What Does it Mean to Be Rational?

One of the most basic assumptions that underlies economic analysis is that people are rational. Given a set of possible choices, an individual in an economic model always chooses the one they think will give them the largest net benefit. This assumption has come under attack by many within the profession as well as by outsiders.

Some of these criticisms are easy to reject. For example, it is common for non-economists to make the jump from rationality to selfishness and denounce economics for assuming all humans only care about themselves. Similar criticisms point to economics for being too materialistic when real people actually value intangible goods as well. Neither of these arguments hits the mark. When an economist talks of rationality, they mean it in the broadest possible way. If donating to charity or giving gifts or going to poor countries to build houses are important for you, economics does not say you are wrong to choose those things. Morality or duty can have just as powerful an impact on your choices as material desires. Economics makes no distinction between these categories. You choose what you prefer. The reason you prefer it is irrelevant for an economist.

More thoughtful criticisms argue that even after defining preferences correctly, people sometimes make decisions that actively work against their own interests. The study of these kinds of issues with decision-making  has come to be called “behavioral economics.” One of the most prominent behavioral economists, Richard Thaler, likes to use the example of the Herzfeld Caribbean Basin Fund. Despite its NASDAQ ticker CUBA, the fund has little to do with the country Cuba. Nevertheless, when Obama announced an easing of Cuban trade restrictions in 2014, the stock price increased 70%. A more recent example occurred when investors swarmed to Nintendo stock after the release of Pokemon Go before realizing that Nintendo doesn’t even make the game.

But do these examples show that people are irrational? I don’t think so. There needs to be a distinction between being rational and being right. Making mistakes doesn’t mean that your original goal wasn’t to maximize your own utility, it just means that the path you chose was not the best way to accomplish that goal. To quote Ludwig von Mises, “human action is necessarily always rational” because “the ultimate end of action is always the satisfaction of some desires” (Human Action, p. 18). He gives the example of doctors 100 years ago trying to treat cancer. Although the methods used at that time may appear irrational by modern standards, those methods were what the doctors considered to be the best given the knowledge available at the time. Mises even applies the same logic to emotional actions. Rather than call emotionally charged actions irrational, Mises instead chooses to argue that “emotions disarrange valuations”  (p. 16). Again, an economist cannot differentiate between the reasons an individual chooses to act. Anger is as justifiable as deliberate calculation.

That is not to say that the behavioralists don’t have a point. They just chose the wrong word. People are not irrational. They just happen to be wrong quite often. The confusion is understandable, however, because rationality itself is not well defined. Under my definition, rationality only requires that agents make the best decision possible given their current knowledge. Often economic models go a step further and make specific (and sometimes very strong) assumptions about what that knowledge should include. Even in models with uncertainty, people are usually expected to know the probabilities of events occurring. In reality, people often face not only unknown events, but unknowable events that could never be predicted beforehand. In such a world, there is no reason to expect that even the most intelligent rational agent could make a decision that appears rational in a framework with complete knowledge.

Roman Frydman describes this point nicely

After uncovering massive evidence that contemporary economics’ standard of rationality fails to capture adequately how individuals actually make decisions, the only sensible conclusion to draw was that this standard was utterly wrong. Instead, behavioral economists concluded that individuals are less than fully rational or are irrational
Rethinking Expectations: The Way Forward For Macroeconomics, p. 148-149

Don’t throw out rationality. Throw out the strong knowledge assumptions. Perhaps the worst of these is the assumption of “rational expectations” in macroeconomics. I will have a post soon arguing that they are not really rational at all.

Quote of the Day 8-23-16

All ownership derives from occupation and violence. When we consider the natural components of goods, apart from the labour components they contain, and when we follow the legal title back, we must necessarily arrive at a point where this title originated in the appropriation of goods accessible to all. Before that we may encounter a forcible expropriation from a predecessor whose ownership we can in its turn trace to earlier appropriation or robbery. That all rights derive from violence, all ownership from appropriation or robbery, we may freely admit to those who oppose ownership on considerations of natural law. But this offers not the slightest proof that the abolition of ownership is necessary, advisable, or morally justified.
Ludwig von Mises, Socialism, 1922

Quote of the Day 8-17-16

It is a profoundly erroneous truism, repeated by all copy-books and by eminent people when they are making speeches, that we should cultivate the habit of thinking of what we are doing. The precise opposite is the case. Civilization advances by extending the number of important operations which we can perform without thinking about them. Operations of thought are like cavalry charges in a battle — they are strictly limited in number, they require fresh horses, and must only be made at decisive moments.
Alfred North Whitehead, An Introduction to Mathematics, 1911

