Over at Crooked Timber, we’ve had various versions of the case for and against the use of (micro)economic rational actor models in the social sciences lately, so I thought I would weigh in with my version of the case against. It has three main elements
First, most rational actor models assume that “rationality” can be represented as “maximization of self-interest”. This assumption is either false or vacuous. Those committed to egoistic rationality tend, when challenged, to oscillate between falsehood and vacuity, in much the manner of the function sin (1/x) as x approaches zero.
A very good example arises with voting. In this 1987 paper pointing out the empirical weakness of rational actor models, I observed out that, while egoistic rationalists will not vote (or rather will vote only in very small numbers), quite a limited amount of altruism suffices to making voting rational. Andrew Gelman made the same point more recently.
Second, the fact that egoistic rationality assumptions work well in a lot of microeconomic applications proves little or nothing about their viability in other contexts; these include macroeconomics as well as sociology, political science and other targets of microeconomic imperialism. Abstractions that work well in one context don’t work well in another. In particular, deviations from given assumptions that roughly cancel out locally may nonetheless be significant in the aggregate. I conjecture that something like this underlies the notion of emergent phenomena, beloved of critics of reductionism in general.
Finally, game theory is much more problematic than is commonly realised. To derive a Nash equilibrium, it is necessary to define the strategy space. In real games this is not a problem. In social, economic and political operations, however, it requires that the participants have shared understandings of the problem, accessible to the modeller. In practice this is hardly ever true, and game theoretic analyses typically proceed with an essentially arbitrary assignment of strategies to players Harold & Kumar Go to White Castle release
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John Quiggin 
The ultimatum game is a good example where humans behaviour (as observed in experiments) is quite different to the rational egoist Nash behaviour (the subgame perfect equilibrium).
Most rational actor models end up with the conclusion that state intervention in market (such as budget deficits, lower interest rates) are useless because people see through the charade.
But people apparently aren’t fully rational.
So the state is needed to clean up the market.
But what if the regulators and the state are as dumb as the market?
Add another regulator is the answer from the state (see Obama’s “cure” for the financial markets).
But then who regulates the regulators who regulate the regulators?
It’s turtles all the way down for Keynesians and Statists of all stripes.
Market actors aren’t rational, but do a damn-side better job than the dumbest of the dumb – academics and government bureaucrats. And worst of all – blind fractional reserve bwankers.
Debates like this would not be necessary if it was accepted in economics that theoretical models which make predictions that differ from experimental result and empirical observation are wrong.
I know it sounds a bit radical, but its worked quite well in astronomy, biology, physics, chemistry, geology…
Is it asking too much for economics to move into the 17th century ?
If economists love their models more than a correlation to reality perhaps they would be better off being absorbed into the mathematics, or even philosophy departments. I know I’m being a bit more than tongue in cheek here, to the point of being offensive. But economists now expect to have a say in just about any aspect of public policy and are offended if their advice is dismissed. I for one am a bit tired of having decisions made that significantly affect my life by members of a profession that is arguably closer to astrology than astronomy in its level of intellectual discipline. If economics cannot substantically prove that the intellectual framework it depends on is a good proxy for reality then why should anyone be listening ? Its not good enough.
I sometimes wonder if in future decades or centuries when social science in general has reached a serious stage of development that our descendants will look back on the relationship between economics and public policy in the 20th and 21st centuries the way we look at medieval kings turning to their astrologers and court witches for advice. Is it really all that much different ?
Astrology at least occasionally gets predictions right by sheer blind chance, and it’s fun to read.
Economists have a remarkable ability to get nearly 95% of their predictions wrong (which is a talent in and of itself) and their cures are generally worse than the disease.
Personal attack deleted – nothing more like this, please.
Do you have any kind of reliable evidence for this wild assertion? The typical justification for this kind of sweeping statement is a gut feeling and a selection of cherry-picked examples, aka (loosely), a personal psychological history and confirmation bias. Do you ever think it’s a little weird how apparently intelligent people can take completely opposing positions on this type of question? I do. Show me the analysis.
If you really wanted a good answer you’d start compiling a comprehensive list of successes and failures: what markets, what actors, what circumstances and try to derive some reality-based analysis, rather that one-size-fits-all feels-right-to-me generalisation. Of course, there are a couple of problems with this approach that really reduce it’s attractiveness: firstly, it’s a hell of a lot of work, and self-effacing work at that, and secondly, simple emotionally-resonant statements just feel better. We’re all “gisters” – we love that “I know what this is all about” feeling but reality is typically more complex.
Q4, 2008, caused by (1) ridiculous value-at-risk models developed by Black-Scholes and (2) insane low interest rates from the Monopolist Of Them All, The Federal Reserve.
The Fed has nothing to do with “the market” (as Tom Woods points out in Meltdown) and it hates competition. The fiat currency monopolists will kill (metaphorically) anyone seeking payment in gold or silver. History has proven this time and again.
