A theme throughout economic theory is that humans act like an “economic man1” or “administrative man”, fundamentally making decisions with an economic and therefore rational mindset. Rational expectations theory2,3 and rational choice theory4 underpin a lot of economic thought, whereby people are believed to be rational actors (like Leonard Nimoy), making decisions for their own self-interest and being able to make choices using computational skills to evaluate all alternatives. Do people really compute NPV5 calculations using Monte Carlo6 simulations in every buying and selling transaction?
Some assumptions held by the rational expectations theory:
- Individuals use their ability to rationalize when making decisions.
- On average, people hold expectations that will be fulfilled and learn from past mistakes.
- Rational expectations are the best guess for the future.
- Although people may be wrong some of the time, on average they are right.
- Values of variables like price, output, and employment are important.
- People behave in ways that seek to maximize their enjoyment of life and profits.
- Expectations about future inflation influence current buying decisions.
- Individuals create expectations based on all available information.
- Resulting predictions are very close to the market equilibrium.
In economics, “rational expectations” are model-consistent expectations, in that agents inside the model are assumed to “know the model” and on average take the model’s predictions as valid. Expectations and outcomes influence each other. There is continual feedback flow from past outcomes to current expectations. Rational expectations is an assumption of aggregate consistency in dynamic models. In contrast, rational choice theory studies individual decision making and is used extensively in, among others, game theory and contract theory.
Rational choice theory makes two technical assumptions about individuals’ preferences over alternatives:
- Completeness – for any two alternatives in a set of choices, one of the 2 is preferred, or the individual is indifferent between the choices. In other words, all pairs of alternatives can be compared with each other.
- Transitivity – if alternative a1 is preferred to a2, and alternative a2 is preferred to a3, then a1 is preferred to a3.
Together these two assumptions imply that given a set of exhaustive and exclusive actions to choose from, an individual can rank the elements of this set in terms of his preferences in an internally consistent way (the ranking constitutes a partial ordering), and the set has at least one maximal element.
The preference between two alternatives can be:
- Strict preference occurs when an individual prefers a1 to a2 and does not view them as equally preferred.
- Weak preference implies that individual either strictly prefers a1 over a2 or is indifferent between them. Indifference occurs when an individual neither prefers either of the choices. Since (by completeness) the individual does not refuse a comparison, they must therefore be indifferent in this case.
Additional assumptions are needed for the rational choice theory:
- Perfect information – The simple rational choice model above assumes that the individual has full or perfect information about the alternatives, i.e., the ranking between two alternatives involves no uncertainty.
- Choice under uncertainty – In a richer model that involves uncertainty about the how choices (actions) lead to eventual outcomes, the individual effectively chooses between lotteries, where each lottery induces a different probability distribution over outcomes. The additional assumption of independence of irrelevant alternatives then leads to expected utility theory.
- Inter-temporal choice – when decisions affect choices (such as consumption) at different points in time, the standard method for evaluating alternatives across time involves discounting future pay-offs.
- Limited cognitive ability – identifying and weighing each alternative against every other may take time, effort, and mental capacity. Recognising the cost that these impose or cognitive limitations of individuals gives rise to theories of bounded rationality (e.g. Herbert Simon’s approach).
As we have seen previously (Capital is well-defined), there are no causative economic models and any predictive outcomes are only valid in a narrow, unrealistic framework with no mathematical consistency. Therefore, for rational agents there are no rigorous models for them to “know” let alone assuming every actor is aware of the model. Rational expectations are expected values in the mathematical sense. In order to be able to compute expected values, individuals must know the true economic model, its parameters, and the nature of the stochastic processes that govern its evolution. If these extreme assumptions are violated, individuals simply cannot form rational expectations.
So what exactly is rationality7,8?
Many philosophers deem rationality as instrumental, as goal oriented. A general principle states that rationality is attainable. Its attainability follows from the familiar principle that “ought” implies “can.” Well-established principles of rationality also treat formation of belief and inference. Consistency is a non-controversial requirement. Holding inconsistent beliefs is irrational unless some extenuating factor, such as the difficulty of spotting the inconsistency, provides an excuse. Perceptual beliefs are rational when the processes producing them are reliable. Vision in good light yields reliable judgements about the colours of objects.
Logic describes in meticulous detail patterns of inference that are rational. For example, if one believes a conditional and believes its antecedent, then believing its consequent is a rational conclusion. Repeated application of rules of inference to prove theorems in logic requires sophistication that ordinary rationality does not demand. Rationality requires an ideal agent to believe each and every logical consequence of her or his beliefs. Rationality governs both deductive and inductive inference9,10,11. Principles of statistical reasoning express principles of rational inductive inference.
