Decision-making underlies almost all aspects of human life, even if it is not obvious. Behavioral economics, it is becoming increasingly clear, can explain the ‘why’ of most such decision-making. It’s only right, then, that in the opening pages of Irrationally Rational—with footprints in academia, business and writing—author V Raghunathan uses his own example to familiarize the lay reader with behavioral economics, while discussing why he decided to write the book. The tension between neoclassical economics, whose guiding principle is that man is a perfectly rational being, and behavioral economics, which simultaneously challenges and builds upon the fundamental theories of neoclassical economics, is made explicit here. The remainder of Raghunathan’s book offers the lay reader a glimpse of the evolutionary history of behavioral economics, as gleaned from the work of ten Nobel laureates and select economists who have yet to receive the honor.
“Irrationality,” as Duke University professor Dan Ariely points out in a Harvard Business Review article — Ariely’s work is recognized in Raghunathan’s book — is the real invisible hand that moves human decisions. Indeed, Ariely cites in that article Alan Greenspan in the wake of the 2008 financial crisis to show how “irrationality” can become institutional: Greenspan spoke of “assuming that the self-interest of organizations, especially banks and others, was such that they were in the best position to protect their shareholders.’ They weren’t, Greenspan soon realized.Do Indian banks, the greening of loans and the NPA crisis reflect such a failure of ‘rational expectations’?After all, here too, bankers are fallible and carry their cognitive biases. How does the perception of the risk embedded in a business venture seeking credit for a banker change when it is backed by a large conglomerate versus when it is a standalone start-up?
Raghunathan takes great care in delineating “irrationality” from unreasonableness. He writes: “So, if a homoculturalis, endowed with all those cultural and socio-psychological frameworks (cognitive biases and intuitive features) in reality, does not make the decisions exactly as predicted by the homo economicus in theory, who is to say that the decisions of the former are irrational?” A good example of this can be drawn from the chapter on the work of Richard Thaler. A juxtaposition of honesty and neoclassical rationality, in a setting with the game Ultimatum. The game involves a “submitter” who has to split a sum of money, with a “responder”. If the responder accepts the split, both may split the money as agreed.
However, if the responder declines, neither of the two gets any money. According to neoclassical rationality, the proposer benefits from the highest positive offer closest to zero, which would also be a gain for the responder, since they start with zero and if they decline the proposer’s offer, they remain at zero.
In such a situation, the respondents are expected to accept any offer, but Thaler’s work shows that in such games, the modal offer was close to 50%, although the average offer would hover around 37%, which is one of the considerations was to signal honesty. that was on offer. But while justice may seem irrational in theory, it certainly does not betray unreasonableness.
Another interesting point comes from the chapter dealing with the work of Elinor Ostrom and Oliver Williamson. Ostrom’s work on the management of the commons, notes the author, demonstrates that “ordinary people are able to create rules and institutions that enable sustainable and equitable management of shared resources”, while sustainable collective action faces challenges of costs that seem unaffordable in the short term and benefits that only arise in the long term. Raghunathan mentions the chapter How Cooperation Emerges – A Primer for India and Indians, but seems pessimistic about the prospects in certain parts of the chapter; indeed, he boldly says that the Indians have learned the wrong lessons from the Mahatma’s uncooperative instrument! But examples abound of good community management, with the state and other such organizational actors playing at most a secondary role.
An example of this is the use, conservation and management of forests. There is ample real-world evidence to show that when this was left to forest-dwelling communities, robust and effective systems emerged, along with superior implementation, compared to top-down management through government regulation or corporate intervention.
The evolution of behavioral economics described in Irrationally… isn’t just about telling us how it came to be, from an ignored, or worse, belittled cousin of economics that still appeals to policymakers, academics and business leaders. It is also about reflecting on the past to identify where neoclassical dogma caused economies, businesses and households to disregard rational expectations so that corrective and preventive action can be taken.
It’s also interesting how evidence-based policy making has come to the forefront along with behavioral economics.
The author carefully explains why he left the Nobel Prize-winning couple Abhijit Banerjee and Esther Duflo out of his book, but notes that their experiments “reinforced patterns of behavior
economy” huge. Today, more and more governments are willing to use “nudges” – theorized by Thaler – to effect change.
From GiveItUp in India to cutting LPG subsidies to Indonesian parent-participation texting schools, nudges are tried, evidence gathered and results established to finally be institutionalized as policy. Against such a background, Raghunathan’s book becomes an essential read for policy makers, businessmen and academics.
irrational rational
V Raghunathan
Penguin Random House
pp 328, Rs 399
