BOOK VIII - Page 2

Herbert Simon and Logic Theorist

1978 Nobel-laureate Herbert Simon (1916-2001), a polymath of promethean creative intelligence, was born in Milwaukee, Wisconsin, and entered the University of Chicago in 1933 where he received a BA degree in 1936 and a Ph.D. in political science in 1942.  He was awarded the Nobel Memorial Prize for economics in 1978.  He spent his career as a faculty member at Carnegie-Mellon University in Pittsburgh, most of it in the Graduate School of Industrial Administration, and later as a faculty member in both the Psychology and Computer Science Departments.  He was also a member of the University’s board of trustees.  His excellent intellectual autobiography, Models of My Life, was published in 1991.

In his autobiography he reports that the most important years of his life were 1955 and 1956, when his interest turned from administration and economics to the psychology of human problem solving, and specifically to considering the symbolic operations that people use in their thinking processes.  He and his long-time collaborator, Alan Newell, had concluded that computers could be applied generally to imitating human intelligence symbolically, instead of just numerically, an insight that Simon says is a crucial step required for genuine artificial intelligence to emerge.  In 1956 his first artificial-intelligence system named LOGIC THEORIST used his “heuristic search” methods to develop deductive-logic proofs of the theorems in Whitehead and Russell’s Principia Mathematica, the seminal text for the Russellian symbolic logic.  However, the fact that this system found proofs in formal logic is purely incidental; Simon rejects the view held by some artificial-intelligence advocates, that symbolic logic is the appropriate language for artificial-intelligence systems, and that problem solving is merely a process of proving theorems.  The significance of LOGIC THEORIST is its implementation of his heuristic-search methods for symbol manipulation.

Simon defines artificial intelligence as symbolic processing, and he defines cognitive psychology as understanding human thinking by modeling problem solving with artificial-intelligence systems.  Newell and Simon have developed many artificial-intelligence systems, several of which are described in their lengthy book titled Human Problem Solving (1972).  Simon views scientific discovery as a special case of human problem solving, and therefore maintains that it can be examined with the artificial-intelligence approach.  However, his artificial-intelligence systems development work was not directed to scientific discovery until later in the 1970’s.  His principal publications pertaining to scientific discovery are Models of Discovery (1977), which contains reprints of his published articles relating information processing concepts to scientific discovery, and most notably his and Pat Langley’s Scientific Discovery; Computational Explorations of the Creative Process (1987), which describes several discovery systems that simulated discoveries of various historic scientific laws and theories.

Just as examination of the evolution of the contemporary pragmatist philosophy of science requires consideration of the issues in physics and especially in quantum theory, so too examination of the development of the artificial-intelligence discovery systems requires consideration of issues in the social sciences including notably economics.  To appreciate Simon’s views on scientific discovery, it is necessary to consider his views on human problem solving by artificial-intelligence systems.  And to appreciate his views on human problem solving, it is informative to consider what he calls his most important contribution to economics, his postulate of bounded rationality.  And to appreciate Simon’s postulate of bounded rationality, it is helpful to review the various alternative rationality theses including Max Weber’s semantical thesis of “ideal-types.”  So, let us start with the prevailing neoclassical economists’ concept of rationality.

Neoclassical Maximizing Rationality and Weber's Ideal-Types

Simon proposes his thesis of “bounded rationality” as an alternative to two other concepts of rationality that have currency among economists.  The first and principal alternative to Simon’s view is the prevailing neoclassical rationality postulates, which say that consumers are rational because they maximize their utility, and that producers are rational because they maximize their profits.  The second alternative to Simon’s is the rational-expectations postulate, which is a distinctive extension of the neoclassical postulate of utility and profit maximization.  The rational-expectations view will be considered below in the discussion of the BVAR type of discovery system.  And since the rational-expectations postulate is an extended version of the neoclassical view, Simon’s critique of neoclassicism also applies to the rational-expectations thesis, which he explicitly rejects. Simon’s bounded-rationality postulate is similar to an earlier view originating in the United States called “Institutionalist economics”, which will also be examined below.  Before turning to Simon’s bounded-rationality postulate, however, consider firstly the still prevailing view in academic economics, the neoclassical postulate of rationality.