Herbert Simon12,13 amended the “economic man” postulate to a choosing organism of limited knowledge and ability; on the ground that humans rarely have available the facts, consistent preferences, and reasoning power required by standard decision theory. He contended that human rationality is “bounded” in that it does not require utility maximization or even consistency. Rather, it requires the application of a certain range of personal values (or preferences) to resolve fairly specific problems one faces, in a way that is satisfactory, rather than optimal, for one. Simon thus relies on actual human limitations to constrain his account of rationality.
Duncan K. Foley14 (2003) has also provided an important criticism of the concept of rationality and its role in economics. He argued that:
“Rationality” has played a central role in shaping and establishing the hegemony of contemporary mainstream economics. As the specific claims of robust neoclassicism fade into the history of economic thought, an orientation toward situating explanations of economic phenomena in relation to rationality has increasingly become the touchstone by which mainstream economists identify themselves and recognize each other. This is not so much a question of adherence to any particular conception of rationality, but of taking rationality of individual behaviour as the unquestioned starting point of economic analysis…
People are routinely inconsistent in making choices and processing information. They act from multiple motives without resolved the conﬂicts inherent in them, and these motives often include aspirations, identity issues, and religious values that are impossible to reduce to material consumption. The dis-confirmation of rational choice theory appears to be one of the few really robust results achieved by the human sciences…
In this sense the claim of rationality tends to become the merely tautological claim that any observed behavior can be rationalized in an appropriate model.
Foley (2003) went on to argue that:
The concept of rationality, to use Hegelian language, represents the relations of modern capitalist society one-sidedly. The burden of rational-actor theory is the assertion that ‘naturally’ constituted individuals facing existential conflicts over scarce resources would rationally impose on themselves the institutional structures of modern capitalist society, or something approximating them. But this way of looking at matters systematically neglects the ways in which modern capitalist society and its social relations in fact constitute the ‘rational’, calculating individual. The well-known limitations of rational-actor theory, its static quality, its logical antinomies, its vulnerability to arguments of infinite regress, its failure to develop a progressive concrete research program, can all be traced to this starting-point.
Mistakes in reasoning by supposedly rational beings are extremely common, even by the most studious of minds. A logical fallacy15,16 is a mistake in an argument, that is, a mistake in an instance of reasoning formulated in language. As the term is used in logic, an “argument” is a group of statements one of which is called “the conclusion” and the rest are called “premisses”.
There are many such fallacies17,18, with the vast majority of the commonly identified fallacies involve arguments, although some involve only explanations, or definitions, or other products of reasoning. They can be broken down into formal or informal, deductive or inductive, or fallacies of relevance, fallacies of ambiguity, or fallacies of illegitimate presumption.
You may be tempted to think of yourself as rational, while other beings are more irrational and their introspective reasoning is unreliable19,20. Research into reasoning21 suggests that people use more stringent criteria when they evaluate others’ arguments than when they produce arguments themselves. They are better able to tell valid from invalid arguments when the arguments are someone else’s rather than their own. This selective focus of reasoning shows how people are not rational agents at times when it involves criticising their own world-view.
Given new evidence, people invested in a given perspective shall – when confronted with contrary evidence – expend great effort to justify retaining the challenged perspective. Cognitive dissonance22,23 can be reduced in one of three ways: a) changing existing beliefs, b) adding new beliefs, or c) reducing the importance of the beliefs. It shows that we aim for consistency between attitudes and behaviours, and may not use very rational methods to achieve it.
Memory recall within people is also highly flexible, so information within the brain cannot be relied upon without aides to be accurate24. Memories can be disrupted by things that we experienced earlier (proactive interference) or things that we experienced later (retroactive interference)25. If someone is exposed to new information during the interval between witnessing the event and recalling it, this new information may have marked effects on what they recall. The original memory can be modified, changed or supplemented26. False recall and false recognition frequently occur in many studies27,28, with even direct testing of brain activity unable to reliably differentiate true and false recollections signals29.
People are bad at conceiving and thinking about non-linear systems30. We apply simple linear solutions to complex, interdependent systems and this results in predictable failure modes, famously noted by D. Dorner31. Dorner defines a complex system as possessing the following characteristics:
- Interdependency – components of the system influence one another. Changing one variable changes one or more additional variables, often leading to counter intuitive secondary effects.
