Rationality and Economics

In The Theory of Imitation, when discussing the philosophical origin of science, I observed that these disciplines, such as physics, chemistry, astronomy, biology, medicine, and geology, only became sciences when they were able to wean themselves from their philosophical progenitor. Usually this involved a change in method, from merely reasoning or speculating about matters of fact to discover the truth about the world, as philosophers do, to testing one’s beliefs and theories by doing careful, controlled experiments, and making precise measurements and observations, as scientists have done ever since the days of Galileo and his contemporaries.

In the case of economics, in order to liberate itself from its philosophical progenitor, this would mean abandoning the philosophical belief that human beings are rational creatures, and that reason is the sole or primary determinant of our actions and decisions. The first economists – writers like David Hume, Adam Smith, John Stuart Mill, and David Ricardo – were philosophers who primarily reasoned about economic matters. Even in the present day, economists generally adhere to a philosophical, rather than to a rigorously scientific, standard of truth, since many of them believe that mere logical or mathematical deduction and consistency is sufficient to establish the truth of their theories. What this means is that, attached as economics still is by an umbilical cord to its philosophical forebear, economists have not the slightest justification for calling their profession a science. The false belief that economics is a science has misled many economists and their students into believing that their laws and theories have the same precision and universal validity as true scientific laws and theories. That this belief is wrong is clearly demonstrated by the many harmful effects which the application of economic theories has produced in numerous countries around the world.

To give an everyday example of how the assumption of rationality fails to account for common human behaviours, let us consider the matter of consumer purchases, a subject that is dear to the hearts of economists. According to the theory of utility maximization, which is one of the basic theories of modern economics, individuals spend their money in order to maximize a theoretical economic entity called utility, which is an amalgam of pleasure, satisfaction, need, and usefulness. According to economists, we buy products like foods, clothes, houses, music, art, and bicycles, and the services of teachers, plumbers, doctors, lawyers, electricians, and police officers because we need them or because they give us pleasure to own or consume them. This theory accounts for differences in people’s preferences by declaring that individuals have different priorities of utility. A smoker obviously has a different priority or preference than a non-smoker, which will influence the purchases one makes.

According to this theory, since human beings are rational creatures, they should never be mistaken about their preferences. And yet, it happens fairly often that we buy things that we later decide we don’t need or want. This is not a fatal objection to the theory of utility maximization, since even economists will admit that human beings sometimes make mistakes. But what happens next – or rather, what fails to happen in some cases – is much more fatal to their widely-accepted theory.

If, as economists claim, all human beings are rational maximizers of their utility, then a person who has made a mistake by buying something one doesn’t want, such as an item of clothing one never wears, should always return it, since by returning it, one can recoup one’s money, with which one can then buy something else. In other words, one would be exchanging something that provides one with no utility for the opportunity to buy something that would give one utility, which is clearly a gain in utility. But as everyone knows, whether from one’s own experiences or the experiences of others, this does not always happen.[1]

Considered from the very different perspective of the theory of imitation, we can easily understand what is going on. People buy things because they see other people using, consuming, owning, or wearing these things, and not because they want to maximize their utility. The pleasure that we experience when we obtain or do something we desire, such as owning a car, watching a movie in a theatre while eating popcorn, going on vacation to a certain place, or eating in a nice restaurant, is the pleasure of imitating the models we have observed. In the case of models that we have observed from an early age, we generally do not make mistakes about our preferences, since these preferences are strong and not likely to change suddenly. It is primarily with models that we begin observing only when we are older, such as when we are adults, that we are more likely to buy things which we later decide we don’t need or want.

It is also important to consider the effects of conformity, since people tend to conform to the behaviour of those who are in their realm of influence. A common example is when we buy something, such as an item of clothing, that soon goes out of style, in which case we may feel embarrassed, and therefore be hesitant to continue wearing or using it. Another example is when we buy something merely because we know that many other people already own it. None of these important determinants of our behaviour enter into the cogitations of economists, who are too busy thinking about abstract concepts like utility, which they have invented to account for our behaviour.[2]

If some people have great difficulty returning things after they decide they don’t want them, it is because they didn’t observe the model of returning unwanted purchases when they were young. In other words, they are inhibited from doing so because they didn’t observe this useful model when they were children. This is no different from the fact that most people lack certain abilities such as the ability to dance well, play a sport, or speak a foreign language, or have no inclination to perform these activities.

