Thursday, 8 October 2009

Selfish basterds: On rationality in Economics (II)

Before proceeding any further, we need to define what does it mean to be rational from an economic perspective. We will say that an agent is rational if this agent takes actions that maximize his expected pay-off from the set of available actions to him, and given the beliefs that he holds about the consequences of these actions (no matter how wrong they can be). That is basically what it means to be rational. It seems a very natural, powerful and simple idea. But then, why do non-economists protest so angrily against this assumption?

I think that the main reason for this is that they are confounding an assumption with an ontological proposition about human nature. Economists do not postulate that people are always rational. Nor that humans are only selfish or materialistic or care only about money. In this post I would like to clarify that rationality is just that, an assumption. In the next one, I will explain why it is not as stupid as journalists relish so much to say.

In "The Methodology of Positive Economics," the leading chapter of Essays in Positive Economics (1953), Milton Friedman argued that it is not important whether humans are actually rational or not. What is important is whether they behave like rational beings, so the rationality assumption can be used fruitfully to explain behaviour. He made the analogy with the study of how leaves locate in the branches of trees. The tree may not truly grow them to maximize exposure to sunlight, but if they behave as if it did, then it is a powerful assumption to make in our study of trees. That is the principle that should guide us in the use of the rationality assumption.

It is true that sometimes economists have jumped into the void of wishful thinking, and postulated that human nature (in case such a thing exists) corresponds to the one of a rational, narrowly-minded, materialistic being. Many market-triumphalists have done that (not Friedman, interestingly enough), and policy prescriptions sometimes have suffered from an abuse of rationality, and more specifically of narow self-interest (they are not the same as we will see next time) as a fundamental belief and not as an approximation to reality. That is precisely why that girl that I mentioned in my previous post in this series thought that Economics was hideous; or why journalists, like Adam Curtis, like to portray economists (and economics students, by extension) as sociopaths. But what should concern us is that any economist willing to make the leap from assumption to beliefs is doomed to do wrong and potentially dangerous economic analysis.

What good economists think is that the assumption of rationality can be a very powerful tool in explaining behaviour. It is a simplification, of course, but without simplifications, no theory has any explanatory power. In that respect, I would like to mention a short story by the Argentinian writer Jorge Luis Borges (in the photo above). In On Rigour in Science, Borges told the story of an empire, whose scientists, after generations, build a map of the kingdom in 1:1 scale. The map was a totally accurate description of reality. But what would be the use of such a map? Absolutely none. The assumption of rationality, Economics in itself, is a map of human and social phenomena. There may be some maps better than others, and we should strive to improve the ones we have, but without them, we will certainly get lost.

(To be continued).

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