Listener 23 December, 2000.

Keywords History of Ideas, Methodology & Philosophy

Take two people, A and B, who do not know one another. Give person A $100. A has to offer to B a share of the $100, say $x. If B accepts the offer, then each keeps their share (that is, B keeps $x and A keeps $100-$x). If B rejects the offer then neither gets any of the money. That is the ‘ultimatum game’.

The logic of the theory called ‘economic rationalism’ is that A has to offer B something or B will say no and A will get nothing too. But A needs only to offer the minimum $1, since B is now better off and so will accept the offer. But when the ultimatum game is played with real people and real money, the most common outcome is A to offer $50 (keeping $50) while the average offer is about $44 (keeping $56). This seems to apply in the US, Israel and Britain. When Wellington economists Judy Bethwaite and Paul Tompkinson tried the game on their economics students (early in the course, so they had not been taught the ‘right’ answer) with hypothetical money (our research funding is not that generous) they too got a mode of $50 and an average of about $44. The dominating conclusion is the experimental outcomes diverge greatly from the theory.

Now one can always patch a theory to bring observation in line with it. But the practical import of most of the patches is that one cannot rely on economic rationalism to predict human behaviour. Inconveniently perhaps, we do not behave like the selfish calculating animals of that theory. US economist Elizabeth Anderson says ‘there is probably no other hypothesis about human behaviour so thoroughly discredited on empirical grounds that still operates as a standard working assumption in any discipline.’ Yet it is was the theory used to inform and justify rogernomics and ruthanasia. Thus many of the foundations of many of the reforms – especially those which involved the public sector – may be deeply flawed. Perhaps that is why we are having so many problems today.

Suppose we design a system based on this economic rationalism. It would tend to reward the more selfish (those who offered less than $20, say) and we end up being ruled by those who lack the generosity and altruism that mark most of our behaviour. Physician Peter Roberts of the salaried doctors’ association has said that there are too many ‘institutional psychopaths’ running our hospitals. Perhaps they are perfectly rational – even sane. It is just they may belong to the minority who offer only $10 in a $100 ultimatum game. Consider a $10 person and a $50 person in a negotiation. A minimal offer may make each better off but the $50 person, incensed that it is not fair, will reject it. Both are bewildered, one because the outcome solution is not efficient, the other because the efficient outcome is not equitable. Complicate the situation to a practical reality far beyond that of the ultimatum game and one side seems pathological, the other naive. Although the rogernomes tried to eliminate the words from the meaningful lexicon, ‘equity’ and ‘fairness’ are fundamental to the human condition.

One study found some Amazonian Indians who generally make very low offers, behaving like the theory says. Auckland university economist, Tim Hazledine points out that the tribe is hardly an example of successful capitalist development. It is those in capitalists societies that seem to behave quite differently from the theory being used to explain capitalism. He thinks that this is a way to start thinking about ‘social capital’. (I am more cautious, because the term ‘capital’ used here has little to do with the economists’ analytical notion, although most non-economics advocates think in some way it does.)

The nagging doubt is if the behavioural assumptions that underpin the economics are plain wrong – if rigorous to the point of rigor mortis – the resulting policy prescriptions may be useless. Consider the debate about retirement policy. Various contributors seem to use a model of savings behaviour which is based on this economic rationalism and is inconsistent with the way people actually save. Their policy prescriptions to increase private savings frequently conflict with actuality, and probably lead to the opposite outcome – less savings, not more. (It may be the advocates behave like the $10 people of economic rationalism. It is just inconvenient for their public policy that the rest of us – the vast majority – do not.)

US economist Richard Thaler, whose research has – time and again – shown the economic rationalism model is wrong, has discussed how the economist’s model of human behaviour has to be modified. He concludes that when the modifications are made, Homo Economus will become – well – Homo Sapiens.

It is because some economists have tried to think about these more realistic accounts, that they live reasonably integrated lives between their understanding of the human condition and their practice of it. The $10 people may exult Ebenezer Scrooge, but Judy, Paul, Elizabeth, Tim, Richard, and your columnist – and indeed many other economists – have no difficulty sharing Tiny Tim’s Christmas sentiment of ‘God bless us every one.’