J Brauer | © Stone Garden Economics
Economists regularly come across criticisms of the rationality assumption in economics or, more generally, of criticisms of rational choice theory. When economists study terror organizations and assume that such organizations behave rationally, people sometimes become upset and say “How can terrorists be rational? Their very acts show that they are irrational, devilish monsters. In what sense exactly is the daily carnage in Afghanistan or Iraq rational?” Likewise, economists argue that financial (and other) markets are expressions of rational behavior by the actors engaged in them. And again people say “Isn’t the ongoing world financial and economic crisis proof that markets are anything but rational? What is so rational about the Greek debt crisis?”
Two aspects are important here. One is that the theory economists use is not called “rationality theory” but “rational choice theory.” I recall one academic who in a keynote speech tried to rubbish economists’ rationality assumption by explaining that there was nothing particularly rational about his own personal liking of brown shoes rather than black shoes. Well said, but wholly off the mark. No economist would argue whether or not it is rational for the speaker to prefer brown shoes; instead, what is rational is that he purchases only brown shoes, given this preference for them and given the fact that brown shoes and black shoes cost about the same.
Choices made—for brown shoes or for acts of terror—result from an interaction of subjective and objective reality. Subjective reality refers to one’s preferences, that is, one’s likes and dislikes, tastes and distastes, and fashions and foibles. Even as people may rationalize their preferences, no economist argues that the way people arrive at their preferences is in fact rational. Thus, we do not argue that the keynote speaker’s liking of brown shoes is the outcome of rational deliberation. And we do not argue that the worldview of would-be and actual members of terror organizations is arrived at by rational means. It is not economists’ business to condone or to condemn anyone’s preferences. Preferences, however come by, merely are the starting point of analysis. Objective reality refers to one’s available resources (income, savings, grants, credit) and to the market prices one faces. Thus, even if the keynote speaker greatly prefers brown over black shoes, surely he would purchase the hated black pair for $100 if the brown pair were to cost $5,000. You see, what is rational is not the preference; what is rational is to match one’s preferences with the given constraints of resources and prices. It is the choice, not the preference, that is rational.
Put this way, one wonders just what critics find so objectionable about rational choice theory, and one suspects that they never bothered to learn what it means. Putting aside just how members of al-Qaida arrive at their views, surely it makes sense that the organization will then employ its resources in such a way that it obtains, literally, the most “bang for the buck.” In other words, economists expect that terror organizations behave like businesses, albeit with the crucial difference that one set of organizations seeks to deliver goods and services and the other aims to deliver bads and disservices. And if that is the case then economics potentially has a great deal to say about how to confront terror organizations. After all, government regulation of economic affairs is in large part about discouraging choices that are deemed socially undesirable.
A second aspect of rationality then concerns just whose rationality society is to follow. As we have seen, the problem is not that individuals, groups, and entities are irrational. To the contrary: The problem is that competing rationalities conflict with each other. Thus, to combat traffic-related pollution and road congestion, high automobile registration costs, gasoline taxes, road usage tolls, and inner-city parking fees discourage driving, especially when combined with subsidized public transport options. Call it “stick-and-carrot economics.” Individuals’ behavior shifts and society gains. But when using taxes and fees to stem pollution and congestion in global air traffic, this seeming rationality can backfire and draw tourist and business travel away from one location toward another. Europe’s high airport fees have permitted Middle Eastern transit hubs to develop where landing right fees are cheap. Increasingly, airlines bypass European stopovers and fly via Abu Dhabi or Qatar. The emirates win, as the rationality of one agent (local government) conflicts with the rationality of other agents (local tourist and hospitality operators). Just whose rationality is to be followed? What in fact is in “society’s” best interest?
As a rule, economists are not to be faulted for applying rational choice theory, but they may be faulted for their relative lack of interest in also considering power and sentiment, that is, how politics and culture in turn bear on economics.
J Brauer is Professor of Economics, James M. Hull College of Business, Augusta State University, Augusta, Georgia, USA.