoons, but the standard model is particularly cartoonish, especially as it’s taught to students in Econ 101. They’re introduced to a fantasyland where perfectly rational people with perfect information in perfectly competitive markets come together in a beautiful dance of supply and demand—with the “invisible hand” perfectly maximizing the welfare of society.

“I don’t care who writes a nation’s laws—or crafts its advanced treatises—if I can write its economics textbooks.”

The centrality of this model in Econ 101 has long been a source of controversy. Its predictions, after all, go to the heart of our politics. The world of the standard model is a place where the free market is so perfect, government interventions only do harm; where workers are paid their marginal product, so exploitation doesn’t exist; where everyone is so rational, people are always best left to their own devices; where culture, history, institutions, identity, norms, emotions, and morals fall to the wayside, and human beings become cold equations narrowly maximizing their own pleasure (or “utility”). To critics, it’s a cocktail of fantastical ideas profoundly divorced from the real world—and textbooks force kids to slurp it up for crude ideological reasons. To defenders, it’s a decent approximation of economic laws, a useful teaching tool, and fine to emphasize given students are also introduced to alternative models and concepts.

It’s true that Econ 101 textbooks introduce kids to issues like monopolies and oligopolies that gouge consumers, externalities that pollute rivers and warm the planet, and a hodgepodge of other ideas that put the utopianism of the standard competitive model in doubt. And to be fair, the model itself, as simple as it is, can at times even possess some surprising explanatory power. Perhaps it’s such virtues that make it so memorable, eclipsing more nuanced lessons that better describe the real world.

Yet, even if it’s not the result of deliberate indoctrination on the part of teachers, it’s been common to hear pundits, politicians, and amateurs cite Econ 101’s fantasyland as if it’s an indisputable truth—the one-and-only model that explains the economy. Economists have built a monument of theory and evidence to the contrary, yet in the minds of many the standard model continues to tower defiantly above it. A long line of critics has argued a big reason why is the content of introductory textbooks. Calls for reform have only gotten stronger as the field has seen dramatic changes—most recently with behavioral economics, which further undermines the standard model, and an empirical revolution, which prioritizes real-world data over fantasyland theory. The question remains whether the waves of these sea changes are crashing forcefully enough on textbook pages.

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“I don’t care who writes a nation’s laws—or crafts its advanced treatises—if I can write its economics textbooks,” once said the late Paul Samuelson, a trailblazing MIT economist who brought a new mathematical formalism to the profession and whose immensely popular postwar textbook Economics shaped Econ 101 more than any other book in the modern era. Samuelson’s textbook combined the traditional microeconomics of the neoclassical school with the newly developed macroeconomics of John Maynard Keynes, and he offered a range of innovations in teaching economic ideas. A child of the Great Depression and a convert to Keynesianism, Samuelson himself was skeptical of the neoclassical fantasyland, especially when it came to the economy as a whole. Writing as far back as 1948, in the first edition of his book, Samuelson bemoaned that the standard competitive model had “done almost as much good as harm in the past century and a half, especially since too often it is all that some of our leading citizens remember 30 years later of their college course in economics.” Yet despite—or perhaps, in part, because of—Samuelson’s influence, far from seeing the death of this model in popular imagination, the decades that followed 1948 would only see its great revival.

The textbook a young Laibson was assigned in the summer of 1983 was the sixth edition of Economics by Lipsey and Steiner, which Harvard had adopted after jettisoning Samuelson’s textbook only a few years before. It’s a stonewash-gray book with an artsy picture of a graph on the cover. Inside it’s got lessons familiar to anyone who’s ever taken Econ 101: chapter after chapter of jargon, equations, diagrams, and exercises dedicated to an abstract mathematical model in which rational consumers maximize utility, rational producers maximize profit, and the two come together in an efficient equilibrium. To be fair, reading through its pages, it’s not as dogmatic about this model as other textbooks, even when compared to popular ones that are still assigned to students today. That said, it doesn’t stand out from the pack. “The neoclassical approach has dominated economics to this day in terms of the pedagogy,” says Laibson, who kept the book as a memento of his seminal summer in Cambridge. He opened it up while we talked, reminiscing about his introduction to a discipline that would define him—and that he would help redefine.

