ON THE RATIONALITY ASSUMPTION - KULLY PAWAkullypawa.com/essays/On the Rationality Assumption.pdf ·...

ON THE RATIONALITY ASSUMPTION

KULDIP PAWA FRIDAY, APRIL 13, 2007

ECONOMICS 499 − HONORS SEMINAR IN ECONOMICS PROFESSOR BRIAN KRAUTH

KULDIP PAWA ON THE RATIONALITY ASSUMPTION PAGE 1 OF 26

eoclassical economics has often presented itself as a model of scientific rigor, as a sort of methodized commonsense rendered in precise mathematical terms. For its

defenders it’s a system of straightforward derivations proceeding from uncontroversial precepts and culminating in irrefutable conclusions which find their veracious reflection in our everyday dealings. I’ve undertaken here a project to examine the philosophical structure of these arguments in order to assess some of these claims and would like to share a few skeptical doubts about the nomothetic programme of explaining economic behavior by using deterministic laws. Specifically, I want to offer some considered reasons why the behavioral assumptions of perfect rationality are problematic as an investigative technique and how its conclusions are suspect with respect to its epistemological grounding. Additionally, I want to offer some ways in which the study of economics can be enriched by insights from philosophy and behavioral psychology.

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To begin, imagine yourself before a typical storeshelf with all its bedazzling panoply of wares that are now on offer. If I understand the traditional economists correctly then the typical consumer confronting such a storeshelf holds a mental balance sheet in her mind on which she tallies up (at some level of her thinking) the ledger of benefits she expects to derive from the purchase against the costs it’ll incur. This seems reasonable enough. But the calculation requires not the uncertain, anticipated utility the monetary outlay may possibly afford but rather the precise enjoyment the economic agent will actually derive from the consumption. For to allow that purchasers to possibly misconceive their expected gratification would necessitate that we delve into why they had such mistaken beliefs. But the economist’s solution now requires that every consumer know well in advance the relative consumptive utilities they know are to be gained from a cross-comparison of each good with every other commodity available in every marketplace. One can’t, afterall, calculate the utility she’ll derive from an avocado if she’s never had one. So, basically, modern economic theory says that consumption is the exercise of an excogitated rationality whereby we consumers compile well in advance a preference-ordered ranking in accordance with our well-defined ideal shopping list of consumption goods and then limit it to what we can afford. And we can do this because we unerringly know in advance the utility we’ll extract from all goods that are now or will ever be available on the marketplace. So we are – or these rational economic agents are (I’m not too sure how realistic this characterization is suppose to be) – egoistic calculators with an encyclopedic knowledge of the relative utilities derivable from every two-way comparison of every conceivable consumption good and have an infinite processing power to be able to immediately calculate which one of the two we/they prefer. In the economist’s jargon, our preferences are thus said to meet the completeness criterion, the first of four necessary conditions defining a rational utility-maximizing consumer: 1.) Completeness: The individual X faced with any two options A and B will either

prefer A to B, or prefer B to A, or else be indifferent between A and B. 2.) Transitivity: If consumer X prefers B to A and C to B, then in consequence she

prefers C to A.


3.) Non-satiation: For any given quantity of any good A, agent X prefers more of that good to less. 45

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4.) Convexity: The marginal utility X derives from commodity A is a decreasing function of its quantity. That is she prefers more to less but at a decreasing rate, such that the successive satisfaction squeezed out of said product or service declines as the agent acquires more of that entity.

These four precepts comprise the basic foundations of neoclassical theory. On the subject of the completeness axiom, Barry Schwartz in The Paradox of Choice argues that more choice is oppressive and not liberating, in support of which he cites a study by Sheena S. Iyengar and Mark R. Lepper titled When Choice is Demotivating: Can One Desire Too Much of a Good Thing? In this survey, Iyengar and Lepper found that when random customers were offered the opportunity to test their preferences from among six varieties of jams in a blind taste test 30% subsequently chose to purchase a discounted jar of their selected variety. Of those who were offered a larger selection of 24 jams only 3% of test subjects opted to use the coupons that they were rewarded toward their selected choice. Conventional theory would lead us to believe that given an opportunity to refine our incomplete preference set and to more closely approximate our stable likes and dislikes should have resulted in more sales in the larger taste test. But Schwartz concludes instead that a greater number of options seems to largely result in indecision and buyer’s remorse. Classical theory fails to consider the search costs which in real-life make it impossible to meet the staggering information and time requirements to behave rationally, that is, by finding those preferences whence maximum utility can be procured. Anyone grounded in the real world can imagine that utility-maximization is an onerous chore and even trying to engage in it would quickly cause its own sizable diminishment to overall utility. So, Schwartz concludes, given the arduous mental exertions and time required to processes so much information we simply can’t exhaustively research our prospective consumption choices and shouldn’t thus try to maximize but should instead “satisfice.” What’s “satisfice,” you ask? This is a term coined by Herbert Simon as an alternative to “maximizing” and would, in this context, amount to a constrained optimization of our preference ranking of consumption bundles from among known and easily available choices and with a consideration given to other epistemic, exertion, and time costs. The standard economic theory would then mislead if the conclusions it reaches won’t hold when omniscience is relaxed. In fact, in addition to being a more realistic starting point for understanding consumption behavior, Simon’s “bounded rationality” notion also helps to explain the existence of brands and other aspects of markets. According to Simon, brand loyalty can thus be seen as a default position, a comfortable frame of reference, that helps avoid having to repeatedly undertake costly comparisons. Simon’s insights can also accommodate the fact that people are prone to occasionally grasping for novelty or to acting on a whimsical fancy inconsistent with their beliefs about their own stable preference rankings. On the other side of the business counter, bounded rationality can also easily reconcile our choices with the fact that we’re


constrained to the assortment available and how the market limits opportunities for agents to act on their preference rankings. In short, our limited fund of associated experiences serves as a cognitive map enabling us to navigate the consumption landscape. Of the four axioms listed above, necessary for generating utility curves, only transitivity would seem to be a falsifiable prediction. Paul Slovic and Sarah Lichtenstein (1983) in series of experimental studies found that their subjects repeatedly made preferences inconsistent with their own earlier stated ordinal combinations. This would seem a direct violation of the standard axiom of transitivity. Moreover, in reviewing other studies, they remark that, “the most striking result of these studies is the persistence of preference reversals in the face of determined efforts to minimize or eliminate them” (599). But the theory’s apologists attempt to explain away this unstable preference structure by arguing that these subjects’ pairwise comparisons may yet be consistent since some utility metric that impinges on the choices is unaccounted for, like time, price, atmospheric pressure, the current phase of the moon, and the sort, that has imperceptibly changed so that the agent’s transitive preference rankings have merely accommodated to the changed circumstances. Simply put, since the agent is sensitive to the context, choice A is no longer choice A even while the agent’s preference schedule remains unchanged. And since all the innumerable determinants of choice aren’t clearly understood, all such experiments are thus effectively invalidated by the obvious fact that some unknown experimental condition below the threshold of experimenter’s awareness is always different at each attempt to ascertain the subject’s choice.

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Moving right along, next, notice that the agent’s utility displays an ever-diminishing but still positive incremental gain associated with any increase in the attainment of a desired commodity. The modern theory of consumer behavior says that agents have limitless appetites to be able to so consume an infinite quantity of their chosen fungibles. In other words, they experience an ever-so-slight marginally gratifying gastronomic delight in another helping and they never quite reach some nauseating disutility from thus gorging themselves endlessly. Granted, an agent’s insatiable appetites are confined by her pecuniary constraints but if we take some relatively inexpensive good (in terms of the consumer’s income) from which she derives utility then it doesn’t seem unreasonable to say then that her budgetary constraint will always kick in long before her physical appetite ever reaches satiation. If her budget is increased, instrumental utility demands that she prefer more over less to attain a higher isoquant (that is, a higher indifference curve parallel to the original). There’s an old objection to philosophical utilitarianism arguing that if happiness is the summum bonum society should strive to maximize, then a heavyhanded dose of brainwashing may well be the best prescription to apply. Neoclassical economists have a ready reply to this line of reasoning. These utility-maximizing agents somehow spring into the world fully-formed with a permanent and unchanging personality in the form of rigidly-fixed preferences. In this vision of the world, advertising, which by its very nature seeks to mold our consumption preferences, is singularly ineffective. What concerns me on this point is that the received economic theory would seem to be an inappropriate model for dealing with agents who undergo any transformation of tastes.