The idea of rationality in economic behavior emerged in the Enlightenment era of Western thought.  The neoclassical postulate of rationality originated in Adam Smith’s doctrine of self-interest set forth in his Wealth of Nations (1776), the seminal document for modern economics.  Smith was greatly impressed by Isaac Newton’s celestial mechanics.  In his Essay on the History of Astronomy Smith described Newton’s celestial mechanics as the greatest discovery ever made by man, and he aspired to describe economic life as a harmonious mechanism, as Newton had done for the heavens.  Ever since then academic economists have been enthralled by this agenda, which has much less empiricism than rationalism.  In Smith’s system entrepreneurs’ rational behavior in pursuit of their economic self-interest unintentionally produces a beneficial and harmonious outcome for the national economy.  This is his famous doctrine of the “invisible hand.”

However Smith’s perspective is not closed or self-contained.  It is part of a larger moral universe of natural laws, which Smith had earlier described in his Theory of Moral Sentiments (1759).  In Smith’s natural-law philosophy the pursuit of economic self-interest is morally constrained by men’s natural sympathy for others and also by their natural desire for the approval of others – a distinctively sociological idea.  Later economists excluded Smith’s moral constraints on the pursuit of self-interest from theoretical economics.  In the twentieth century these constraints came to be recognized as sociological or institutional structures instead of natural moral laws, and an attempt to re-introduce them into economic analysis was made by a school of economists called the American Institutionalists.

Almost one hundred years after the Wealth of Nations a new development occurred in economic theory, which is now called the “marginalist revolution”, and which might also be described as the completion of Smith’s agenda for a Newtonian economics.  The term “marginal” means incremental or differential, and the incremental economic analysis lends itself to mathematical expression with the differential calculus developed by Newton.  The result is an elegant mathematical rendering of economic theory that many academics find compellingly attractive, in which the rationality postulate became a matter of calculating the global maximization of consumer utility and producer profits by setting the first derivative of the relevant mathematical function to zero and then calculating the positive maximum critical point in the function’s second derivative.   The theory of relative price determination describes the allocation of all goods and services in an optimally efficient manner later called “Pareto optimality” after the economist Vilfredo Pareto. 

A half century later there was another revolution called the “Keynesian revolution” named after the English economist, John Maynard Keynes.  Pre-Keynesian economic theory had assumed that the Pareto optimum allocation resulting from rational maximizing behavior by each consumer and producer would also maximize income, output and employment for the whole economy, as both Adam Smith and the marginalists had believed.  In his General Theory (1936), however, Keynes set forth a new thesis saying that individual maximizing behavior could result in less-than-full-employment equilibrium or stagnation, which he said had occurred during the Great Depression of the 1930’s.  This new thesis resulted in economists’ dividing economics into the “microeconomic” theory of relative prices, which is about the determinants of maximally efficient allocation of resources in response to consumer preferences, and the “macroeconomic” theory of maximal aggregate income, output and employment determination.  But while Keynes produced a revolution in economic theory, he did not explicitly attack the classical economists’ rationality postulate of individual human behavior, even though his consumption and liquidity preference relations did not conform to the classical rational psychology of maximizing postulates.  Nonetheless his underemployment equilibrium thesis cogently attacked the classical economists’ optimistic thesis of maximized national income, output and employment.

