WHAT YOUR GRANDMOTHER DOES NOT KNOW ABOUT RATIONALITY

First Published on Irrational Beauty

Let's start with an exercise: Ask your grandmother (or your mother, your father or that uncle living in the countryside), which separates the human species from other animals.

I could bet with you that her answer will gravitate between 2 concepts:

·  God (whatever her God) made Men with the ability to think.

or

·  We evolved and we are capable of being rational.

Although from completely different philosophical points of view, both responses point in the same direction: We are different because we are rational!

Well, if you are minimally literate in the latest discoveries of so-called Behavioral Science, you view this conclusion with a certain discomfort, correct?

This wonderful multidisciplinary effort of economists, sociologists, and psychologists , known as behavioral science , has rocked some things we took for granted about human behavior and about how we make decisions.

And one of the findings of behavioral economics [i] that perhaps more bother the more traditional economists and has generated criticism at various levels may be the idea that we, humans, are not rational when dealing with choices, at least not at all times. [ii]

It seems rather small, but the idea that we are rational always, however, is one of the bases of so-called mainstream economic theory [iii], of which virtually whole microeconomic theory of consumer choice depends on (CALDAS, 2003) .

Thus , as the microeconomic theory of firm’s choice and neoclassical macroeconomics [iv] can be understood as extrapolations of consumer theory [v], we can say that possibly all models and economic analyzes already made based on these premises should be, at least,  revisited (CARDOSO, 2008).

Since behavioral economics is a multidisciplinary field, it is common for researchers and enthusiasts, especially in areas other than economics, to have a harder time understanding what the economist understands by rationality.

The purpose of this essay is to briefly discuss the basis of what is meant by rationality in the mainstream economy and to point out the impacts that a break in the premise of maximizing rationality can bring to economic science.

And Rationality is born

The model of maximizing rationality of agents was established in the neoclassical research program, [(CALDAS, 2003, pp 4) and (AUGUSTO, 2009, pp. 1).

This premise pervades in most of neoclassical developments and for this reason it is believed to be one of its basic postulates. Then, in this section, discuss the concept of maximizing rationality, the axiom of ergodicity, and its implications for the structure of theory.

It was said above that the rationality attributed to the agents in the neoclassical theoretical body is the maximizer. In this case, we remain to clarify maximizer of what.

At the neoclassical level, agents are Utility maximizers (ISLA, 2000, pp 348). In general, we can say that the agent, in all his choices, will try to optimize an objective function (which may be the utility function, profit function, total cost function, etc.), given certain constraints such as information stock and previous allocations (ISLA, 2000, pp 348).

Jeremy Bentham, in his work of 1789 [vi] , already enunciates the Principle of Utility . For Bentham, all actions [vii] are commanded by relativizations between pleasure and pain generated as a consequence of those.

In short, the aim of every man would be to seek, incessantly, the maximization of his happiness [viii], or rather its utility, once happiness is the consequence of this (BENTHAM, [1789] 1979, pp . 3) .

The utility, in this author, is seen as an intrinsic attribute of things. It would be the property that the object has to provide pleasure or decrease pain (BENTHAM, [1789] 1979, pp . 4) . Bentham proposes a whole legal system based on this principle, where each state action should seek to maximize the utility of the collectivity.

The author even proposes a method of measuring the Utility generated by each act (BENTHAM, [1789] 1979, Chapter IV).

John Stuart Mill deepens the thinking of Bentham, introducing the question more firmly into English moral philosophy of the early nineteenth century (SANTIAGO, 2003, pp. 7 and 8).

With the emergence of neoclassical thinking in the late nineteenth century, the rational-maximizing paradigm plays the central role in economic studies (JEVONS, [1871] 1983, pp . 47) .

A Bit of Formal Boredom

Before continuing this development, it is worth pausing briefly and analyzing the possible interpretations made by economists of the concept of rationality.

The rationality of the maximizing agent could be interpreted by the Rationality Principle or by the Rationality Hypothesis  (VANBERG, 2004, pp . 2) .

The Rationality Principle , in Vanberg's proposition, considers the interpretations that the agent is always rational , considering at the time of choice the set of preferences and beliefs that he possesses at that moment.

It would refer to the "local" subjective consistency of human action. "Local" in the sense that it refers solely to the preferences and beliefs of the agent at the time of choice (VANBERG, 2004, pp . 2) .

For example, it would be rational, according to this principle, if the agent, in a moment of anger, would commit an act of violence that would condemn him to death if he were judged by the judicial system.

Although in the long term, the total Utility of this agent would be impaired (he would die sooner than expected), at the time of the act of violence he maximized his satisfaction because he considered only the anger that dominated him.