Or, if the agent’s forward-looking expectations toward the attainment of a consumption experience and her backward-looking perspective over the same experience are always in perfect alignment then there’s no problem on these accounts (evolving tastes and regrets). But if the agent suffers the painful stab of second thoughts, if the novelty of a purchase wears off, if the selection is somehow colored by the vicissitudes of her passing moods, or if the agent otherwise has an unstable preference structure then we’ll either need to make modifications or resort to another model altogether. Perhaps, then the conventional theory is best viewed as offering a snapshot of the agent’s temporal selves, characterizing, as it does, preferences as fixed and unchanging. If, however, consumption is the exercise of a dynamic process of receiving socially conditioned choices then modeling consumption behavior as a static exercise of acting on pre-existing likes and dislikes will obviously prove inadequate. Even something so simple as a preference for oranges over apples is embedded in a specific social context, founded upon the current state of the chooser’s knowledge about available uses for these products. If she should subsequently discover a new recipe for apple pie this preference ranking may change. So, in each instance the agent is polled this preference structure is unique. People’s preferences are also labile and can adopt themselves to the available choices they happen to find themselves inhabiting. Consider, just as one example, how many people who grew up poor during the depression were taught by hard experience to foster limited expectations. Along this same track, Amartya Sen notes in Development as Freedom,

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[D]eprived people tend to come to terms with their deprivation because of the sheer necessity of survival, and they may, as a result, lack the courage to demand any radical change, and may even adjust their desires and expectations to what they unambitiously see as feasible. The mental metric of pleasure or desire is just too malleable to be a firm guide to deprivation and disadvantage (63).

Hidden within its core this approach supposes that all social phenomena can without any loss of substantive content be reduced to the choices of individuals. In the profession this assumption is known as methodological individualism. Institutions, society, firms, households, and groups, according to methodological individualism, are nothing more than collections of atomistic economic agents. Not only does this Consumer Demand Theory (or Utility Theory or Consumer Behavior Theory) interpret all economic phenomena as the consequences of the behavior of well-informed, rational, self-interested individuals, it also supposes them to arrive at their decisions independently based solely on their own egoistic preferences. Now, I grant that egoism may be behaviorally indistinguishable from altruism if the egoist gets the appropriate pleasure from the well-being of others and also feels appropriate distress at the suffering of other agents. But since in the orthodox theory, each agent is concerned strictly with her own singular utility – her indifference curve is unrelated with that of any other agent’s utility function – all decision-making must, of consequence, be an independent act that doesn’t take account of influences from, or consequences to, other agents. This seems to


preclude the possibility that utility-maximizers can be behavioral altruists or that they may be used to model sociometric interactions. Most shopping in the real-world may well be done on behalf of other people. As Michael J. Silverstein says with a touch of bathos in the concluding lines of Treasure Hunt, “The primary consumer in the developed world is female, and a major factor in her value calculus is love” (245). His argument here is that a large portion of consumer behavior is directed toward the attainment and maintenance of some companionship or for the provision of dependants.

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Other than perhaps the acquisition of bare necessities, a large measure of our commercial decisions are tied to some intuitive sense of our financial wellbeing which, in turn, rely on some consumer confidence measure, a sense of job security, our credit rating, the current unemployment rate, minimum wage standard, prospects for preferment, and so forth; that is, a great deal if not most consumption is contingent on some amalgam of the decisions of other players in the economy. Most of our utility-derivations are thus inextricably entangled with the concomitant utilities of other economic actors. Our interdependence on this abstract conception of the “state of the economy” is a constant source of anxiety. Other consumption decisions are best taken after consulting the advice of trendsetters, tastemakers, coupon-clipping mavens, film critics, book reviewers, advice columnists, peer groups, social networks, recommendations and ratings from other users, Consumer’s Reports, etcetera. And this interconnectedness only seems to becoming more expansive and reticulate with the ever-deepening complexities of our organizational structures, further reliance on technology, the burgeoning of e-commerce, globalization, proliferation of telecommunication connectivities, and so forth. In a famous series of 1951 “conformity experiments,” sociologist Solomon Asch required a subject and several confederates (members of the experimental staff who the subject was led to believe were fellow participants) to answer a few obvious questions. He found that while the subjects answered the simple questions correctly roughly 70% of the time, rebuffing attempts by the confederates to persuade them, they were visibly made uneasy and insecure in choosing what would, under normal circumstances, have been considered the patently correct choices. The effect of the experiments was to show how our opinions are at least partially influenced by interpersonal judgments and how opposing such dependencies can lead to paralyzing insecurity, doubt, and even conformist behavior. Utility-maximization models would seem thus to overlook how our utilities are inextricably enmeshed with the utilities of others; how we’re reliant on opinions; how our utilities are constrained by prevailing mores or notions of propriety or normalcy; how we conform or rebel against the reigning fashion choices of others; how we’re made to conform with societal expectations; how we participate in socially-conscious boycotts; how we desire to garner social ascription of successful achievement; or how we strive to maintain or enhance our social status through our consumption choices. The consumption choices of utility-maximizers is strictly directed toward their own personal satisfaction. If economic agents are concerned not so much with the


absolute position of their consumption patterns but rather their standing relative to other agents or some reference group then utility-maximization analysis is bound to mislead.

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I want now to gather up these various strands to offer what an alternative approach might look like. Another strategy would inquire the agents’ of their own understanding of what actually animates their shopping behavior through surveys, focus groups, behavioral experiments, and the like. It would discern the various subtle and finely nuanced emotional inflections they themselves associate with their shopping experiences and not just throw all such justifications into some catch-all category like utility-maximization. Actual economic agents linger doubtfully over extravagant buys, vacillating irresolutely for long periods, forestalling the purchase for fear it may be regretted latter, or else they rush to the cash-register for fear they may change their minds and ever after suffer the commodity’s lack. They regularly find themselves wavering indecisively between the overflowing abundance of offerings, wondering what Tasty WheatTM will taste like, making impulsive purchases, exercising a brand preference, confused over whether the ensemble up for consideration is in keeping with their evolving self-conception, contemplating whether if given as a gift the purchase will be appreciated, and on and on. At the other end of the transaction, real world manufacturers vie for prime shelfspace at eye-level, jockey endless with each other for the attentions of the consumer, fluctuate prices to confuse the unwary, use subtle manipulations of advertising and mood-setting atmospheres. There’s a recent book exploring some of these real-life interactions between goods and consumers called Why We Buy: The Science of Shopping by Paco Underhill which does some interesting anthropological fieldwork in American and Canadian shopping malls, observing and surveying some of the evolving developments in the culture and habits of their denizens. Since utility-mazimizationism can’t give qualitative descriptions of these various interactions (it merely traces the quantity desired against price) it abstains from such subjective evaluations that concern many shoppers as: whether the packaging is biodegradable, the article’s splurge value, whether the good is fair-trade, organic, fat-free, machine-washable, comes with an optional second air-bag, accrues air-miles, and all the other fine gradations in utility-derivation associated with these qualitative assessments. Further, in orthodox economics, the intentions agents espouse, the methods they deploy, and the outcomes that result are perfectly aligned so that the consumer’s desired ends are directly derivable with absolute certainty from the consumers’ observed behavior. This simplistic, perfectly linear alignment of intent, means, and ends is a contribution usually attributed to the noted M.I.T. economist Paul Samuelson and is known in the trade as “revealed preferences.” Observed behaviors are, by this understanding, nothing other than the manifestation of the employed motives. This Consumer Demand Theory consequently bears a family resemblance to a now outdated psychology called behaviorism, generally associated with the late Harvard psychologist B. F. Skinner. Behaviorists likewise offered a mechanistic science of behavior espousing a scrupulous unwillingness to venture into the murky waters of human motivations. Like neoclassical economists, Skinnerians were content to merely catch whatever should emerge at the surface and categorize it into some universal law of human behavior. Like