Laibson’s path to becoming a card-carrying behavioral economist—a label that proclaims defiance of the neoclassical school—began while he was an undergrad at Harvard. At the time, the neoclassical idea that people behave rationally, aka rational-choice theory, was still on the march. Rational-choice theory has its roots in the late nineteenth century, but its mathematics were refined, developed, and championed by Paul Samuelson in the mid-twentieth century, and it has dominated the field ever since. The theory, which rests on pretty equations, bestows human beings with a power known as constrained optimization; that is, it asserts that people know what they want and, in the face of constraints like the amount of money they have, optimally obtain it with laser-like focus and discipline. It’s a model that assumes people lack cognitive biases and emotions, always heed the laws of probability and logic, and make all choices with flawless analysis of costs and benefits. And it’s a model that was long left unquestioned in Econ 101—even though it’s a critical ingredient in the cauldron of assumptions needed for the invisible hand to work its magic. This model had already spent over a century at the heart of microeconomics, but when Laibson was a student, it was taking over macroeconomics with the so-called rational-expectations revolution, which convinced economists to bring rational actors into macro models.

All models are cartoons, but the standard model is particularly cartoonish, especially as it’s taught to students in Econ 101. They’re introduced to a fantasyland where perfectly rational people with perfect information in perfectly competitive markets come together in a beautiful dance of supply and demand.

Most in the Harvard economics department, Laibson says, never dogmatically embraced models where people always behave rationally. These models, after all, had a bunch of predictions that didn’t square with reality. For instance, rational agents always manage their money as if they have a master plan to maximize their lifelong happiness, so problems like inadequate saving for retirement can’t exist. With the other assumptions of the standard competitive model, markets filled with rational agents always become efficient, and supply always equals demand, so it becomes harder to explain problems like prolonged unemployment and housing and stock market bubbles. Rational-choice models even predict that economic competition can rid society of discrimination. The professors most influential in Laibson’s economic studies at Harvard were never swayed by such extreme conclusions. That said, it took Laibson reading work outside his economic classes, by a psychologist named George Ainslie, to reach his turning point.

Ainslie had pioneered thinking on what’s known as hyperbolic discounting, a cognitive bias that makes people irrationally prefer tiny rewards now over much bigger rewards later. It’s a simple idea that explains why we have a hard time sticking to diets, quitting smoking, or saving for retirement, and it might be taken as common sense outside of economics: we have problems with delayed gratification. It’s also an idea that, as Laibson would later brilliantly demonstrate in his dissertation at MIT, can have deep economic consequences. Yet, as simple and important an insight as it is, most Econ 101 textbooks, even today, would leave you believing it doesn’t exist.

Although it represents a discipline that values competition and choice, the economics-textbook market has, ironically, long been characterized by monopoly and homogeneity. In 1988, the same year Laibson graduated from Harvard, the market for Econ 101 textbooks was in such a sorry state that the economist Joseph Stiglitz argued there was a market failure brought about by monopolistic competition. Even though its sales had begun to decline, the big dog was still Economics by Paul Samuelson, which had by then already become far and away the best-selling economics textbook of all time. While the book contained Keynesian lessons that pointed to the types of failures of the free market that could lead to depressions in the economy at large, Samuelson’s textbook also popularized the neoclassical ideas and methods that became synonymous with Econ 101. Together with its accessible prose, the textbook offered a formula so successful and influential that almost every economics textbook in its wake imitated it. In the words of Stiglitz, the market had become dominated by Samuelson “clones,” particularly when it came to microeconomics. This wasn’t an accident, he believed. There were big costs and uncertain benefits for professors to change their Econ 101 curriculum, and if books departed too far from the status quo, they might lose customers. Monopolistic competition in the textbook market, Stiglitz said, created a “centripetal force” that resulted in “too many similar products at the center of the market, too few products at the fringes.”

