Today’s Public Choice Seminar at George Mason University featured Yale University’s Truman Bewley. His talk was on his interview study of pricing practices. The talk featured many good points (which can be found in the first link I provided), but he also said something important. Dr. Bewley said (and I am paraphrasing as I do not recall the exact quote): “If you find someone is acting irrational, you may not understand the person’s objectives or the constraints they face.”
This is an incredibly important fact to remember when discussing economics: rationality is about a person acting to achieve a certain goal. An act in one context may be rational but in another context it is not. For example, if a person’s goal was to lose weight, then not exercising and eating junk food would be irrational. Conversely, if a person’s goal was to gain weight, eating junk food and not exercising would be rational. The end objective is different.
This explanation of rationality is not problematic when doing microeconomic analysis. We reasonably assume that people have a goal in mind and a way to achieve it; that is, they are rational.* However, problem arise when discussing a collective (a town or a nation, for example). Given multiples of people, it becomes more and more difficult to determine what objectives are, and even more so what rational courses of action are. Remember that collectives do not make choices; only individuals choose. Therefore, there cannot be a “collective” decision, or a “collective” goal. Furthermore, measuring those outcomes becomes problematic. What one person might consider a step forward, another might take as a step back.
As an extreme example of my point, let’s take a look at a recent campaign slogan: “Make America Great Again.” That is an objective. But what does that mean? To some, it means preventing non-whites from entering the country; they feel our culture is being tainted. For them, it’d be perfectly rational to erect a border wall, deport, or disenfranchise those groups. For others, making America great means lifting the economic welfare and standard of living for all. To this group, kicking out non-whites would be irrational, as would be scaling back international trade. For a third group, it may mean increasing funding for social programs. For that group, raising taxes and building redistribution programs would be rational.
You can see the problem of looking at collective (or macroeconomic) rationality; it doesn’t really exist. Often, as pointed out by James Buchanan, the “rationality” and “objectives” are determined by the analyst’s prejudices. As we just demonstrated in the paragraph above, that can cause problems.
None of this is to say macroeconomic or collective analysis serves no purpose. Despite my obvious Austrian economic sympathies, I’m not ready to jump on the “Macro is voodoo” bandwagon of many of my colleagues. What this is to say is one must be careful in analysis and interpretation, especially when discussing the collective “we.”
*Some do object to this assumption by pointing out mistakes that people may make or how they may be manipulated. While this is true, no part of economic analysis assumes perfect rationality 100% of the time. We’ve quite a lot of tolerance for mistakes. However, it is a general assumption that has been shown to be reasonable over time. Generally speaking, people are smart. To quote Walter Williams, if your theory requires people to be stupid, it’s going to be a bad theory.