neoclassical economists they attempted to offer an epiphenomenal account for objective observed behavior using a simple stimulus-response mechanism without reference to the inner mental processes that may have produced it. Observed behavior, according to behaviorists, can be modeled by ignoring outright the neuro-cognitive determinant of the motor response and the social scientist need merely presuppose the operation of some predictable compulsion that’s universal to the species, as for instance that the agent sought to derive a psychic reward or to avoid some subjective brain-event akin to pain. Economic agents are in this manner modeled as epistemic engines of the most basic sort who are merely pushed and tugged by their instinctive reflex toward/away from the presented stimulus whence utility/disutility may be had/avoided.

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This radical behaviorist approach fell out of favor among psychologists somewhere in the 1960 and there may well be some lessons here for neoclassicals. This approach merely requires that the agent perform the observed tasks in a functionalist capacity and she needn’t at all be emotionally engaged in her “choices.” Choice is here redefined, since it’s doubtful whether agents can even exercise their fully-defined choice in this linear procedural process which seeks to restrain the observed behavior to some mechanically predetermined simplifying assumptions. And if the categories are made general enough and broad enough, we can ensure that whatever we observe can effortlessly be fitted into them. It certainly seems a strange investigative enterprise to peremptorily require that the answers sought should conform to some simplifying assumptions made at the outset. This mechanistic stimuli-response conception of behavior may be fine for heated polymers or even for bacterium phototaxis but people simply refuse to be so predictable. Furthermore, several thought-acts can manifest themselves in a common observable behavioral pattern. Some behaviors may spring from desires that may not admit explicit formulation of the sort required by the deduction. Most of our emotive and ethical reasoning may well be of this sort. Such an approach is incapable of differentiating an accidental behavioral property from an essential characteristic of the agent’s intentions. Agents are also acutely attuned to contextual differences that the behaviorist approach is wholly incapable of capturing. Psychologists have found it’s not only interesting to delve into the subjective cognition involved in decision-making but more importantly, the functionalist account misses out on what’s oftentimes the essential element in an adequate explanatory account. This element is sometimes referred to by philosophers of mind as qualia, a sentient experience from which arise observable behaviors. This qualia (or qualitative facts), this missing ingredient in behaviorist explanations, essentially seeks to grasp what the agent’s mental process actually is that manifests itself in the observed behavioral patterns: What are people actually thinking when to do such and such? The intent sought, the means employed, and the resultant outcome needn’t all be identical, consistent, linear, or even predictable. Anthropologists might here make reference to an emic and etic distinction. Neoclassical explanations are strictly etic for being only from an outside spectator’s perspective. What they lack is an emic account that would offer the perceptions of the experience in terms meaningful to the percipient.


This Consumer Demand Theory is purportedly about choice but the analysis is decidedly unable to even minimally model actual choice. It merely employs an ex post facto rationalization to ensure the postulated determinant results in the observed consequent. One need then only concoct some self-interested reason which the agent could possibly have employed which is sufficient to produce the observed behavior. In addition, the very fact that this analysis is as applicable to a cloistered ascetic Medieval monk as it is to a modern-day mallrat shopaholic should serve as warning sign of its synthetic vacuity. Isn’t utilitity-maximizationism, one would reasonably have thought, ostensibly supposed to be about offering some substantive explanation for modernday capitalist consumption behavior? It all leaves one to wonder whether there’s any individual or behavior or even animal or plant to which it’s not applicable. And this generality comes at the expense of the theory’s inability to offer any meaningful categories to classify behaviors.

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Utility Theory can further be seen as a form of teleological explanation and can claim an even older lineage, for these sorts of accounts are reminiscent of Aristotelian entelechy. This strategy basically consists in explaining observed phenomena by positing a disposition in the object, such that the observed behavior becomes the actualization of this inherent potential. Such tautological explanations are by their very nature empty of explanatory content and generally conform to the following explanatory structure: Question: Why did agent X do action A? Answer: It’s in the nature of such agents to do A. There’s a comical illustration of this in Jean-Baptiste Moliere’s The Imaginary Invalid in which a doctor when asked why opium makes one sleepy, confidently replies that it’s because it contains within it a dormative principle. Are rationality explanations of this sort? Do they do any more explanatory work than simply relocate the mystery of observed behaviors by tucking them neatly under definitional terms? Is neoclassical economics just a shell game of high concepts? When asked: Why did economic agents do A? The economist replies: They sought to maximize their utility; that is, they actualized their inherent desire. At its most banal some defenders of this assignment of purpose want the concept to say nothing more than “Agent X sought to maximize something.” So, basically, the agent did what she did because that’s what she wanted to do. Just so that this claim of “rationality” or “utility-maximization” isn’t indictable on a charge of dogma – that is, an intransigent belief system effectively rendered impervious to refutation – I’ll take it that economists forward these explanations to really say something more meaningful. Toward the formulation of this more meaningful definition, consider the question “Was Mother Teresa rational?” If this question is answered in the affirmative then this would effectively eviscerate the concept “rationality” of any useful explanatory work. Or, perhaps, even worse, it just requires that we become cynics about what this saint was really up to; that deep down her seemingly selfless acts and altruism can effectively be reduced to self-interest. But if it’s answered in the negative then “irrationality” has its


virtues and neoclassical economics isn’t a complete explanatory account of all human behavior. I’d council economists to take the second option. Historically, political economy never sought to explain all human actions, a fact attested to by William Stanley Jevons, the co-founder of neoclassical economics:

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[E]conomy does not treat of all human motives. There are motives nearly always present with us, arising from conscience, compassion, or from some moral or religious source, which economy cannot and does not pretend to treat. These will remain to us as outstanding and disturbing forces; they must be treated, if at all, by other appropriate branches of knowledge (Brief Account of a General Mathematical Theory of Political Economy, 1).

I offer then two other motives, in addition to rationality, that may dispose economic agents to act of their own free will: principle and affection. One can purchase an automobile out of instrumental rationality (because it’s the most cost-effective means of meeting her transportation needs), out of emotive reasons (as a status symbol, because she likes the color, to please someone else, etcetera), or out of some axiological belief (because it’s environmentally-friendly, the brand has proven reliable, because it’s Canadian-made, etcetera). Hereafter, I’ll use the term “rationality” to mean exclusively instrumental rationality. And these goals can, of course, conflict. For instance, should someone upon principle decides to return some purchased masterpiece that they subsequently discovered was stolen by the Nazis, then this may cause great disutility. Now, I don’t mean to suggest that I’m offering a complete list of human motivation; this tripartite division is less a recipe than a list of some key ingredients that are patently absent from the economist’s explanation. Utility theory is often presented as only a way station to the derivation of a market’s demand function; the uncoordinated activities of innumerable independent decision-makers each rapt in their own quest for sensuous gain, we’re told, naturally results in socially optimal outcomes. This brings us then to a much more serious and devastating objection to this whole utility-maximization project. We simply can’t aggregate the judgments of many different unique individuals, each with their own incommensurable personal utility rankings, to arrive at the market demand curve, as is so casually done in microeconomic classes today. If I value apples less than oranges yet only have apples while you value oranges less than apples yet only possess oranges, then by trading we can create wealth (that is, achieve a higher overall social utility). So, to prevent an altered distribution from creating wealth requires that each individual value every single good in exactly the same measure of utility. Remember, I had earlier said that each consumer is unique. Well, we now require that society is composed of identic drones. According to these Sonnenschein-Mantel-Debreu conditions, as Keen points out, “in a society consisting of many different individuals and many different commodities the market demand curve is probably jagged and slopes every which way” (25). We thus run into an internal logical inconsistency in moving from the unconstrained satisfaction of personal preferences to any claim about societal wellbeing. In extrapolating from individual, self-centered behavior to the market demand curve requires that we all have a


common, one-size-fits-all social utility function. This logical disjunction between the unconstrained maximization of individual utility and the didactic need for a market demand mechanism is usually remedied by imagining society as a “representative consumer.” This manifestly absurd assumption demanding a deadening, stultifying uniformity in individual consumption effectively severs Consumer Demand Theory from General Equilibrium Theory. There’s simply no necessary connection between the two; utility-maximization is unrelated to market equilibrium except under some very strict absurdly unrealistic restrictions.

