Economic Rationality and the Common Good

 

Whatever is real is rational, and whatever is rational is real.

(G. W. F. Hegel)

One of the prime responsibilities of a government is ensuring economic prosperity; indeed there is a prevailing view in the modern state, in a world that is interconnected and largely cosmopolitan, and in which tribal loyalties are attenuated, that this is its only responsibility. Personally, I think that is too narrow a view; there are, after all, alternative traditional concerns for the moral community of nations rooted in religion and custom, which may be declining, but are still influential, and emerging narratives, such as those of justice-based and environmental lobbies, that wield an increasing influence over policy decisions. All stake a claim to the ‘moral high ground’ of the common good. But given that economic viability is a first order issue for individual survival and political credibility, other issues must, for natural and pragmatic reasons, find accommodation within an economic framework, rather than vice-versa. The issue to be considered here, then, is whether our evolving ideas about human nature point to weaknesses in how orthodox economic thinking, particularly the idea of economic rationality, addresses the common good.

Two narratives on economic rationality

Although economic theories can be complex, they are rooted in fairly simple views of human nature and of the common good. The two great economic narratives of the modern period are undoubtedly those of the liberal free-market and the socialist command economy, which are fundamentally opposed in their interpretation of human nature and their expectation of the type of economic environment in which we should live and which serves the common good.

The economic theory of the free market is derived largely from Adam Smith (1723-1790) in his most important work, The Wealth of Nations. Smith observed that people pursuing their own advantage unintentionally benefit others, which he considered more effective than people deliberately trying to benefit others. This has been expressed as the working of an ‘invisible hand’ in the emergence of a free market maximising the potential and prosperity of the greatest number. Economic rationality on this view is whatever benefits an individual and, I suppose evolutionists would argue, those in whom an individual has a genetic investment, without regard to whether that self-interest was altruistic or merely selfish.

It is worth remembering the context in which Smith was writing, a world rather different from that which we inhabit today. For most of history individuals had been subjected to tyrannical government of one sort or another. In the eighteenth century Europe was experiencing the flowering of mercantilism along with liberalisation and Smith was able to see many – at that time novel – examples of trade being carried out free from the interference of the state as he travelled through different countries. Moreover, Smith wrote in a milieu in which he could assume a fairly coherent culture, one that included Christian beliefs and the social and cultural norms that grew out of the Protestant ethic and – at least his intended audience – a sophisticated and educated background. In such a setting the idea of rational self-interest made sense. Whether the same can be said today, in a world saturated with images of evanescent celebrity and multiplying opportunities for both self-improvement and self-destruction, is a key question.

In hindsight, even the golden age of liberal economics should give us pause for thought; it coincided with the early stage of capitalism and some of the most violent social dislocations of working populations and the subjection of industrial workers to horrific conditions. Though capitalism made some people very rich – as it continues to do so – there is little evidence of the improvement of the lot of the majority – what today we might refer to as the ‘trickle-down effect’ – manifesting itself outside of the political will to regulate boundaries of permissible economic activity. Self-regulation for the common good, in other words, has generally been in short supply. Individual capitalists sought to improve the lot of their workers, moved by conscience, human compassion or religious conviction, but for the most part improvements were fought in the political sphere and by the enactment of laws. Even in America, probably the country most committed to the idea of the free market, Congress was forced to enact laws in 1914 to prevent the establishment of monopolies, a clear case of government interfering to protect free trade being undermined by the unregulated market. In the last few years, after the denouement of the recent global financial crisis, most governments have acted to regulate the banks and financial markets considered responsible, to some degree.

In reaction to the injustices and suffering created during the early period of capitalism, socialism emerged and advocated social and economic justice over that of individual empowerment and enrichment [1]. Many groups and ideologues claiming to be socialist vied with each other during the nineteenth century, but the ideas of Karl Marx, particularly in Das Kapital emerged as the defining statement of socialist economic thought. Marx believed that the advent of capitalism, based on property ownership, represented the final stage in the alienation of workers from their labour. This alienation could only be ended when the workers rose up and destroyed the capitalist system, eradicated bourgeois institutions such as marriage and private property, establishing a communist paradise in which the ruling idea would be “from each according to his abilities, to each according to his needs”.