The most stable international monetary system was based on gold. The most unstable on govt-controlled fiat currencies.
QED.
What other evidence do you need?
Jim, do you have any evidence to the contrary (that academics and bureaucrats do at least as good a job as market actors)?
“The typical justification for this kind of sweeping statement is a gut feeling and a selection of cherry-picked examples, aka (loosely), a personal psychological history and confirmation bias.”
So where is the evidence that supporters of free markets and limited government are more susceptible to these types of biases and psychological quirks? Have there been studies done by psychologists? Can you reference any? Or is it merely a gut suspicion of yours?
Jim?
The state eventually ends up existing for itself. All bureaucrats around the whole shuffle paper from one side of their desk to the other and think they are doing such great work the diasters they cause require them grow their departments even more, and either tax the suckers to pay for them or borrow the money from our children for their little empire to grow.
Until it all collapses under the collective weight of the parasites. Which is where the US is right now – and we will be in 15 years’ time.
Well MU, for example, about 80% of small business startups fail. If you get advice from the government or the advice of people who actually study business you do significantly better. I’m certainly not trying to argue that governments always make better decisions – clearly they have their own problems – but it’s not a black and white situation. I’m actually agnostic so support a case-by-case analysis in the public v private debate. What kind of annoys me is the fact that people willing to make doctrinaire and emotional statements just dumb down the debate.
It is black and white when it comes to money. Free market money works. Fiat money enforced by govt never does (at least in the long run).
You need some guiding principles because if you wanted a statistically verifiable case for every argument you’d be dead before you did anything.
You know ABOM – part of what you say is right. Here is Howard extending gold pass free airline travel to any retired MP resulting in some pathetic MPs travelling twice a week for years after a five months stint as a pollie.
Do I hear any resounding sounds from the Rudd government they will reduce it? No!! Its pathetic. We hear Tony Abott saying kick the people on welfare but I bet he wants his JH gold airline pass when he retires as well. In these sort of rorts – you are right – it doesnt matter what side it is. They both do it.
When they get these ridiculous benefits they are ripping off Australian taxpayers and they think they are worth it. Its unethical, indecent and no better than the scandals that erupted in the UK. They should all get off the damn gravy train because the ordinary man pays for their excess, the ordinary man who is facing rampant higher unemployment abnd who is astonished at the excess. Vote to detsabilise is all I suggest. Both major parties are way too comfortable with indecent pecuniary benefits…parasites on the public purse.
There is a large and growing body of evidence that shows rational actors should not be used but we face the problem of how to model markets when the actors are not rational. Personally, I think that rational actors might be a good way as a start in teaching students about micro but we should move beyond this because the theory is obviously flawed.
Alice, 100% of what I’m saying is right.
And what part of “let’s elope” don’t you agree with?
Nothing at all ABOM.
My bag is packed and Im waiting!. Throw in the MacAllens, the boardshorts and a brick or two and Ill bring my paperweights (well…pebbles anyway). The plane fares are very cheap right now – we dont even need a gold pass…lets just go and leave the madness behind.
My silver wouldn’t fit on the plane unfortunately.
Alice, or my silver…hmmmmmmmm
Only joking! 🙂
Once I get enough gold accumulated I’ll call you and we’ll be off in a flash!
SWIO @ 3: “Debates like this would not be necessary if it was accepted in economics that theoretical models which make predictions that differ from experimental result and empirical observation are wrong.
I know it sounds a bit radical, but its worked quite well in astronomy, biology, physics, chemistry, geology…”
Oh dear oh dear, it isn’t radical as much as it is silly – as least as silly as microeconomic imperialism (an apt term if I may say).
The silliness of treating economics as a natural science arises from the observation that, in contrast to natural science, economic systems depend on philosophyical ideas – moral philosphy – (underlying ‘culture’). Micro-economic imperialism is equally silly in the sense that a very narrow specific set of theoretical results that emerged during a particular period in the intellectual history of humans is taken as the gospel, ignoring both, the conditionality on philosophical ideas and, worse still, theoretical results where the micro (single actor) problem is treated simultaneously with the aggregation (ie on the society level).
But, at least in my mind, economics does intersect with natural science in the sense that the philosophical questions are confined to the ‘material welfare’ of humans.
Apologies in advance for typographical errors – I still haven’t got glasses.
JQ
I agree that the “rational actor” model is a dead loss particularly in the context of a democracy. It is not that the voters in a democracy don’t get a say, but that the mechanics of democracy expresses the irrationality of voters. In other words a democracy does generally express the popular vote but those damn voters are irrational. We need more smart independent intellectuals to educate the voters. I think this subject is important if we want to achieve a worthwhile democracy.
Alice, one obvious cure to the politicians’ perks problem is to fund them with a hypothecated tax on current politicians, with the remunerations of those being set independently.
I see, the judgement on who is rational is to be left to Ubiquity.