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So, how exactly does the self-organization of atomistic agents, each actuated solely by considerations of her own personal advantage, result in a smoothly functioning market economy? Neoclassical economics doesn’t offer any satisfying answers. But it seem safe to conclude that preference-satisfaction alone is an inadequate explanation. Supposing society to be a collection of unique individual agents is a source of further knotty problems for the standard theory because, as prices change, the relative wealth of each individual also changes, leading to a new distribution. In short, there’s a different demand curve for every distribution of the communal wealth. So, a change in price doesn’t just cause a movement along the demand curve but rather it literally effects some warping of the curve itself. But if we just go along with the neoclassical economists and simply assume a society of drones then the whole problematic issue is elegantly solved with the sacrifice of just another small portion of the theory’s remaining realism. It should always be borne in mind though that this conception is rightly prone to the criticism that it requires a conception of some collective social intentionality instead of each individual agent being allowed to be her own person and to do her own thinking. Let’s accept then that spontaneous order, growth, innovation, and all that sort of other good stuff somehow arises in modern capitalist economies as a supervenience from the interactions of unique decision-makers. And this emergent property of these innumerable transactions among the complex networks of buyers and venders has about it a gestalt property that can’t be reduced to the operation of identical cogs, that is, of the sort represented by undifferentiated consumers, which can be examined extricated from their native social networks. Or, at least not by some simple arithmetical aggregation of the behaviors of such individual heterogeneous agents. And it has to be further accepted that unintended repercussions of socially destructive outcomes can arise out of even perfectly rational behaviors such as bank runs and selling frenzies. Individual rationality is perfectly consistent with collective insanity. I had earlier outlined how conventional economics employs an over-simplification of human motivation. I’d like now to undertake a quick overview of a related issue: how the standard fare of economic theory also assumes a univocality in reasoning agents engage in acting upon those motivations. This makes use of quasi-Kantian notions of a single type of rationality: that governed by a universal enlightened self-interest all consenting agents will come to the same conclusion; that they’ll each put the same relative weights on the various pieces of evidence; that given the same evidence all persons will form the same beliefs; that they’ll all act upon this information in the same manner; that they’ll all hold the same degree of belief in a hypothesis or prediction;


that they’ll all form a common attitude toward risk and uncertainty; and the like. According to this conception, if only we could filter out the obscuring clutter of our idiosyncratic and culturally-instilled intuitions, we’ll all converge on a consensus set of beliefs.

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This archetypical pattern of rationality in turn implicitly invokes a commitment to a fixed conception of human nature. Famously, the 17th century English philosopher Thomas Hobbes held a mean opinion of humans in general as little better than civilized savages who, he maintained, if removed from society would revert to their “natural state” of engaging in endless war with each other. Social order, Hobbes urged, arises from the ability of a single person who consolidates enough power by force to subdue other members of society. And driven by a desire to secure safety from every other person, all right-thinking members of society, in their own self-interest, would thus willing surrender their freedom and submit to this sovereign authority. John Locke, a later 17th century English philosopher, similarly appealed to this theoretical pre-communal “natural state of man” to enunciate his own claims of such “laws of nature.” But in direct opposition to Hobbes, Locke held that humans are naturally altruistic and cooperate as a matter of course. Social order, according to him, arises out of a mutually agreed upon contract whereby citizens consent to delegate their authority to a ruling body. The 18th century Genevan philosopher, Jean-Jacques Rousseau, argued for a more amorphous conception of human nature as molded by society, somewhat like the shape of a liquid is defined by its container. He actually motivated the idea that the Enlightenment Europe of his day was decadent and but imparting little more than vices. But that’s neither here nor there. Neoclassicists are wont to affirm a Lockian view of humans as naturally peaceful, harmonious, and co-operative over the other two canonical conceptions. Do humans have some fixed essential nature? The plasticity of human nature seems to elude any precise articulation and is probably as varied as the number of people there are in the world. So if people reason differently then modeling reasoning that uses some single, objective, universal, cross-cultural, and timeless construal of narrow self-interest is bound to lead one astray. My interest here is in merely pointing out that an alternative position as Hobbes outlines is as defensible as the neoclassical position. And so I’ll try to construct a rough sketch of such an alternative vision. This sanguine picture of crowds of identical automatons actuated purely by an instrumental self-interest can as easily be imagined as a combustible mix that threatens at any time to violently erupt into economic anarchy. What’s to curb an agent’s acquisitive impulse that seeks to arrogate to herself as large a share of societal output as she can manage or to look to other agents as nothing more than opportunities to exploit their persons, property, and obeisance? If our well-functioning economy is really an overlay upon such a seething cauldron continually threatening to boil over into open hostilities then one might appeal to the various guiding institutional structures, our “social capital,” to help explain why crime, corruption, and covert acts of subterfuge and subversion aren’t the norm rather than rare exceptions. Even accepting such a abject vision of human nature, I suppose, one could yet maintain that self-interested voluntary exchange


can still lead to a coherent and efficient economic organization. But a fuller account would now have to give a good deal of weight to requisite social arrangements that can best facilitate efficient economic organization such as legal, ethical, political, and social mechanisms that ensure that contracts are honored, violence and coercion discouraged. Such enabling constraints can arise situationally but are usually a heritage which result from countless refinements over many generations of social disruptions, revolutions, imperial fiats, tribal council debates, etcetera. Or, that’s the 18th century Irish philosopher, Edmund Burke’s argument in his Reflections on the Revolution in France. From this perspective, supposing optimal social outcomes somehow invariably arise from allowing individuals to maximize their singular utilities would be akin to arguing that not just the most optimal set of moves in a chess game but the very rules themselves somehow spontaneously materialize from each player’s sheer will to “win.” Sure, agents may possess an inherent valence which reliably enables them to arrange themselves into the stable configurations that we observe in our familiar economic organizations but it requires appropriate institutions as a catalyst to facilitate this reaction.

