This post and the subsequent discussion prompt me to make a point about the use of the term “rational” in economics and game theory.
I think the people in the linked posts confuse the common definition of “rational” with the way that economists and game theorists use the term. Economists and game theorists axiomatically define a “rational” choice as one that will give the highest chance of accomplishing a previously defined goal given a specific set of parameters. That choice is defined axiomatically as the “rational” choice. Rational in this context does not mean wise, intelligent, most-good-for-the-most-people or any of the other concepts attached to the word in common speech. For example, in poker, game theory defines a different set of choices as rational depending on whether you want to make a killing, come out even or use the game as a pretext to transfer some money to a friend. Game theory does not comment on which of the three goals constitutes the most rational choice.
In the real world, we cannot even begin to establish the parameters of a “rational” consumer or political choice. Which is it more “rational” to purchase: Coke or Pepsi? Which is more important: short-term material equality or long-term political equality? Is it more rational to work as much as possible to generate the highest possible income than it is to work less so you can enjoy time with your family? Is it rational for poor people to vote for politicians to give them money today or vote for a free market on the chance they will be better off long-term? All these questions are meaningless because they ultimately devolve to non-logical, emotive preferences. Different people have different preferences, thus different goals and thus different “rational” choices.
The idea that individuals either as consumers or as voters make “rational” choices presupposes that every human being or, indeed, any human being at all, can at any moment understand the totality of every human interaction at any given instant and that the person can predict all the future possible interactions. Clearly, this is impossible. Rather it is the emergent behavior of billions of interactions that produces optimum outcomes more often than do choices based on more-limited information. Even more realistically, we have to make tradeoffs between all the possible choices, and collectively we have to have a means of negotiating those trade-offs between ourselves.
Whether we choose to define its outcomes as “rational” or not, we can say objectively that the free market processes many orders of magnitudes more bits of information than does the political system. Politics deals with airy abstracts in which all the real-world detail has been stripped out. The free market, by contrast, marks the fall of every economic sparrow — or at least every piece of gum purchased. Unless someone can come up with an explanation for why less information is better, we can presume that the free market will work better over the long run.
“Politics deals with airy abstracts in which all the real-world detail has been stripped out”…nicely put. Moreover, it must *inherently* do sobecause the bandwidth of the political process is very limited.
Consider all the Congressional time, Executive time, agency time, and punditry that have been devoted to the ridiculous discounted-converters-for-the-analog-to-digital-tv issue. Now imagine an equal quanta of political bandwidth being devoted to each of the millions of economic issues which range from equally-important-as to much-more-important than this issue. Obviously, it would be imposible.
Obviously, it would be imposible.
Unfortunately, this is not obvious to everyone.
The people to whom it is not obvious…and there are indeed many of them…are usually those who either (a)have little exposure to the details of how the economy runs and really don’t understand how complicated it is, or (b)have excessive faith in the objectivity, goodwill, and capabilities of experts and of theory-based decision making techniques.
One common “solution” to the limited-bandwidth problem is to put rigid procedures in place for decision-making: that way, the supreme authority doesn’t have to actually see each individual case, but can still be assured that its (assumed) superior wisdom will be followed in all of them. Here is an example of how this kind of thing helped to destroy GM.
Macro Economics
(Compare to “micro economics”) The study of overall statistics about income, debt, production, and employment. You would think that statistics are dull, but macro economics is a center of intellectual ferment. Motto: “We just don’t know, but we are willing to guess”. Critics say that it is history confused by mathematics, or mathematics splattered by history.
Macro economics is noted for the gigantic cost of the occasional government experiments carried out with fanfare in times of crisis. Experiments in good times are never advertised or acknowledged, for fear of being held responsible for yet again ruining a good thing.
(More …)
Micro Economics
(Compare to “macro economics”) The study of how people exchange money to trade goods and services, organize businesses, and assign value. Critics say this is sociology spoiled by mathematics. Most knowledge about rational economic interaction was discovered by 1950. It remains to find rational people to apply it to.
Most practitioners advise business, receiving plentiful work in exchange for giving up chances for government appointment.
(More …)
Good post. The only ‘school’ of economics I am aware of that fully takes this type of reasoning on board is the Austrian school. But they’ve been out of favour for a long time. The other schools either explicitly or implicitly define an objective rationality in order to make the inter-personal value comparisons necessary to perform calculations on aggregates. As an engineer I would say calculations based on false premises are useless. That doesn’t seem to be the consensus in the world of economics, however.
>>Whether we choose to define its outcomes as “rational” or not, we can say objectively that the free market processes many orders of magnitudes more bits of information than does the political system….Unless someone can come up with an explanation for why less information is better, we can presume that the free market will work better over the long run.
The free market process is itself the result of a choice within the political system. But even more fundementally, why do you think that processing more bits means coming up with a superior answer?
Your post admits that rationality is a very iffy assumption at best. We have no way of knowing whether human beings make individual choices that aggregate to a policy outcome that is objectively desirable (e.g. preserving the environment).
So why do you think that aggregating all these individually irrational choices, as the market does, results in a “better” result over the long run? This isn’t snark by the way, I’m just having difficulty following the argument here.
