Decision making underlies nearly all aspects of human life, even when this is not apparent. Behavioural economics, it is increasingly becoming clear, can explain the ‘why’ of most such decision making. It is, therefore, only apt that, in the early pages of Irrationally Rational, author V Raghunathan—with footprints in the academia, the corporate world and writing—uses his own example to familiarise the lay reader with behavioural economics, as he discusses why he decided to write the book. The tension between neoclassical economics, with its guiding principle of man as a perfectly rational being, and behavioural economics which simultaneously challenges and builds on the fundamental theories of neoclassical economics, is made explicit here. The rest of Raghunathan’s book offers the lay readers glimpses of the evolutionary history of behavioural economics, as derived from the work of ten Nobel laureates and select economists who are yet to receive the honour.
“Irrationality”, as Duke University professor Dan Ariely notes in an article in Harvard Business Review—Ariely’s work receives recognition in Raghunathan’s book—is the real invisible hand that moves human decisions. Indeed, Ariely quotes, in that article, Alan Greenspan in the aftermath of the 2008 financial crisis to show how “irrationality” can become institutional: Greenspan spoke of “presuming that the self-interest of organizations, specifically banks and others, was such that they were best capable of protecting their shareholders”.They weren’t, Greenspan realised soon enough. Do Indian banks, the ever-greening of loans, and the NPA crisis mirror such a failure of ‘rational expectations’? After all, bankers here too are fallible and carry their cognitive biases. How does the perception of the risk embedded in a business venture seeking credit change for a banker when it is backed by a large conglomerate versus when it is a standalone start-up?
Raghunathan takes great care to delineate “irrationality” from unreasonableness. He writes, “So, if homo culturalis, endowed with all those cultural and socio-psychological frames (cognitive biases and intuitive characteristics) in reality, does not take 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 Richard Thaler’s work. A juxtaposition of fairness and neoclassical rationality, in a setting involving the game, Ultimatum. The game involves a “proposer” who must split a sum of money, with a “responder”. If the responder accepts the division, both get to divvy up the money as agreed.
However, if the responder refuses, none of the two get any money. As per neoclassical rationality, the proposer stands to gain from the highest positive offering closest to zero, which would also be a gain for the responder given they are starting with zero and if they refuse the proposer’s offer, they remain at zero.
In such a situation, responders would be expected to accept any offer, but Thaler’s work shows, in such games, the modal offer has been close to 50% even though the mean offer would hover around 37%, signaling fairness was one of the considerations that went into the offer. However, even if fairness seems irrational in theory, it certainly doesn’t betray unreasonableness.
Another interesting point of note comes from the chapter that deals with the work of Elinor Ostrom and Oliver Williamson. Ostrom’s work on managing the commons, the author notes, demonstrates that “ordinary people are capable of creating rules and institutions which allow for sustainable and equitable management of shared resources”, while sustainable collective action faces challenges from costs that seem prohibitive in the short term and benefits that accrue only in the long term. Raghunathan titles 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 says, cheekily, that Indians have drawn the wrong lessons from the Mahatma’s non-cooperation tool! But there are examples galore of good community management, in which the state and other such actors of organisation play, at the very best, a secondary role.
One such example is forest resource use, conservation and management. There is ample evidence from the ground to show that when this was left to forest-dwelling communities, robust and effective systems have emerged along with superior implementation, compared to top-down management by state regulation or corporate intervention.
The evolution of behavioural economics that is detailed in Irrationally… is not about just telling us about how it has come into its own, from being an ignored, or worse, disparaged country cousin of economics that still finds favour among policymakers, academics and business leaders. It is also about reflecting on the past to identify where neoclassical dogma caused economies, businesses and households to fail rational expectations, so that corrective and preventive action can be taken.
It is also interesting how evidence-based policy making has risen in tandem with behavioural economics taking a front-row seat.
The author carefully explains why he left the Nobel-winning couple Abhijit Banerjee and Esther Duflo from his book, but makes note of the fact that their experiments “validated behavioural
economics” immensely. Today, governments in increasing numbers are willing to use “nudges”—theorised by Thaler—to drive change.
From India’s GiveItUp to bringing down LPG subsidies to Indonesia’s parent-participation SMSes from schools, ‘nudges’ are being piloted, evidence collected and outcomes established to finally get institutionalised as policy. Against such a backdrop, Raghunathan’s book becomes an essential read for policymakers, businessmen and academics.
Penguin Random House
Pp 328, Rs 399