Quote of the Day 8-12-16

Individual man is the product of a long line of zoological evolution which has shaped his physiological inheritance. He is born the offspring and the heir of his ancestors, and the precipitate and sediment of all that his forefathers experienced are his biological patrimony. When he is born, he does not enter the world in general as such, but a definite environment. The innate and inherited biological qualities and all that life has worked upon him make a man what he is at any instant of his pilgrimage. They are his fate and destiny. His will is not “free” in the metaphysical sense of this term. It is determined by his background and all the influences to which he himself and his ancestors were exposed.
Ludwig von Mises, Human Action

It’s Not Your Fault

Note: Although this post is my longest so far, 1500 words is not nearly enough to form a full argument on a topic as big as free will. I’m also not a philosopher so this post is very much outside my area of expertise. I don’t expect the words here to convince anybody, but they are what I believe and I hope they give some idea of the philosophy that drives much of my thinking on economics and politics.


I used to believe in free will. In fact, I hardly considered the idea that there was any other possibility. Success, I thought, was built entirely on making good choices, failure on making poor ones. And perhaps it was because I had been relatively successful that I was so averse to believing those choices came from anything other than my own free will. I chose to work hard, chose to stay out of trouble, chose to be respectful to others. Those choices led to good grades, good relationships, and a good life. Most importantly, those choices were mine.

Nobody can say I’ve never changed my mind.

“I don’t believe in free will.” I don’t remember how the conversation got to that point, but I do remember my feeling of disbelief when I heard a friend say those words at dinner one night in the Umass dining hall. My initial thought was to throw my fork at him, to flip over my plate of food, to do something so unpredictable that he would be forced to admit that the only explanation was that I did it of my own free will. Of course, I didn’t do any of those things. I did spend the next hour arguing with him and several hours after that furiously googling to find evidence that free will was real. What I found instead was that Einstein believed “everything is determined, the beginning as well as the end, by forces over which we have no control” and that neuroscience has offered evidence that free will is nothing but an illusion. The debate over free will vs determinism is complex and has not been settled, but in reading the various arguments, I consistently found myself drawn more to those that opposed free will. It was time to admit I was wrong.

Think about anything you’ve ever done, any choice you’ve ever made. Now try to think about the reason that you made the decision in the way that you did. I can’t think of any action I’ve ever taken that wasn’t fully shaped by my past experiences. For me, free will means that if I could repeat the exact same situation twice, I would make a different choice each time. But why would that be? The choices I make are the ones I believe to be optimal (broadly defined) at any given point in time and what I believe to be optimal can only come from what I have learned in the past. I was lucky enough to be born into a stable family in the richest country in the world. If I were an orphan growing up in inner-city Boston, would I be where I am today? Unlikely. If I were born in Kenya? Not a chance. The opposite thought experiment is also revealing. If somebody else lived through my life in exactly the same way I have until this point, wouldn’t they just be me? Why would they make any choice differently from the ones I make?

Take away all the people you’ve met in your life. Take away all of the books you’ve ever read, all the movies you’ve ever seen, all the websites you’ve ever visited. Take away your genetics. You didn’t have control over any of those things, so they can’t be the result of your free will. But without them, what is left? Are you anything more than everything you have ever experienced? I’m not so sure.

Imagine that you could see your future, not only the one that actually occurs, but every possible future based on every possible action you could ever take. In this case, it should be clear that there is only one set of choices that make sense, the ones that lead to the best life (again defining best in the broadest possible way – I am not saying that people have to be “rational” in the usual economic sense of the word). Adding uncertainty complicates the problem, but it doesn’t change the basic principle. Every decision has to have a reason for being made, regardless of whether that reason is based on a complicated calculation, a simple heuristic, or pure instinct. If I knew everything about you, from your memories to your genetics, from your predictions of the future to your emotional state, I claim that I would have enough information to predict exactly what you would do next because I would be able to observe exactly the thought process that led you to make the decision.

Although determinism seems like a scary idea – your path is already set before you make your choice – the alternative is actually worse. There is only one way out I can see, one hope for “free will,” and that’s pure randomness. Again consider the situation where you live the same life in the exact same way up to a decision point. There are only two options. Either you make the same decision each time, which is then by definition a decision that could be predicted given full information, or you make a different decision given the same circumstances, which means there must be randomness involved. It can’t be randomness like flipping a coin – knowing the speed at which your thumb moves, the air resistance, the weight of the coin, and every other factor means the result is fully determined before the coin lands. Quantum mechanics appears to offer the possibility of true randomness, where only the probabilities of an event can ever be predicted, and some have used this phenomenon as an argument against determinism. But decisions being driven by pure randomness does not really support free will either, at least not in the way most people would think about it. In this version of the story, your path may not be fully determined, but now it’s completely random. Either way, your choices have nothing to do with you.

