Economics and Rationality
I find it a bit disturbing how basic economics assumes that our decisions are always rational. If you aren't disturbed, think bubbles and the 2008 recession - there's no room for these possibilities in basic economics because of the rationality assumption. And yet they happened, and the 2008 recession rocked the economy of the world. Some countries are still dusting their pants off to this day. And yet, all the smartest people in the world, from Greenspan to the White House just didn't see it coming. After all, that Lehman CEO, being such a rational guy, knew exactly what he was doing, didn't he?
Disturbed yet?
Let's examine the entrepreneur - literally the engine of today's economy. He/she does wonderful stuff, creating innovative businesses that outperform the competition, which in turn creates more demand, which turns the crank of the entire economy. But from a rationality point of view, has the entrepreneur got it together? Well, if rationality means being able to weigh risk, I'd say no. Doesn't he know how many startups fail, how much capital gets wiped out, how many hours of work get ruined? Failed entrepreneurs can become the laughing stock of the entire industry. The risks are just too damn high. From a rationality point of view, an entrepreneur is insane, ignoring the risks, completely willing to fail. And yet, the economy would be nowhere without entrepreneurs. That's the truth.
I personally believe people are driven as much, if not more, by their insecurities as they are by rationality. Most of the time, insecurities align with actions that lead to economic growth. One person may buy a new car just because their neighbor did. Another person might work day and night to start up a new business because he grew up in unfortunate circumstances. I'm generalizing, but remember, insecurities can drive people to murder and countries to war, so we're talking about powerful stuff here. Insecurities and the emotional baggage they carry color our rationality much more than we are conscious of.
When our insecurities don't align with economic growth, we get screwed. When the hot shot banker decides to give housing credit to a family that's financially underwater just because he gets a fat check and pat on the head from his seniors, we get screwed. When the CEO privately encourages accounting tricks to inflate earnings because he can't stand to face failure, we get screwed.
And so on.
I know there are emerging behavioral branches of economics - I just hope these come to the forefront well before the next great recession.
Disturbed yet?
Let's examine the entrepreneur - literally the engine of today's economy. He/she does wonderful stuff, creating innovative businesses that outperform the competition, which in turn creates more demand, which turns the crank of the entire economy. But from a rationality point of view, has the entrepreneur got it together? Well, if rationality means being able to weigh risk, I'd say no. Doesn't he know how many startups fail, how much capital gets wiped out, how many hours of work get ruined? Failed entrepreneurs can become the laughing stock of the entire industry. The risks are just too damn high. From a rationality point of view, an entrepreneur is insane, ignoring the risks, completely willing to fail. And yet, the economy would be nowhere without entrepreneurs. That's the truth.
I personally believe people are driven as much, if not more, by their insecurities as they are by rationality. Most of the time, insecurities align with actions that lead to economic growth. One person may buy a new car just because their neighbor did. Another person might work day and night to start up a new business because he grew up in unfortunate circumstances. I'm generalizing, but remember, insecurities can drive people to murder and countries to war, so we're talking about powerful stuff here. Insecurities and the emotional baggage they carry color our rationality much more than we are conscious of.
When our insecurities don't align with economic growth, we get screwed. When the hot shot banker decides to give housing credit to a family that's financially underwater just because he gets a fat check and pat on the head from his seniors, we get screwed. When the CEO privately encourages accounting tricks to inflate earnings because he can't stand to face failure, we get screwed.
And so on.
I know there are emerging behavioral branches of economics - I just hope these come to the forefront well before the next great recession.
posted by Hasnain at 8:30 PM
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