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Here’s another difficulty I’ve found with rationality analysis: Which organizational principles should be taken as fundamental and which derivative? I find that economists regularly incorporate societal norms without explicitly stating them. But if neoclassical economics conceives itself as comprehensive system of the axioms of human action then this background knowledge that informs its conclusions should be stated upfront. To take just one example, no commitment to equality is explicitly stated in the assumptions but is employed extensively throughout. To illustrate my point, imagine a utility-maximizing phenom, a person who can invariably derive an insatiable ecstasy many magnitudes in excess of what the collective sum of all other social agents can achieve. Since according to the received wisdom, the ultimate purpose of the economy is to maximize collective instrumental utility (not social justice, for instance), this would seem to mandate that we, the rest of society, ought to subsist at the most bare minimum utility levels, if we must, just so that we can endeavor to satisfy the needs of this phenom. And this isn’t a purely academic exercise either since many medical procedures today are now exorbitantly expensive, placing enormous strains on our already severely stretched healthcare budgets, merely to provide a wisp of some utility measure to its unfortunate recipients at the cost of depriving great utils of utility to others. I don’t see any way of refuting this redistribution using the static analysis of social utility maximization. Or take the other extreme: Since it’s accepted that all agents experience a diminishing marginal utility – they value less each additional unit of income – and since all utility functions count equally, then this would seem to require a complete equality in income. Here utility-maximization seems to endorse a radical income egalitarianism. I’m aware that there is an argument here about the trade-off between allocative efficiency and productive efficiency so that such redistribution schemes potentially reduce incentives to create more wealth. I merely want to point out that that the two cases pull utility analysis in different directions, each hinging on whether equality (in medical health or material means) is assumed to be applicable or not. The point I want to press


here is that just so such unstated assumptions don’t sneak into the analysis in an ad hoc manner, purely in interests of intellectual honest, of course, they should be stated or derived. In this section I take up some of the justificatory arguments that have been offered for neoclassical theorizing. The study of economics is saturated with laws, laws which are asserted with an intimidating certitude and magisterial finality. These nomothetic claims are usually presented in an undergraduate course as staid and settled issues. The impression here is clearly that such truth-claims are founded upon an objective body of facts which are neatly organized into seemingly uncontroversial theories; that these claims constitute capitalism distilled down to a select network of logical relations, set in terse equations, and rendered as predictable statistical regularities. These so-called laws come with such names as the Law of Diminishing Returns, Law of Supply and Demand, Law of Comparative Advantage, Law of Diminishing Marginal Utility, Law of Capital Formation, Iron Law of Wages, Malthusian Law of Population, Ricardo’s Law of Rent, Say’s Law of Markets, Engel’s Law, Wieser’s Law of Opportunity Costs, Okun’s Law, Gresham’s Law, Law of One Price, Walra’s Law, etcetera. Some of these “laws” are axioms, others are analytic derivations from first principles, and others still are just heuristic rules. So far as I’m aware there’s no economic law that can be said to be an empirical regularity that isn’t of a tautological nature except perhaps the Law of Demand but even this law – more appropriately termed a tendency – admits exceptions. People don’t always act in strict compliance with the predicted regularity of this “law” since some “snob goods” have upward-sloping demand curves (Blaug 138). In all fairness though, in the foregoing conclusions one would have to admit the indecisiveness of the evidence and the unwillingness on the part of economists to develop and test unorthodox hypothesis. All these issues are extensively dealt with by Blaug.

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Economic analysis regularly mandates the adoption of certain core postulates upon which the discursive method can then be constructed, such as: rational economic agents have complete and accurate information about every conceivable present and future contingency; they have fixed and complete preference rankings and the computational power of supercomputers; that goods are all homogenous and infinitely divisible; that there exists perfect competition under which there are no barriers to entry and exit from the market; that transactions are costless; that each player can read the contents of other people’s minds and thus has perfect information about her competitor’s preference rankings; goods and laborers can be freely transported anywhere in the economy; that there’s some default state of equilibrium in competitive markets to which the sector of the economy under analysis naturally returns; that there’s some precise optimum state; and so forth. The claim here is that the overlayering of realworld complications obscures our view of the workings of these supposedly simplified realities; all of which appeal to nothing more than intuitive plausibility to promote their acceptance. The very heart of economics, it seems, demands such mental exercises in which we’re to imaginatively enter into these sorts of make-believe worlds where people can then be constrained to behave in a predictable, deterministic manner. These first


principles basically constitute thought-experiments in which we’re to imaginatively strip away the obscuring details of our experiential economies. They seem to rest on little more than the belief that beneath the dynamism of frenzied speculators, technological innovations, rapid overturn of employees, evolving political and legal conceptions, fashion fads, etcetera. lie stable, general principles, tendencies, or patterns that hold constant over time and across cultures.

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Experience is particular, uncertain, contingent, and probabilistic. Laws, on the other hand are necessary, certain, and universal. So how do economists move from experience to laws? Further, if these suggested theories aren’t even statistical regularities then how exactly do such claims come to warrant the imprimatur of economic law? What afterall justifies the nomothetic appellation of these claims if far from being deterministic they aren’t even seemingly probabistic? According to Lawson, this status of law employs a logical structure that codifies a sentence stating some demonstrable recurrence or regular association (or in Humean terms a “constant conjunction”). One means to do this – as economists do – would be to use the Deductive-Nomological model of explanation (or D-N model for short). Deductive models of explanation have been around since the ancient Greeks but a systematic exposition of such nomological constructions was provided by Carl Hempel and Paul Oppenheim in their Logic of Explanation (1948). The D-N model has a structure of the sort that if the explanandum (the theory, i.e. utility maximization) is true then the explanans (the behavioral event in need of explanation), under the governance of a stated law, necessarily follows as a logical consequence. This is a valid epistemological structure if the phenomena submits to a regular, predictable behavioral pattern under the stipulated operant conditions and can be codified into a theoretical law-like statement of the sort: under conditions C, chemical A added to chemical B, invariably results in chemical D. But in such a closed system of rigidly deductive derivations the conclusion is only as valid as the premises. Such aprioristic reasoning adds no new information and merely reorganizes claims contained in the premise. So we must recur to the postulata: What’s the ontological status of the a priori propositions? How representative are “representative agents”? The conclusion is always contingent upon the relative truth or falsity of the starting axiomata. The factual accuracy of the starting assumptions still remains a materially pertinent concern. But this justificatory structure is prone to three other more serious objections: It’s guilty of a logical deductive fallacy called affirming the consequent. If the antecedent, axiom A, is supposed invariably to result in the consequent, behavior B, it doesn’t follow that if B is true that A must of necessity also be true. This is a problem since economists can always be accused of having constructed their model with a view to arriving at an empirical correspondence with the observed behavior. Let’s try an example. If we observe that agents are now sporting mohawks then this must be what the behavioral instantiation of the Law of Utility-maximization requires. Granted, the postulates don’t in themselves usually yield any empirical implications; we need to add auxiliary assumptions of the sort:


Major premise: Statement of a governing law under stated operant conditions Minor premise: Statement of auxiliary statement

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Conclusion: Statement of the economic behavior to be explained For the last example, the complete deductive structure would look something like this: Agents seek to maximize their utility if they willingly purchase some good If agents are observed purchasing mohawk haircuts then this must be what maximizes their utility Therefore, agents are observed willingly purchasing mohawks If the assumptions are deficient in some way, other structures of the model can be tweaked to make compensating adjustments. And since the use of ad hoc modifications can’t be controlled for, it remains an open question whether the theoretician has discovered some prerequisite conditions for behavioral data or merely constructed an artificial conceptual framework tailored to fit the behavioral system she seeks to model. In this case, since part of the operant conditions for utility-maximization is that agents arrive at their decisions independently, the choice to get a mohawk may not be what maximizes individual utility but may have been done as a result of social pressures. Another sin against logic this logical structure commits is called the fallacy of the undistributed middle. The posited explanandum may well be a sufficient condition to produce the observation, but it’s a mistake to assume that this derivation to be the actual antecedent that resulted in the observed behavior. So, if there are multiple paths to the explanans then the posited logical structure needn’t be the correct path. Perhaps, an example might help. Some confluence of factors led to the stock market crash. If we assume that all participants in the run-up to the crash were rational agents, had perfect information, prices were freely-floating, and the like, then the crash must have been due to the government-imposed halt on trading. Therefore, the government caused the crash In other words, pinning the crash on the government could be one means of arriving at the desired consequent without being the correct factor or part of a actual confluence of factors. Again, it would seem that an appropriate use of the syllogism minimally requires that the logical first principles (i.e. the rational agents assumption) be shown to be true (if it’s to be forwarded as one possibility). It seems we need independent verification of the logical starting points. Even if we accept that the analysis is applicable to the make-believe world of the idealization, one can always refute the pure theory’s claim to be describing any real economic agents or imparting any practical guidance about dealing with actual economies.


