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Economic rationalism

June 13th, 2003

My Wednesday post on the term ‘rational’ has brought forward some discussion of the term ‘economic rationalism’, which is now most commonly used in a pejorative . One commentator voiced the widely held assumption that the term was coined by Michael Pusey. In reality, the term was used, mostly positively for about 20 years before Pusey wrote Economic Rationalism. And although the term evolved gradually, the person who did most to popularise it was Gough Whitlam. The history of this phrase tells us a lot about the evolution of the economic policy debate in Australia. Read on for a piece I wrote in 1997, describing this history.

Although used much earlier by sociologists and social historians, the term ‘economic rationalism’ first entered the Australian lexicon in the 1970s. When the Whitlam government came to power, related formations such as ‘economically rational’ were used to describe the arguments of the group in the Labor Party, including Whitlam himself, who sought reductions in protective tariffs and agricultural price support schemes. By implication, opposing claims were regarded economically irrational. A little later, the term ‘economic rationalists’ was used to describe the supporters of free trade within the Labor government. This was a first step on the path by which the term radically changed its meaning.

Whatever the origin of the term, it has evolved a great deal since the 1970s. ‘Economic rationalism’ then referred to policy formulation on the basis of reasoned analysis, as opposed to tradition, emotion and self-interest. With the exception of support for free trade, there was no presumption in favour of particular policy positions. The views of the first generation of economic rationalists were generally in the economic mainstream of the period — Keynesian in macro terms and supportive of the ‘mixed economy’ in micro terms.

During the period of the Fraser and Hawke governments, both the intellectual character and the theoretical and policy content of economic rationalism changed. The critical and sceptical thinking that characterised the first phase of economic rationalism was gradually replaced by a dogmatic, indeed, quasi-religious, faith in market forces and the private sector. More and more, economic analysis was based on deductions from supposedly self-evident truths, which were effectively immune from any form of empirical testing. Many of the beliefs that are now central to ‘economic rationalism’ would have been regarded as irrational prejudices by the first generation of economic rationalists.

By the 1980s, economic rationalists had largely adopted the microeconomic views of the Chicago school, rejecting ideas of market failure in favour of the belief that the simple neoclassical model of perfect competition was a good description of the economy, or would be in the absence of undesirable government intervention. A variety of arguments were used to show that most market failures were unimportant or self-correcting. At the same time, the public choice theory of politics was used to introduce the idea of ‘government failure’. It was argued that, because of the systematic distortion of the policy process by interest groups, the costs of government intervention were greater than the costs of the market imperfections that government policies were supposed to remedy.

The evolution of economic rationalist attitudes towards the public sector followed a similar path. Mainstream economics provides a range of arguments for and against government intervention in particular cases. Consistently arguing against government intervention, economic rationalists came to rely on the view, naturally popular in the business sector, that private enterprise is inherently superior to government action. This view was reinforced in the 1980s by the perceived success of the ‘Thatcher revolution’ in the United Kingdom, and by the apparent dynamism of private sector entrepreneurs like Bond and Skase.

Nevertheless, the ambiguity surrounding the term ‘economic rationalism’ persisted. A survey of academic economists (Anderson and Harris 1996) revealed general agreement concerning the set of policies that constituted the program of ‘economic rationalism’. However, while those who identified themselves as opponents of economic rationalism agreed that economic rationalism involved strict opposition to government intervention and a belief in the inherent superiority of private enterprise, there was disagreement among those who regarded themselves as economic rationalists. Some ‘hard-line hawks’ agreed with the view that economic rationalism implied support for laissez-faire, but others adhered to the older definition, claiming that economic rationalism was nothing more than the application of mainstream economics to policy issues.

These ambiguities were exploited by some defenders of economic rationalism, such as James, Jones and Norton (1993), when their policy program came under attack during the 1989-90 recession. When responding to critics such as Pusey (1991), Toohey (1994) and Langmore and Quiggin (1994), they claimed that economic rationalism merely means policy formulation based on rational economic analysis, which, presumably, no-one could disagree with. The rest of the time, they assumed that economic rationalism implies support for radical free-market reform.

The style of argument adopted by economic rationalists is well illustrated by Parkin, who says:

Achieving a redistribution of income and wealth by taxing incomes is inferior to taxing expenditures while taxing capital income is the least efficient of all. Progressive taxes are also highly inefficient. These are not statements of opinion. They are fact.

I assume that what Parkin means is that these propositions may be derived as logical deductions from an economic model based on the assumption that individuals, with no inherited wealth and facing perfect labour and capital markets, rationally optimise their lifetime work and consumption patterns. Even with these assumptions, I do not think Parkin’s claim that the optimal tax schedule is linear rather than progressive is justified. It is a matter of fact that the assumptions underlying the life-cycle model are not exactly satisfied in reality. Contrary to Parkin’s assertion, it is a matter of opinion whether the differences between reality and the model are sufficient to invalidate the policy conclusions derived from the model. But the use of dogmatic assertion, and the claim that anyone who holds contrary views is not a real economist, are standard features of economic rationalist rhetoric.

Despite these rhetorical manoeuvres, ‘economic rationalism’ became a primarily pejorative term in the 1990s. In part, this change arose because economic rationalists, who now dominated the main economic policy-making institutions, found it less necessary to justify their views in public debate, and therefore less useful to identify themselves as members of a school of thought. The shift also reflected a substantive change in the policy debate as it became evident that radical free-market reforms had failed to deliver the promised benefits. (The jury is still out on whether any net benefits have been realised. On the whole the evidence suggests that microeconomic reform has yielded modest benefits in Australia, but that the unconstrained dominance of economic rationalism in New Zealand has led to consistently poor outcomes.)

