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Economic Rationality, Twenty-First Century Style
A critical examination of its realism, pragmatic value, and ethical consequences
Dennis S. Gouran
THE PENNSYLVANIA STATE UNIVERSITY, USA
In 2011, U.S. Congressional figures engaged in a protracted debate focusing on the debt ceiling, the disposition of which portended dire consequences in the minds of both those arguing the need to raise it and the opponents of doing so in the absence of corresponding spending cuts if their respective positions failed to prevail (Newton-Small, 2011; Rogers, 2011). The debate unfolded intermittently from early January to August 2 (“Timeline,” 2011), which was the date on which Treasury officials anticipated that the extant debt ceiling on borrowing would be reached, with the United States thereafter having to default on loans from its creditors (Murse, 2011) and to face economic difficulties the country certainly did not need.
With the last-minute agreement of August 2, the worst fears of those taking part in the debate failed to materialize (Davidson, 2011) even though the subsequent Standard and Poor’s (S&P) unprecedented downgrading of the U.S. credit rating from triple A to double A did send ripples of concern throughout an economy that at best was in a fragile state of recovery at the time (Murse, 2011). Not coincidentally, within days of the S&P action, approval of Congress matched its then-historic low of 13% (Jones, 2011).
While averting what could have been a much more serious crisis, the parties involved in the debate nevertheless did harm and in the process engaged in argument, much of which MarketWatch commentator Rex Nutting (2011) characterized as “silly,” “ridiculous,” and even “crazy.” In a spirit of somewhat greater charity than Mr. Nutting displayed, I would posit that the parties’ inability to do better stemmed in large part from a basic misconception, if not downright corruption, of the concept of economic rationality and collateral pursuit of a set of negotiation strategies and practices that severely limited the prospects for arriving at not only a mutually acceptable settlement, but a beneficial one as well. I have taken the elaboration of this view as my principal task. In so doing, I think it important to note that my purpose is to examine behavior of elected officials that seems to fly in the face of generally understood notions of economic rationality, not to offer a critique of the concept itself.
Economic Rationality
Economic rationality, often referred to as “classical economic theory,” in its most pristine sense is an idealization of the process by which individuals choose among alternative modes of addressing problematic situations in ways that maximize positive outcomes related to the material well-being of those involved. Although characterized in various formulations, the process typically has the person or persons choosing carefully: defining the nature of the problematic situation, identifying all of the pertinent criteria for assessing choice options, weighting the criteria in terms of their perceived relative importance in specifying conditions in need of satisfaction, generating the possible options, assessing each option in terms of each criterion, and endorsing the one that apparently best satisfies the criteria (see, for instance, Bazerman & Moore, 2013, pp. 2–3). Others have appropriated such characterizations and applied them to non-economic situations (e.g., Gouran & Hirokawa, 1996), even though some would question the propriety of such extensions (Zafirovski, 2003).
Thanks to Herbert Simon (1955), as a description of how individuals choose, whether in the narrower or broader sense, economic rationality’s adequacy, except for the most restrictive of choice situations, is subject to serious reservation if not outright repudiation (Beach & Connolly, 2005; Frame, 2013; Singal, 2013). Within limits, however, there is reason to believe than one can increase the likelihood of making positive consequential choices by behaving generally in line with the logic of classical theory, but within the framework of what Simon (1982) came to refer to as bounded rationality.
An assumption underlying the conception of economic rationality is that those confronting a problematic situation ostensibly requiring choice have the single motive of maximizing desired outcomes. Obviously, this is not always the case. People frequently find themselves in situations involving mixed motives – one stemming from a desire to optimize personally rewarding outcomes and another directing them to focus on the necessity of making concessions to others involved if there is to be a settlement, as with the debt-ceiling debate. However, this does not preclude acting in a manner consistent with the maximization of joint outcomes. In fact, to do so is to behave rationally in the classical sense, but the process in such a domain entails negotiation, not unilateral action. For this context, the perspective that Howard Raiffa (1982, 2001) has developed is both informative and better suited for examining rationality in the debate of interest.