This then brings me to a third logical fallacy. The logical structure has no means of distinguishing between universal generalizations from mere accidental generalizations. 645

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Under perfect competition only the most efficient firms survive Given the present state of business in Vancouver it’s presently not efficient for firms to build 10,000 story buildings Consequently, no 10,000 story buildings are observed in Downtown Vancouver I see no means within the logical structure whereby such nonsense derivations can be eliminated. I take such a limitation as mandating an understanding of the institutional context outside the D-N structure. Before going further I think it best to define two new terms: There are certain things known by direct measurement, that is, empirically, such as the unemployment rate, GDP, and the price index. Call these observational terms (or o-terms for short). There are other things known conceptually, cognitively, relationally, or theoretically, such as “If the unemployment rate dips below the NAIRU (Non-Accelerating Inflation Rate of Unemployment) then the economy will experience an ever accelerating rate of inflation,” “A rise in the minimum wage will result in an increase in unemployment,” and “lump sum taxes introduce no economic distortions.” Let’s agree to refer to these latter sorts of statements as theoretical terms (or T-terms). To avoid confusion, I’ll just refer to laws, postulates, and axioms as T-terms. Now, a reasonable question at this point might be to wonder whether the natural sciences don’t similarly depend on many such purely operational conditions of dubious realism. How are economic idealizations any different than the simplifying assumptions the “hard” sciences regularly engage in, such as treating the earth as if it were a perfect sphere, outer space to be a perfect vacuum, frictionless freefall, point masses, inertial systems, or any number of other ideal entities which correspond only approximately to real-life referents (if at all) and merely serve to facilitate the manipulation of mathematical constructions? Actually, there’s a radical difference in kind from the sort of idealizations economists engage in from the idealizations the natural sciences posit, such as Newton’s First Law, Ohm’s Law, or the Ideal Gas Law. The latter spring not from an a priori system of deductions but rather as extrapolations from indisputable facts of experience. All these idealizations maintain close correspondence with reality such that they could be arrived at independently by an empirical-inductive method whereby a skeptical investigator can gather her own sense data to replicate the preliminary generalizations and then attempt to extend the observed domain further by seeking where the posited idealization claims observations may be found. So far as I can discern, economic laws proceed from a fiat-like imposition of the idealization and then through a priori reasoning seek to derive conclusions which may submit to empirical verification (again, with the possible exception of the misleadingly named Law of Demand). Economic theory’s departure from matters of fact is right at the outset. This contrasts sharply with the usual procedure in the natural sciences where T-terms are put in the service of o-terms; their


explanatory value is assessed in terms of how well they help organize o-terms. Economists, on the other hand, defend the primacy of theory over data. The limited facts that have been collected are the real contents of a theory which give it its form and constrain its explanatory domain. Scientific theories are best seen as shorthand schemes for organizing facts. If too many anomalous o-terms crop up which aren’t constrained by the reigning T-term then, in Kuhnian terms, we’ll need a new paradigm to think up replacement theories. How common are lawbreakers, economic agents who live in violation of orthodox tenets? If they outnumber rational agents then we would have good reason to suppose that the laws won’t serve as a reliable guide in explaining behavior.

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In probably the single most cited paper on the methodology of economics, Nobel laureate Milton Friedman, attempts to reply to many of these complaints I’ve outlined. In addressing these various reasonable objections, he submits in The Methodology of Positive Economics (1953) that axiomatic assumptions employed in economics are merely heuristic devices to render economic phenomena more manageable and tractable. According to Friedman’s understanding of science, T-terms need merely make correct predictions and facilitate the construction of policies that work. Still, these useful rules of thumb are then applicable to the extent that agents actually obey the mathematical equations. Or put another way, the nomothetic causal mechanisms, utility maximization, for instance, needn’t be in accord with the thought processes we regularly employ in confronting our economic decisions so long as we behave as if our decisions were informed by utility maximization. This causal account needn’t be the guiding principle actually animating our economic decisions but it can merely be its unintended consequence, as for instance gauged by a statistically reliable generalizations for a sufficiently large sampling set. But he goes much further. In what Paul Samuelson has popularized as the methodological F-twist, Friedman argues that “the more significant the theory, the more unrealistic its assumptions” (218). Theories, in Friedman’s view, are of necessity not presented as accounts of reality, but as abstractly simplified accounts. And the more this theoretically selective focus abstracts from the complicated reality it models, in its attempt to isolate some key features, the more unrealistic it becomes. Musgrave points out that Friedman confuses three very different types of assumptions which he helpfully unpacks as follows: 1.) Negligibility assumptions concern the influence of some countervailing mechanism that can safely be ignored as of inconsequential significance in an account of some phenomena. Musgrave’s example here is air-resistance which for heavy objects near the ground can effectively be dismissed since it doesn’t for most objects alter too greatly the parameters of the phenomena (gravity) being examined. If some such complicating force too greatly obscures or inhibits the operation of the causal mechanism in the manner prescribed by the law then it’s obviously not negligible and the theorizer will then need to resort to a heuristic remediation (noted below). 2.) Domain assumptions specify the necessary conditions under which the theory is applicable. If in moving from the explanandum to the explanans the specific aspects of


actuality to which a model is being applied don’t even remotely meet the criteria required by the logical initial conditions (what I earlier called “operant conditions” are now referred to as domain assumptions), it effectively invalidates the theory’s application. As a consequence, one could argue, that such models are severely limited in their practical implications since the real world rarely ever seems to even come close to conforming to the conceptual starting-points demanded by the derivation. One would then also need to independently determine the extent to which the concrete setting resemble the abstract assumptions; that is, where and to what extent agents actually maximize their utility under certainty; agents have stable, well-behaved set of preferences; perfect competition can be said to hold; agents don’t suffer from “money illusion,” etcetera. If the model requires some highly idealized setting which is constrained in these sorts of peculiar ways – where laws hold only ceteris paribus – whereas the real-life situation refutes such conditions or entails added relevant complications which the model doesn’t incorporate, the derivation would again seem inapplicable. We need then to delimit applicable realms for the analysis to those rare aspects of our social relations where the laws can be said to serve as approximately true. Such theories thus seem severely limited in their scope. This is the high price of resorting to unrealistic precepts.

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This concern over determining the extent to which the idealization diverges from the applied domain is effectively dismissed by Friedman as irrelevant. Regardless, given this reasonable objection, neoclassical claims stand direly in need of justification. Why afterall should we expect that analysis that presupposes rational agents (narrowly defined), instantaneous adjustments, the existence of hypothetical equilibrium states, etcetera. to be applicable to all real-world settings irrespective of whether or not these domain assumptions obtain? Carrying the argument to its logical conclusion, the real-world extrapolation is valid to the extent that the applied realm is relevantly similar to the restrictive operant conditions used to derive the conclusions. 3.) Heuristic assumptions are a means of simplifying the problem with counterfactuals. These simplifying assumptions take a position suppositionally, it needn’t be literally true, to function as a sort of convenient fiction. Musgrave’s example here is Newton’s use of the two-body problem in which he supposed the solar system could be analyzed as composed of only the sun and the earth. So, if heuristic assumptions are invoked then the neoclassical models aren’t claiming to be making rigorous conclusions about full empirical reality. Such considerations as time, uncertainty, delayed adjustments, information asymmetries, disequilibriums, the interconnectedness of agents’ decision-making, etcetera are, by this means, being heuristically set aside as unnecessary complications. These complications can then supposedly be incorporated to work toward a more realistic model, just as Newton hoped the three-body problem (which would include the moon) could then be solved with more sophisticated techniques which he lacked. Newton, in extrapolating from the various planetary interactions that he observed hypothesized that the universal law of gravity which he formulated would allow him to construct this simplified but, nevertheless, valid constructed reality. The question then is: Do economists likewise have warrants to believe that their counterfactuals can accurately


disentangle and isolate the salient features of the economic phenomena in this way. Are these highly stylized conceptions simplified version of some specific aspect of concrete reality or mere artifacts of a constructed reality? Are economists discerning some preexisting pattern or imposing their wishful desire for such a simplified version of reality?

