The Dreaded Specter of Nihilism in Economic Theory

July 30th, 2015
in macroeconomics

Fixing the Economists Article of the Week

by Philip Pilkington

There’s a funny point on which almost all economists that I’ve come across agree upon — from neoclassical to Marxian to Post-Keynesian. And that is that something which they call “nihilism” must be avoided at all costs.

Follow up:

Let us first try to pinpoint what exactly this so-called nihilism is. A good starting point is Marc Lavoie’s seminal Foundations of Post-Keynesian Economics (a book which, incidentally, I hear is under substantial revision as we speak).

The second chapter of the book is entitled ‘Theory of Choice’ and deals with how Post-Keynesian economists should understand decision-making by economic agents. Lavoie is categorical in that marginal utility theory should be rejected and on that we fully agree. Tied to this Lavoie tells us that we should also reject the assumption of absolute rationality on the part of economic agents — again, I agree with this.

Next, however, Lavoie claims that we need to put forward what he calls a theory of procedural or bounded rationality. He quotes Cyert and Simon who define bounded rationality as such:

The rationality of the business firm is a rationality that takes accounts of the limits on its knowledge, on its information, on its capacity for computation, and on its understanding of theory. It is a rationality that makes extensive use of rules of thumb where a more exact application of theory is impossible whether because this theory is not understood, because the data needed for estimating its parameters is not available, or because the decision must be made under conditions of uncertainty. (Pp. 51-52)

I in no way disagree with this characterisation of how real world business firms make their decisions. I also think that this “rule of thumb” approach is applicable to some extent to individual agents — at least when it comes to activity such as meeting absolute living requirements (heating bills etc.); less necessary consumption and savings allocation/speculation have a completely different dynamic. I do, however, object to the use of the word “rationality”. We will come back to this in a moment but let us first turn to the question of nihilism.

Lavoie discusses what he calls “nihilism” on page 59 of the book. He does not provide a definition of the term, but I think we can derive one from what he has written. It seems that what worries Lavoie is that if we push the Post-Keynesian of uncertainty too far we have to then admit that there are no laws and regularities underlying economic activity — and thus that economics is largely a crock. Tied to this Lavoie is concerned that if we push the uncertainty concept too far we will find ourselves in a world characterised by total and utter chaos with no order whatsoever. What Lavoie calls “nihilism” then is more accurately called “epistemological nihilism” — that is a denial that we can have any knowledge of anything whatsoever.

He goes on to say that neither of these things follow because people follow rules of thumb in line with bounded rationality. Again, I agree with this. But the term “rationality” seems to me misleading and leads to the wrong conclusions.

The term “rationality”, as Joan Robinson once pointed out, is a circular concept. It assumes that agents act in line with some sort of theory — usually marginal utility theory — but the theory, in turn, is always grounded in the fact that agents are rational. Thus the theory really says nothing beyond “agents act as the theory says they act”. It is, in essence, a tautological argument.

The same holds for Lavoie’s use of the term. It doesn’t really tell us anything beyond the fact that agents act in line with how Lavoie thinks that they act. Thus when he uses the term “irrational” to describe the supposedly nihilistic universe of lawless chaos, all he is really saying is that in such a case the agents don’t act as he thinks that they act. In a very real sense then the term “rationality” is a moral argument in that peoples’ actions are judged purely on how well they conform to a given theory — neoclassical or otherwise.

This brings us to the next point: do economic laws really exist “out there”? I have argued before that they do not; that economics is simply one system among others which we use to organise our lives. In this conception it is true that some systems of action are better at achieving set goals than others. But the goals themselves need not be characterised as “rational” or “irrational” or anything else. They are simply seen as arbitrary and, ultimately, subject to our own moral judgement which precludes any application of economic theory.

I would argue that the “rules of thumb” that Lavoie discusses in his theory of bounded rationality are also arbitrary. Whether a firm or an individual has this or that goal in mind is basically arbitrary, although again there are better and worse ways of achieving this goal. This does not mean that these arbitrary rules of thumb lead to nihilistic chaos. They still produce regularities — although they certainly do not produce Laws, which in science must be timeless — and so we do not need to give up on economic theory altogether.

Still though, the specter of nihilism looms large and it is, so far as I can see, exaggerated. It is the yawning abyss that has people continuing to build bridges out of tautologies. Better, in my opinion, to just ignore it and get on with things. The day that economists stop using the term “rationality” is the day that they finally move away from becoming a modern day Church of Reason and become rather more humble in their role.

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