A defense of Homo economicus – he ain’t dead yet!

This is not a defense of me – would much rather leave that to others if ever that was called for. Rather I am talking about the economic concept of Homo economicus.  I am in many ways replying to an article that describes the concept as a myth which can be read here. While not essential to follow this blog, it will give background to the criticism I am responding to.

The definition at least can be agreed – Homo economicus refers to people acting as rational utility maximizers as they make economic decisions. The concept is used for both consumers and producers – basically anyone involved in an economic activity. This creates a model by which economists try to explain behaviour and make predictions that are born out by empirical evidence.

1. The concept is right wing

I have to reject that – maybe the concept is used by people on that political side in your respective country. It however does not make the concept right wing. Just because the conservative party is seen as market friendly and has a good  relationship with the Adam Smith Institute does not mean Adam Smith was a conservative (or would be a member of the ASI for that matter).

The other similar criticism is it is based on the prejudice of the economist. That the assumptions that underpin the model (rationality, self-interest, information) are picked in such a way to support political normative public policy. Again, that is not really the case. The model stands or falls by whether it explains anything at all and whether the predictions are born out. For example, the concept would suggest that if the price of a good fell then everything else staying the same more of the good will be demanded, and more will be supplied. Many real applications based on this understanding of human behaviour are born out – regardless of what people think about the assumptions or the prejudices of those involved.

2. Does the model explain the real world?

There is no such thing as value free analysis. But the test of a model of human behaviour is the predictions. That is the ultimate test that it describes the reality of what is going on, not that it models that reality perfectly. For example Homo economicus does not take into account differences in decision making choices based on biological differences – but when theories based on the model are applied to different genders it does not break down. Some may say this does not reflect the real world accurately enough. The key thing is it does not break the theories that rely on the concept.

3. Are we rational?

In the examples given in the article (for example alcoholism) the argument makes a distinction that it does not recognise. It assumes it is rational for all to have the goal for a healthy liver. Without getting into why some people are alcoholics and others are not the problem exists because the critics of the concept are focusing on the goals rather than the means. The concept is referring to the means by which a person attempts to achieve the goals they have. The goals are subjective. The means by which you seek to achieve them however can be objectively measured or at least compared to other competing means.

The concept does not say that the goals are healthy or beneficial to society. Maybe in the long run not even for the person concerned. But that is a normative assumption. The concept is not concerned with whether the person is morally right, only in how they pursue their ambition by efficient means possible or known to the individual.

The law of large numbers suggests that most people will be rational in how they approach things, even though we differ in many ways from each other.

4. We are not self-interested?

Well I fear they have not read The Selfish Gene to understand the correct way to view what is going on in biology. Again they talk about the goals being in conflict with an overall goal (that of survival). Yet that goal may not actually be a rational one at all in all circumstances. In short self interest can be applied to other people in ways that are not appreciated by a simple one person world view that the critics take. If we want to understand evolution it is useful to think of biology in terms of genes as Dawkins does. If we are talking about how people make choices in economic reality Homo economicus stands up tall because it makes a useful application. 

4. Information

Well most critics fail to mention that economics treats this as a crucial problem in real life and has something to say on it in  economic theory. The idea of asymmetric information is one studied over and one that does not actually break down the concept of Homo economicus. Why the article does not mention for example the economist Arrow (on used cars and which are lemons) on this I have no idea. But it can be modelled.

5. It is not based on realistic assumptions

Well most models are not. They are deliberately streamlined with the minimum necessary detail in order to explain what is going on. Simplicity is key even when what is being modelled is complex. The key thing for a model is the results. Are they useful? Does the model make valid predictions? Is there an application for the model?

Homo economicus is a concept, a model of human economic behaviour that feeds into theories used in economics. To describe it as right wing is nonsensical. It is noticeable that the critics do not focus on whether it’s predictions are wrong or not useful. The main complaint is that we are not perfectly rational, self interested or have access to perfect information.

Yet in the real world where these conditions may not exist, the concept proves useful, whether describing price theory, consumer choice, wage theory or many other applications. To say that the theory breaks down in real life is not born out by how economics is used by economists every day.

6. So what about neuroeconomics?

Not mentioned in the article, but some people want to model more realistic assumptions into economic theory. In particular by how the brain makes decisions. Now neuroscience is something that I find fascinating. I do not think that economic theory itself will be proved wrong – empirical evidence would do that for us making a concept obsolete or wrong. If blending the two sciences, or specialists working together helps to explain humans in better or sharper detail then great stuff.

For example the issue of how we think about risk may suggest that we treat it possibly based on neurochemistry rather than cold hearted calculation, as this article claims on differences between a rational money making strategy and “loss aversion”.  Yet I see it building on economic theory rather than replacing it. Adding to it rather than rewriting the textbook.

The key thing is that it should be aiding us in understanding the world as it is, not as we want it to be. The former is positive economics, the later is normative economics. Bear that distinction in mind when anyone, especially a politician of the left or the right, talks to you about economics. Also when economists talk about it too.

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