Lenin and Stalin took the philosophical doctrines and economic theories of Marx and turned them into a programme for communist revolution and a communist totalitarian state, respectively. While Marx saw the proletarian revolution as rolling on the iron rails of historical destiny, Lenin and Stalin were more pragmatic: they saw the communist party as the vanguard of the proletarian revolution to come and therefore ruling by absolute right. Communist dictatorship was justified as it assured the future common good of justice, prosperity and peace. Regimes and political parties claiming the label ‘socialist’ have spanned a broad spectrum, from the genocidal Khmer Rouge, Stalinist Russia and Maoist China, to horrific, brutal or corrupt totalitarian regimes such as North Korea, China and Cuba, to de facto one-party states such as those in Zimbabwe and Venezuela, to the mild socialism and social democracy within the West that are fully embedded within democratic traditions.

Is there such a thing then as socialist idea of economic rationality? I think that one can be extracted from Marxist thought and socialist reality. It starts from the assumption that work is virtuous (as a contribution to the common good) and should be fairly rewarded, but in a competitive world in which the winner takes all the only guarantor of fairness is the state (as a representative embodiment of the people) and, therefore, the state should control and direct economic activity for the common good [2]. Although starting from different presuppositions, this cannot be too far off a Rawlsian concept of social justice (Rawls, 1977). In reality the various forms of socialism, by neglecting the agency of the individual and its desires in social and economic activity, have distorted the various components of this formulation. Under communism the state assumed total control of all property and the means of production, micro-managing (as we would say today) production goals, prices and availability. Those who lived through the years of the cold war cannot forget the unrelieved grimness of daily life under communism, the empty shops and the queues for basics, the lack of freedoms, the almost comical distortions of the command economy, and the lack of economic parity with western economies. Such conditions have been virtually reproduced in contemporary socialist economies. On the other hand, where milder forms of socialism have taken root, it has often seen the expansion of state largesse to the detriment of the economy as a whole. Socialism as an economic strategy seems to be caught in the dilemma that the more enthusiastically it is imposed the more economically devastating the result.

Given the social and economic cost of socialism, why does it persist? What has been surprising in the aftermath of communist regimes in Russia and Eastern Europe is the genuine nostalgia some people feel for that way of life, for the benefits with which ordinary citizens were provided, for the simplicity of life, for the greater solidarity and community spirit. There are a number of possible reasons. One is the social narrative supplied by the regime, which however cynically it would have been received by some people, during some periods gave shape to people’s sense of who they were. The other is that the economic hardships engendered by the command economy created a second ‘black’ economy characterised by barter and a high degree of economic and social interdependence. Possibly also the restricted availability of consumer goods slowed down the flight into self-indulgence facilitated by most forms of new technology and thus helped preserve traditional social bonds and cultural activities.

The fact that two such disparate economic ideas and economic systems coexist is not a mere accident of history. They underlie the complexity of human psychology in relation to economic activity. We want the freedom to pursue our own benefit and that of our family and even larger social grouping. We are also sensitive to issues such as justice and fairness, which are not predicated by rational self-interest but which have a bearing on our economic outlook. Freedom requires both a sense of responsibility to be knowledgeable about what serves best our long-term interests, but also an element of risk which is irreducible. Socialism in principle removes these from the private sphere and socialises them; and to some extent any system in which social bonds are considered worth preserving must do this; society, after all, cannot be a zero-sum game. But a just society must also create the space in which individuals can have the opportunity to create wealth, and not just for themselves and their immediate families, but for the common good. Squaring this circle is proving difficult, but remains the holy grail of advocates of the good society.

Human nature and rationality in economics

Critics of the free market notion of rational self-interest could point out with some justification that many, if not most, of the decisions we make are based on irrational rather than rational processes, and this much has been established in psychological studies that have looked at decision-making in purchasing. These studies have informed the new wave of advertising and marketing strategies used in, for example, the layout of shopping centres. This is not even to speak of the advent of advertising which will increasingly be targeted and personalised based on tracking our online life and interests. Writ large, it can be argued that irrational forces are at work in the economy as a whole. The euphoria that accompanies an economic upturn is well understood; that this same euphoria all too frequently translates into recklessness, both at the individual level, the corporate level and even national level, is also well attested.