Although it represents a discipline that values competition and choice, the economics-textbook market has, ironically, long been characterized by monopoly and homogeneity.

Stiglitz’s deeper concern was the education that students were receiving. While he thought Samuelson’s textbook was a good representation of economic thinking in the 1950s, he worried that new textbooks weren’t keeping up with fundamental advances in the profession. At the time, he was leading an attack against the neoclassical fantasyland with insights about how imperfect information has deep implications for markets in the real world. Take, for instance, the problem known as adverse selection, which can arise when insurance companies don’t have full information about their customers. Sick people might have a greater likelihood of buying health insurance, a move that causes companies to raise premiums to cover costs, causing healthy people to opt out of buying policies, making premiums go up even higher, which pushes more healthy people out, and so on. Even with perfect competition, the market spirals into oblivion because of imperfect information. The only solution is either insurance companies screening for healthy people, with sick people getting screwed, or the government intervening to produce a better outcome.

It was advances of the field like these, which helped policymakers understand market failures affecting millions of people, that Stiglitz worried economics textbooks failed to effectively absorb. Yes, over time textbooks were updated as ideas became tested and widely accepted by the profession. But the problem was that when a new idea arose, it was packaged simply as another addendum to the standard model; sort of like, “P.S., the stuff you learned in earlier chapters is actually kinda bullshit.” Instead of core revisions of their material, textbooks became like bloated encyclopedias of concepts, each representing another pesky footnote indicating why the neoclassical fantasyland wasn’t real. “This kind of adaptation should not be confused with fundamental change,” Stiglitz complained.

Thirty years later, the field has widely embraced the behavioral-economics revolution and is still in the throes of an empirical revolution that prioritizes big data, randomized trials, machine learning, and host of innovative methods to decipher cause and effect in the real world. As a whole, the field has again shown itself adaptable to evidence and scientific progress. Yet the market of economics textbooks still exhibits the same problem Stiglitz saw in the eighties.

The two juggernauts of today’s textbook market are Economics by McConnell, Brue, and Flynn, which was first published in 1960, and Principles of Economics by Gregory Mankiw, which was first published in 1998. Combined, they are estimated to make up around 40 percent of the textbook market, with a multitude of similar books picking up slivers of the rest. Both adopt the accessible style and much of the substance that Paul Samuelson pioneered in Economics seventy years ago, but, in the wake of the societal changes and the rational expectations revolution of the 1970s and 1980s, the ideas of neoclassical microeconomics have risen in stature while those of Keynesian macroeconomics have fallen in stature.

McConnell, Brue, and Flynn, after long ignoring anything that reeked too much of psychology, finally began teaching core insights from psychology-infused behavioral economics in 2011, the 19th edition of their book. They explain in the preface that they added behavioral insights in a section at the end of chapter 6, which is about consumer behavior. “The new material is intentionally at the end of the chapter,” they write, “not only to show that behavioral economics extends standard theory (rather than replacing or refuting it) but also so that the new material is modular and thus can be skipped by instructors without loss of continuity” (emphasis added).

Instead of core revisions of their material, textbooks became like bloated encyclopedias of concepts, each representing another pesky footnote indicating why the neoclassical fantasyland wasn’t real. “This kind of adaptation should not be confused with fundamental change.”

To his credit, Mankiw, who teaches Econ 101 at Harvard (called Ec 10 there), began mentioning behavioral economics in the 4th edition of his textbook, published in 2006, five years before his competitors did. In the latest edition, Mankiw expanded this section to feature a profile of Richard Thaler, the founder of behavioral economics (and who last year won a Nobel prize for his efforts). Yet any mention of behavioral concepts doesn’t appear until page 461 of chapter 22, titled “Frontiers of Microeconomics,” which also still houses the concept of imperfect information pioneered by Stiglitz and others—even though that frontier was reached over thirty years ago. The placement of this content at the end of the book makes it even easier to skip than it is in McConnell, Brue, and Flynn, especially given the expectations for teachers to squeeze dense economic lessons into one or two semesters.

