Wednesday, May 02, 2007

Economics and Identity

Last week I went to George Akerlof's lecture on Economics and Identity. It was about how people's identity shapes their utility functions. People's views on how they should behave and how others should behave determine the utility they get out of their actions, and hence their choices.

Classic economists would agree that people's identity matters in the utility they gain, but they would claim that it is already accounted for in the utility function. People's unique tastes (and hence their identities) are reflected in their unique indifference curves. One's tastes and identity are nobody's business and taken as a given.

Akerlof, on the other hand, thinks identity can be economists' business. A person's (or group's) identity and the ways it plays into the utility function can be identified. Identity is not simply tastes that inexplicably differ from person to person. Members of the same group expect similar things from themselves and life. It is a systemic element of the utility function.

Akerlof gave examples. The first one was the high school drop-out, unemployment and crime rates among African Americans. The identity, the alternative culture reinforces itself, low expectations lead to low performance where success becomes the exception.

The example on housewives was especially telling because it showed how identity can change over time. There was a time when women could live up to the society's and their own expectations by tending to their children and husbands. They were happy. Expectations shifted over time. Now women in the western societies are expected to live up to their "potential," both in their private life and in the workplace. They are the most fierce judges of themselves. Their happiness depends on success on both fronts, and they make their choices accordingly.

People's ideas on how they should behave and how others should behave can change. If such a change is desirable for economic, political or social purposes, policies can be designed to make that change come along. This gives policy-makers a chance to alter people's utility functions, which wouldn't be possible if they were just seen as tastes. Another example Akerlof gave was school policies that failed to change students' identities because they simply catered to them.

This idea has striking parallels with constructivism in political theory. Constructivism argues that without any material change in the pay-offs associated with different options, people can still change their minds because they view these options differently. One idea goes out of fashion and another one replaces it. Of course, this takes away from the prediction power of a theory that would simply assume rationality.

The contribution Akerlof makes is in the same vein as Daniel Kahneman's. Kahneman showed that people cannot objectively judge the utilities they will gain from different options. Therefore an economist will find it very difficult to predict a person's actions correctly by simply assigning each option a utility value.

Akerlof's explanation not only adds to the scope of policy making, but it may actually improve the explanatory power of economics, because it allows a peek into the utility function. Only if economists are open-minded, of course.

1 comment:

Craig said...

How does global greed / economics play out on the oil front? Social identity be damned, they will charge us what they want, they are a cartel and we have built an entire global system dependent on oil. -- I'm curious about your thoughts on this.