The Rationality Principle would not be empirically verifiable, since, being a choice possible, it will necessarily be in accordance with the person's preferences and beliefs at the moment, considering that the person has good mental health (CALDAS, 2003, p. 6 and 7).

By the same reasoning, it can be deduced that this principle, by the Popperian paradigm [ix] , would not be scientific, since it cannot be refuted (CALDAS, 2003, pp. 6 and 7) . Thus, the Rationality Principle could not compose the body of propositions of economic science (VANBERG, 2004, pp . 3).

On the other hand, Rationality Hypothesis  would refer to the interpretations that the agent considers not only his beliefs and preferences at the moment of the decision to make a choice, but rather his beliefs and preferences as a whole, those that are maintained over time , that is, the agent considers his whole system of beliefs and preferences when making any choice (VANBERG, 2004, pp . 3) .

In our previous example, let us now assume that the agent, dominated by anger, considered the preference not to go to jail, or the preference of not to be sentenced to death on account of a serious crime, or the belief that one should not attempt against another human being and decide not to commit the act of violence.

In this case, it would be maximizing its Utility because it would not be relativizing only the beliefs and preferences directly linked to the decision to commit the act of violence or not, but rather its system of beliefs and preferences as a whole. The "local" subjective consistency is abandoned for "global" consistency (VANBERG, 2004, pp 4).

The Rationality Hypothesis is therefore empirically verifiable, given that given the set of possible choices and constraints, the agent can make a choice that does not maximize his utility , given his system of beliefs and preferences, and is thus irrational such choice (VANBERG, 2004, pp . 3) . It is also scientific by the Popperian paradigm, since it accepts refutation (CALDAS, 2003, pp. 4 and 5) .

Neoclassical Consumer Theory interprets human behavior by the Rationality Hypothesis .

The basis of this theory lies in the acceptance of the proposition that each consumer has a utility curve [x] which contains all your preferences and which should be maximized [xi] .

In this way, each choice of the economic decision maker is in accordance with its system of beliefs and preferences (CALDAS, 2003, pp. 7 and 8).

I'm Rational, Therefore I am

Rationality can be formally defined as the quality of human conduct that is directed towards an end (FERREIRA, 2004, p. Entry: "rationality"). Thus, we can conclude that every action that looks at a purpose is rational (MISES, [1966] 1990, pp. 30-33).

Irrational would be a reflex or a flawed act, that is, something not deliberate (MISES, [1966] 1990, pp 33). For the formulators of these ideas, in the middle of the nineteenth century, it was impossible to know for sure the mental processes that lead the agent to define such ends.

The human being, as economic decision-maker, would be a "black box" (ISLA, 2000, pp . 348) .

Neoclassical economics does not bother to criticize the preferences of agents. It is neither more nor less rational for neoclassical theory that an individual prefers to drink whiskey instead of water only because it is proved that the former brings more harm to health than the latter.

Provided that such choice is in accordance with the individual's preference system [xii] it will always be rational (MISES, [1966] 1990, pp. 31 and 31) .

If, for example, the act of being suicidal is seen consciously and consistently by the individual as being favorable to his satisfaction, considering his system of preferences and beliefs, then even this act is rational.

That said, it is useless to discuss the rationality or irrationality of decisions that define objectives or preferences, since they will always be rational, from this point of view (MISES, [1966] 1990, pp . 30).

Rationality in neoclassical economics is concerned with the means that individuals choose to achieve their goals. The objectives are thus considered as data (MISES, [1966] 1990, pp 34).

On this basis, we can reorganize our concept of rationality, specifying it a little more.

Rational action (or decision) is one that uses existing means in the most efficient and consistent way possible, targeting a specific and predetermined goal, that is, in which there is perfect coherence between means and ends (AUGUSTO, 2009, pp . 2) .

I need to stress that it is not claimed that the action will necessarily reach your goal. There is always the possibility that the action fails to achieve its purpose. However, even so, it is still rational (MISES, [1966] 1990, pp . 32).

The individual can choose between different means to achieve the same goal.

Some consumer can choose between different goods that satisfy his needs; the firm can choose between different technologies that produce the same amount of product.

As such, individuals will always choose the medium that is most efficient [xiii], given the assumption that resources are scarce. (AUGUSTO, 2009, pp . 2).

The decision maker (consumer, for example) will prefer to choose the medium (goods, to satisfy his need) that is less scarce (has a lower price) and will use it in the most efficient way, thus doing the least waste (AUGUSTO, 2009, pp 2) .

The Black Box of Rationality

In front this exposition, one can perceive that there are three characteristics underlying this rationality.