In philosophical terms, the opposite of rationalism is not irrationalism but empiricism, that is, a willingness to form beliefs on the basis of experience rather than from a priori deduction. Empirical evidence never yields the dogmatic certainty that accompanies logical deduction. I interpret the economic experience of the last two centuries to show that an unregulated market economy is inherently unstable and that a mixed economy, with an appropriate allocation of productive activity between the public and private sectors yields outcomes superior to those generated by either of the polar alternatives – laissez-faire capitalism and comprehensive socialism. Others, particularly those who focus on the strong performance of the US economy the last decade, have drawn conclusions more favourable to the market economy.

Empiricism is consistent with an approach to policy-making based on willingness to adjust the role of the public sector in the light of new experience and of innovations in technology and policy design. Such an approach is more rational than economic rationalism.

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  1. cs
    June 13th, 2003 at 21:16 | #1

    Wonderfull discusion John. It seems that there are two very closely related stories. On the one hand, we have economic reasoning (including the presumptions of those who presume that particular species of this reasoning is the only permissable reasoning); on the other hand, we have the specific history of the popular Australian movement against economic rationalism; which has led to the term’s pejorative connotations. The precise relationship and interaction between the two stories is perhaps the hardest trick.

  2. June 14th, 2003 at 00:10 | #2

    I have to say John, for an economist, your essays are suprisingly easy to read.

    Have you had any involvement in educational texts? Some of the stuff we get recommended reads more like Shakespeare than Quiggin. I could do with an excuse to go to the library…

  3. June 14th, 2003 at 02:33 | #3

    I agree with cs, this is an excellent article. Anyhow, I have a minor tic about your use of the word “empiricism”.

    Here’s an analogy commonly attributed to Francis Bacon: rationalism is like a spider, and empiricism is like an ant. According to Bacon, one should avoid behaving “like either the ant, who collects sticks to create a pile of sticks, or the spider, who spins its web entirely out of its own substance. Instead, scientists should emulate the bee, who collects pollen and combines it with her own substance to create honey.”

    You are apparently using “empiricism” in a common sense of the term but it’s worthwhile to note that “empiricism” is famous for mistaken ideas such as the tabula rasa (the mind is a blank slate), positivism (aka logical empiricism), emotivism, and radical behaviorism (see google for definitions and history).

    Empiricism and Rationalism are not themselves substantive doctrines, but rather locii of similar attitudes and positions, so the demarcation is a bit “fuzzy”. Although the resemblance between “economic rationalism” and “philosophical rationalism” is probably tenuous at best (via discussion at http://www.abc.net.au/money/currency/features/feat11.htm )

  4. June 14th, 2003 at 03:52 | #4

    Theory without evidence is hollow.
    Evidence without theory is blind.
    Or some such Kantian antimony.

    It is certain that economic rationalist theory is good, but only as far as it goes.
    An ounce of history is worth a pound of theory.
    To be fair to the liberal neo-classical school, they have shown a philosophical leaning towards empiricism, the locus classicus being the methodology of positive economics .
    But they usually wind up massaging the evidence to fit the theory, or ignoring naughty evidence (misbehaving parameters).
    If you want a real hard core dose of rationalism, try Austrian economics, I hear Pr Q has already copped a blast from these apostles of reason.
    The axiomatic-deductive method rationalises all human action according to the principles of human nature – no controlling evidence required.
    The real problem with economic rationalism is not dodgy models or ignored/interpreted evidence, it is crooked nature of man and society:
    the same societies may not fit the model through different times
    different societies may not fit the model accross a variety of spaces
    A given economy evolves through stages of development, & is more/less efficient for different times.
    Thus the US prospered under a heavy socialist command economy in the forties, but paupered under lighter socialistic measures in the seventies.

    The same economic system brings different results to different socio-biological groups, for a given time.
    Free enterprise is working very well in the North America and East Asia, but tanking in Russia.
    Socialistic measures seem to work well enough in practice (if not in theory) in Scandanavia
    Nothing seems to work very well at all in Latin America (yet still they muddle through).

    The problem seems to have been solved by the economic rationalists through the simple expedient of
    making the real economy resemble the ideal model!
    This is rather like the communist trade unionist who makes industrial relations resemble the marxist economic theory of class struggle by constantly provoking industrial conflict and strikes.

    Still, it may be that we need a dose of bracing competition for our own good, a bit of contrived Darwinism to bring out the best, and pronto. The trouble with rational welfare maximisation is that it leads to equilibrium and stagnation. Economic growth and dynamism creates unhappiness -which is irrational (ask Saudis or a Buddhist).
    Yet it is the fastest and most effective way to learn more, work smarter relieve man’s estate.

  5. June 14th, 2003 at 06:08 | #5

    Yeah, I think Jack wrote most of my current textbooks.

  6. derrida derider
    June 14th, 2003 at 21:27 | #6

    I’m no economic rationalist in the terms used above, but let me put in a word for them.

    Anybody who saw first-hand, as I did, the state of the industrial museums and sheltered workshops that passed for Australian manufacturing and Australian quangos in the late 1970s was entitled to think there had to be a better way. And those caring academics, union bureaucrats and secondary school teachers that formed the backbone of the centre-left (and still do) were to the forefront of the resistance to any change in them

    I can’t help noticing, BTW, the number of supposedly progressive people who seem to yearn for the economic and social “stability” of the 1950s (a fairly mythical stability, BTW) – Peter Botsman comes to mind. There are many true conservatives on the left.

    The term ‘economic rationalism’ has long since ceased to carry any real meaning – people use the term the way Jo B.P. used to use the term ‘socialist’ – as a slogan to avoid actually having to think about the specific proposal at hand (the implied syllogism seems to be “the person proposing that is an ecorat/socialist. Ecorats/socialists are wicked. Therefore that proposal is wicked.”)

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