Defining the economic approach to politics

At the heart of an economic approach to politics are rational choice and efficiency. We must first consider what economic reasoning or the economic approach is, a question that turns out not to be easily answered.

Whether the aforementioned elements of the economic approach must go together or whether they can be treated separately for some purposes is an important question we do not try to answer here. In the section below we deal with rationality and efficiency.

Rationality

What does it mean within the neoclassical framework to choose rationally? To answer this question, we must first introduce some subsidiary concepts: preferences (goals), beliefs, opportunities, and actions. Preferences describe the goal states of the individual with respect to the environment. Goals must be weakly ordered, affectively, for consistent preferences to exist. Second, beliefs are important too. The choosing individual must have some infor­mation about alternative goals - for example, how obtainable they are, re­lations between different actions and outcomes, and costs, in terms of direct expenditures of resources and forgone opportunities.

To see why each of these terms is important for rational choice explanations, let us examine each in more detail. If the object is to explain behavioral outcomes (or simply actions), we must know what agents want, what they believe, and what their resources and constraints are. Preferences must as­sume a particular form. We must be able to rank outcomes, and that ranking must be transitive. In other words, we can say a > b > c (a is preferred to b, b is preferred to c) and that a > c (transitivity). While these requirements may seem straightforward when applied at the individual level, we will see later that the transitivity requirement is by no means easily satisfied for groups (aggregates of individuals).

The second component of the rational choice scheme is beliefs. As Elster puts it: “In order to know what to do, we first have to know what to believe with respect to the relevant factual matters. Hence a theory of rational choice must be supplemented by a theory of rational belief” (1986:1). The emphasis on beliefs implies that individuals do not act out of pure habit or emotion. They hold some beliefs about the causal structure of the world, beliefs that provide hypothesized links between alternative actions and their conse­quences defined in terms of utility. We may believe that avoiding eggs and eating oat bran will prolong our lives, but we may be wrong. Or, an example more to the point in a book on political economy, we may think that a federal governmental structure, involving a territorial division of political respon­sibility among spatially distinct units, promotes peaceful relations among different ethnic and religious groups, when in fact such divisions provide organizational resources for group conflict. Or we may believe that a policy of export-oriented industrialization is best for a less developed country, “best” defined in terms of growth of output and sectoral composition of the economy.

The third component of the rational choice paradigm concerns resources and constraints. Sometimes this factor is omitted (see Elster, 1986), not out of neglect but because it enters implicitly under preferences. Preferences and resources would seem to be distinct. What one wants and what one can get are two different things unless aspirations are completely determined by possibilities. At a given moment, it makes sense to talk as Elster does, of a “feasibility set,” the set of actions that are possible, given logical, physical, and economic constraints. In doing this, resources and constraints are folded into the structure of preferences themselves and cease to operate “externally.”

The fourth and final component is the actions themselves, the observed choices of agents. The aim of rational choice theory is to explain these choices. The core claim is that preferences and beliefs are exogenous and fixed and that choices respond to changes in incentives (costs) at the margin.

The essence of a rational choice explanation embodies a conception of how preferences, beliefs, resources, and actions stand in relation to one another (Elster, 1987:68). This relation can be broken down into two parts. First, there is a consistency criterion that applies to the structure of preferences and beliefs. Second, there is a series of correspondence requirements. An action is rational when it stands in a relationship to preferences, beliefs, and resources. Those actions are rational when they can be shown (ex ante rather than ex post) to be the best actions possible to satisfy the agent’s preferences given his or her beliefs, that the beliefs are rational given the evidence avail­able, and, finally, that the amount and quality of the evidence available can be justified in terms of cost/benefit ratios (Elster, 1987:68). In a fully specified account of rational choice, actions, beliefs, and the evidence on which these beliefs are based should be arrived at through rational calculation.

Several points we haven’t yet discussed are often the source of confusion in rational choice explanations. The first has to do with rationality and self­interest. Although the two terms are often treated as synonymous, they are distinct. As Sen points out (1989:320), the rationality criterion is purely procedural. It specifies nothing about the content of pursued goals. By con­trast, the idea of self-interest at least implies a location where want, desire, or need are registered. But, in principle, there is nothing inconsistent about rational behavior that tries to advance the well-being of others (spouses, children, friends, or humanity).