In the first place, we may say that it is formal, for it concerns the manner in which certain ends are attained, though it does not give content to action.

It is also instrumental, since it represents an instrument that allows agents to achieve their goals. We can also say that rationality describes the behavior of the individual, but not the determinants of action. Rationality alone is not capable of motivating action. It is only the instrument that allows the action to be carried out. The determinants of action are in the "black box" of the human mind (AUGUSTO, 2009, pp . 3) .

Finally, we can say that neoclassical rationality is cognitive-deductive. The rational agent captures information about the possible means available and suited to its purpose. That is, it is cognitive in the collection and processing of information. It is deductive because it starts from premises (your belief system and preferences) to arrive in a logical way to conclusions. This conclusion is necessarily the best possible action, given the means available.

The universe in a nutshell

As preferences have mensurable value and resources are scarce, the agent's reasoning is reduced to a maximization calculation (AUGUSTO, 2009, pp. 3 and 4).

Although the agent's intention is always to maximize his objective function, there is no guarantee that he will succeed in all cases. Even choosing the best course of action, the individual can err in using the means and end up not achieving his goals in a satisfactory way (MISES, [1966] 1990, pp . 32) .

Although the agent is able to err, it does not mean that he is not rational. If the choice is the result of a sensible deliberation in relation to the information and means available and aiming at a goal, it will always be rational, even if it does not reach its goal. (MESES, [1966] 1990, pp. 32 and 33) .

After repeated errors and failures, the agent ends up associating an error probability distribution with each event with which it has contact.

After the event is repeated many times, such probability distribution becomes very accurate, being really useful to predict the probability of occurrence of each event. On average, the calculations coincide with the facts (JEVONS, [1871] 1983, pp . 45).

This assumption is based on the Law of Large Numbers, from statistics (HERSCOVICI, 2004, pp . 819) . For this to happen, it is necessary to have the possibility of repeating the same event n times and that the temporal mean of the event is equal to its spatial mean (HERSCOVICI, 2004, pp . 819).

These premises characterize an ergordic universe. In this universe, the frequency of the event is the same at all points of time, past and future, giving a deterministic character to events (Herscovic, 2004, pp . 819) .

This ergodic world tends to be stationary, since it becomes possible to predict the probability of all events occurring in the future.

Agents, through process of trial and error, choose, over time, the best means to achieve their goals and, once in this situation, will not change their plans, since any exogenous change is perfectly predictable. The system maintains its qualitative characteristics and the entropy is null; the universe is perfectly deterministic and stable (HERSCOVICI, 2004, pp . 820).

A skyscraper with Sand Foundations

Much of these developments and ideas were made on the basis of uncontrolled observations made by their authors [xiv], philosophical and normative understandings about how the human being should behave and simplifications in order to make possible the formal modeling of behavior.

It is important to understand the age and context in which these ideas flourished and developed.

They come from the Victorian and Protestant Anglo-Saxon thought of the mid-nineteenth century. Utilitarianism was regarded as the ultimate theory that should understand human thought.

European man was regarded as the apex of human development and his greatest trophy was the ability to produce science. Cold and mathematical rationality was what separated him from the uncultured barbarians of the colonies.

In the most restricted field of economics, there was a crisis of mistrust regarding the ability of the so-called Political Economy to solve real problems and connect with the practical world.

Neoclassical economics emerges from this broth, seeking to add mathematical formalism to the understanding of the human being as decision-making agent.

The simple reference, at the time, to the possibility that European man might be frequently affected by cognitive biases, to have a rationality limited by scarce mental resources, and to deal with this by developing behavioral heuristics that work in a way, let’s say, automatic, would be regarded as an unforgivable heresy by these theorists.

So does it mean that the whole economics is wrong?

I am optimistic about this point.

This Economy modeled on maximizing rationality postulate is valid to some extent. After all, much has already been developed and applied over the last 150 years based on these ideas.

However, if I were allowed to, I would put economic theory based on maximizing rationality as a special case of a larger economic theory, which considers our systematic evaluation errors when we are faced with uncertainties and few available cognitive resources.

The behavioral economy has not yet reached this stage but is seeking this course.

Efforts such as Propect Theory that expand the scope of established traditional theories are in my view the way to deepen our understanding of how we make decisions, design better public policies, and help people be happier.

References

AUGUSTO, A. G. (2009). Racionalidade e Atomismo na Escola Neoclássica. Fonte: International Association for Critical Realism - Conferência Anual - UFF: https://www.uff.br/iacr/ArtigosPDF/27T.pdf

Azeredo, L. (2009). Minha Tese. Rio de Janeiro.

