24 February 2015

The forgotten dignity of Homo Economicus


Poor chap. Never mind his perfect rationality, his perfect information, his perfect foresight, his perfectly immediate reactions to market signals, his perfectly enlightened self-interest – the Homo Economicus, once a much solicited model, has fallen into disrepute. He now carries the heavy load of popular anti-capitalist resentment on his shoulders. Psychologists frown at his wretched character; and Nobel laureate Daniel Kahneman is only one representative of a whole field of research that has been devoted to proving that none of his traits are truly real, not even in the sphere of free markets.

Philosophers alongside Michael Sandel view the greedy Homo Economicus as the culprit behind an evil commercialization of life, if not as the incarnation of man relapsing into the state of nature, where life was, as Thomas Hobbes (1588-1679) famously phrased it, “solitary, poor, nasty, brutish and short”. Wouldn’t a society composed of purely selfish beings be a moral nightmare?

In the depressive musings of political scientists and sociologists like Richard Sennett, our capitalist institutions leave no room for anybody but the emotionally impoverished Homo Economicus, which thus becomes self-fulfilling. And to top it off, even the economists now shun him: he who once used to be their man. Behavioural economists like Richard Thaler from Chicago, Andrei Shleifer from Harvard and Ernst Fehr from Zurich devote their research to his deconstruction. The list of empirically “proven” behavioral biases, fallacies, anomalies and second-best heuristics for decision-making is growing daily, to the effect that the Homo Economicus begins to resemble famous Nessie: We all liked to believe in the existence of that strange animal, but we now know it was a sham.

In some sense, the discussion about the Homo Economicus is a no-brainer. Did anybody ever believe that real people would be perfectly rational, perfectly self-interested and all the rest? Did any serious economist ever build a model hinging critically on those obviously unrealistic assumptions? Hardly so, and certainly not those who are commonly quoted by anti-capitalists as the intellectual midwives of free markets.

Adam Smith (1723-1790), the founding father of economics as a distinct science, clearly didn’t narrow his view on mankind down to the strict Homo Economicus . He knew very well how irrational people sometimes tend to behave, how easily they fall prey to vanity, envy, self-conceitedness and other passions. And while he described a flourishing economy as the result of individual actions inspired by “self-love”, it was clear to him that “how selfish soever man may be supposed, there are evidently some principles in his nature, which interest him in the fortune of others, and render their happiness necessary to him” (Theory of Moral Sentiments, I.I.I.1).

Nobel Laureate Friedrich Hayek (1899-1992), often pejoratively described by his critics as a “paleo-liberal” or an “ultra-liberal”, probably never so much as even met the Homo Economicus . While his economic theories on business cycles, on capital and savings did imply the notion of purposeful, although not selfish human action, his broader approach was characterized by the humble Socratic recognition of our given and inevitable lack of knowledge.

When knowledge, as in Hayek’s conceptual world, is widely dispersed and comes into being only through the interaction of people within a framework of competition, then perfect information and perfect foresight are ruled out by definition. If we held on to these hypotheses, we would assume away the marvel of spontaneous order, of social coordination as the “result of human action, but not human design”, as Hayek would quote the Enlightenment philosopher Adam Ferguson.

Not even Gary Becker (1930-2014) – another Nobel Laureate who pioneered the use of the economic approach in explaining human behaviour more widely, which brought his theories the nasty label of “economic imperialism” – thought that the Homo Economicus was a reality. “If you think that being rational means selfish individuals, coldly calculating, only worrying about themselves and about their monetary benefits, then that’s obviously a caricature”, he once admitted in an interview (in Karen Horn: Roads to Wisdom, Elgar 2009, p. 145). Becker’s frank recognition might set the psychologists’ minds at rest.

