18 September 2009

Anticipating the Irrational

I have always argued with the neoclassical economists over the power of 'rational expectations', mainly because I don't think most human beings act according to rational impulses most of the time. For those who are not well versed in economics jargon, rational expectations theory suggests that many players in the economy - employees, employers, politicians, consumers, and so on - are making informed guesses about what will happen in the future and base their current behaviour on this.

An example might be somebody deciding not to put their house on the market because they think prices are likely to rise next year. Or employees demanding wage rises because they expect prices to rise, or accepting lower wages because they expect prices to fall. Clearly, there is a lot of politics at play here, since a media which manipulates public opinion may - if the rational choice theorists are correct - influence their demands in the free-for-all that is the capitalist conflict over economic value.

But what I notice at present is how those in the private and public sectors are behaving quite differently in an economic crisis. Now that unpleasant material is flying in all directions from the metaphorical fan, the private sector players - who are there because they are comfortable with risk - are exercising the utmost political pressure to gain advantage for themselves, primarily by refusing to play the game of fair shares (continuing to claim their bonuses) and scaring and bullying the government into subsidising this.

Meanwhile, those in the public sector - who are there because they are risk-averse - are anticipating cuts and radically reducing costs in preparation for cuts that haven't arrived yet. Thus in my university we are preparing to cut expenditure by 15% over the next three years, although no figures are available for investment in universities for next year. In other words our apparently 'rational' behaviour is itself causing a significant shrinkage of the economy, and guaranteeing an extension of the Recession, making it likely it will turn into a self-reinforcing negative spiral.

Perhaps this is unsurprising. Those who came with the theories about rational expectations were themselves academics. They live in a world of brainy, cautious, forward-looking types and they have simply modelled the world they know. It now becomes clear what deeply irrational behaviour this can generate.

Rational expectations grew from one basic assumption: people behave selfishly. This assumption is in itself self-reinforcing, since is is hard to behave with generosity and grace when everybody else is scrabbling for the fastest buck, and harder still when the prevailing ideology tells you that this is irrational behaviour.

University planners may feel more comfortable that we public-sector employees cut our own throats before politicians do it for us. But by causing such a massive shrinkage of the public sector - which should actually expand during a recession - they are guaranteeing that the Recession will be longer, deeper, more costly and more painful. Having worked in a university for seven years I would not have expected rational behaviour from the bureaucrats who dominate the higher education sector, but to see such short-sighted and self-destructive reactions is depressing indeed.


  1. Ah! If we question the rationality of others, how can we be sure that our own rationality is not suspect?

    Rational expectations grew from one basic assumption: people behave selfishly.

    I'm not sure that is correct. Rather "people act in their own self interest" which is not quite the same thing. Self interest may and often does include collaboration with others.

    But the Big question is how do we know what is our own self interest?

  2. I am happy in my own irrationality these days!