By some strange omission the irrational aspects of human nature do not feature at all in standard economic theory, which remains firmly wedded to the doctrine that economic decisions are fundamentally rational. This bias underlies the extreme mathematisation of modern economic theory as taught at universities. There are exceptions to this though. One of the great twentieth century economists, John Maynard Keynes, in his book The General Theory, was also concerned with the irrational aspects of the human psyche which he collectively referred to as ‘animal spirits’. Written during the Great Depression of the 1930’s, it proposed a number of measures to ameliorate the economic conditions of the time. The US government was keen to seize on the solutions he proposed that could be immediately implemented. The more subtle analysis, of how government could manage economic expectation through taking mass psychology into account, was quietly forgotten. Two contemporary economists, George Akerlof and Robert Shiller, have resurrected this neglected aspect of Keynes work. The authors’ contention is that only by taking the irrational into account does a true picture of these phenomena and of the entire economy begin to emerge. It will also, they argue, provide a more balanced view of economic activity and a more nuanced perspective on the role of government in the economy, neither the laissez faire of liberal economics nor the heavy hand of socialism. [3]

There is, in fact, also theoretical evidence that rational self-interest may result paradoxically in poor outcomes. In game theory, a branch of mathematics concerned with the logical outcomes of people behaving rationally under given conditions, there is something known as the ‘prisoners dilemma’. This states that when a player has more to gain individually by cheating than by cooperating with a partner, but more to gain by cooperating with a partner than by them both cheating, they will nevertheless both end up cheating and so end up with the worst result. The logic runs as follows: if I cheat I will end up with the best result (even though the other person will end up with little or nothing); I would like to cooperate, but if I can think of cheating so can my partner, and if my partner cheats I will end up with little or nothing; therefore, it is in my interest to cheat. The logical result of rational self-interest is that both partners cheat and end up with the worst result.

There are a number of variants of the prisoners’ dilemma attempting to explain through the application of game theory to economic decision-making how rational choices lead to paradoxical outcomes, such as the travellers’ dilemma (Basu, 1994). I came across the following example a few years ago, which imagines a long beach with two access points, one at each end, through which everyone who goes on to the beach must enter and exit. Two ice cream sellers park their vans, one at each entrance, and ply their trade. Both are able to take advantage of the flow of tourist passing both ways. One of them reasons, however, that if he were to move further in along the beach he would not only be able to gain all the trade he already enjoys but also encroach on some of the potential customers of the other seller. Naturally, his counterpart, seeing this move and unwilling to be taken advantage of, mirrors his actions. This process repeats itself until they will eventually both end up at the centre of the beach. What is interesting is that both will now have less trade than they had when they were parked at the entrance, firstly because many people will not venture that far down the beach, secondly because their custom at the centre will have to be shared.

In the 1960’s a population biologist called Garrett Hardin published a paper called The Tragedy of the Commons. It was basically a scaled-up version of the prisoner’s dilemma that denied the role of rational self-interest in realising a collective good and recommended coercion in matters of population control. Named after the common lands which existed in England during the Middle Ages until the Enclosure Acts, which belonged to no one but on which all farmers could graze their animals, Hardin theorised that it was in each farmers’ interest to overgraze the common lands as the benefit of each additional animal was realised by the owner alone, but the negative effects of overgrazing were borne by all who had access to the land, thereby ensuring its exploitation and ultimate destruction. Hardin surmised that, similarly, it was in everyone’s interests to maximise the number of children they had when social and economic conditions favoured large families, to the detriment to society as a whole.

The Tragedy of the Commons, so-called after Hardin, is one argument advanced in favour of coercive government acting to prevent our selfish destruction of the common good. However, in The Origins of Virtue, Matt Ridley contends that Hardin misunderstood the nature of the common lands, arguing that they were not a free for all, but were controlled by a system of jealously guarded rights and obligations honed over generations. He cites many other examples of the communal settlement of dilemmas arising over the issue of public goods by the imposition of rules and regulations, by limited ownership, by penalties, and so on, none depending on the bureaucratic hand of the state. In fact – despite counter-factual examples like China’s one-child policy –in much of the developing world families have voluntarily limited themselves to an average of two children as a result of education, women’s emancipation and the prospect of economic advancement. This latter case illustrates the point that while the heavy hand of government is always unwelcome, it is nonetheless the case that good government policy aids good decision-making, in this case the provision of educational and economic opportunity for women.

