Tuesday, 22 September 2009

Selfish basterds: On rationality in Economics (I)

In this series of entries, I would like to reflect on the assumption of rationality in Economics. By using my personal experience and some elements from economic theory, I will discuss the common misconceptions on Economics, economists and rationality. Today, I will start with some personal anecdotes.

In my MSc dissertation, I worked with a model of coalition formation in which individuals differed in resources and abilities and could get together in order to produce output. Over and over again, I found that in the equilibrium of that model the more able agents formed groups with other able agents and that the group structure was ordered in that way. I say that I got that result over and over again because I found it outrageous so I checked and rechecked my computations. I did not like the fact that MY model yielded a hierarchical world in which people ended up merging with people similar to them and the less able and less rich got excluded. The fact was that I was letting my personal ideas obscure my economic thinking.

A few years later, I was a recently appointed lecturer at the University of Edinburgh and I was about to run my first economic experiment. As part of the process, I had to find subjects. I resorted to traditional methods like posters, showing up at the beginnning of lectures and distributing flyers across George Square. Students mostly liked the idea of being paid £10 for an hour of their time so the experience of chatting them up was pleasant. However, I remember vividly the visceral reaction of one female student. When I told her that we were looking for people to participate in research in Economics she answered "I hate Economics, I don't want to have anything to do with it. It's hideous."

Since last year, I have taught game theory on the MSc on Carbon Management that we run jointly with the Business School and Geosciences. I performed a simple classroom experiment in which students in the course played a public good game. They had to decide whether to contribute towards a public fund or not. Individual payoffs (I actually paid them in cash) increase with the number of contributors if you contribute too, but they increase even faster if you remain out. In equilibrium everybody should free-ride. Most students were shocked to find that, indeed, very few of them contributed. They thought that the world, and even themselves, was different. But once they felt the power of incentives, they were the first ones in leaving moral self-images aside.

Last Spring, I gave a workshop on economic experiments to students interested in the topic. I reported one experiment ("The Competitive Advantage of Sanctioning Institutions," O. G├╝rerk, B. Irlenbusch and B. Rockenbach, Science, 2006), in which subjects had to choose whether to play the game above or another version in which after contributions decisions are made, they could punish others at a cost. As you can expect, contributions are typically much higher in the latter case. I asked the audience which game they thought that subjects selected more often in the first round of the experiment. They all answered "the one with punishments". They were dismayed to find that it was actually in the other way around and that contributions were very low. I asked one student why she answered in the way she did. She replied "because that is how I would like the world to be, a world where people are nice".

So the moral of this first post is the following: Don't let your good feelings mix up with your Economics. Otherwise you will not be doing a good service to yourself nor to the world.

Only if you are ready to abandon your prejudices and your self-image as a saint, then you can continue reading.

(to be continued)

1 comment:

  1. John Cochrane’s Response to Paul Krugman:

    How Did Economists Get It So Wrong?
    Published: September 2, 2009