Soon afterwards economists began applying statistical inference techniques to estimate equations with the macroeconomic data developed by 1971 Nobel-laureate economist Simon Kuznets of Wesley Mitchell’s National Bureau of Economic Research, in order to describe national economic conditions.  Both the availability of these data and the development of the computer occasioned the evolution of a specialty area in economics called “econometrics”, although earlier there were Institutionalist economists whose statistical analyses of economic data have also been called econometrics.  Since Trygve Haavelmo’s 1944 paper, however, nearly all the econometricians have been neoclassical economists requiring that the selection of explanatory variables for the equations constituting the econometric model be “justified” by neoclassical theory.  Thus, until very recent years econometrics was exclusively the application of statistical testing techniques to econometric models structured in accordance with neoclassical microeconomic and macroeconomic theory.  Even today any econometric model that does not result from such a priori imposition of the neoclassical theory upon the data is derisively referred to as “atheoretical.”  In this respect neoclassical economics still bears a burdensome legacy from the romanticism of the earlier times.

The above overview of the neoclassical rationality theses of human behavior reveals that rationality is not viewed by economists as just one of many alternatives.  It has served as the foundation for modern economics since its founder Adam Smith.  Anyone attempting to overthrow the use of maximizing rationality theses is attempting a new scientific revolution in economics that would be much more radical than any of the revolutionary developments within the history of neoclassical theory.  Nevertheless, there have been dissenters such as the American Institutionalists, and the reason for their dissent has always been the empirical inadequacy and simplistic unrealism of the neoclassical theory with its heroically imputed rationality theses.  Neoclassical theorists have not been completely unaware of these problems caused by their fidelity to the maximizing rationality theses.  Before turning to Simon’s alternative, consider briefly Max Weber’s thesis of the “ideal-type”, a semantical contrivance proposed to defend the neoclassical rationality concept against its critics.  Simon does not refer to Weber, but Weber proposes the same ideas that Simon explicitly and specifically opposes.

Weber’s discussion of his doctrine of the ideal-type or “idealtypus” can be found in English translation from the German in The Methodology of the Social Sciences (Tr. by Shils and Finch, 1949), and principally in the chapters titled “’Objectiv­ity' in Social Science and Social Policy” and “The Meaning of ‘Ethical Neutrality’ in Sociology and Economics”, and in Max Weber’s Ideal-type Theory (1969) by Rolf E. Rogers.  Weber’s philosophy of sociology contains ambiguities that have been noted by recognized Weberian scholars including “Weber’s dilemma”, which is discussed below.

Weber defined the ideal-type as a mental construct that has two basic features: The first feature is it involves one or several points of view. According to Weber’s theory of knowledge this perspectivism is characteristic of all concepts including both natural science and social science concepts, because no concept can capture reality in all its potentially infinite variety of aspects. Weber explicitly rejects the copy theory of knowledge, which he finds in the German Historicist philosophy of social science, and he refers to the Historicists’ claim of pure objectivity in science as the “naturalistic prejudice”.  In the present context what is noteworthy is that the rational aspect of human behavior is the central aspect of reality that Weber includes in the ideal-type in so-called “pure” economic theory. 

The second of the two features of the ideal-type is that it involves a one-sided accentuation or intensification of the perspective or point of view in the ideal-type.  Nonrational considerations are not denied, but the maximizing postulate is knowingly made unrealistically extreme as a limiting case.  Weber explicitly rejects the charge that the ideal-type is a complete fiction, but he calls it “utopian”, since historical concrete individuals seldom conform in their behavior to the accentuated, maximizing rationality described by the ideal-type.  Thus individual instances not conforming to pure economic theory do not falsify the theory containing ideal-types.  As Weber explicitly states, the ideal-type is not a hypothesis and it is not tested by its application to reality.  Weber says that the ideal-type is used to compare theory to reality, in order to reveal by contrast the irrational aspects of human behavior.  What neoclassical economists call “pure theory” utilizes ideal-type concepts exclusively, and it assumes the maximizing rationality, which almost never corresponds completely with reality but only approximates it.