Another often cited example is how the interests of both fishermen and consumers was sustained in the past not only by territorial limits, imposed by national governments [4], but also by local knowledge of the fishing grounds and an acceptance that this was a resource that this had to be shared and harvested in a sustainable way, which raises the possibility that self-interest may best be served by cooperation. There is experimental backing for this. One of the puzzling aspects of the prisoner’s dilemma is that if it is played repeatedly it tends to lead to cooperation, which is what we experience in the real world: in real world situations most people tend to trust each other, cooperate and get along. However, the logic of the dilemma is that rational self-interest should result in the worst-case scenario and the refutation of this logic needs to be explained. Just as repetitive playing of noughts and crosses leads to the realisation that there can be no winner and the abandonment of play, so repetition of the prisoners’ dilemma reinforces the rule that rational self-interest is overall best-served by cooperation.

Humans are highly attuned to fairness or the lack of fairness in a situation. This may be one of the reasons for the continuing appeal of socialism; it responds at a deeply atavistic level to the inherent injustice of so much of the world’s economic poverty and institutionalises grievance against those who are seen as unjustly favoured (such as bankers in the current climate). Some experiments have looked at the relationship between our sense of fairness and spite. They turn on adding a new element to the prisoners’ dilemma. Under a system in which all benefit by cooperation, those who exploit the system by not cooperating gain a significant advantage, while those who do cooperate lose out. If the option for the exploited to pay for the punishment of those who defect is added the outcome is very different. Despite the exploited losing even more, they experience satisfaction at seeing the exploiters punished. Moreover, in future rounds group cooperation is far more common (Whitfield, 2009). This suggests that despite its unblemished record of economic failure, socialist rhetoric, invective and militant espousal of marginal causes may have a sensitising effect on the machinery of capitalist productivity, and its socially-grounded morality eventually come to permeate all layers of society.

The relationship between self-interest and cooperation is complex, reflecting that human life is multi-layered and that not every issue, even within the economy, can be reduced to purely monetary considerations. This means that the resolution of dilemmas is likely to be highly differentiated. The case of the ice cream sellers, given above, could be resolved in several ways: one or both could drop their prices, sparking a mini-trade war, eventually forcing one out of business (zero sum game); they could agree to a territorial strategy allowing both to make a fair living (cooperation); one could focus on the quality market and high service (niche). Some issues, though, do not really have the same scope for economic resolutions. A recent case of some NHS trusts tendering out their care provision for the elderly and dying to private companies through negative auctions is deeply offensive to our sense of social obligation and the dignity of human life in its most vulnerable stage (Bennett, 2009). All societies must eventually recognise that for the common good there are some obligations for which the bottom line is not a consideration.

Conclusion: rational economics and the common good

If, as Hegel suggests in the quotation from The Phenomenology of Mind reproduced at the start of this essay, the rational and the real can be identified, that seems an idea worth exploring for its potential implications for economic rationality. As the economy is a complex system of interrelation and interdependence, it implies that a concept of economic rationality cannot be based simply on individual choice but on choices which individuals make in regard of their relationships to others upon whom they depend and who depend on them, beginning perhaps with those closest, but rippling out to the most abstract idea of the public good.

Just as – at the risk of tautology – self-interest is that which serves the long-term benefit of the individual, rather than just the immediate gratification of desires, the common good is that which allows the collective benefit to be sustained, rather than squandered to featherbed a favoured constituency or appease a particularly vocal case of special pleading. And just as we as individuals struggle to negotiate a reasonable compromise between pleasure and our own sense of integrity and self-worth, our societies too seem to be in an incessant quest for a dynamic equilibrium in which the competing demands of the individual and the whole, compassion and incentive, freedom and security, and progress and preservation can be recognised and reasonably accommodated. In this the state, embodied in the government of the day, has a role to play in sifting, innovating and building upon the best ideas of its predecessors.