The process for maximizing joint outcomes under conditions in which one finds oneself having to deal with other parties having different preferences is known as “decision analytic” (Bazerman & Moore, 2013, p. 176). It entails a number of characteristics that presumably are evident when those taking part in negotiations are behaving “rationally” in the more realistic sense of Simon’s (1982) conception of bounded rationality. Within such a framework, a rational negotiator either does, or at least should, consider three factors: (1) the parties’ alternatives to a negotiated agreement, (2) their respective interests, and (3) the relative importance of those interests (Raiffa, 2001).
The first consideration influences the determination of the parties’ respective aspirations, or desired outcomes, and reservation prices, or the minimum acceptable outcomes. Levels of aspiration are typically explicit, whereas reservation prices are not and are, therefore, sometimes open to serious over- or underestimation. If one’s best alternative to a negotiated agreement (BATNA) is favorable, one’s level of aspiration is apt to be high and the reservation price fairly close to the level of aspiration. If the reservation price falls between that of the other party and that party’s level of aspiration, a “positive zone of agreement” exists, and the number of possible mutually acceptable agreements is proportional to the width of the zone (Beach & Connolly, 2005, p. 121). When this condition does not exist, the zone of agreement is negative, and no settlement is possible unless at least one of the parties adjusts his or her reservation price.
The second and third considerations relate to how negotiators are apt to interact in their efforts to reach an agreement or settlement concerning the matters in dispute. Parties often enter negotiations by claiming initial value, that is, making known their professed levels of aspiration and offering justifications for why their preferences should have priority. Levels of aspiration, however, are not necessarily accurate reflections of interests, as when an employee seeking a raise in compensation would find greater personal leave time more to his or her liking because the actual interest is increased opportunities for leisurely pursuits. Negotiations are rarely about single issues and their relative importance likewise can affect how one pursues a settlement in a dispute. In the preceding illustration, the employee might want both a raise and more leisure time but, because the latter is of greater personal importance, would be willing to accept a smaller raise if accompanied by an appropriately compensatory reduction in workload.
When the parties to a dispute have done well in dealing with the three considerations noted, their prospects for achieving integrative settlements are much better than if they have not (Raiffa, 1982, 2001). They succeed at what Bazerman and Moore (2013) called “creating value” (p. 180), whereby mutual gain – also known as a “Pareto-superior agreement” (p. 189) – is the outcome. The reasons that such outcomes do not materialize more frequently are numerous and varied, with many being beyond the scope of this essay. In the remainder, I discuss several influences that appear to have been operative in the debt-ceiling debate of 2011, and how they contributed to the parties’ inability to manifest behavior consistent with the principles of economic rationality, even though they may have viewed themselves as eminently rational. As Matthew Hancock and Nadhim Zahawi (2013) have noted, in a recent survey, 48 percent of respondents from a general population reported themselves as always acting rationally. One presumes that elected officials would see themselves as so acting in much greater proportions. The particular influences on which I have chosen to focus are cognitive ones that Bazerman and Moore (2013) discuss at some length: the fixed-pie mentality, framing, the escalation of commitment, and anchoring.
The Fixed-Pie Mentality
The view that disputes necessarily reduce to conflicting interests fosters a distributive approach to negotiation and decision making in mixed-motive situations. This approach, in which the parties view the activity as a zero-sum game, unfortunately, is fairly common (Beach & Connolly, 2005). In addition, it encourages both parties to devalue their adversaries’ concessions (Curhan, Neale, & Ross, 2004). This further reduces the possibilities for the maximization of joint outcomes.
The debt-ceiling debate of 2011 revealed evidence of both tendencies. Although the matter of primary interest, raising the debt ceiling or having to default on loans beyond a certain date, appeared to be clear, some in Congress seized on the opportunity the issue presented to tie the action to spending cuts. Others saw this as holding a necessary action hostage and, while nevertheless receptive to some such requirement, were unreceptive to the amounts and types of cuts proposed by those seeking to attach strings to the actions. Thus commenced the seven-month trek toward what some justifiably perceived as very serious economic contingencies and longer-range adverse consequences, as those in adversarial roles became increasing entrenched in keeping “the other side” from realizing its aspirations – prevailing, if you will. This is clearly inconsistent with, if not antithetical to, the view that Howard Raiffa’s (1982, 2001) decision-analytic approach to negotiation embodies.