Thus the ideal-type is a semantical contrivance like Heisenberg’s concept of a closed-off theory, because it is what Popper calls a “content-decreasing stratagem” to evade falsification.  It is unfalsifiable, because it is protected from falsifying evidence by the stratagem of restricting its applicability in the face of contrary evidence and thus of denying its falsification.  What is conventionally called “pure economic theory” with its ideal-types is true where it is applicable, and it is deemed inapplicable wherever it would be falsified.  In other words all observed human behavior is “rational” and suitable for economic analysis wherever neoclassical economic theory applies to it.  And it is “irrational” and unsuitable for economic analysis wherever the theory does not apply.  If there is anything that distinguishes the ideal-type thesis, it is that the evasive denial of falsification by contrary evidence is so unabashedly explicit.

It may also be noted that when the Weberian neoclassical economist compares his ideal-type with observed behavior in order to detect irrational behavior, he is not using it as a counterinductive “detecting device” as Feyerabend advocates.  When Galileo was confronted with the Aristotelian tower argument opposing the Copernican heliocentric theory, Galileo’s response was to revise the language describing observation.  And when Heisenberg was confronted with the apparently continuous Newtonian track of the free electron in the Wilson cloud chamber, his response too was to revise the Newtonian language for describing the observed cloud-chamber tracks.  These are examples of counterinduction.  But when the Weberian neoclassical economist is confronted with observed anomalous “irrational” behavior, no attempt is made to reconcile the reporting language of observation with the ideal-type language of neoclassical theory, much less to revise the theory.  Instead the reported anomalous observations are just dismissively excluded from economics.  The Weberian regards the observed “irrational” behavior as a phenomenon to be excluded from neoclassical theory rather than as one to be investigated for a more empirically adequate post-neoclassical economic theory, much less as a phenomenon to be included in a reinterpreted or revised test-design language.

Many contemporary economic theorists are only less explicit in their dogmatic adherence to neoclassicism with its definitive maximizing rationality.  They are reluctant to dispense with the elegantly uniquely determinate mathematical solutions enabled by merely setting the first derivative of the demand equations to zero and then checking the second derivative for a maximum inflection point, even though the commercially viable econometric models used in business and government almost never have their equation specifications deductively derived from maximizing assumptions.  Yet the accepted college economics textbooks are replete with graphs that do not represent actual measurement data, but are just imaginary descriptions of what the received theory says the measurement data should look like. 

The siren of mathematical elegance has compellingly seduced these blackboard economists.  They are scandalized by the observed absence of optimizing behavior and the rejection of their maximizing theses, because it implies that paradigmatic problems thought to have been so elegantly solved after two-hundred-fifty years of theoretical development in the neoclassical tradition have not actually been solved at all.  Ensconced academic economists have dutifully labored for years to earn their doctorate credentials and then have obsequiously groveled before the journal editors and referees to get their papers published and before their colleagues to get tenure.  They do not welcome being advised that their ostensibly empirical theory depends on a content-decreasing stratagem, a self-deceiving linguistic contrivance, which makes their received theory only slightly less semantically vacuous than the formal differential calculus used to express it, and that it is hardly more ontologically realistic than the Ayn Rand romantic-utopian novels used to propagandize it for the general public – to say nothing of reactionary American politicians.  But the Great Recession that started in 2007 has produced a crisis for economic rationalism.

Interestingly Lloyd S. Shapley, a recipient of the 2012 Nobel Prize for Economic Sciences, told the Globe and Mail (15 October 2012) that he has never in his life taken a course in economics.  As 2001 Nobel-laureate economist Joseph Stiglitz explains at length in his book Freefall: America, Free Markets, and the Sinking of the World Economy (2010) that the failure of economic rationalism has been egregious, since these rationalistic dogmas underlie the practices that caused the Great Recession.  And it might be added – just they had caused the Great Depression of 1929-1933.  In the chapter titled “Reforming Economics” he states that economics has moved from being a scientific discipline into becoming free-market capitalism’s biggest cheerleader.  He critiques its Walrasian general equilibrium approach and its fallacious belief that the so-called efficient or perfect market unrestrained by any government regulation is self-correcting, and he references recent studies that show there is no scientific basis for this belief.  He reports that as a graduate student he soon concluded that rationality is nonsense, that his colleagues had an irrational faith in the assumption of rationality, and that shaking their irrational faith would not be easy.  He describes various cases in which people systematically act irrationally including their behaviors that produce speculative bubbles.  Doctrinaire neoclassical economics might be a paradigm for Kuhn’s dogmatic “normal science”, save for the crucial fact that for its true believers its elegant rationalism admits to no anomalies that might occasion correction, much less a new scientific revolution.  Yet today there are still true believers blithely ignoring falsifying data and experience, and teaching their elegantly deductive Scholastic-like dogma to unwary students. They are latter-day Weberians.

