Given a choice between definitely getting $1,000 or having a 50% chance of getting $2,500, what will you accept? This was one of the lab experiments that the psychologist Daniel Kahneman and a leading expert in judgment and human decision-making Amos Tversky did sometime around 1979. What did they discover? They found that people were more likely to accept the $1,000. Why is that an interesting result or one of any significance?
If the assumption of the rationality of economic agents as assumed by neoclassical economics is true, then you would expect them to be indifferent between the two choices because the expected utility of both options is same. Expected utility of a payoff equals the amount of payoff multiplied by the probability of getting the payoff. But the subjects investigated by Kahneman and Tversky showed risk aversion by preferring the certain $1,000 over the risky $2,500, even though both their expected utilities are same, thus violating the rationality of the homo economicus, or economic man, assumed by neoclassical or modern economic theory.
They presented these findings and other such several classes of choice problems in their 1979 paper “Prospect theory: An analysis of decision under risk”, in which preferences systematically violated the axioms of expected utility theory. This paper laid the foundation for the new field of behavioural economics. Over the years, behavioural economics went on to find many more such biases and examples of irrational behaviour, undercutting the reasonableness of the assumption of homo economicus in modern economic theories.
The perfect rationality of homo economicus imagines a hypothetical agent who has complete information about the options available for choice, perfect foresight of the consequences from choosing those options, and the wherewithal to solve an optimisation problem (typically of considerable complexity) that identifies an option which maximises the agent’s personal utility. To that should be added that the agent cares narrowly only about his own utility or is only self-regarding, to complete the description of homo economicus. But are we able to gather such complete information when making economic choices or do we have the computational capacity to solve optimisation problems?
For example, a standard grocery store offers millions of combinations of items that are within one’s budget. Can you really maximise by choosing the best one? You cannot. Why? As Herbert Simon argued as far back as 1957, we cannot aspire to optimal maximisation given that we make decisions under uncertainty with insufficient knowledge, feedback, and computational capacity (so-called “bounded rationality”).
As he put it, we can only “satisfice” by using heuristics to guide our decisions and not “maximise”. Sir James Mirrlees in discussing ‘bounded rationality’ pointed out that the choices we make are all influenced not simply by a cold calculation of self-interest but external factors such as education, advertising and experience. These are further blows to the assumption of homo economicus by modern economic theory.
That we may be merely narrowly self-interested has been shown by economic anthropologists not to hold in traditional societies. In traditional societies, it is kinship-based reciprocity that guides people’s choices regarding production and exchange of goods, christened the “gift economy”. This is in stark contrast to the market economy because a gift economy or gift culture is a mode of exchange where valuables are not traded or sold, but rather given without an explicit agreement for immediate or future rewards. We offer support to the community with the expectation that this will lead to an improvement in the welfare for others.
Further, laboratory experiments have shown that people care about fairness and occasionally even act altruistically, such as in the Ultimatum Game where people prefer to forgo money than accept an unfair deal. Even the Father of Economics, Adam Smith, claimed in his book ‘The Theory of Moral Sentiments’ that individuals have sympathy for the well-being of others, and are not merely narrowly self-interested.
So, we can see that humans are not perfectly selfish, perfectly rational, and relentlessly self-maximising. Yet, it has been found that economics students tend to exhibit more selfishness than other students. Even brief exposure to commonplace neoclassical economics assumptions measurably nudges behaviour toward self-interest.
When such people believing in homo economicus and behaving as one become professional economists holding positions of influence where they are even advisers to heads of state, you can imagine how skewed their policy recommendations can be and what havoc they can wreak on the economy and how wrong they can go with their predictions. And that has been so going by the various economic crises over the years, the 2008 crash being a case in point.
If we assume that man is narrowly self-interested and motivated solely by financial gain, it inclines us towards a free-market where individuals are rewarded for productivity leading to a more efficient economy. This becomes a motivation for policy prescriptions like more and more privatisation with diminishing role for government and its welfare measures. But, as Peter Fleming points out in ‘The Death of Homo Economicus’, “Leaders of industry enjoy a state-funded socialism because they understand that pure capitalism is a mere impossible abstraction that is meant for the masses to toil with, out there beyond the perimeter.”
Truly speaking, we are other-regarding, reciprocal, heuristic, and intuitive moral creatures. It is our highly evolved prosocial nature of cooperation that has enabled us to thrive on the planet. If we continue to defend homo economicus as a useful fiction — a tool for modelling and understanding the economic world — then it becomes a story we tell ourselves about ourselves, thus giving permission and encouragement to some of the worst excesses of modern capitalism, and of contemporary moral and social life.
(The author is content writer; and blogs @ https://selfrealization.home.blog)
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