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I wish to argue that neoclassical precepts such as perfect information and perfect completion are under-specified for only stipulating some requirements at the phenomenological level without any consideration of how the agents’ apperception of such physiological and institutional settings may itself alter their behavior. How would living in such a reality mould the perceptions of the economic participants? How would actually being armed with complete info about everything itself alter the agents’ conceptions of themselves is conveniently left out of the account by being assumed to be unchanged. But if beliefs are the unobservable engine of the economy then whether the classic assumptions effect some change in these beliefs should be a serious concern. This would require that the initial conditions be independently tested or else a reasonable objection would be to claim that people might well change their behavior in some way as an adjustment in such alien social spaces. How can economists be sure that we can isolate some behavioral patterns without affecting others? If one supposes agents to have malleable dispositions and limited capacities then their behavioral responses can’t be abstracted away so effortlessly from the institutional, cultural, and historical contexts from which they arise. So such assumptions aren’t harmless heuristic expedients if they can’t empirically or persuasively account for whether there would be behavioral distortions. As such, the heuristic assumptions of neoclassical economics resemble the hypothetical “natural state of man” mentioned earlier. Musgrave’s conclusion is that none of these assumptions can be ignored outright and should always be carefully accounted for in the analysis. Hence, Friedman’s assertion that assumptions don’t matter is then true only of negligibility assumptions and only under very specific conditions. Well, what’s then Friedman’s measure of a good theory? How can we ever be sure that we’ve got it right? According to Friedman T-terms are to be judged not by their implausible assumptions but by their ability to generate predictions that can then be tested against the inherent facts of the world. The “[theory’s] very success shows them [assumptions] to be irrelevant for the phenomena to be explained” (218). He advocates an extreme form of instrumentalism, saying that, “the only relevant test of the validity of a hypothesis is the comparison of its predictions with experience”; not on the basis of its assumptions or its ability to explain (214). His approach is a sort of black box theorizing, according to which the unproven and improvable starting assumptions are “largely” irrelevant. What matters is whether the predictions the theory makes are found to be reasonably accurate. The theories may be founded upon unrealistic and restrictive requirements but they can yet be assumed to have a general applicability, to supposedly tease out some testable implications. As an example, he says that one needn’t even ascertain whether perfect competition or monopoly conditions reign in the given market the T-term is to help


explain. The theoretician is free to apply her analysis to any firm regardless. So agents can be treated “as if” they were maximizing their utility curves whether or not they actually conceive themselves to be doing any such is beside the point. What’s wrong with this account? First off, if one assumes the consequent in constructing one’s theory, freely employing ad hoc adjustments to do so, and then attempts to see whether an empirical verification instantiates the model, should it be any surprise that the predictions it makes are then borne out by the evidence? Note also that the assumptions aren’t what’s directly tested. The T-terms need to be conjoined with various subsidiary statements that interpret the high level generalization for the specific domain being tested. So the general law never really comes under direct empirical scrutiny. To be a meaningful claim about the world the T-terms can’t be tautologies or near-tautologies so that when one tests whether agents are acting “as if” they’re exhibiting maximizing behavior there must be some instances clearly defined wherein it can be said to be the case that agents are behaving “as if they aren’t” doing any such.

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Then there are the numerous problems associated with testing such theories. How adequate a job do such T-terms as the Consumer Behavior Theory do in organizing observables? Suffice it to say, there are strikingly few empirical facts to substantiate many of the T-claims neoclassical economics teaches than what one might be led to expect and many are outright contradicted by some studies. The predictive record of neoclassical T-terms is not very impressive. Most troublesome is how neoclassical economists seem dismissively unconcerned by this lack of grounding for their theories. I could fill many multiples of the few pages I’ve used here to go into such issues but I’ll just direct the interested reader to the surveys of Blaug and Hausman (1992) for these matters. I’ll limit myself here to just one such issue, the demand curve. After canvassing some of the empirical evidence for the aggregate demand curve and how it seems to differ from what its theoretical underpinnings would instead suggest (straight Engle curves, homogeneous of degree zero in prices and money incomes, substitution effect over the income effect, etcetera.) Blaug supplies the following quote:

In the circumstances, there is a good deal to be said for Mishan’s proposal to wipe the slate clean of the theory of consumer behavior: “after all the display of technical virtuosity associated with such theorems, there is nothing the practicing economist can take away with him to help him come to grips with the complexity of the real world. Indeed, he would be no worse off if he remained ignorant of all theories of consumer’s behaviour accepting the obviously indispensable ‘Law of Demand’ on trust” (Blaug 145).

It’s been my contention throughout this paper that we could well have chosen any number of other pre-analytic starting points which are in better accord with the behavioral findings, such as bounded rationality, path-dependant prices, malleable dispositions, and the like. But it’s this blithe unconcern with these axioms’ lack of facticity that impedes the formulation of some such more realistic starting points. Why not institute axioms on the basis of observational evidence instead of their amiability to mathematical formalism?


Consider an alternative account for observed economic behavior: Everything in the economy is as God decrees. If one antecedently undertakes to view the world through some such narrowly constrained framework and then seeks to substantiate it with corroborating evidence, it can always be found. It’s especially easy if the framework’s perimeters are broad enough. Utility explanations are exactly of this sort for not being meaningful segmentations of world. It’s hard to even imagine what sort of evidence could possibly refute near-tautologies of this sort. In fact, it’s always possible to find some verificationist support that lends some, howsoever slight, credence to any theory. In fact, neoclassical economists can, as we’ve seen in the case of transitivity axiom of utility, for good reason, always object that the theory has been conclusively refuted. So, the question shouldn’t be whether there exist some corroborating instances that support these hypothetical speculations but rather if an independent and skeptical experimenter can arrive at the theoretical claim as the best explanation by reliably replicating the observational findings or for its supporters to offer up some means whereby they’d accept the T-term’s falsification. Many testimonials of the sort given here by Fritz Machlup could be supplied to the effect that many economic T-terms are by design unfalsifiable.

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But [any] test [of maximizing behavior] would be gratuitous, if not misleading. For the fundamental assumption may be understood as an idealization with constructs so far removed from operational concepts that contradiction by testimony is ruled out...” (Machlup 11)

I want now to take up Friedman’s claim that people needn’t necessarily think “rationally” (broadly defined) but need merely behave as if they were rational (broadly defined).

“[some critics] concentrate on the largely irrelevant question whether businessmen do or do not in fact reach their decisions by consulting schedules, or curves, or multivariable functions showing marginal cost and marginal revenue” (219).

He emphatically dismisses all objections about whether such claims impart any understanding. So if these concepts aren’t the very medium of people’s thoughts what is the ontological status of such claims? Why exactly do they allow us to make correct inferences about reality (if, in fact, they do)? This is a distinction between what’s true and what’s useful. False beliefs (i.e. in Santa Clause) can have some utility but they can also mislead. This is as true for idealizations in the natural sciences as for those in economics. One could then still reasonably inquire after an adequate explanatory account of the actual causal mechanism that generates the prediction. It seems a natural human tendency to then attempt to explain this functional dependence (if it really exists) between the T-terms and the o-terms. The fancy word for this dependence is “correspondence rules.” How exactly then does the very unreality of model enable us to model reality? Alternatively, one might just throw up her hands and lament how the world of heterogeneous agents is too complex and that neoclassical explanations are about as good as it gets. So, one might just accept economic models as elaborate metaphors to serve as


mere conceptual aids toward an understanding, or as Blaug says, a sort of “filing system for organizing our ideas” (98). I have no objection to such attempts, that is, if they’re accepted as such, save perhaps to point out the artificiality of such theorizing. When I’m in a restaurant perusing the menu it just seems implausible to me to accept the claim that I’m performing a set of deductive calculations in an attempt to situate myself on a higher indifference curve, given some antecedent set of stable and well-ordered preferences. People simply don’t think in such terms.