More surprising, the heart of Mankiw’s book, chapter one, which outlines his “Ten Principles of Economics,” is virtually identical to his first edition published twenty years ago. These ten principles, a hallmark of the book, read like a neoclassical Ten Commandments, delivered from up high on Mount Sinai. The only thing that’s really changed since the first edition are some graphics and new examples in information boxes (like “Adam Smith would have loved Uber”). His first five principles all outline the neoclassical vision of markets and human behavior, including principle 3: “Rational People Think at the Margin.” Nowhere is there any mention that people often aren’t completely rational, nor that they don’t always have full information to make rational decisions and that such realities can have huge consequences for them and markets at large. There’s not even a sentence previewing a more critical exploration of these ideas more than four hundred pages later.

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According to the economist David Colander, back in the 1950s, when Samuelson’s textbook became the standard for economics education, the content at the core of textbooks wasn’t far removed from the theories and tools that the professors teaching courses actually believed and used. But economists have made leaps and bounds in theory and methods since the 1950s, and reading through today’s textbooks, it’s clear that they haven’t kept up with the field’s advances. The situation now is such that, as Colander writes, “What economists do is quite different from what they teach,” and as the field has progressed, the chasm is widening.

There are many plausible explanations for why the standard model remains so central to Econ 101—even as it’s become more and more peripheral to how economists understand the world. For one, the math is easier than the models and empirical tools that economists actually use. “With the mathematical and statistical gulf between the research that economists do and the training that undergraduates have growing ever wider, it becomes harder and harder to relate what economists do to what they teach,” Colander writes. For teachers who want their students to get hands-on experience with any model, unrealistic assumptions like perfect rationality, competition, and information might be handy.

The standard model, Laibson says, can also serve as a benchmark for other models. It represents the ideal. Teachers can introduce this simple model first and later contextualize issues like monopolies, externalities, irrational behavior, and so on. In this way, students also go through the historical progression of the field. “It’s sort of like if you’re going to learn physics, we’re going to teach you classical physics first, and then we’re going to get on to general relativity later,” Laibson says. But, he stresses, “Maybe that’s fine in physics, but in a social science, I think it’s useful to know right from the start that these very strong assumptions are really a benchmark model, not a model that we think accurately describes the world.”

“In a social science, I think it’s useful to know right from the start that these very strong assumptions are really a benchmark model, not a model that we think accurately describes the world.”

The fact that the standard model not only doesn’t accurately describe the world but also supports right-wing policies has led progressives to argue that the reason it remains central to Econ 101 is ideology. It was such a belief that led nearly 70 students to walk out in protest of Mankiw’s introductory course during the “Occupy” movement in 2011. The economist Mark Thoma agreesthere’s a “conservative bias” in Econ 101 textbooks and classrooms. Another economist, John Komlos, puts it this way: “In mainstream classrooms free markets become God’s gift to humanity, government is the boogeyman, and taxation is a burden on society’s well-being.” Going even further, the law professor and author James Kwak argues that the lessons of Econ 101 are tied up in a political project that he refers to as “Economism,” which he blames for providing intellectual support for a rightward shift of the United States over the last few decades. “Economism presents a clean, uncluttered picture of the world stripped to its bare essentials, which can be communicated quickly and easily, dispensing with messy and uncooperative facts,” he writes, bemoaning the use of Econ 101 as a conversation stopper in political debates and as a wellspring for powerful interest groups that want legitimacy for a self-serving economic agenda.

Laibson, who combines the zeal of a reformer with the reserve of an ambassador for an economics department that houses diverse perspectives, conceptualizes the problem as having less to do with ideology. It’s true, he says, that not all teachers have enthusiastically embraced new paradigms like behavioral economics and some may be reluctant to fundamentally revise their material. But the profession as a whole is willing to change: “Economists are very open to evidence that contradicts whatever theory they happen to be using,” he says, pointing to the wide embrace of behavioral economics and the recent accolades of its pioneer, Richard Thaler. “Someone who was considered a nutcase in 1982 has the Nobel Prize in 2017.”

