Since the late 18th century, and the writing of the modern economic patriarch, Adam Smith, the human at the centre of the modern economic narrative has been presumed to be a ‘rational man’ — an individual who will make logical choices based on available information, to maximise the benefit to himself, at that moment, at minimum cost. This predictable figure has been described by renegade economist Kate Raworth as the “atom” of economics, the basic unit of economic thought “whose composition has profound consequences”.
In recent years, that atom has been split. What is revealed is a complex mesh of intertwining strands — nudge theory, heuristics, cognitive theory and other disciplines — all contained within the spaghetti bowl of ‘behavioural economics’. These have contributed to a critical reappraisal of ‘rational man’ and a growing recognition that human choices are often deeply irrational
and driven by strongly ingrained ethical norms.
Examples of irrational behaviour by humans are manifold. One famous example is illustrated by the Ultimatum Game: Two individuals are given a lump sum of cash to share between them, but only one of them, ‘person one’, may choose how that money is split. Should ‘person two’ refuse the deal, then they both lose everything. If both players conformed to ‘rational’ behaviour, whatever person one offers, person two should accept every time, as something is better than nothing. The reality is very different.
As Raworth explains in her book, Doughnut Economics, in experiments
in the US, person one tends to offer person two a 45% share, which is usually accepted. However, person two will usually reject a share below 20%.
The reasons for this are complicated, and the result of a cocktail of internal and external motivations that make up our human behaviour. One strong incentive may be the imposition of justice — person two would rather lose everything than allow person one to unfairly profit through greed.
For those keen to criticise economics as a pseudoscience that has failed to predict and prevent recurring economic calamity, the rational man offers an easy target.
In purely mathematical terms, this is deeply irrational behaviour,
but at a societal level, the decision could have strategic motivations.
By supporting a system of values in which deals are fair, person two increases the likelihood of other transactions being mutually beneficial. This is, arguably, a result of respondents living in a society with high dependence on everyday transactions, and an interest in ensuring equality in those transactions — what economists call ‘reciprocity’.
The importance of reciprocity is supported by the fact that the results
of the Ultimatum Game vary significantly between cultures, depending
on their levels of mutual codependence. Among the Machiguenga of the Peruvian Amazon, where people are relatively self-sufficient, person one tends to offer person two a share of around 25%, and person two almost always accepts. By contrast, among the highly codependent villagers of Lamalera, Indonesia, person one will usually give away around 60% of the money. Rejections are rare.
Given this complex picture of human economic behaviour, you might question the whole premise of situating a rational man at the heart of economic theory, or indeed the whole purpose of economics given its reliance on unreliable 18th-century precepts. For those keen to criticise economics as a pseudoscience that has failed to predict and prevent recurring economic calamity, the rational man offers an easy target, and the Ultimatum Game a wealth of ammunition.
Robert H Frank is an economist at Cornell University, who set up the first undergraduate programme for behavioural economics in 1983. “It is to Smith that we owe the insight that the pursuit of narrow self-interest in markets often promotes society’s welfare,” he says. However, “Smith’s modern disciples err by assuming that people are purely self-interested in the narrowest sense, and that Smith claimed that free markets always deliver benign outcomes. Both views are profoundly mistaken.”
Frank’s criticism of Smith’s ‘modern disciples’ reflects the common belief among many contemporary economists that the problem with ‘rational man’ is not the idea per se, but with the way it has been misrepresented. A generation of economists, such as Frank Knight and Milton Friedman, emerged in the late 20th century — at times of political and economic anxiety: the great depression and the cold war respectively — to champion Smith’s core ideas of self-interest and rationality as the foundation for what later became known as neoliberal economics. In this crucible, Raworth writes, rational man was transformed from “a model of man … into a model for man”.
“The great depression was a big challenge to economists,” says Wendy Carlin, a professor of economics at University College London, “because [economics] didn’t have a way of understanding how you could have long-lasting unemployment and weakness of demand. Then you have another crisis around the 1980s with the inflation crisis, and that pushed economics in another direction, neoliberalism, which you could see as trying to focus attention back on a rather narrow view of self-interested behaviour
and economic freedom.”
In The Theory of Moral Sentiments, Smith wrote “how selfish soever man may be supposed, there are evidently some principles in his nature, which interest him in the fortune of others and render their happiness necessary to him, though he derives nothing from it except the pleasure of seeing it.” Somehow, however, in the hands of neoliberal economists, this flexible approach to rationality got lost.
The problem with ‘rational man’ is not the idea per se, but with the way it has been misrepresented; transformed from “a model of man … into a model for man”.
Economists such as Raworth and Frank are engaging in a panoply of emerging disciplines to paint a more nuanced picture of human economic action. In his new book, Under the Influence: Putting Peer Pressure to Work, Frank argues that we have yet to grasp the full effects of behavioural contagion on economics.
“Behavioural economics has made it possible to question the conventional assumption that people are narrowly selfish and perfectly rational,”
says Frank, and that is a healthy development. But a more important intellectual change remains to occur. Until we recognise the importance
of behavioural contagion in people’s choices, we will fail to enact the policies needed to deal with society’s biggest problems.”
Frank argues that behavioural contagion can be utilised to make
a persuasive case to the wealthy for the adaptations necessary to mitigate climate breakdown, such as steeper progressive taxes to reduce inequality and fund green technology. While the wealthiest would see their taxes rise and their net incomes fall, their relative bidding power among their wealthy peers (who would also pay higher taxes) wouldn’t be affected and “the same penthouse apartments overlooking Central Park would therefore end up
in the same hands as before”.
“If leaders explained to voters that higher top tax rates wouldn’t alter their relative bidding power,” writes Frank, “most would be capable of grasping that no real sacrifices would be necessary.”
Only time will tell whether behavioural contagion, and behavioural economics more generally, can position economics in a better place to
prevent further crises. One thing is for certain though: human irrationality
is here to stay.