Furthermore, the theory of imitation can readily account for things which the theory of utility maximization cannot account for, such as the fact that different people have different preferences (because they grew up observing different models of behaviour), and why people today buy many more things than people did in the past (because they observe a much larger number of models – in television programs, movies, photographs, and on the Internet – than people did in the past). It is the desire to imitate and conform that makes people buy the latest fashion in clothes, even when the clothes they already own are not worn out and could still be worn for many more years; it is the desire to imitate that makes some people eat in expensive restaurants – and, moreover, prefer to eat in a restaurant that is full than in one that is empty – for those who have never observed this behaviour before will not want to do so; it is the desire to imitate that makes people go on trips and vacations; and the same is true of all the other things we spend our money on. Furthermore, the theory of imitation can also account for the fact that some people, such as ascetics who deny themselves even the basic necessities of life, try to consume as little as possible: because, when they were younger, they observed or heard or read of, and therefore admired, individuals who behaved in this manner.

Instead, the theory of utility maximization takes these differences as idiosyncratic differences between different individuals or groups of people, but without being able to account for them. Although it may do a decent job of explaining some aspects of consumption behaviour, the theory of utility maximization is based on a falsehood.[3] This is only one example of how economists have failed to take into consideration important determinants of our behaviour like imitation, inhibition, and conformity. It is this failure that accounts for the fact that their theories are not very good at explaining human behaviour, and when they make predictions based on their theories about people’s behaviour, their predictions often turn out to be wrong.

To give another example of the very different results or expectations that follow from the theory of imitation and the economists’ assumption of rationality, let us consider the relationship between interest rates and investment, which is an important economic subject. According to the economist’s view of human behaviour, when interest rates are low, then the rational human being should borrow money in order to invest it or start a new business, with which one can earn money, thereby enabling one to pay back the loan while making a profit for oneself. But the theory of imitation declares that those who have never observed this model before will have no inclination to borrow money, regardless of the rate of interest. And this is in fact what we find in many poor countries that do not have a well-developed system of credit: usually those who borrow money are those who are indigent and in want, and they borrow only so they can stay alive, that is, in order to pay for current consumption, or to pay off debts, and not to invest or start a new business with which they can earn money and improve their economic situation. It is only those who are familiar with these kinds of Western or capitalist business practices that are willing to engage in them. Hence, in many poor countries, lending is usually small-scale, often at exorbitant rates of interest, and – most importantly from the economists’ perspective – it does not stimulate economic growth, and therefore it does not create jobs.

Because economists’ have completely overlooked the importance of models of behaviour in determining people’s behaviour, they have naively assumed that a lower rate of interest will have the same effect in all countries, namely to stimulate investment. If one were to imitate the economists’ example of generalizing from the behaviour of people in capitalist countries to the behaviour of all people in the world, one might as well assume that all people can speak and understand English, that all people know how to read and write, that all people can play the piano, that all people practise Buddhism or believe in God, or that all people have the same culinary tastes and preferences – none of which naive beliefs is true.

In the case of investing in things like real estate or the stock market, if human beings were truly rational creatures, then they would never get carried away by overconfidence and, by their collective delusion and the behaviours which result from this delusion, create financial or real estate bubbles, which, when they burst, can cause a calamitous decline in prices, thus leading to an economic recession or depression. But such events do occasionally occur because human beings are imitative creatures. When people see or hear of others making money by buying stocks or real estate, they believe that they too can make money by doing the same thing, which causes their prices to go even higher, at least for a time. But the higher the prices rise, especially when this happens in a short period of time, the more likely that they will drop just as precipitately. Hence, although the assumption of rationality cannot account for speculative bubbles, since their regular occurrence directly contradicts the economists’ assumption of rationality, they are easily explained by the theory of imitation.

It is important to understand that to deny that human beings are rational creatures does not mean that all our actions are therefore irrational, in the sense that we usually mean this word. For to draw this unwarranted conclusion would be to continue applying the rigid logical habits and categories which I am rejecting, in this case the inference that if A (rationality) is false, then its opposite, not A (irrationality), must be true. Instead, like all good scientists and sensible people, we must examine human behaviour as it really is, and not the way that certain people like economists believe it to be, according to the theories or beliefs which they hold to be true because everyone else they know holds them to be true.[4]

Even if our actions are not the result of a rational or logical thought process, many of them have the semblance of rationality. This is due to a combination of the imitation of sensible or traditional models of behaviour that have been shown, by repeated experiences, to be beneficial or advantageous, and the inhibition of embarrassment, which has the effect of restraining our emotions and behaviour. It is this semblance of rationality that has misled innumerable theorists and writers in the past, and not only in the realm of economics, into repeating the falsehood that human beings are rational creatures. But not everything that is imitated is wise or sensible, and this includes the behaviours that are studied by economists.