BENTHAM, J. ([1789] 1979). Uma Introdu??o aos Princípios de Moral e Legisla??o. S?o Paulo: Abril Cultural.

CALDAS, G. J. (2002). O Caráter Humano e Social da Economia. Fonte: Revista Eletr?nica PET-ECO - UnB - n. 1: https://vsites.unb.br/face/eco/peteco/dload/monos_012002/gustavo.pdf

CALDAS, G. J. (Setembro de 2003). O Postulado da Racionalidade em Economia: Seu Significado e Suas Limita??es. Fonte: Universidade Nacional de Brasília - Programa Especial de Treinamento: https://www.unb.br/face/eco/peteco/dload/monos_012003/Gustavo.PDF

CARDOSO, F. G. (2008). Elementos para Integra??o Analítica da Micro e da Macroeconomia. Disserta??o (Mestrado em Economia) - UFRJ. Rio de Janeiro.

FERREIRA, A. B. (2004). Novo Dicionário Aurélio da Lingua Portuguesa. Curitiba: Positivo.

HERSCOVICI, A. (2004). Irreversibilidade, Incerteza e Teoria Econ?mica: Reflex?es a Respeito do Indeterminismo Metodológico e de suas Aplica??es na Ciência Econ?mica. Estudos Econ?micos - v. 34 - n. 4 - out-dez 2004, 805-825.

ISLA, A. (2000). From Procedural to Complex Rationality Relations: Observed System and Observing System. European Journal of Economic and Social Systems - n. 4, 347-363.

JEVONS, W. S. ([1871] 1983). A Teoria da Economia Política. S?o Paulo: Abril Cultural.

MISES, L. v. ([1966] 1990). A??o Humana. Rio de Janeiro: Instituto Liberal.

MYAGKOV, M., & PLOTT, C. R. (1997). Exchange Economies and Loss Exposure: Experiments: Exploring Prospect Theory and Competitive Equilibria in Market Environments. The American Economic Review, 801-828.

PARETO, V. ([1906] 1996). Manual de Economia Política. S?o Paulo: Nova Cultural.

SANTIAGO, S. Q. (2003). Filosofia Moral e Economia: As Idéias de Mill e Rawls. Monografia no ambito do PET-UnB. Brasília.

VANBERG, V. J. (2004). The Rationality Postulate in Economics: Its Ambiguity, Its Deficiency and Its Evolutionary Alternative. Journal of Economic Methodology - 11:1 - March 2004, 1-29.

Notes

[i] I will use "behavioral science" and "behavioral economics" in a changing way in this essay, even though I know that strictly the meaning is not exactly the same

[ii] As an example, see Myagkov and Plott's criticism of the prospect theory in MYAGKOV, M., & PLOTT, CR (1997). Exchange Economies and Loss Exposure: Experiments: Exploring Prospect Theory and Competitive Equilibria in Market Environments. The American Economic Review, 801-828.

[iii] Mainstream neoclassical economics and can be understood as synonymous in scope in this assay.

[iv] In this essay I understand as neoclassical economists those who are faithful to the marginalist and utilitarian tradition and follow the thinking of economists such as Gossen, Jevons, Menger, Edgeworth, and Walras more or less consistently. From this group, of course, patriarchs of schools critical of it, such as Schumpeter, Veblen, Keynes, and Kalecki, should be excluded, but not developments closer to the neoclassical scope subsequent to Keynesian criticism, such as neoclassical synthesis and the New Classical movement.

[v] Since the same analytical references, same axioms and basic premises are used.

[vi] "An Introduction to Moral Law and Principles" (Uma Introdu??o aos Princípios de Moral e Legisla??o)

[vii] It is worth noting that Bentham and Mill gave more importance to the effective agent of action, while the neoclassical developments always prefer to use the term choice (choice), or decision to indicate a triggering event of economic consequence, choosing even to call the economic agent of decision maker.

[viii] Happiness would be the balance of pleasure, discounting the pain.

[ix] For Karl Popper, respected philosopher of science, the main feature of scientific knowledge is the possibility of being refuted (Caldas, 2002, p 6).

[x] Pareto, believing that Utility can not be measured, only ordered, presents an alternative view to the utility curve: the indifference curve. However, this fact does not change the essence of our analysis, since it works with the same concept of rationality as the previous neoclassical authors. For further discussion of the indifference curves and their relationship with the utility curves, cf. (PARETO, [1906] 1996).

[xi] The same analysis to be applied to Firm’s Theory, since the "representative company" has a profit function that must be maximized, considering the constraints given.

[xii] This is, respect the assumption of rationality.

[xiii] Which accuses the least unnecessary waste of resources.

[xiv] That is, practical experience.

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