In the sinking global economy, more people are taking to the oceans, often crossing the Atlantic or Indian ocean in rickety, makeshift boats with the idea of migrating from one country to another. They are not the most desperately poor, as you might imagine from the considerable risk involved, but are wage earners who have managed to save several months’ pay to invest in the venture.
That so many people would risk everything they have on such foolish schemes hints at how dysfunctional the world economy is. Economists like to imagine that the economy is basically rational, yet irrational behavior, often just as irrational as hoping to cross an ocean on a makeshift boat, is found at every level of economic success, all the way up to the billionaire-investor who is so sure of his own ideas that he buys out a company only to shepherd it into bankruptcy.
Irrational economic behavior is not just a matter of taking inappropriate risks. People also behave irrationally in trying to avoid risks, and in countless other ways. But irrational risk-taking, where the payoff is almost purely imaginary, while the negative consequences are all too real, is particularly vexing to neoclassical economic theory.
Neoclassical theory is 19th-century economics based on a metaphor of physical tension, modeled mathematically in a way that isn’t true even in physics. The idea is that if you do something economically askew, there will be some kind of economic force, the invisible rubber band, if you will, to push you back toward a more rational or balanced economic behavior. For example, in theory, if you are applying for a job and asking for a salary that is too high, the many rejections you receive should eventually lead you to lower your expectations. That’s in theory. In reality, if you apply for thousands of jobs and are not hired at any of them, there are dozens of things that might be wrong, including the possibility that your salary requirements are too low, along with the possibility that you simply need to be more patient. There is certainly pressure in being unemployed, but the pressure does not tell you how to adapt, and the same is true in most other gaps that develop in the economy. Neoclassical theory should have been mostly tossed out in the 20th century as economists such as Keynes and Galbraith pointed out how weak it was, but it is still holding on, and indeed has helped to create the recent collapse of Wall Street.
If the rubber band metaphor struggles to describe the routine functioning of the job market, it is helpless in the face of the irrational risks that make up such a large part of the economy. Risk-taking leads eventually to real damage, possible on a scale large enough to wipe out the context of the previous decisions. If you cross the ocean on a boat only to find yourself sold into slavery, if your bold bet-the-company strategy wipes out the company, or if the untested vaccine you take leaves you paralyzed, you cannot exactly go back to where you were before and adjust your previous decision to make it more balanced. Knowing that your previous decision didn’t create a proper economic balance doesn’t tell you what to do now. Simply put, irrational risk-taking tends to leave people even more clueless than they were before. Even rational risk-taking can have this effect, but this is the primary economic effect of irrational risk-taking.
There is no simple solution to this. With the right knowledge, people can minimize risks and stay safe, but knowledge itself is a commodity that is subject to the same irrationality as the rest of the economy. Who hasn’t had the experience of studying a subject only to learn some things that turned out later to be not true, or dangerously incomplete?
The irrationality in the economy makes it harder to understand, manage, and predict. Economic behavior encompasses both rational and irrational decisions, and in the aggregate, it is irrational enough that it defies rational analysis. The best we can do, most of the time, is keep track of the economic trends — and this is easier to do if we do not automatically assume that there is anything fundamentally rational in the trends we are observing.