I am also far from saying that people do not reflect or weigh their options before making decisions. But the fact that we engage in this activity does not mean that we are rational creatures who always use our reasoning faculty to determine the best outcome before we act or decide on a particular course of action. For this would be to continue imitating the mistake made by Aristotle when he defined us as rational animals, by failing to recognize the great importance of imitation, conformity, and contempt in determining our actions, decisions, and behaviour, including in cases where we deliberate before acting.

Human beings are not rational creatures. Although we may behave at times as if we were rational, and we often do reflect between various alternatives before deciding on a course of action, this does not change the fact that we are imitative and conforming creatures. This is the fundamental truth that economics has ignored ever since its philosophical conception, development, and continued attachment. To the extent that it has erred, in both its theories and the policies, predictions, plans, and forecasts that are based on those theories, it is often because it has overlooked this basic truth about human nature, and hence, the true determinants of our behaviour.

Another of the unrealistic assumptions made by economists is that labour is perfectly mobile, meaning that all workers are willing to do whatever work happens to be available, provided it is the best-paying job they can get. But this is clearly untrue, for even in a booming economy, some positions or occupations remain short of workers. This may be due to a lack of skills or an inability to perform certain jobs, but it may also be due to the fact that the native inhabitants are not willing to do certain kinds of work, such as work that requires hard manual labour, or work that is regarded as being dirty or disreputable.

Apart from overlooking the strong human tendencies to imitate and conform to the behaviour of others, economists have failed to consider basic human motivations like embarrassment and contempt, both of which prevent people from doing certain things. Either one of these motivations can prevent people from doing certain kinds of work, which means that it is not simply the level of wages that determines the kinds of work that people are willing to do. This explains why there are some jobs that go unfilled even when there are many unemployed people looking for work: because, in the case of most people, there are certain jobs which they refuse to perform because they regard these jobs as being beneath them. Hence, many countries have found it necessary to permit inhabitants of poorer countries to enter their countries to perform these kinds of work, since, because they did not grow up there, they did not acquire the prejudice or disinclination towards these kinds of work that the native inhabitants have.

Economists have artificially stripped human beings of the emotions, desires, imitative and conforming tendencies, and other forces which can and do influence their behaviour. As a result, they spend far too much time thinking of human beings as general, abstract, and idealized rational creatures, rather than what they really are, which is flawed, wayward, emotional, impulsive, imitative, conforming, and imperfect earthly creatures who are subject to a wide variety of emotions and desires which can and frequently do influence their behaviour in undesirable ways, including in economic matters. This is like assuming that human beings don’t need to eat or sleep, or they never get tired, or a physicist who declares, “Let us assume there is no gravity or friction, or there is no limit to the speed of light,” meaning that the transmission of information can take place instantaneously at long distances. Clearly, the conclusions that are deduced from such unrealistic assumptions will have nothing to do with reality. And yet, many economists fail to realize this simple fact – that if you begin with unrealistic assumptions about the world and people’s behaviours, then you will also end up with unrealistic conclusions about these things.

In addition, many people, and not just economists, often think of the market as something that is separate from all the individuals who, together, comprise the market. But the market is nothing more than the aggregation of their actions, decisions, mistakes, panics, and herd behaviours. Here, for example, is a description of the financial panic that followed the assassination of Archduke Franz Ferdinand, the event that triggered the start of World War One:

Instead, [British Chancellor of the Exchequer] Lloyd George decided that the Bank of England should go the whole hog by guaranteeing all approved bills accepted before 4 August [1914]. Within four months the Bank had discounted bills worth £120 million. In effect, the government paid the City’s [London’s financial sector’s] bad debts, and rewarded those privileged citizens who happened to be engaged in financial business.

‘Financiers in a fright do not make an heroic picture,’ Lloyd George wrote of this crisis. ‘One must make allowances, however, for men who were millionaires with an assured credit which seemed as firm as the globe it girdled, and who suddenly found their fortunes scattered by a bomb hurled at random from a reckless hand.’[5]

Apart from its falsehood, another important reason why the economists’ assumption of rationality must be abandoned is because it has misled many economists and other writers into holding a completely unwarranted faith in the operations of the free market. In other words, it has led them to espouse the folly of free-market or laissez-faire capitalism, which is just as mistaken and dangerous a theory as communism. In their extremely naive view, the free market can do no wrong, while the government, when it exceeds the narrow limits imposed on it by economic fundamentalists, can do no right – both of which are overly simplistic beliefs that do not accord with reality in a great many instances.