It’s not in fact trivial to define “objectively desireable” ends. ‘Preserving the environment’ is not a complete description of an end. For example: one way to preserve the environment would be to release a virus that kills every human on earth. Hey presto, greenie heaven. So, to be complete, the cost must always be defined when stating a goal. Of course then we get into an argument as to how much we want to spend on ‘preserving the environment’. Thus it becomes a matter of subjective opinion again.
The key feature of the market is the way it generates prices. Prices give us an informed/rational basis for decisions about ‘preserving the environment’. That is they let us know how much a certain amount of ‘preserving of the environment’ is worth to us in terms of other things that we like.
On the other hand, politicians like to talk in terms of un-costed absolutes: they’re potential blank cheques signed by the taxpayer.
So at face value we are comparing a process where costs are unknown/irrelevant (politics) to a process where costs are known to a more or less exact degree. On its face which process is more likely to succeed in reaching a goal? (keeping in mind that a goal must be costed to be a real goal).
brett,
thanks, but actually that still doesn’t address the question.
prices only gives us information to the extent that they accurately aggregate individual preferences.
if the individual preferences are not rational (or at least, not when aggregated) or are subject to externalities (as real-world preferences inevitably are) or the market itself is subject to manipulation (as many real-world markets are) then they do NOT give us good information. in fact, they are actually misleading.
This gets back to Shannon’s original point about ‘rationality’. There is no sense in which preferences can be designated ‘rational’ or ‘irrational’. They are what they are. The market coordinates those preferences through prices. Prices enable people to know what are the costs of their preferences in terms of what other people do. For example, if my preference is for something very out of the ordinary or very new (and hence in short supply) then I will have to pay a big price. People whose preferences are aligned with those of most other people will pay a smaller price to gain satisfaction, because the market serves them beter.
The market is the ultimate democracy in that sense. “Every penny casts a vote”.
There are many examples of perverse incentives in the political world. Most perverse incentives that are blamed on the market (eg pollution) are actually caused by a lack of an appropriate market.
SeanF,
The free market process is itself the result of a choice within the political system.
Not really given that the free-market exist prior and external to any particular polity. People have been trading long before anything we recognize as states arose. Even after the rise of early states, most such states ignored trade. During the period of roughly 1000-1400 in northern Europe, no laws or taxes on trade existed. The military aristocrats simply did not view trade as anything important. Non-violent law merchant law governed trade. Only after trade grew to be very profitable did the militarist step in to demand their share.
Even today, markets operate across political boundaries to the extent that no country can completely ignore the operations of the free-market. If someone waved a magic wand tomorrow and did away will all violence, governments would disappear but the free-market would remain.
But even more fundementally, why do you think that processing more bits means coming up with a superior answer?
Well which level of information would you find more useful: Western Hemisphere or 30°16′2″N 97°45′50″W? It’s about granularity. More information lets you more accurately predict the future behavior of any system. It lets us custom fit solutions to individual wants and needs instead of relying on a one size fits all. Would you prefer to make your own clothing selections or would you prefer to wear a Mao suit? Look at how government deals with broad generalities whereas the free-market deals with specific detail.
Your post admits that rationality is a very iffy assumption at best.
Actually, I’m saying that rationality can only be defined axiomatically. In game theory the “rational” choice is the choice that mathematically will most likely result in the achievement of your goal. You cannot objectively define a “rational” goal. A lot of political argument does involve the assumption that there exist a set of goals which are universally agreed to be the most desirable and that therefore there exist a matching set of rational choices. In reality, no such “rational” goals exist.
We have no way of knowing whether human beings make individual choices that aggregate to a policy outcome that is objectively desirable (e.g. preserving the environment).
“Preserving the environment” is not an objectively desirable. First, its far, far to vague to actually be the basis of decision making. Second, except for very wealthy urbanites, most human beings don’t value the environment over human lives. For the billions of people living subsistent lives putting the environment before people is insane. Would you be better off if humanity had never come to the new world. That would have “preserved the environment” but a great deal of the modern world and many of the people who populate it would not even exist. Would you consider that objectively desirable?
It says a lot about the shallow and cartoonish level of information processing in politics that “Preserving the environment” would be considered by many to be an actual operational goal. The free-market would not have such a vague definition. Instead, it would zero in on specific such a “X” number of people are willing to expend “Y” resources to preserve “Z” hectares of natural area.
So why do you think that aggregating all these individually irrational choices, as the market does, results in a “better” result over the long run?
I think what you’re really saying is why do I think aggregating all these individual irrational goals results in a better result? As I pointed out, rationality is restricted only to evaluating the means to an end, not the end itself.
But even if I accept your terms I would turn the question back to you: If the free-market represents the aggregation of irrational decisions of individuals, then what does democratic government represent. Why would people make “irrational” decisions in their day-to-day lives and then suddenly turn “rational” when they enter the ballot booth?
If you think about it, I think you’ll find a nasty little streak of elitism running through your political thought. You intuitively believe that most people are irrational but that leftist elites are rational. Therefore, clearly, people should turn over more of their decision making to their “rational” betters. This is really the only model that explains why government could make better decisions than the free-market while operating on less information.