Yet in truth not all economists are purists devoted to their orthodoxy of “pure economic theory”.  The ascendancy of econometric modeling has made such evasion of empiricism more difficult, because the “rational” and the “irrational” are inseparably commingled in the measurement data.  The econometrician constructing models from time-series historical data would rather make statistically acceptable models, than to incur large error residuals in his statistical equations, and try to dismiss them as merely “irrational” behavior that can be ignored notwithstanding egregiously bad forecasts.  While the ostensible practice in academia today is still the Haavelmo agenda (discussed below), in which equations are specified on the basis of neoclassical theory, a growing number of economists are evolving into practicing pragmatists.  They have turned increasingly to data analysis for their equation specifications, and include in their equations even such heretical noneconomic factors as demographic, sociological or political variables, which are never found in sanctioned textbooks’ pontificating neoclassical theory.  And Simon is so scandalously heretical as to replace the sacrosanct maximizing rationality postulates.  Read on (carefully).

Simon’s Postulate of Bounded Rationality and “Satisficing”

In his autobiography Simon relates that in what he calls his first piece of scientific work, a study in 1935 of public recreation in the city of Milwaukee, he saw a pattern that was the seminal insight for what was to become his thesis of bounded rationality.  For this study he was examining the budgeting process for the division of funds between playground maintenance, which was administered by one organization, and playground activity leadership, which was administered by another organization in the Milwaukee municipal government.  He found that the actual budget allocation decision was not made as economic theory would suggest.  What actually occurred was that both of the two organizations wanted more funds for their distinctive functions, and he generalized from this experience that people bring decisions within reasonable bounds by identifying with partial goals for which their own organizational units are responsible.  The Institutionalist economist John Commons calls this a “rationing decision”.

This insight was taken up in Simon’s Ph.D. dissertation (1942), which he later published as Administrative Behavior (1947), the book referenced by the Royal Swedish Academy of Sciences as an “epoch-making” book, when they awarded him the Nobel Memorial Prize for Economics in 1978.  In his autobiography Simon writes that his entire scientific output may be described as a gloss on two basic ideas contained in his Administrative BehaviorThey are that (1) human beings are able to achieve only a very limited or “bounded” rationality, and (2) as a consequence of this limitation, they are prone to identify with subgoals.  The first of these ideas is fundamental to Simon’s critique of neoclassical rationality, and the second is fundamental to his theory of human problem solving and artificial intelligence.

In his autobiography Simon says that his “A Behavioral Model of Rational Choice” (1955) reprinted as chapter fourteen in his Models of Man (1987), was his first major step toward his psychological theory of bounded rationality.  In that early paper he states that the neoclassical concept of rationality is in need of fairly drastic revision, because actual human behavior in making choices does not satisfy three basic assumptions underlying neoclassical maximizing rationality.  Those three assumptions are: (1) a decision maker has knowledge of the relevant aspects of his environment, which if not absolutely complete, is at least impressively clear and voluminous; (2) a decision maker has a well organized, consistent, and stable system of preferences; and (3) a decision maker has a skill in mental computing, that enables him to calculate for the alternative courses of action available to him the singular course that will enable him to reach the highest achievable point in his preference scale.