Now you might be a bit confused. The previous argument is starting to sound something like “you didn’t build that,” a rallying cry for democrats like Obama and Elizabeth Warren to justify taxing the rich. And there is some logic to that connection. If you aren’t the source of your own actions, why should you be responsible for their consequences? Sure, most rich people worked pretty hard to make their money, but even that hard work only came because they had good influences pushing them in the right direction. Other individuals and institutions (yes, even the government) deserve much of the credit for their success and it therefore seems natural to redistribute some of the rewards. So how do I reconcile determinism with libertarianism? Why is my blog dedicated to Hayek rather than Karl Marx?

It’s all about incentives.

If people’s choices are entirely determined by outside forces, then the institutions and laws that define the environment in which they live become especially important. Without free will, taxing the rich is no longer a question of fairness, but without the reward, why should an entrepreneur take the risks required to start a new business? Why should a manager put in the work required to make that business run well? Why should a worker do any more than the bare minimum to avoid getting fired? Conceding that all people had help in achieving success is not an argument against allowing them to keep all of the benefits of that success, because those benefits are themselves one of the most important factors in pushing them to make good decisions.

In other words, I’m not a libertarian because it’s right. I’m a libertarian because it works. Free will doesn’t exist, but acting as if it does ensures that incentives push people to act in ways most would consider desirable.

So why should we care? If we are better off pretending free will exists even if it doesn’t, why bother with this discussion at all? I think it has to do with perspective. Next time somebody does something you disagree with, remember that they come from a very different place than you do. They didn’t have your parents, your teachers, or your friends and therefore they could never have developed the same set of values you have. It doesn’t excuse immoral actions, but it does shift the blame. Rather than hating people that do bad things, rather than strive for vengeance, or for harsh punishments, the goal should always be to change the environment that caused those actions in the first place.

But more importantly, rejecting free will can give you a better perspective on your own life. Every person’s life will be filled with success and failure, and it’s easy to take these results personally, to admire your own achievements and blame yourself for your flaws. These feelings are important – they drive you to become a better person. But I’ve found that recognizing the influence others have had on your life can remind you to never get too high or low. When you succeed, stay humble. And when you fail, remember that it’s not your fault.

 

Quote of the Day 8-7-2016

There is the fact that man’s mind is itself a product of the civilization in which he has grown up and that it is unaware of much of the experience which has shaped it – experience that assists it by being embodied in the habits, conventions, language, and moral beliefs which are part of its makeup. Then there is the further consideration that the knowledge which any individual consciously manipulates is only a small part of the knowledge which at any one time contributes to the success of his action.
F.A. Hayek, The Constitution of Liberty, p. 75

Welcome

Welcome to the Pretense of Knowledge! I started this blog primarily for my own benefit – to organize my thoughts and polish my writing – but I hope you will find something interesting to read here as well. The main focus of most posts will be on economics, but I also plan to write on politics, philosophy, and occasionally throw in a couple posts on sports and entertainment.

Since my site shares its title with F.A. Hayek’s Nobel Prize speech, you may have already guessed that I approach most topics from a Hayekian libertarian perspective. If you don’t know what that means, here or here might be a good place to start (and if you’re feeling more adventurous try this). Essentially, it means that I won’t be voting for either Clinton or Trump in November. It means that I think markets work well most of the time and that when they don’t the government still tends to make things worse. And it means that I think the American military is about five times larger than necessary, that we should be knocking down walls rather than building new ones, and that politicians shouldn’t have anything to do with what you do in your bedroom or what you put into your body.

But besides paying my respects to Hayek, the title “the pretense of knowledge” has a deeper meaning for this blog. In his speech, Hayek criticized the arrogance of economists who believed that their knowledge was so great that they could make numerical predictions with accuracy comparable to the physical sciences. Instead, he urged the social scientist to recognize the “insuperable limits to his knowledge.” In my writing I will attempt to adhere to that philosophy. I have no doubt that a large proportion of the ideas I present turn out to be totally wrong and I fully expect in two years (or two months) I will look back on my early posts in disgust. So if you disagree with something I say, tell me why in the comments and try to keep an open mind. Hopefully, we will be able to learn from each other.

Over the next couple days I will have posts coming out about Hayek’s economics, about why 2016 is the best year yet, and about free will vs determinism. I also plan to do a series of posts criticizing modern macroeconomics and will likely have some smaller posts as well.

Thanks for reading!

Chris