Economists often argue that in their research their engage in positive science, which means that they use models of human behaviour to test the consequences of various policy scenarios. Importantly, they do not engage–in their own contention–in normative analysis, i.e., they do not attempt to formulate prescriptions as to which policies/modes of behaviour are the right ones (except when “right” means “welfare maximising”). There is much to be questioned about that, including whether economics actually deserves being called a science or whether welfare maximisation is or, in fact, can be normatively neutral as a source of guidance for analysis. I will not dwell upon these questions today. Rather, today’s topic is the model of human behaviour conventional economics rests upon and whether one can call the application of this model–the so-called homo oeconomicus–positive analysis.
One of the most famous proponents of the idea that economics is essentially only about positive analysis and that normative questions are beyond the discipline’s realm was the late Milton Friedman, author of Essays in Positive Economics, one of the intellectual leaders of the Chicago School of Economics and a highly controversial figure, indeed.
Friedman and other members of the Chicago School were the creators and propagators of Rational Choice Theory. This theory or, rather, model of human behaviour is still very influential and widely applied in conventional economics today. Its basic assumption–indeed, its essence–it the homo oeconomicus, a representative agent who has stable, unchanging and pre-existing preferences, perfect knowledge and information, knows no uncertainty or ambiguity and acts to maximise a utility function which includes only his self-interested goals and in most applications equals income. Based on this, economists in and beyond Chicago have assessed and evaluated policies, projects etc. for decades.
I won’t dwell here upon the question whether homo oeconomicus represents a moral human-being–while Friedman and others argued that there is nothing morally wrong in being selfish*, this is irrelevant for our discussion here, for we want to talk about positive, not normative analysis. But is economics based on Rational Choice Theory a positive science?
Well, the problem is that Friedman’s claim that economics is and should be positive, and the behavioural model he was a proponent of are contradictory. There is no such thing as homo oeconomicus–psychological research has been showing us for decades that people do not act “rationally”. Indeed, at least two “Nobel Prizes” in economics went to psychologists who proved Friedman and his disciples wrong (Herbert Simon in 1978 and Daniel Kahneman in 2002). We do not exhibit anything like stable preferences. Often, we do not have any, so they have to be “created” in the course of social processes. We do not possess perfect information and knowledge and are not even always able to aquire them if needed (as some more “progressive” models assume). Every day we have to deal with uncertainty and ambiguity–and we are not very good at that. And last but not least, our motivations go far beyond self-interest and money. So, behavioural assumptions based on the vision of a homo oeconomicus are wrong.
But wasn’t it Milton Friedman who in the most famous of his essays in positive economics argued for a kind of Ockham’s Razor, i.e., models as simple (simplistic?) as possible, provided they offer realistic predictions–which he claimed the Rational Choice does? Unfortunately, the work of psychologists, behavioural and experimental economists and, more recently, neuroeconomists has shown that the behavioural predictions of standard economic models have little to do with how people really behave and make decisions. This ranges from micro-environments such as simple games (e.g., the classic Ultimatum Game from game theory) to highly complex macro-environments such as financial markets (see, e.g., this book and that one). Today, it should be obvious that homo oeconomicus is nothing but an illusion, a myth.
What does this mean for Friedman’s and other economists’ claim that their science (?) is positive? Well, it means a lot. An analysis is positive rather than normative as long as it generates predictions showing what will happen when a policy is inforced given how people behave. Economics based on Rational Choice Theory–i.e., most of economics–instead offers predictions based on how “rational agents” behave. Since those hardly exist and cannot be assumed to be a non-distorting simplification (see above), an analysis based on the assumption of their existence becomes in effect normative–“Look, if you would behave like a bunch of homini oeconomici, this policy would be welfare maximising whereas that other one would be Pareto-inferior. Therefore, we all should behave so to achieve this optimal, efficient and welfare maximising outcome.” (the latter sentence being mostly implicit but always present)
So, must economics be normative in the sense of my above argumentation? Or is there a way out of the dilemma? I believe that there is (I leave aside the question of the definition of the goals against which economics has to analyse and assess policies). There are ways to incorporate the insights from psychology into economic analysis (see the work of Herbert Simon, Daniel Kahneman, Amon Tversky, Richard Thaler, Paul Slovic and others). The resulting models are not as unambiguous and simple as those based on the assumption of homo oeconomicus–closer to reality means closer to the mess of our everyday world–, and they surely are themselves imperfect and can’t incorporate all the biases, limitations, heuristics etc.–no model can–, but they are much closer to the ideal of positive economics than what Friedman and his followers are calling it.
* – In this context, the famous baker-example by Adam Smith is being invoked, which is another case of misrepresentation of quotes. As pointed out by Amartya Sen, Smith believed that self-interested action is beneficial for the whole society only under very specific circumstances and that this is not a generalizable rule.
- Daniel Kahneman Thinking, Fast and Slow, Penguin, 2012.
- Amartya Sen Rational Fools: A Critique of the Behavioural Foundations of Economic Theory, Philosophy and Public Affairs 6(4), 1977.
- Milton Friedman Essays in Positive Economics, 1953.