The problem, Laibson says, is that even as economists embrace new ideas that further undermine the standard model, it takes a while for these insights to be distilled, packaged, and shipped to new students. This process is slowed, he says, by the pressures of standardized testing and the costs for teachers of changing their curriculum. Such factors help produce a textbook marketplace that favors incumbents and has incentives to maintain tradition. “You need decades to train people in these new areas so they can eventually teach this stuff in their classrooms,” Laibson says. “And some of that training occurs in graduate school. Some of that training occurs after graduate school. But it takes time for the ideas to filter through the profession.”

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It’d be one thing if Econ 101 simply produced generations of students with misguided beliefs about how society really worked. But there’s been a more pernicious aspect to how Econ 101 has traditionally been taught: the stubborn idea that not only are people rational, they are selfish. And not only are they selfish, but acting selfishly can lead to the best outcome for society—because in the neoclassical fantasyland of perfect competition, perfect information, no negative spillover effects, and so on, selfishness counteracts selfishness in a way that maximizes the welfare of society. If someone is making an insane profit exploiting people, any person can set up a new firm and bring the price down because there are no entry barriers in a world of perfect competition. The competitive process continues until profit disappears and the price of goods and services reaches the cost it takes to produce them, the best possible outcome for consumers. Greed becomes virtue in the neoclassical fantasyland because it’s part of the mechanism through which the invisible hand creates its miracles.

Modern textbooks usually ascribe the invisible hand doctrine to Adam Smith. In fact, as various historians have painfully documented, nothing could be farther from the truth. Smith, in his very limited uses of the metaphor, never proclaimed people are completely selfish nor perfectly rational, and he did not ascribe the mystical power to free markets that modern textbooks claim he did. His first book, A Theory of Moral Sentiments, is all about the better angels of human nature, stressing that we are moral creatures who are motivated by much more than just material wealth. He used the invisible-hand metaphor rather narrowly in The Wealth of Nations to describe a special situation where a merchant was choosing whether to invest at home or abroad. This merchant may perceive risks to trading overseas and decide to invest domestically instead, which in turn supports jobs and commerce at home. In this case, Smith wrote, the merchant would be “led by an invisible hand to promote an end which was no part of his intention.” This narrow metaphor is galaxies away from the much later conception of the invisible hand, which is connected to an elaborate vision of the world based on the mathematics of neoclassical economics. This neoclassical vision received a major boost in 1954 when Kenneth Arrow and Gérard Debreu published widely influential mathematical proofs that showed that under a long list of strict assumptions, an idealized, perfectly competitive free market maximizes the welfare of society. These proofs became known in the field as the “fundamental theorems of welfare economics,” of which one is known more colloquially as “the invisible hand theorem.”

Modern textbooks usually ascribe the invisible hand doctrine to Adam Smith. In fact, as various historians have painfully documented, nothing could be farther from the truth.

According to the scholar Gavin Kennedy, it wasn’t until Paul Samuelson misinterpreted Adam Smith’s Wealth of Nations quotation in his textbook that Smith was linked to the invisible-hand doctrine of modern conception. This modern conception became powerful because it tapped into the zeitgeist of the Cold War when leaders sought an intellectual canon against central planning. Since 1948, virtually all economics textbooks cite Adam Smith as the father of the invisible hand doctrine—a reality that the economist and historian Mark Blaug considers to be “a historical travesty of major proportions.” While he may have bungled the history of the invisible hand, Samuelson was always critical of the idea in his textbooks. Even after his early editions, when Arrow and Debreu made what Samuelson called a “revolutionary discovery,” he cautioned “before writing home to announce the final victory of the invisible hand doctrine, we should pause to consider the stringent assumptions that are used to prove the theorems about the competitive model.”

