Ha Joon Chang: confused on bounded rationality and economic regulation

In this third and final of the series on Ha Joon Chang’s critique of ‘free market economics’ I examine his account of ‘bounded rationality’ and the case for greater economic regulation. As in much of his work the policy conclusions which Chang draws simply do not follow from his premises.

In chapters 16 and 19 of 23 Things They Don’t Tell You About Capitalism, Chang asserts that free market economics rests on the view that actors are fully rational and that individuals always know what is in their best interests when deciding to buy, sell and invest. Drawing on Herbert Simon he argues that people often do not know what they are doing because the limitations of the human brain make the world too complex to fully understand. Thus, there are often advantages from restricting individual choice in order to reduce the complexity of the problems people face. One way to do this is to rely on administrative hierarchies such as firms, which operate on internal command and control procedures. The existence of corporate firms which ‘plan’ their activities Chang says demonstrates that so called ‘free market economies’ are to a significant extent ‘planned’ – and that the existence of such hierarchies demonstrates that ‘planning’ is often superior to more decentralised structures. Similarly, rules and regulations that limit choice can result in better decisions. Just as consumers who have limited attention spans often adopt routinised decisions – such as buying well known brands rather than risk unknown products – so rules and regulations can reduce the complexity of the choices people face and limit the things that may go wrong. From this Chang concludes that we should see greater government regulation not as an inhibitor of economic growth but as a way of reducing uncertainty. In the specific context of financial markets he argues that to avoid future crises complex financial instruments should be banned ‘unless we fully understand their workings and their effects on the rest of the financial sector and … on the rest of the economy’ (p.177).

Reading Chang’s book you would never know that free market economists such as Coase, Hayek and Vernon Smith have done more than anyone to examine bounded rationality and the role of hierarchy and rules as social ordering mechanisms. Granted, 23 Things is a semi-popular work, not a purely academic analysis – but an honest attempt to convey what ‘free market economics’ is about would have made some reference to these writers’ contribution – assuming Chang understands it.

Read the rest of the article on the Pileus blog.

Dr Mark Pennington is the author of Robust Political Economy: Classical Liberalism and the Future of Public Policy.

IEA Fellow of Political Economy

Professor Mark Pennington is a fellow in Political Economy at the Institute of Economic Affairs and is also a lecturer in Political Economy at King's College, London. Mark holds a PhD from the London School of Economics, has been published in a number of publications and is co-editor of The Review of Austrian Economics.