But what about the economists themselves? If practically nobody thought that the Homo Economicus was a faithful description of real man, why did this chap stick around at all? In the interview, Becker gave an explanation that is representative of the economic mainstream: he used the fiction of the Homo Economicus and the underlying rational choice approach simply as a heuristic tool, as “a very powerful engine of analysis that helps us understand a lot of the problems of the world”, a world where people react to incentives and must make choices under constraints.

Critics however typically object that this heuristic device, since it relies on faulty assumptions about human character and preferences, necessarily leads the economists astray and invalidates most of their policy recommendations. At first sight, this objection may appear reasonable. For example, it would seem only natural for economists to argue in favour of incentive pay in order to increase productivity at work. Researchers like Bruno S. Frey from Zurich however have shown that this would not necessarily be a good idea at all, since such an artificial, extrinsic incentive might very likely drive out an existing strong intrinsic motivation.

Workaholics are usually addicted to what they do, not to the money that they earn. In that narrow sense, they aren’t true homines economici, since they are neither rational nor financially selfish – but the introduction of incentive pay might change that, to their own profound frustration as much as to the detriment of the firm.

Similarly, the very existence of paid community workers who regularly come to pick up the trash from the lawn in the public gardens may reduce the intrinsic motivation for the citizens to keep the gardens clean in the first place. Bringing in pecuniary aspects here only creates irresponsibility (moral hazard) and a tragedy of the commons that would otherwise not necessarily be there to bother us. These economic findings are very much in line with the fears brought forward by political scientists and sociologists who worry that the institutions and mechanisms of capitalism “infect” our psyches and erode our social ties. This is exactly their bottom line: in the end, markets need and breed greed.

Things aren’t so simple, however. In fact, whether the Homo Economicus is a useful analytical tool even though it has rather little to do with real man depends crucially on the questions which it is supposed to help answering. As usual in any kind of academic inquiry, the adequacy of different analytic methods depends on the issue at stake. When the question is a microeconomic one, like in the aforementioned examples, the Homo Economicus is a mixed blessing. He helps us to anticipate and explain some, but not all, and perhaps not even the most important possible reactions to incentives and changes in them.

While it might be erroneous to base one’s decisions on these assumptions alone, they nevertheless remain a useful device for approximation. If we translate self-interest simply as purposeful, advantage-oriented behaviour and rationality simply as prudence, and if we thus forget about his stylized perfection, the Homo Economicus allows at least a first good guess about market reactions and results. For instance, it is generally not unreasonable to expect demand to decrease when prices rise. That’s not only better than nothing, it is the very foundation without which no economic laws whatsoever could be discovered.

There is even less reason to say good-bye to the Homo Economicus when we lift the debate to a higher realm and talk about the general economic order and rules, a field of greatest interest for the social scientists of all brands. How can we live together peacefully and flourish? How can we ensure cooperation rather than conflict? How can we best benefit from markets as an ingenious device for social coordination? Questions like these address the ethical underpinnings of life in society, but the Kantian categorical imperative to which political philosophers and other social scientists usually resort cannot provide a robust solution. As the German philosopher and economist Karl Homann has pointed out, it won’t help to implore individuals to behave cooperatively and ethically if the framework isn’t supportive.

In order to find out which kind of framework is necessary, we need to picture social interaction as a prisoners’ dilemma situation where everybody would like to act morally but fails to do so because the others are likely to systematically exploit him. The rules of the game and their enforcement must be devised in such a way that mutual exploitation is effectively suppressed.

The Homo Economicus assumption, boiled down to its relevant core, i.e. purposeful behaviour and advantage-orientation, is indispensable in this context. Whether it reflects real observable behaviour or not, it does urge and help us to work out a robust, exploitation-proof set of rules of the game for modern society. In this lies the forgotten dignity of the Homo Economicus.

Karen Horn is an independent author and teaches the History of Economic Thought at various universities. She also serves as the President of the Friedrich A. von Hayek Gesellschaft (Berlin). She is the author of “Roads to Wisdom – Conversations with Ten Nobel Laureates”.