But as America saw a dramatic rightward shift, not all textbooks were as explicitly critical of this idea. Read through many and it’s easy to get the impression that human beings are completely selfish creatures, and because of the magic of free markets, society nonetheless flourishes. With such lessons at the forefront of economics textbooks, it should come as no surprise that a sizable number of studies have found evidence that economics education makes students more selfish (even after controlling for the fact that more selfish people might go into economics in the first place). John Ifcher and Homa Zarghamee, for instance, found that “even brief exposure to commonplace neoclassical economics assumptions measurably moves behavior toward self-interest” in lab experiments with students.

“The notion that people might not care about each other or might not care about fairness, that was kind of par for the course,” Laibson says. “We were saying, ‘This is a model of human behavior: everyone’s selfish. Okay, now what do you want to do?’ And there’s tons of good psychology that says when you’re giving people examples of behavior, they think they should behave that way.”

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For millions of high schoolers and college students, Econ 101 is their one and only time to get an understanding of the discipline, its way of thinking, its vital concepts, and its tools. Yet they often spend an inordinate amount of time exploring a model that is profoundly divorced from reality. It’s easy to see how an ugly, money-grubbing view of human nature and a neoclassical fantasyland alien to the world around them might turn off people from learning about or even appreciating insights in the field of economics.

The economics that Laibson has come to know and love is not the economics that’s traditionally been taught in Econ 101. The economics he loves is rich with data, experiments, and openness to ideas from fields like psychology. It’s an economics that is innovative, exciting, and fun and that equips students with a critical lens to view the world. A few years ago, Laibson came to the realization that many students did not get this view of economics in introductory courses. “And I thought, I want to fix this,” he says. “I want to write a book that helps people realize what I feel about economics.”

After realizing the monumental undertaking it is to write a textbook, Laibson partnered with Daron Acemoglu and John List, two other rockstar economists with a similar reputation for pushing the boundaries of their field. Their aim was to create a book that was not only accessible and fun but also grounded in the modern, evidence-based economics that they know and love. After years of research, writing, and revisions, the first edition of their textbook, Economics, was released in 2015, and a second edition was released this past year.

In the preface to their book, Acemolgu, Laibson, and List proclaim that while they will explore the conventional concepts of economics, their mission is to open students’ eyes to more contemporary ideas and tools like game theory, new empirical methods, and behavioral economics. “It is these modern concepts, which are small parts in most Principles textbooks, that occupy center stage in ours,” they write. “Today, economic analysis has expanded its conceptual and empirical boundaries and, in doing so, has become even more relevant and useful.”

Like their competitors, Acemolgu, Laibson, and List explore the standard competitive model early in their book. But unlike their competitors, they put up critical signposts all along the way to contextualize it and remind readers of the limits of the model. For instance, when introducing the neoclassical technique of constrained optimization, they include crucial caveats like, “We don’t assume that people always successfully optimize,” “We are not calculating machines,” and, “People often make mistakes.” Their textbook’s pages are also dripping with empiricism. “In our experience, students taking their first economics class often have the impression that economics is a series of theoretical assertions with little empirical basis,” they explain. The textbook covers all the experimental tools economists use to test models and learn about cause and effect. Moreover, each chapter contains “Evidence-Based Economics” and “Letting The Data Speak” boxes that explore real research and data on the theoretical concepts the authors introduce.

Instead of a few pages buried in the last chapter, Laibson, Acemolgu, and List scatter concepts from behavioral economics throughout the book. And they dedicate entire chapters to issues like the economics of information and the social dimensions of human behavior. In that latter chapter, they explore the economics of charitable giving and altruism (as well as revenge), and even include an incredibly meta box that asks, “Is Economics Bad for You?” They mention studies that suggest learning economics makes people more selfish and analyze why that might be. The authors emphasize that “a common misperception is that economics tells us that we should be completely selfish,” and they set the record straight that it does not.

The textbook marketplace does not display the perfect rationality, information, and competitiveness of the standard competitive model, which is maybe why Laibson’s innovative textbook has yet to dramatically disrupt it. But Laibson, whether rationally or not, remains optimistic that his field—and Econ 101 with it—are changing for the better.