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Is neoclassical economics really as good as it gets? Should you now find yourself comparison shopping for a more appropriate methodology one alternative is epistemological realism. Realism conceives science as an explanatory enterprise that should attempt to render intelligible observational facts in terms of entities posited by theories that are meant to be taken as literally true. If economic models are advanced merely as abstractly conceived conceptual aids to the understanding, heuristic devices, or expedients for generating predictions, that needn’t have any referent in reality, one could then reasonably ask what explanations are then factive. One’s naturally led to wonder if there can’t then be furnished some provisional account of why people are observed to behave the way they do. The models putatively offer to describe “how” rather than seriously questioning “why.” Philosophers of social science usually frame this distinction in terms of “causal explanations” and “reason explanations.” An example of the former sort of explanatory account would make reference to some involuntary response of the autonomic nervous system over which the agent is incapable of exercising any deliberative choice or that her capacity to exercise this volition is greatly diminished. If an economist in formulating an explanation employing a causal account for some human agent, she’s effectively saying something of the sort: Agents suffer from madness, coercion, or a “weakness of will” who in maximizing their utility, experience a compulsive urge that must of some external necessity be discharged in the purchase of the sought item. The other type of explanation, “reason accounts,” suppose the behavior to be of a purposive nature. To meet some basic explanatory adequacy (at say, a criminal trial) a reason explanation would make the agent’s behavior, given the evidence, intelligible; it would make sense with reference to agent’s intentions and known characteristics; it would be plausible; and it would fit into a clear, unified, coherent narrative context. So for those of us who subscribe to a realist conception of the theory-building enterprise and wish to interpret such claims in terms of referents, that is, people’s beliefs, require causal accounts. Instead of proceeding from the conceptual starting point of supposing some single generic “rational chooser” it may make more sense to use a perspectival approach to canvass the patchwork of belief systems people actually employ in confronting their economic situations. As for instance, in attempting to reconstruct the agent’s own construals she employs in confronting her shopping experiences. One would simply gather o-terms – evidence of occurrences, surveys, psychology experiments, marketing research, and the sort – and attempt to organize them into the most plausible explanation. One would use methods familiar to the other social sciences such as methodological subjectivity that attempt to enter sympathetically into the subject’s actual reasoning.


Friedman, interestingly enough, doesn’t rule out such efforts to interrogate agents of their actual motives:

I do not mean to imply that questionnaire studies of businessmen’s or others’ motives or beliefs about the forces affecting their behavior are useless for all purposes in economics. They may be extremely valuable in suggesting leads to follow in accounting for divergencies between predicted and observed results; that is, in constructing new hypotheses or revising old ones. Whatever their suggestive value in this respect, they seem to me almost entirely useless as a means of testing the validity of economic hypotheses (242).

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I have serious misgivings about whether the construction of abstract models is the best route to making sense of all economic phenomena. The model-building approach is a bottom-up, skeletal approach that aspires to catalog in a compendious framework of precise axioms, from which supposedly can be generated all the variegated commercial transactions we observe around us. As an alternative to this foundational approach in which one attempts to construct hypothetical, abstract, unrealistic, and analytic structures that attempt to arrive at observables, I’d like to motivate a top-down, contextual approach employing a more empirical, concrete, and descriptive method that doesn’t stray so far from what can strictly be discerned from peering out the window at the hurly-burly of commercial life. Specifically, I want to defend the use of ideographic explanations in economics over nomothetic explanations, that is, subjective and contingent accounts in favor of those given in terms of general and universal laws. One would under such a research programme formulate T-terms as schemes to organize observables. But in working from given specifics toward some generalizations it may well turn out that there aren’t any meaningful claims to be made outside limited markets, cultural settings, historical periods, or even eccentric personages. Are there any laws that can help predict human behavioral patterns? Is there any domain in which people can be expected to always behave in some fastidiously prescribed way? Every agent is just a bundle of capacities that admit of degrees of multiple realizability. In the realm of human action, some behavioral patterns may be more probable than others but nothing’s inevitable. All this talk of the laws governing maxims of our economic behavior, or market forces, conveys a sense of the economy as something apart from the desires and beliefs of its participants. It’s better modeled as a collection of self-actuated engines which regularly engineer their own economic environment to better suit these beliefs and desires. And if the outcomes deviate too far from what agents perceive as a desired, ideal, “optimal,” or “perfect” state of affairs, if it violates some personal or societal sense of fairness, then “economic incentives” are of nugatory use in explaining such outcomes. If there’s a socio-economic machine that generates the causal relations we observe in our commercial affairs then its generative capacity is this web of beliefs that agents affirm in their actions. What may in some situations appear to be “suboptimal outcomes” may well be “optimal” since the models fail to consider how non-economic factors as social justice are an unmeasured metric in neoclassical theory that don’t register on any hedonic indices. Neoclassical mechanical


accounts of human behavior presuppose some context-independent propensities of agents as dependable economic regularities which can be relied on to produce fixed relations that can be used in the construction of a comprehensive system of behavioral laws. One needn’t then take historical and cultural specificity into account. But without some such set of fundamental universal regularities our efforts toward causal explanations are for nought.

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Defenders of the received doctrine also draw a sharp subjective/objective divide supposing in essence an interdependence of beliefs and behavior. But institutional beliefs can create their own reality. I have in mind here such facts as that money is merely an artifact of a “economic construction of reality”; since without a general social acceptance of these intrinsically worthless pieces of paper as a medium of exchange the whole economy would straightway collapse. So, if the economy is at least partially socially constructed then the economist’s posited relationships which depend vitally on such a subjective/objective bifurcation may not hold if beliefs change. All economic facts then seem to have at least partially some observer-dependant properties, that is, relative to some interpreter. So, formulating laws concerning the behavior of thinking agents introduces its own special difficulties. Namely, beliefs (T-terms) feed on observed facts (o-terms), that is “revealed preferences” of other agents, which then cause thinking participants to revise their beliefs to better accord with the new state of affairs in the real world. Such beliefs become self-fulfilling by agents who act on them. If economic facts are theory-laden then prevailing expectations can materialize. For a realistic model then one should take account of such dynamic interactions as how the price of a security and the performance of the issuing company feed off each other; how the evolution of product experiences and consumer tastes are jointly determined; a loan or a default has a direct bearing on the lender’s credit rating which, in turn, affects the debtor’s ability to obtain further financing; a sustained price movement in any one direction becomes self-validating; how laborers and management negotiate wages; how the prevalence of compatible software for a popular operating system or keyboard layout causes such products to become even more popular; and so forth. In short, these common behavioral patterns can’t be treated as endogenous to the analysis. Assuming agents to be creatures of causal determinism described by static stimuli-response mechanisms can’t capture these sort of complex latticework of a dynamic two-way interactions. Neoclassical economics is saturated with innumerably many attempts to eliminate such reflexivities: supply and demand are by fiat determined independently, each utility function is independent, wage-earners are oblivious to the current employment rate, the popularity of a toy is of no consequence to potential buyers, selling or buying frenzies among stock traders is impossible, etcetera. This is just another complication that can’t be incorporated into the tenets of orthodox theory in any simple additive way. The scope of nomothetic theorizing is limited further by the fact that the analysis itself has the potential to influence the behavior of the subject it seeks to model. So that there isn’t even a strict independence between the theoretician and her subject of study. Hence even if neoclassical beliefs are inaccurate descriptions but yet if they’re held


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