Crisis and Rationality: Behavioural Economics and the Ideology of Irrational Exuberance.

The rise to prominence of behavioural economics, and behavioural finance, following the global financial crisis or the great recession or whatever you want to call it is a curious affair, well worth pondering especially given the way that behavioural economics is popularly represented.

The key insight promoted by behavioural approaches, which is surely correct, is that humans are not rational cost-benefit calculators, and most particularly humans make irrational choices under risk and uncertainty. So behavioural economics attacks one of the key underlying conceptions of neoclassical economics namely Homo economicus.

Popular representations of behavioural economics emphasises the irrational basis to the global financial crisis; to a considerable degree the economic crisis is due to “irrational exuberance.” The story is familiar. Mania and euphoria, of a decidedly irrational variety, in financial markets during the upswing of the business cycle encourages excessive risk and debt as projections of future trends, ever increasing asset price rises, are formed upon no real rational basis and constitute the foundation of, irrational, action.

This is a convenient picture for the system of power, which is why it is so readily promoted. It is convenient because the emphasis is upon human nature itself; forget about Goldman Sachs, Lehman Brothers, AIG et al this is how we humans roll. The global economic crisis has a rational basis. More to the point it has a rational institutional basis. The emphasis upon behavioural economics encourages the idea that the crisis has an irrational basis founded upon human nature and by so doing obscures its rational and institutional basis.

You can decry bankers so long as you don’t decry banks.

Back in the day, after World War Two, behaviouarlism dominated political theory. This was the idea that the proper route to theory lay in the study of political behaviour, for instance voting behaviour. Institutions and social structure were ignored, and they were ignored because of the dominance of a distorted logical positivism, taking its cue from Ayer’s Language, Truth and Logic, that took intellectual currency after World War Two. Institutional and structural analysis was associated with philosophical realism, and the distorted and crude positivism of the era had it that, following the ruthless application of the principle of verification, only external behaviour could be observed and so only it could form the subject matter of theory.

A trenchant and to the point critique of behaviouarlism was aptly entitled Apolitical Politics, for its crude positivism totally neglected study of “the good life” the raison d’etre of politics according, correctly, to Aristotle.

Behaviouarlism was much akin to behaviourism in the sciences of the mind, which also enjoyed currency at that time and which also was based on a crude and distorted logical positivism. Much as in political theory only overt behaviour could constitute the basis of theory; mental entities, such as computations, rules and representations, in the mind could not be observed so fell outside the sway of inquiry.

Behavioural economics, I submit, is just like this. It ignores the institutional and structural bases of economic society; you can formulate a behavioural theory of economics with no corporations, no social classes, no money even. It is strikingly similar to neoclassical economics in this regard, which should not surprise us as the philosophical foundations are of a type similar.

The global economic crisis has a rational basis because in capitalism investment is dominated by financial corporations, that is by institutions of a certain type, whose remit is to make a profit so that shareholders may have a permanent return on investment; today, tomorrow, forever. Excessive risk and debt during the upswing of the business cycle is institutionally rational in a system requiring the competitive pursuit of profit. The decisions that corporate managers make have an institutional rationality but a systemic irrationality, and systemic risk plays little to no role in the decisions that they make. This is especially so given moral hazard; the financial sector has had the best financial crisis one can possibly have and continued short term speculation for short term profits remains a perfectly rational, not irrational, form of action.

Whenever you observe a type of individual rationality but collective irrationality you know trouble is brewing. Although even the element of collective irrationality can be oversold, given the reality of bail outs and moral hazard.

The behavioural model of crises discussed initially, which stresses mania and euphoria, sounds decidedly Minskyan. There is a similarity here, but it is superficial. The Minsky model is formed upon an institutional basis, namely a financial system dominated by for profit finance corporations. Minsky himself, the son of Menshevik parents, has been doubly ignored. His financial instability hypothesis was ignored, but what has been even more ignored is his socialism.

Minsky argued for a socialist system of public investment dominated by very different institutions to the type dominating our economies today, those being socially owned financial institutions. The Minsky model is dangerous because it quite obviously tears asunder the intellectual basis of neoliberal ideology. That is, the Minsky model shows that a system of investment dominated by for profit corporations is irrational in contrast to the greater rationality of socially owned investment corporations.

This is critical for we are talking here about information and its rational processing. See how this cuts neoliberal ideology, which comes out of the socialist calculation debate, right to the bone?

I am sceptical of economic theory, understanding theory in scientific terms, but I think certain varieties of institutional economics (which focuses on institutions and organisations rather than markets and behaviour), post Keynesian economics and the sociological method of Marx are useful tools of analysis. Neoclassical economics is still dominant, and behavioural economics is the aspiring, though safe as in safe for the system of power, challenger.

When you put the philosophy, politics and economics together like so you’re doing the Placido Domingo as Paul Keating had it. What a nice. thunderous brew it makes. Heady it can be. I admit I be listening to Beethoven No 9 as i type.