Emotions versus reason in economics

By Dr Frank Shostak

According to a relatively new field of economics called Behavioural Economics (BE), emotions play an important role in an individual’s decision-making process. On this the Nobel Laureate Vernon Smith writes,  

People like to believe that good decision making is a consequence of the use of reason, and that any influence that the emotions might have is antithetical to good decisions. What is not appreciated by Mises and others who similarly rely on the primacy of reason in the theory of choice is the constructive role that the emotions play in human action. 

For example, if consumers become more optimistic regarding the future, then this is going to send an important message to businesses regarding investment decisions. According to BE followers, whether consumers are generally patient or impatient determines whether or not they are inclined to spend or save today. Behavioural economists emphasize the importance of personality. An emphatic person is regarded more likely to make altruistic choices. Impulsive people are more likely to be impatient and not so good at saving up for their retirement. Venturesome people are more likely to take risks – they will be more likely to gamble (Michelle Baddley, Behavioural Economics. A very short introduction. Oxford 2017. University Press). 

Can however, individuals ascertain the facts of reality by means of emotions? According to Ayn Rand, emotions are not the tools of cognition. 

An emotion as such tells you nothing about reality, beyond the fact that something makes you feel something. Without a ruthlessly honest commitment to introspection- to the conceptual identification of your inner states – you will not discover what you feel, what arouses the feeling, and whether your feeling is an appropriate response to the facts of reality, or a mistaken response, or a vicious illusion produced by years of self-deception…  

Various goods that support and enhance a man’s life are discovered by reason. Once individuals have established that a particular tool is likely to enhance their life and wellbeing, individuals have to figure out how to produce it. The figuring out is done by means of reason and not by means of emotions. By means of reason man can establish the relationship between things and their suitability to support man’s life. Reason therefore is the man’s means of survival. 

Through various experiments the practitioners of BE have concluded that people do not always behave rationally. What however, the BE practitioners have discovered has nothing to do with whether people are rational or not. It has to do with the flawed premise of popular economics i.e. that people’s preferences are constant. The proposition that people are like machines that never change their minds.   Obviously, people do change their minds, so it is not surprising that the BE practitioners have discovered that real people’s behaviour systematically deviates from the one of the human machine as depicted by the mainstream economics. 

Despite the criticism of mainstream economics, BE retains the constant valuation scale of individuals in its analysis. By introducing emotions, BE supposedly makes the human robot of the mainstream economics more humane. Nevertheless, because of the constant valuation scale it remains a human robot.

Observe that psychology is an important element in behavioral and experimental economics on the ground that human action and psychology are supposedly inter-related disciplines. However, there is a distinct difference between economics and psychology. Psychology deals with the content of ends and values. Economics, however, starts with the premise that people are pursuing purposeful conduct. It does not deal with the particular content of various ends. 

According to Rothbard, 

A man’s ends may be “egoistic” or “altruistic”, “refined” or “vulgar”. They may emphasize the enjoyment of “material goods” and comforts, or they may stress the ascetic life. Economics is not concerned with their content, and its laws apply regardless of the nature of these ends.

Whereas, 

Psychology and ethics deal with the content of human ends; they ask, why does the man choose such and such ends, or what ends should men value?

Economics deals with any given end and with the formal implications of the fact that men have ends and utilise means to attain these ends. Consequently, economics is a separate discipline from psychology. By introducing psychology into economics, one obliterates the generality of the economic theory.

Contrary to mainstream thinking, both Mises and Rothbard held that valuations do not exist by themselves (valuation scale) regardless of the things to be valued. On this Rothbard wrote, “There can be no valuation without things to be valued.” Valuation is the outcome of the mind valuing things. It is a relation between the mind and things. 

The Misesian framework of consumer choices 

Following the Mises framework of thinking labelled as praxeology, we can ascertain the distinguishing characteristic and the meaning of human action. For instance, one can observe that people are engaged in a variety of activities. Thus, they may be performing manual work, driving cars, walking on the street or dining in restaurants. The distinguishing characteristic of these activities is that they are all purposeful. 

