A critical analysis of the concept of rationality

Written by Naitik Shah

I still remember the day I attended my first economics lecture. It was the first day of my high school and unfortunately it was also my first class of the year. I was nervous as I had absolutely no clue as to what economics meant. The professor entered the class and took his seat. He placed his books down and then stood up went on to write the following four things on the board. First, “Economics is the study of how rational individuals maximize their unlimited wants given their limited resources”, second, “individuals are rational”, third, “Wants are unlimited, because rational individuals would want everything they can lay their hands on”, and finally, “the resources available to these individuals are limited.” These four statements form the very basis of economics and is the very first thing that anyone is taught. Of these four statements, the rationality assumption forms the basis of all economic theory; on its shoulders lies the entire canonical of economic theory. However, have you ever stopped for a minute and asked yourself what if this assumption doesn’t hold? What if rationality is too strong an assumption? Let’s step back for a minute and analyze what it implies to be rational and the implications of this assumption.

Simply put rationality implies that each and every individual in the economic model should act in a manner that will maximize his/her well being. Although this makes perfect sense, since if everyone in the society maximize their well being then the well being of the society as a whole will be maximized. However, this in turn also implies that if individual X can improve his well being by cheating he should; if firm X can increase its profits by using underhanded tactics and creating a monopoly for its good then it should. This clearly contradicts what we are trying to achieve as if someone cheats then one person, who cheats, is going to be well off at the cost of the person he cheats. The total well being of society could still be maximized depending on how much individual X who cheats gains and individual Y who is cheated looses, but this is not what economics is trying to achieve. The purpose of economics is to promote the well being of all individuals in society. Another drawback of rationality is it leads to the exclusion of concepts of charity, generosity, voluntary work and equity. These have been either are called instruments of indirect self-interest or normative science. But don’t you think that these concepts aren’t merely an instrument of normative science or a side-effect of indirect self-interest? I believe that they are conscious actions taken by rational individuals with the sole purpose of helping others and I am sure you would agree with me. As a result, reducing them to mere indirect self-interest denies an important aspect of human nature, i.e. selflessness; something that cannot be understood in the conceptual framework of a self-interested economic man.

The way this problem can be solved is by expanding the concept of rationality so that it includes concerns for welfare, justice and the effects of ones action on others. Thus economic agents will now be concerned about not only their well being but also the effects their actions will have on others, giving then a new conscience. This newly found conscience will allow then to take into consideration the effects of their actions on others, making them more likely to provide complete information as well as ensuring that there are no externalities generated by their actions. This in turn will solve problems like coordination conflict encountered in current models of market. Finally, it will make our economic agents more sociable, and bringing them closer to reality, which in turn will allow us to talk about communities, governments and common beliefs. This will also lead to the introduction of a new mesolevel in our analysis of society, something which is vital but has been missing until now. The reason that this level of analysis is important is because a lot of our policy decision as well as preferences are decided on this level; for example our stand on abortion more or less depends on our upbringing, which in turn is determined by our parents and their beliefs. These are things that are determined as communities and not as individuals, hence reducing such decisions to an aggregate of individuals decisions would be a big mistake and wouldn’t provide any insight into the process through which these decisions are arrived at.

Thus what is need right now is for us to realize that when we say economic agents are rational, it implies that individuals maximize their well being, while taking into account the effects of their actions on others. If this is how we would have been taught economics then global warming wouldn’t have been a problem today, neither would have we seen the crash of Enron, or the declaration of dividends for its shareholders by Northern Rock.