The result of this erroneous chain of reasoning is the following: whereas individuals are ignorant, selfish, subject to irrational passions and emotions, and otherwise imperfect, the purifying mechanism of competition in a free market corrects these negative aspects of human nature by rewarding the good and punishing the bad. It is this fundamental mistake that is at the heart of the beliefs espoused by the advocates of free-market capitalism, and accounts for their overestimation of the beneficial effects of unregulated capitalism.

But what do we find actually happens in the real world, as opposed to the abstract, idealized world of the economists? Provided we are not blinded by the erroneous assumptions made by economists, which prevent them from observing reality objectively, and instead make them view the world through their highly distorting, rationality-tinted glasses, what we will see is that, like a willful and misbehaving child, human emotions, desires, prejudices, and the like continue to intrude on, influence, and distort the operations of the free market.

To give just one example, there are economists who have actually argued, in all seriousness, that the free market is the best way to combat racism, because, left to itself, the free market will overcome strong and established patterns of discrimination that are due to hatred against certain groups of people, and therefore government laws, regulations, or interventions to punish and deter racism and its discriminatory consequences are not necessary. But when the majority of people are prejudiced towards a certain group of people, as the majority of white people were towards black people prior to the 1960s in the United States, or when a minority uses its political power to oppress and discriminate against the majority, as happened in South Africa during the period of apartheid, then the belief that the free market will correct these tendencies is nothing more than wishful thinking. For these prejudiced people, if they are free to do as they want, will continue to discriminate against those they hate or regard as inferior to themselves. The prejudiced business owner or manager will continue to refuse to hire or serve black people, even if this hurts one’s business, because the desire for profits is only one of many variables that determine people’s behaviour, and certainly not the only one, as the myopic economist believes.

The economist, narrowly thinking only of the business owner’s profit and loss, argues that his desire to increase his profits will make him suppress his prejudices and hire or serve black people. But if this argument were actually valid, then there would never have been any prejudice and discrimination in the first place. The prejudiced business owner, being the rational creature described by Aristotle – who, incidentally, never met him, since the great Greek philosopher died long before he was born – would have recognized that it was in his best interest not to discriminate against black people, and would therefore have modified his behaviour, and not waited until the enlightened economist came along and told him how he ought to behave in order to maximize his profits for the benefit of both himself and the society in which he lives. But the strength and continued existence of racism clearly show the absurdity of the economist’s argument. This is just one example of how reality does not match the economist’s unjustified optimism in the curative – or it were better to call it the miraculous – powers which many economists attribute to the free market.

The mistake made by economists is to assume that the desire for profits will override all other considerations, an assumption that in some instances is clearly false. This mistake is due to their very silly habit of considering only this single determinant of human behaviour, while ignoring all other determinants of our behaviour. For them, no other human emotions enter into their calculations except the twin desires for profits and the desire to avoid economic losses. But as we have seen, this approach leads to false conclusions and beliefs because we must consider more than just this single variable in order to understand people’s behaviour and predict the way they will behave. After all, in the economists’ own case, the desire to study and understand economic phenomena was not the result – as they must believe according to their simplistic theory of human motivation – of the economist’s desire for profits, since most economists could probably earn more money doing something else, such as working in the financial sector. Money is not the sole determinant of the kinds of work that people want or are willing to do. To paraphrase Hamlet, There are more things in the world, Economist, than are considered in your narrow – and frequently mistaken – philosophy of human behaviour.

Like language, relationships, sports, war, art, music, science, hunting, and other human activities, the market is only one kind of human behaviour. And, like these other activities, economic behaviours are not free from the constraints, emotions, desires, and other factors that influence and shape human behaviour in these other areas. One can arbitrarily delimit a certain type of behaviour as one’s field of study, as the economists have done, but this does not mean that it is not subject to the forces that influence and determine our behaviour in other areas. Economic behaviour does not have some sort of special or independent status that sets it apart from the behaviours that are studied by writers and researchers in other disciplines like psychology, anthropology, and history. It is this artificially isolationist approach, rather than the requisite global approach, that has misled economists into making claims that are foolish, incorrect, and occasionally complete nonsense.

