Homo Economicus- “rational” self-interest, or risk-pooling…?

Economics is one of those topics that can easily cause eyes to glaze over and attention falter, yet it is an area that it is unwise to ignore because of the often-controversial interplay between economics and public policy. After all the discipline’s original name was Political Economy for a reason.

What politicians understand (or fail to) about economics, and whose advice they listen to (or reject) has a significant impact on the welfare of the citizens of every state.

Like many other disciplines, economics goes through cycles of what is considered “orthodox”, appropriate, or relevant- whether Neo-Keynesian or Neo-Liberal or any other “school”- but each approach is generally based upon certain core assumptions about human behaviour, so that these can be used to construct the models used to drive decision-making and policy.

So, one has the core construct of “homo economicus”- the figurative human being characterized by the ability to make only rational, self-interested decisions, who “attempts to maximize utility as a consumer and economic profit as a producer”. The idea is that this individual will analyze and understand all relevant factors and then assess the “expected utility” of each potential outcome and choose the one most beneficial to his or her welfare.

There is just one slight problem with this: human beings do not make purely rational, self-interested decisions. Not only that, but the real world is so complex that making the best decisions and acting wisely through time is subject to significant uncertainty, feedback loops, questions of agency, random events, incentives…. We could go on!

Not only that but human beings are subject to outbreaks of altruism, in which they most certainly do not seek to maximize “expected utility”, because they realize, to quote John Donne: “No man is an Island, entire of itself; every man is a piece of the Continent, a part of the main.” In other words, life is not just about competing for personal gain or advantage, but often depends on cooperation to generate the better outcome for the majority. One can, of course, see echoes of Benthamite Utilitarianism in this- promoting the greatest happiness of the greatest number.

Naturally, because human beings are emotionally and intellectually “messy”, they are also unpredictable, even if, in the majority of circumstances they are likely to act or decide a certain way. Of course, the more factors one introduces, the more uncertain the actual outcome is likely to be because mental capacity can only cope so much. As such, human beings often need to rely on resources beyond their own.

The concept of (re)insurance is, to state the obvious, based not upon maximum expected utility, but upon risk-pooling, because the world is uncertain. Bad things do happen in spite of the best of intentions or the most rational of decisions, and (re)insurance is there to mitigate the consequences of poor or unpredictable outcomes.

Awbury provides coverages to protect its clients against credit, economic and financial risks, based upon models which factor in human “messiness”, because an effective and pragmatic approach produces much better outcomes than one based upon the supposed mathematical rigour of expected utility and some idealized, but constrained model.

The Awbury Team


Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.