Where Do We End Up When We Forget That Value Is Subjective

Among the favorite arguments of those who advocate for the highest possible level of state intervention in the economy and centralized planning is the one regarding the irrationality of human behavior. People are weak and lacking in virtue, extremely changeable and impressionable, prey to temptations, prone to aggression toward others or indifferent to their fate, unaware of their own interests, and incapable of social cooperation. They are also unable to learn, making voluntary education useless.

In other words, people never truly mature, but can only be externally forced, through coercion, to behave “as if” they were mature. As such, it is absurd even to consider that economic freedom and the market economy could function unrestrained.

Obviously, critics of economic freedom are fighting a purely abstract ghost, not really supported by any serious theorists of classical liberalism and its more radical variants. No one has ever promised a paradise of absolute rationality. “The market” cannot be a paradise, just as no society of entirely private law can be. Economic freedom has a functional premise: a moral imperative - the voluntary mutual respect of everyone’s property rights, the non-aggression principle. And since no one can deny that people are more than imperfect, a world without conflicts and rights violations is unimaginable.

Interventionism and planning, however, which postulate the benefits of a “legitimate” monopoly (at least tacitly accepted) of “legitimate” violence, additionally endowed with rational knowledge of the needs and interests of everyone and the best ways to satisfy them, are the sure path to both injustice and inefficiency. For state regulators are, evidently, as “human” as the rest of us, with the same flaws, and not even the explicit adherence of their peers can advance them “ontologically” in rank.

In short, interventionists catch themselves in their own trap: how can you give “irrational” people “legitimate” power to decide over their fellow humans, over society in general?

And the Austrian school of economics is the only one that has shown that there is, in fact, no contradiction between what we correctly perceive as “harmful” or even “self-destructive” behaviors and the fact that, fundamentally, people still make “rational” decisions. The dilemma was resolved through the subjective theory of value, which also taught us that there is no “correct” calculable level of prices for goods and services.

Here it is worth recalling the Friedman-Savage metaphor of the “billiard player”, which remains alive in the minds of many economists. At the time of its conception, rational expectations, central to the permanent income hypothesis and dynamic neoclassical approaches to consumption, were repudiated on the grounds that people do not consciously consider- even perform non-trivial mathematical derivatives mentally - when making sometimes instantaneous consumption decisions.

The analogy comes with a reply: if scientists have built a model for the actions of an ideal billiard player, involving cumbersome calculations, and an expert player behaves consistently with this framework, achieving similar results but using different cognitive mechanisms, then the model is considered satisfactory. Following this logic, if managers’ actions credibly mimic those of profit-maximizing agents, we should be satisfied, even if the means by which this occurs elude us. After all, if the manager acted irrationally, decision-making would not be entrusted to them.

This approach was limiting, because without proposing a coherent mechanism, a theory cannot shed light on why firms’ or households’ decisions with similar preferences are heterogeneous. Still, the fact that the authors chose an “experienced” player as an example is not coincidental and foreshadowed discoveries in prospect theory. The System 1 way of thinking that coordinates spontaneous decisions relies on prior experiences, while heuristics shaped by past situations help make quick decisions that are “mostly correct” and spare decision-makers psychological costs.

Six years after the analogy, Savage himself introduced the concept of subjective expected utility. In fact, he accepted the possibility that individuals assign probabilities based on a personal belief system, recognizing that agents can differ in their capacity to evaluate unknown, objective probabilities.

The Friedman-Savage metaphor omitted a firmer defense of rationality found in von Mises’ contemporary praxeological framework, which assumes that human action is inherently rational - any deviation from rationality is inconceivable. He exemplifies that the behavior of a neurotic person is based on an internal logic involving clear means and ends, despite being perceived as atypical and “irregular from the outset”. While most may adhere to conventional, instinctual economic actions, such as precautionary savings, some rational beings, intentionally or lacking a conservation instinct, reject such norms. Having erroneous expectations is permitted by rationality.

Becker may have been inspired by this when he developed the theory of rational addiction. When developing an “addiction” to a good - say, gambling - that could have negative health or financial implications, an agent rationally sets periods of intense consumption and withdrawal. Addiction, described as a state variable, accumulates based on prior consumption experiences.

It thus became clear that neoclassical theory can be redeemed - and freed from analogy - by resorting to experience and learning - often deliberate and a byproduct of experience. Finally, von Mises expressed his caution, noting that “reason and experience show us two separate realms (...) no bridge connects -so far as we can see today -these two spheres”.