Neo-classical economics is built upon a series of behavioural assumptions that can be reduced to three main characteristics: rationality, self-control and self-interest. Effectively an economic model of this type assumes that individuals will act in a way that achieves maximum utility, and as they pursue this goal the market will follow. In this essay I will argue that it is useful to use these assumptions to model and explain history, as is attributed to Friedman (1953) irrationality is a self-defeating idea, but the results should still be viewed within reason and with some skepticism due to the idea of bounded rationality and the fact that in reality individuals are “dumber, nicer and weaker than Homo Economicus”.
In his classic paper on the spinning jenny Allen's assumptions lead him to the conclusion that the famous invention was adopted in Britain rather than elsewhere because it was profitable due to the high-wage economy. Allen (2009) has made some mistakes in this paper. Firstly, it is questionable that the ‘she’ Allen uses as his protagonist adopting the Jenny was indeed the actor that bought the machine, and secondly whether she had perfect information of the benefits to productivity or the difference between the price compared to opportunity cost of acquiring it. As Thaler (1996) points out ‘the assumptions of unbounded rationality, unbounded willpower and unbounded-selfishness are convenient. But they are bad economics’. An individuals rationality is limited by their time to make decisions and the ‘slow computer’ like aspect of our brains. This idea of ‘bounded rationality’ must be taken into account when assessing important historical occurrences such as the industrial revolution. It is ‘bad economics’ to make the assumption of perfect information across history - especially in time with much worse information sharing that we have today. Furthermore, it is a mistake to assume the agents of history were to act rationally when making decisions in the same way we define rational today, it is possible that individuals circumstances and the atmosphere at the time were able to warp rationale, rendering them unpredictable.
In application to Allen’s theory, it is possible that as the jenny was becoming progressively popular in Britain it became a ‘craze’ to own one, meaning that regardless of rationality individuals followed the market. Failure of the jenny to catch-on in foreign markets could be also be attributed to the ‘prospect theory’. Which explains that losses create 2x as much pain as gains yield pleasure, this risk averse nature of the individual may explain why certain individuals took the irrational choice to not buy the jenny.
Although there is the view that the behavioural assumptions of economics are to some degree fantasy, it can be argued that it is necessary to create a model based on some ‘fundamental’ assumptions to try to explain history. The idea of ‘abstraction’ that Mill (1848) used to ‘subtract away a whole lot of non-economic aspects of human behaviour to focus on the narrowly economic’ explains that by removing complications it is possible to offer a generalised account of history. As Mary Morgan continues ‘the process of abstracting is associated not just with generalising, but also with conceptualising’. In this sense it is useful to make assumptions and to generalise them when looking at the past, but if we take into account the failures within Allen’s paper it is necessary to view results achieved in this way within reason and with skepticism.
Bibliography
Milton Friedman, “The Methodology go Positive Economics”, in Essays on Positive Economics, (University of Chicago press 1953)
Robert C. Allen, The Industrial Revolution in Miniature: The Spinning Jenny in Britain, France, and India, (Published online in The Journal of Economic History 2009)
Robert Thaler, "Doing economics without homo economicus" (S. G. & W. J. Samuels 1996)
Daniel Kahneman, Amos Tversky, Prospect Theory: An Analysis of Decision Under Risk, (Econometrica 1979)
John Stuart Mill, Principles of Political Economy, (1848)
Mary S. Morgan, Economic Man as Model Man: Ideal Types, Idealisation and Caricatures, Journal of the History of Economic Thought (2006)
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