The second common point of confusion concerns the methodological status of preferences. Are they to be thought of as psychological data (as mental or emotional states) or as behavioral data that conform to specified consistency requirements? Neoclassical economics has largely opted for the latter course, treating preferences as revealed through the actions of agents themselves. That is, preferences are reconstructed out of the actions in which agents engage. Agent i prefers a to b if, when both are available, i chooses a over b. While this threatens to erode some of the content of our previous remark that actions need to stand in a certain relationship to preferences, for the moment we pass over this problem.

The debate over the status of preferences is related to the broader theo­retical controversy about the nature of agents engaging in economic trans­actions. While the very terms “rational” and “choice” suggest conscious agents weighing the costs and benefits of various alternatives, there is a substantial group of neoclassical economists who see rationality as a pattern of behavior that is adaptive or functional for the needs of certain individuals and groups.

The third source of confusion, or at least complexity, concerns the unit to which the terms of rational discourse are applied. If the unit is a collectivity, there may be severe problems of aggregation of preferences, so much so that it is impossible to say what the social preferences are. This was the message of Kenneth Arrow’s Social Choice and Individual Values (1951). Arrow argued that when decisions are made in groups through democratic procedures, there will not exist a social welfare function that (1) expresses the preferences of the collectivity as a whole and (2) conforms to the consistency requirements established for individual preference orderings. Thus a rational choice ex­planation may fail at the level of the political system either because collective agents do not behave rationally or because the very idea of what is rational for the collectivity breaks down.

Efficiency

The second major component of the economic approach is the efficiency orientation. Since economic reasoning is a means-ends calculus with available means inadequate to satisfy all ends, the economic method must assume a specifically defined condition of scarcity: Resources are inadequate to satisfy fully desires expressed in preference orderings.

Thus the general idea of efficiency has to do with the way resources are used. A firm’s productive efficiency has to do with the way it uses its inputs of land, labor, and capital to produce goods and services.

There is one more efficiency concept to introduce, that of efficiency for the collectivity, or Pareto optimality. Pareto argued that economists could judge one distribution as better than another if this distribution improved the lot of at least one person without harming the condition of anyone. The core claim is that a collective allocation is optimal if resources cannot be rearranged so as to make anyone better off without making anyone worse off. Any policy that is redistributive (that takes from some and gives to others) violates the Pareto condition.

An important question arises in this framework having to do with the connection between rationality and efficiency. Given the preceding discus­sion, we ask whether efficiency is implied by the very idea of rational choice. If people behave rationally, do they automatically behave efficiently? Let us try to answer this question first, by making a distinction between normative and explanatory uses of the efficiency criterion and second, by examining the differences in the meaning of efficiency within market and political set­tings.

Efficiency may be used only as a normative yardstick, a standard by which to assess different choices, distributions, and allocations. Nothing is predicted or explained by efficiency. It does not enter as a term in theories about why decision makers allocate resources the way they do. Instead, it is simply used to evaluate the properties of allocations, however these allocations are made. On the other hand, efficiency may be thought of as an active factor in pro­pelling economic decisions, or rather decisions economically made. In the latter event, efficiency achieves theoretical status as an operative force in the actual process of making decisions or, at the least, as part of the selective structure that determines which decisions survive and reproduce.

If efficiency is used only as a normative criterion, there is no necessary connection between it and rational behavior, at least in one sense - no pre­diction is made as to how individuals will behave. Yet, even here inefficiency would have to raise doubts about the rationality of agents. Individuals could do better given the resources they have, yet they don’t. What is the problem? Thus the failure to behave efficiently implicates the rationality of individuals.

Departing from efficiency as a normative device, let us ask the same ques­tion: Does rationality entail efficiency? An answer to this question depends on the environment within which persons pursue their interests. Within a market setting, individuals engage in voluntary exchange. Agents decide for themselves, on the basis of their own interest, whether to participate in transactions in which they will give up their goods in return for others. For agents to engage in exchange, they must believe they will be better off: otherwise they will refuse. The capacity to say “no deal” and to “exit” is an inherent property of the market. Thus, in market settings individuals will trade until they reach the highest possible levels of satisfaction. As Wolff and Resnick put it:

In neoclassical theory, there is a precise and necessary correspondence between a fully competitive private-property economy and an optimally efficient one. The insight of Adam Smith is retained in neoclassical economics: each individual having the power (freedom to act in his or her own self-interest) will be led as if by an “invisible hand” (the fully competitive market) to actions that produce the maximum wealth (efficiency) for a society of individuals. (1987:89)