Why is it that societies with compulsory voting, like Australia, seem to have less extreme outcomes than other societies? Could it be that those labelled ‘irrational’ by, say Ubiquity, provide enough well diversified private information input into the political process so as to at least take off the hard edges of the committed tribes?
@swio
I really liked your comment and the post of Quiggin. Swio, Can you please just answer my question: are you an economist? Because the real impressive thing to me is that despite the failures, young economists are becoming less and less critical. And this is the consequence of the system of incentives. In my University/Deaprtment the chair (a famous economist in line for the Nobel..) made it clear that in order to get a tenure we have to publish in a few “qualified” journals and that to publish there the thing we needed was to “get to know the editors and possibly the future reviewers”. Cleraly, whoever controls these few journals control my career. How will it ever change then?
@Ernestine Gross
or it could be that the committed tribes are evenly balanced and the uncommitted provide noise such that the outcomes vary either side of ‘commitment’
Pm says
“Alice, one obvious cure to the politicians’ perks problem is to fund them with a hypothecated tax on current politicians, with the remunerations of those being set independently”
PM – if we did that…watch the perks shrink to a respectable size. Thats the trouble…they are not funded by a tax on incumbents (in other words let them make contrutions in the here and now to their perks later and we would soon see how much they dont need those perks.)
nanks @ 22, Not sure you have an “OR”.
Ernestine Gross #20
“I see, the judgement on who is rational is to be left to Ubiquity.”
I am humbled but I am not the chosen one …
OK perhaps I deserved your more than subtle ridicule as a result of my very general sweeping statement. So to restate my point without implying all voters are irrational I am just more pessimistic about public opinion. The general public is inflicted with deep seated biased beliefs about economics. For example that protectionsim raises living standards…… and the only way politicans can remain in power is to preach in the public interest (but serve the special interest).
I think gentelman like JQ play an important role in providing a medium for dissemination of valuable economic ideas to the public. We then are more likley to have a better informed public and a better democracy. You can’t rely on the sophist like tactics of politicans.
Democracy in principle is OK but more than often fails to deliver because voters views are irrational and influential.
Ubiquity @25,
I fully concur that Prof Quiggin’s writings on his blog site and elsewhere is a public good (dissemination of ideas about economics and politics)with the possible benefit of “a better informed public and a better democrarcy”.
Please demonstrate, in a rational (logical) fashion, how your paragraph, “Democracy in principle is OK but more than often fails to deliver because voters views are irrational and influential”, follows from your preceeding paragraphs.
Ernestine @26
I will entertain your comment and disregard its derogatory undertones:
First Ernestine,a democracy, to steal the definition is” the political orientation of those who favor government by the people or by their elected representatives”.
I will expand on the definition of irrational in this case is the “rationally ignorant economic actor who discounts information according to its reliability”
Uncritically swallowing empty promises is stupidity not ignorance.
Furthermore, you would agree voters are “influential” in a democracy. Consider it an axiom. Further we could say the government is influenced by the peoples voting power as to what policies it implements.
In my opinion Democracy “in principle is OK”. It provides a mechanism by which the state is accountable. The state is accountable to the those who vote, the people.
So all that needs to be shown is that policies implemented by the state are irrational. If I can show this then I can clearly draw a conclusion that the people (voters) are irrational at least in the economic sense that I have alluded to in my above comments.
I used “protectionism” as an example of irrational economic policy. There are many examples of this and in the current economic climate is back on the economic agenda.
http://www.abc.net.au/news/stories/2009/07/02/2615375.htm
I will stop here as I am sure we quite easily could disagree and perhaps agree on at least half a dozen other economic policies, which is not the topic on this thread. Suffice to say the debate in the wider public sphere is important and gentelman of Mr Quiggin calliber should facilitate this debate on either side of the political spectrum to minimise the effect of the irrationally ignorant economic actor.
@swio
Ummm… you don’t know much about empirical social science, do you? The standard of the data is so poor, as are the experiments, that you cannot disprove in the way you can with physics. This is why there is so much theory in economics.
Incedently, astronomy also does not have experiments.
Gradstudent, please read the comments policy and avoid gratuitous snark in future. Apart from anything else you are wide open to a spelling snark. This probably means, according to the laws governing such things, that I have mis-spelt something myself, but there you go.
In reply to Ubiquity @27 but without being constrained by his perceptions, I’d like to say a few words on:Individual agent rationality and international trade.
I propose: It is irrational for an individual agent (person) to vote for a ‘free trade’ policy if he or she does not get a share of the gains from trade (assuming they exist) for most of his life. I note that the self-interest is not necessarily of the egoistic type (eg elementary micro-economics) but may include altruistic preferences in the sense that the agent’s choices takes into account the material welfare of a subset of all people (eg children, relatives, the ‘poor’ somewhere in the world).
The foregoing is not meant to be support for ‘protectionism’ – an ism word which IMO signals dogmatism – but rather a call for a more equitable distribution of gains from trade (assuming they exist) among people in this world.