Since, as discussed, the real economy clearly contains much that is irrational, economic rationality implies policies which – given the impossibility of eradicating irrationality – work to contain and manage it. As a non-economist I have few specifics, beyond the obvious that the state should promulgate the national narrative on the economy, be the creator and maintainer of the conditions for economic prosperity and instigate or legislate for buffering against boom and bust, economic manias and depressions. However, the preceding analysis suggests that, in addition, government should be furthering civil society and generating social capital by encouraging cooperation at every level, building – or allowing the building of – dynamic systems into the society and economy, as a basis for private initiative and communal prosperity, but also for spreading and managing risk, such as that posed by unemployment, accident, sickness and old age, that we know we do not face those entirely alone.

Notes

 

  1. Though routinely touted as ‘radical’, the radicalism tends to be limited solely of its rhetoric; socialism in practice is one of the most atavistic and reactionary of social movements, steeped in tribalism and suspicion of the outsider seasoned with accusatory invective, factionalism and infighting. It is not even a particularly modern phenomenon, as all pre-modern societies have been communal to some degree and socialism consciously boasts a distinguished historical pedigree, claiming precursors in monastic orders, radical Protestantism – such as the Brethren of the Free Spirit, the Levellers and the like – or the ideals and spirit of the French revolution.
  1. Marxists would interpret this differently, seeing the injustice in structural terms, workers (the proletariat) having only their labour to trade, while the capitalists generate income from ‘rent’ on the means of production, such as land, property, capital and labour. The solution to this injustice is asserted to be the destruction of the capitalist class and the appropriation of the means of production by the workers.
  1. Along with the reappraisal of Keynes’ macroeconomic approach in such recent developments as quantitative easing following the economic downturn in America and Europe, there has also been a revival of a more narrative and empirical approach to economics inspired in part by Keynes, but also by theoretical developments such as chaos theory and complex systems theory, which, while having a mathematical basis, are rooted in real-world and human-scale observation and seek to unify the global with the local, in which the particular story has become a renewed focus of interest. The conceptual landscape of tipping points (Gladwell, 2000), freakanomics (Levitt and Dubner, 2005), black swans (Taleb, 2007) and nudge theory (Thaler and Sunstein, 2008) are all attempts to marry individual stories with observation and overarching economic and social theory.
  1. Such as the British government was able to exert in the days before the Common Fisheries Policy of the EU created a global free-for-all exacerbated by Soviet-style quotas which has brought local fishing industries and a number of marine species to the brink of extinction.

Bibliography

George A. Akerlof & Robert J. Shiller (2009). Animal Spirits: how human psychology drives the economy and why it matters for global capitalism. Oxford: Princeton University Press.

Kaushik Basu (1994). ‘The Traveler’s Dilemma: Paradoxes of Rationality in Game Theory’. The American Economic Review, Vol. 84, No. 2, Papers and Proceedings of the Hundred and Sixth Annual Meeting of the American Economic Association (May, 1994), pp. 391-395.

Rosemary Bennett (2009). ‘Elderly left at risk by NHS bidding wars to find cheapest care’. The Times, Monday June 1, 2009.

Malcolm Gladwell (2000). The Tipping Point: How Little Things Can Make a Big Difference. Boston, MA: Little, Brown & Co.

Garrett Hardin (1968). ‘The Tragedy of the Commons’, Science 13 December 1968:Vol. 162. no. 3859, pp. 1243 – 1248

John Maynard Keynes (1936). The General Theory of Employment, Interest and Money. London: Macmillan (reprinted 2007).

Steven D. Levitt and Stephen J. Dubner (2005). Freakonomics: A Rogue Economist Explores the Hidden Side of Everything. New York: William & Morrow.

Karl Marx (1867/1887/2015). Capital: a Critique of Political Economy. Moscow: Progress Publishers.

John Rawls (1977/1999). A Theory of Justice. Cambridge, MA: Harvard university Press.

Matt Ridley (1996). The Origins of Virtue. London: Penguin.

Adam Smith (1776/2007). An Inquiry into the Nature and Causes of the Wealth of Nations. Amsterdam: MetaLibri.

Nassim Nicholas Taleb (2007). The Black Swan: the Impact of the Highly Improbable. London: Penguin.

Richard H. Thaler and Cass R. Sunstein (2008). Nudge: Improving Decisions about Health, Wealth, and Happiness. New Haven, CT: Yale University Press.

John Whitfield (2009). ‘Cruel to be kind’, New Scientist, 16 May 2009, vol. 202, No. 2708, pp. 42-45

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