A few days ago, the celebrity among German economists, Hans Werner Sinn, published a short piece in the Süddeutsche Zeitung in which he defends economics against common and, according to him, mistaken criticisms. I won’t take issue with all 6 points he raised (invisible hand, ecology vs economics, Keynesianism vs neoclassical economics, competition, neoliberalism and homo oeconomicus), instead focusing on the last one. I had started writing a post on this anyway, so Sinn’s commentary comes just-in-time. The main question behind my criticism of Sinn’s presentation of the problem is: what do we need homo oeconomicus for?
Let’s start by reminding ourselves what homo oeconomicus is: it is a behavioural model, a fictitious persona who possesses perfect information or can at least acquire as much of it as he needs; always acts so as to maximise self-interest based utility, does not let society influence her preferences, which are given and complete; her choices are always consistent and can be used to identify her “preference orderings”; her choices are based on prices only, as prices reflect all relevant information about goods and services. She is perfectly rational.
I once wrote a post here in which I criticised the behavioural model of homo oeconomicus as reflecting economist’s implicitly normative ideas about how people should think and act, rather than being an accurate (positive) description of how we do behave. Our preferences are not consistent, they are not stable, they depend on the social environment we are in, which does not allow us to be 100% selfish, even in case we are inclined to this. Our knowledge about the world around us is inherently limited and we perceive it in a systematically biased way. Prices are poor information providers for many goods and services. Some things do not have any. And so on.
Now, economists like this model a lot. At times, their love for it leads them to very strange comments on real-world human beings:
Evidently the run-of-the-mill players are not strategically sophisticated enough to have figured out that strategy DD is the only rationally defensible strategy, and this intellectual short-coming saves them from losing.
This is a quote from a landmark book on the game theoretical problem known as Prisoners’ Dilemma. It is a reaction of the authors on results from economic experiments in repeated prisoners’ dilemma games, in which actual people obviously didn’t arrive at the socially irrational, Pareto inferior Nash equilibrium predicted by economic theory (strategy DD).
What has Mr Sinn to tell us about homo oeconomicus? He argues that the idea behind using homo oeconomicus is not to make predictions about actual behaviour, but to show a counterfactual – how would a policy work if people were rational? Such an approach, it is claimed, helps to avoid paternalism. However, the paternalism argument only holds for those aspects of the homo oeconomicus that are considered “bad” – mainly, selfishness (and even then only under the assumption that the model still holds when people are not selfish). Meanwhile, many of its aspects are “good” things that people equally lack, as e.g. a rational treatment of uncertainties or non-conformity. The design of policies on the basis of such assumptions is paternalistic, as we know that people are not as rational (in the positive sense of the word), but implicitly ask them to be so if the so-designed policy is to work out.
Nonetheless, Sinn is right in pointing out that homo oeconomicus is just a model. Like any model, it constitutes a simplification of reality. The point of a model is not to be “realistic”, but to be able to provide explanations of reality that match our actual experiences and stand up to empirical tests. There are areas in which homo oeconomicus is useful as behavioural model (especially in relation to markets for private goods – much less so, however, when public goods are the object of analysis). Thus, I don’t think – at least not any more – that it is a good idea to discard it altogether.
The problem with homo oeconomicus, however, is that its use is extremely undifferentiated. It has been applied virtually everywhere, from the analysis of financial markets to “markets for marriage”. However, in areas in which knowledge limitations are important; in which social conventions play an important role; in which uncertainty and ignorance are prevalent; in which markets are imperfect or absent; in which power is distributed unequally; etc. – the “basic” homo oeconomicus is useless, or even harmful, as when analyses based on it are used to inform public policy. Indeed, one of the “founders” of homo oeconomicus, Francis Edgeworth, explicitly restricted its applicability to war and contract, deeming it inappropriate in other areas. In cases going beyond the “domain” of homo oeconomicus, there is a need to use a broader perspective. As one of my colleagues said: you may start with homo oeconomicus but then think about which extensions and modifications of this basic model are sensible in the given context. In some contexts, minimal modifications might be sufficient – in others, they may be so far-reaching that the end-result would have very little in common with the “economic man”.
Often, critique of homo oeconomicus – including my own – tends to be too undifferentiated. Critics make the same error as those economists and other social scientists who stick to the basic homo oeconomicus model, in that they implicitly assume that there is another, better, but equally one-size-fits-all behavioural model. Alas, there is none. Depending on the specific exercise, very different behavioural models can be useful, ranging from the basic all-rational homo oeconomicus to other, completely different “homini“.