John Stuart Mill looked upon political economy [which today is called economics] “not as a thing by itself, but as a fragment of a greater whole; a branch of social philosophy, so interlinked with all the other branches that its conclusions, even in its own peculiar province, are only true conditionally, subject to interference and counteraction from causes not directly within its scope.”[6]

The logically consistent and mathematically rigorous – but unrealistic and pragmatically fragile – edifice of laissez-faire capitalism is based on the false assumption that human beings are rational creatures. It is this falsity that accounts for the fact that it has never been adopted by any country or group of people in the history of humanity – why all sensible groups of people have found it necessary to check, correct, curb, and counterbalance the harmful effects of unrestrained capitalism, along with its driving force, the selfish desire for profits. And it is this same falsity that explains why, if it were ever adopted or implemented, the actual consequences that are produced by this system would diverge greatly from the overly optimistic but highly unrealistic expectations of its overzealous advocates.

Economists must perform three basic tasks if they are to purge their discipline of the many errors, falsehoods, and misconceptions that presently beset it: first, they must abandon the false belief that human beings are rational creatures; second, they must make their theories consistent with the laws and theory of imitation;[7] and third, from now on, they must test their cherished theories and hypotheses, rather than assuming, as most economists have done until now, that mere logical or mathematical consistency is sufficient to ensure that they are true. Coupled with this last requirement is the readiness to reject or modify their theories if they are refuted by real-world evidence, something that many ideologically-blinded economists have very conspicuously failed to do in the past. Henceforth, the writings of any economist who continues to base one’s work on the assumption of rationality should automatically be considered suspect, in the same way that the work of any astronomer who continues to adhere to the geocentric model, which places the Earth at the centre of the solar system or Universe, would also be considered suspect and most likely wrong.

In order to make proper use of this new starting point, it will be necessary for economists and their followers to change the way they think about economic phenomena, as well as the behaviour of individuals and corporations. Instead of the logical, rational, dispassionate, and omniscient individuals – previously the hypothetical but not-very-realistic creatures which economists theorized about – whose behaviour was not subject to the checks, inhibitions, and herd behaviour which in reality characterize many of our actions, we begin with human beings as they really are: selfish, ignorant of many things, prone to committing errors, occasionally stupid, desirous of gaining control over others in order to accomplish their aims, whether by foul means or fair, subject to the sway of irrational emotions like greed, fear, covetousness, and unjustified optimism about future events, and whose behaviour is highly susceptible to being influenced by their knowledge of what other people are doing or not doing, regardless of whether these actions are good or bad, legal or illegal, or beneficial or harmful. In other words, we must purge economics of the false assumption that has been at the heart of its theories and explanations from its inception, the deleterious intellectual inheritance that was bequeathed to economists by their primitive philosophical forebears, who, to their descendants’ detriment and confusion, erroneously infused the cult of rationality in many fields of human knowledge.

 

[1] Of course, the economist would come up with an explanation to account for this real-world contradiction of their theory, such as that the time it takes to go to the store and return the item is not worthwhile for certain individuals because they could obtain more utility by doing something else with that time, such as working to earn more money. But if it was worth the individual’s time to go to the store to purchase the item in the first place, then surely it is worth one’s time to return to the store to get the money back with which one can then buy something else that will provide one with more utility than the unwanted item.

[2] This example illustrates the economist’s common but erroneous tendency to view each individual as being completely separate from everyone else, both in terms of one’s actions and the decisions one makes. In other words, economists have failed to take into consideration the very strong influence that the behaviour of other people has on our own behaviour. Again, this oversight is due to their mistaken belief that we are rational creatures, since a rational creature would not do something simply or primarily because other people are doing it, or have done it in the past.

[3] Similarly, the Ptolemaic model of the Heavens, which assumed that the Earth lay at the centre of the Universe, was able to account for the observed motions of the other planets, including the anomalous fact that, during a part of its orbit, the planet Mercury appears to reverse direction. However, the central feature of this model – that the Earth rather than the Sun is at the centre of the solar system – is of course wrong.

[4] That economists regard these false theories as true cannot, of course, be explained by the belief that human beings are rational creatures, since it is not at all rational to believe something that is false. But their behaviour is easily explained by the fact that economists are imitating and conforming creatures, since it can easily happen, as has been amply demonstrated throughout all of recorded history, that a group of people believe something that is false simply from their strong tendencies to imitate those they admire and to conform to each other’s behaviour.

[5] Universal Man: The Seven Lives of John Maynard Keynes by Richard Davenport-Hines, chapter 3. William Collins, London, 2015.

[6] Small is Beautiful: Economics as if People Mattered by E.F. Schumacher, p. 27. Hartley & Marks, Point Roberts, Washington, 1999.

[7] In the same way, the sciences of astronomy, chemistry, and biology, in addition to being consistent with each other, are all consistent with the laws and theories of physics.

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