Framing
Another factor that often contributes to decision makers’ inability to behave in a manner consistent with the precepts of economic rationality is the way in which they frame the outcomes of the choice options they are considering. A substantial number of framing effects have received attention in scholarly literature relating to decision making. Of most interest in the context of the debt-ceiling debate of 2011 perhaps is the framing of outcomes as gains and losses. The human tendencies in this regard are not always apparent to agents, as both Dan Ariely (2010) and Max Bazerman and Ann Tenbrunsel (2011) have aptly noted.
Spawned by the pioneering work of Nobel Prize Laureate in Economics Daniel Kahenman and his long-time colleague Amos Tversky (see Kahneman, 2011), scholarly inquiry into the framing of outcomes related to choice options has revealed a consistent tendency for decision makers to be risk-averse in the case of gains and risk-prone in the case of losses, or, more accurately, in their avoidance. For instance, a person earning $1000 in supplemental income for which the income tax bite is, say, $250, might decide to avoid incurring the certain cost by not reporting the income and, in the process, risking having to pay much more in a combination of the tax, delinquency penalties, legal fees, and the like. Such behavior is putatively irrational.
It appears from the evolution of the debt-ceiling debate of 2011 that advocates on both sides of the dispute, especially the part centering on the magnitude and categories of spending cuts, were caught up by the impulse to avoid loss in respect to the positions they had staked out and, thereby, took the consequent risk of losing far more. In fact, in holding out as long as they did, this appears to be precisely what occurred. If one considers opportunity costs, that is, those the competing parties incurred by pursuing given courses of action during the seven-month debate at the expense of potentially more profitable ones (e.g., figuring out in specific ways what cuts in spending were actually necessary and desirable, as well as how they might have been best implemented, or possibly looking to the longer range and attempting to determine how to honor the “partnership between the generations” of which Edmund Burke spoke – see Ferguson, 2013, p. 14), it seems virtually certain that those participating in the debate could have achieved something of greater legislative merit than they did. It is hard to imagine their achieving anything less than they did.
The Escalation of Commitment
A constraint on possibilities for behaving as much in line with the canons of economic rationality as we might is sunk-cost thinking (see Bazerman & Moore, 2013), or the tendency to make current decisions as a way to rationalize past ones that have produced less-than-desired, if not clearly unwanted, outcomes. When this type of mentality sets in, it can lead to an escalation of commitment that may persist over long periods, not only to the detriment of the decision makers involved, but also to those affected by their decisions (Arkes & Blumer, 1985; Staw, 1981; Staw & Fox, 1977).
The escalation of commitment is by no means exclusively an individual phenomenon. It clearly is in evidence in multi-party contexts, of which negotiation is one. In such contexts, one may have an even greater inclination to escalate than when acting alone. Bazerman and Moore (2013) have identified four reasons why one might escalate commitment in one’s interactions with others who are party to a negotiation, including “perceptual bias,” “judgmental bias,” “impression management,” and “competitive irrationality” (pp. 128–131). As to the debt-ceiling debate of 2011, the final two may be particularly apropos.
In the debate, the participants, of course, not only were addressing one another but external audiences as well. Motivated by a desire to fare well in the eyes of these other audiences, whether consciously or not, it makes sense that one would argue and defend prior positions on issues in the interests of projecting strength and, thereby, currying favor with the members. Primary season, after all, was not that far off, and certain voting blocks were of importance. This, however, does not fully accommodate the excesses in commitment that “competitive irrationality” seems to capture. Once one has gone so far down the escalation path, the motivation can shift, becoming less a matter of wanting to prevail as a strong desire to avoid coming across as a loser. What might appear to some as mere intractability or rigidity of personality when an individual escalates commitment makes more sense perhaps when one considers it as the consequence of a shift in motivation. This makes the behavior no less irrational, however, in the sense of one’s moving further and further from being able to achieve any outcome other than failure.
Anchoring
Anchoring is often the source of biased, if not always poor, judgments. It reflects a tendency to use arbitrary, possibly irrelevant, reference points in making assessments of probability and value, which are the two indispensible elements in models of rational choice (Bazerman & Moore, 2013). A good, and common, example occurs when an employer bases salary increases on extant salaries, irrespective of the performance of those being considered for them. Hence, those with the lowest salaries may receive the lowest increases even though in some cases they may have contributed more to the success of the organization than have their better-compensated counterparts.
In the context of negotiations, parties may have difficulty ev...