Then in his “Rational Choice and the Structure of the Environment” (1956) reprinted as chapter fifteen of Models of Man, Simon proposes replacing the neoclassical postulate of maximizing behavior with his more modest postulate that he calls “satisficing” behavior.  “Satisficing” means that instead of optimizing, the decision-maker’s limited information and limited computational ability require that he adapt “well enough” to achieve his goals instead of optimizing.

The first chapter of his Sciences of the Artificial (1969) reveals that Simon identifies exactly the same things about neoclassical rationality that Weber identified as the two basic features of the ideal-type.  Firstly like Weber’s thesis of viewpoint in the ideal-type, Simon calls neoclassical rationality an “abstract idealization”, because it selectively directs attention to the circumstances of the decision-maker’s outer environment for his adaptive behavior.  Similarly in the chapter “Task Environments” in his Human Problem Solving (1972) he says that it is the task that defines the “point of view” about the environment, an idea that is comparable to Weber’s thesis that the ideal-type contains a point of view determined by one’s interests. 

Secondly just as Weber said that the accentuated rationality in the ideal-type is “utopian”, Simon calls neoclassical rationality “heroic” to describe its unrealistic character, and later in 1983 in his Reason in Human Affairs again without referencing Weber, he describes optimization as “utopian”.  But unlike Weber, Simon does not dismissively relegate to the status of the “irrational” all the decision making that does not conform to the neoclassical ideal-type of rational maximizing behavior.  Instead Simon considers the empirical inadequacy of neoclassical rationality to be good reason for replacing it with his more realistic thesis of bounded rationality.

In the second chapter of his Sciences of the Artificial and then in his “From Substantive to Procedural Rationality” in Models of Bounded Rationality Simon uses the phrase “substantive rationality” for the neoclassical maximizing rationality, which considers only the decision maker’s goals and outer environment.  And he uses the phrase “procedural rationality” for the satisficing psychological cognitive procedures including the decision maker’s limited information and limited computational abilities consisting of what Simon calls the decision maker’s inner environment.  He says that the study of cognitive processes or procedural rationality is interesting only when the substantively rational response is not trivial or obvious.  It is usually studied in situations in which the decision-maker must gather information of various kinds, and must process it in various ways to arrive at a reasonable course of action for achieving his goals.

Simon refers to the Pareto optimality described in the economists’ theory of general equilibrium, which combines the individual maximizing choices of a host of substantively rational economic participants into a global optimum for the whole economic system, as the “ideal” market mechanism.  Then he says that there is also a “pragmatic” market mechanism described by the 1974 Nobel-laureate economist Frederich von Hayek that is more modest and believable, because it strives for a measure of procedural rationality by realistically tailoring decision-making tasks to the limited computational capabilities and localized information available to the economic decision maker, with no promise of optimization.  Simon quotes at length a passage from Hayek’s “The Uses of Knowledge in Society” in American Economic Review (1945), in which Hayek asks, what is the problem we wish to solve when we try to construct a rational economic order?

Hayek answers that the economic calculus does not describe the optimization problem, since it is a problem of the utilization of knowledge that is not given to anyone in its totality.  The price system is a mechanism for communicating information, and the most significant fact about it is the economy of knowledge with which it operates, that is, how little the individual participants need to know in order to be able to take the right course of action.  Simon maintains that it is Hayek’s “pragmatic” version, that describes the markets of the real world, and that the substantive rationality of neoclassical theory is worthless, since executable maximizing algorithms do not back it up.   He says that consumers and business firms are not maximizers, but rather are satisficers.  They accept what is “good enough” because they have no choice.  The rationality that they actually use is a satisficing procedural rationality.  Examination of the limits of rationality leads to consideration of the price system as an institution that reduces the amount of nonlocal information which economic participants must have to make “reasonable”, i.e., satisficing, decisions.