Furthermore, we can establish the meaning of these activities. Thus, manual work may be a means for some people to earn money, which in turn enables them to achieve various goals like buying food or clothing. Dining in a restaurant can be a means for establishing business relationships. Driving a car may be a means for reaching a particular destination. 

People operate within a framework of means and ends; they use various means to secure ends. We can also, establish from the above that actions are conscious and purposeful. 

Behavioural and experimental economists such as Vernon Smith reject the view that human action is conscious and purposeful. According to Smith, 

He (Mises) wants to claim that human action is consciously purposeful. But this is not a necessary condition for his system. Markets are out there doing their thing whether or not the mainspring of human action involves self-aware deliberative choice. He vastly understates the operation of unconscious mental processes. Most of what we know we do not remember learning, nor is the learning process accessible to our conscious experience—the mind………Even important decision problems we face are processed by the brain below conscious accessibility.

We suggest that to object that human action is conscious and purposeful contradicts the objector for he is engaging in a purposeful and conscious action to argue that human actions are not conscious and purposeful. 

Various conclusions that are derived from the knowledge that human action is conscious and purposeful are valid as well, implying that there is no need to subject them to various laboratory tests as is done in the experimental economics. For something that is certain knowledge, there is no requirement for any empirical testing.

Means-ends and consumer choices

Note again that by mainstream thinking individuals are presented as if a scale of preferences is hard-wired in their heads. The valuation scale determines choices regarding goods and services. 

Why individuals have decided to assign importance to a particular good versus some other good?  The reply here is the valuation scale. The individual in this framework is reduced to a machine that automatically selects goods based on the valuation scale. This must be contrasted with the Mises’s framework of conscious and purposeful action where reason determines individuals’ valuations. 

In the framework of means-ends, individuals assess or evaluate various means at their disposal against their ends. Individual’s ends set the standard for valuations and thus choices. By choosing a particular end, an individual also sets a standard of evaluating various means. 

For instance, if my end is to provide a good education for my child, then I will explore various educational institutions and will grade them in accordance with my information regarding the quality of education that these institutions are providing. Observe that my standard of grading these institutions is my end, which is to provide my child with a good education.

Alternatively, if my intention is to buy a car, there are all sorts of cars available in the market, and as such, I have to specify to myself the specific ends that the car will help me to achieve. For instance, a factor I may need to consider is whether I plan to drive long distances or just a short distance from my home to the train station and then catch the train.

My end will dictate how I will evaluate various cars. Perhaps, I will conclude that for a short distance a second hand car will do the trick. Since an individual’s ends determine the valuations of means and thus choices, it follows that the same good will be valued differently by the individual as a result of changes in his ends. 

At any point in time, people have an abundance of ends that they would like to achieve. What limits the attainment of various ends is the scarcity of means. Hence, once more means become available, a greater number of ends, or goals, can be accommodated—i.e., people’s living standards will increase. 

Another limitation on attaining various goals is the availability of suitable means. To quell my thirst in the desert, I require water. Diamonds in my possession will be of no help in this regard. 

Observe that the means-end framework is the essence of any human action whether the action is in accordance with what is regarded as rational conduct, or not. 

Furthermore, once it is accepted that human actions are conscious and purposeful it will not make much sense to extract preferences in a laboratory, or by means of questionnaires, since only something that is constant and hard wired in human brains can be extracted. 

Hence, the various results obtained from laboratory experiments, or from questionnaires do not advance our understanding of human action as far as economics is concerned, but on the contrary prevents us acquiring any meaningful knowledge. 

Conclusions

By casting doubt on the notion that reason is the main faculty that navigates human actions, behavioural economics in contrast emphasizes the importance of emotions as the key driving factor of human actions. 

By means of psychological analysis, the practitioners of behavioural economics have supposedly demonstrated that people’s conduct is irrational. Consequently, the practitioners of behavioural economics may have unintentionally laid the foundations for the introduction of government controls to “protect” individuals from their own irrational behaviour. 

For instance, wide fluctuations in financial markets can be attributed to irrational behaviour, which can damage the economy. Hence, it will make a lot of sense to restrain this irrationality by a dosage of restraining regulations.