- Intransparency – the system contains unknown elements and relationships. We are unable to fully understand all aspects of the system at a given time.
- Temporally dynamic – systems change and evolve over time.
Humans have a strong tendency to guard their opinion of their own competence in acting. Some logical planning behaviour can be used to give flexibility in providing better strategies, like risk analysis.
This deviation from the rational actor concocted by economists, is due to humans deploying mental short-cuts to make sense of the world around them. Heuristics32 play a massive part in most animal’s brain processes to aide chances of survival and create a model of the outside world and it’s relations to the world and other beings. They are simple decision algorithms that ignore information.
The gaze heuristic is the simplest one and works for humans if an object is already high up in the air: Fix your gaze on an object, start moving, and adjust your speed so that the angle of gaze remains constant. A person who relies on the gaze heuristic can ignore all causal variables necessary to compute the trajectory of the object – the initial distance, velocity, angle, air resistance, speed and direction of wind, and spin, among others. By paying attention to only one variable, the person will end up where the ball comes down without computing the exact spot. The same heuristic is also used by animal species for catching prey and for intercepting potential mates.
In some cases, less-is-more33,34 in terms of the internal model produced avoiding over-fitting35 of the known data, if data is sparse. Over-fitted models have high goodness of fit but low generalization performance, i.e. increased variance within the equation for prediction error: Total error = (bias)^2 +variance+noise. Though if full-information models are used with appropriate caution placed on the training set inductive bias, then these outperform heuristics. People usually make decisions that they deem ‘good enough’, trading accuracy for less effort spent on a problem with what available information they have. This gives rise to a large range of cognitive biases that ensure that humans are irrational in most situations – though evolutionary satisfactory for the survival of the species. Even if the underlying models predicted by capitalist thinkers were based on some evidence-based validity, expecting all humans to act and interact consistent with the model assumptions would be wishful thinking.
The themes on what constitutes reality and how to interpret empirical data, is constantly debated. Not least in the discussion of the differences between frequentist and Bayesian inference in statistics36-39, which are at the heart of scientific publications. In frequentist statistics, the parameters are fixed (null hypothesis assumed true) and the data considered variable (one sample from a hypothetically infinite sample possibilities), whereas, in Bayesian statistics, the parameters are variable and the data is considered constant or fixed.
Due to the capitalist paradigm, research will often not be published in journals if a result is not statistically significant and hence funding reduced. A research finding40 is less likely to be true when the studies conducted in a field are smaller; when effect sizes are smaller; when there is a greater number and lesser preselection of tested relationships; where there is greater flexibility in designs, definitions, outcomes, and analytical modes; when there is greater financial and other interest and prejudice; and when more teams are involved in a scientific field in chase of statistical significance. Simulations show that for most study designs and settings, it is more likely for a research claim to be false than true. Moreover, for many current scientific fields, claimed research findings may often be simply accurate measures of the prevailing bias.
There are even questions on whether consciousness itself is an illusion41-45.
Nietzsche’s 4 Great Errors46,47 mirror the heuristics point of view, that people take a simplistic explanation as better than none. As your brain creates dreams during sleep to create a viable and consistent fabrication of reality that explains physiological events occurring during slumber; so too during waking hours the representations which were produced in reaction to certain stimulus have been misinterpreted as its causes. Nietzsche’s program of a “revaluation of all values” seeks to deny the concept of “human accountability,” which, he argues, was an invention of religious figures to hold power over mankind. “Men were considered “free” only so that they might be considered guilty – could be judged and punished: consequently, every act had to be considered as willed, and the origin of every act had to be considered as lying within the consciousness”. Instead, Nietzsche attributes behaviours to internal physiological states.
Max Stirner48 also highlights how fixed ideas (spooks) permeate the brains of humans even the concept of the ‘truth’. Phantasms of the mind (e.g. God, nationality, state, money) often possess a being and the phantasms become the basis of their outlook on life and their decisions. It can be easier for someone to become possessed by a fixed idea rather than trying to rationally decipher the world and act in a fluid calculating way that benefits themselves.
In summary, people can be viewed as rationalising entities, not rational agents. Where an incomplete view of the world is concocted inside their heads and therefore the old economic view of the world can be discarded, or at least revised immensely. Even overlooking the absurdity of a system based on obtaining and using tokens of negligible use value (money) as the basis of all human life, the assumptions that the capitalist system uses are completely flawed and based entirely on faith.