Bounded Rationality, Institutionalism, and Functionalism

Simon’s description of the real-world market-determined price system as pragmatic and as an institution places him in the worthy intellectual company of the American Institutionalist School of economic thought, even though he does not identify himself as such.  Therefore, a few background comments about this school of economics and about its principal advocates are in order.  In the “Introduction” to his Types of Economic Theory the Institutionalist economist Wesley Clair Mitchell says that in the history of economics there have been different types of economic theory, not only because there have been different types of problems, but also because there have been different conceptions of human nature.  At issue is the neoclassicals’ concept of human nature, which motivated the classical economists to construct a deductive theoretical economics based on their maximizing rationality postulates. The American Institutionalist School was founded as a revolt within the American economic profession, which rejected the formal and abstract deductivism in neoclassical economics and instead appealed to experience.  It had its roots in the pragmatist philosophy, the only philosophy indigenous to the United States, which itself was a revolt in the American philosophy profession, a revolt that rejected the natural-law and utilitarian traditions in European academic philosophy. 

The founding father of American Institutionalism is an iconoclastic economist and eccentric individual named Thorstein Veblen (1857-1929).  In his “Why is Economics not an Evolutionary Science?” in his The Place of Science in Modern Civilization (1919) Veblen characterized the neoclassical economists’ hedonistic psychology as describing man as a “lightening calculator” of pleasures and pains, who passively responds to his environment and is unchanged by the environment.  Veblen rejected this conception of human nature and proposed instead an “anthropological” conception, in which the individual’s psychology is formed by institutions prevailing in the community, and most notably he proposed that the institutions evolve. Thus he introduces what today would be called a sociological perspective.  He also therefore proposed that economics itself is an evolutionary science that employs a “genetic” type of theory, which describes the cumulative cultural growth of economic institutions, instead of the “taxonomic” type of theory used by neoclassical economists such as the Austrian school.  He rejects the Austrian’s ad hoc attempts to save their natural-law explanations from deviant facts by invoking “dis­turbing factors.”  He also explicitly references Charles Darwin, and rejects the German Historicist School as pre-Darwinist for offering only enumeration of data and narrative accounts instead of genetic theory.

Another noteworthy representative of American Institutionalism is John R. Commons (1862-1945) of the University of Wisconsin.  In his Institutional Economics (1934) Commons states explicitly that he is following the pragmatist philosophy of Charles S. Peirce, the founder of pragmatism at Harvard University.   In the second volume of this book Commons discusses Weber’s ideal-type concepts, and he criticizes their fixed and unchanging character.  Commons states that the utopian character of the ideal-type only becomes more utopian as scientific investigation advances.  Instead of the ideal-type Commons proposes the “changeable hypothesis”, that takes into account new factors revealed to be relevant in the investigation, and that retires from consideration old factors found to be irrelevant. This amounts to demanding that economics become more empirical.  Weber had explicitly denied that the ideal-type is a hypothesis.  Commons says that use of changeable hypotheses makes less utopian the utopias that our minds create.  Commons anticipates Simon in important respects, but unlike Simon, Commons does not explicitly propose revising the maximizing assumption in the neoclassical rationality postulate.  But he rejects its centrality to economics.  A typical Institutionalist, he maintains that in addition to economic interactions described by neoclassical economics there are other, namely institutional, factors that are also operative in determining the outcomes of economic transactions.  

In both his earlier works and again in his final work, The Economics of Collective Action ([1950] 1970), Commons proposes a “negotiational psychology” as opposed to the hedonist psychology of the utilitarians.  He also calls it an objective and behavioristic psychology instead of the subjective psychology of pain and pleasure, because it is the psychology of language, duress, coercion, persuasion, command, obedience, propaganda, and a psychology of physical, economic, and moral powers.   He therefore distinguishes three types of transactions: (1) bargaining transactions, which occur in the market, and which is the type treated in neoclassical economic theory, (2) managerial transactions, which occur between levels in organizational hierarchies, and (3) rationing transactions, which are agreements about apportioning, such as occur in budgeting decisions.  Simon’s experiences with rationing in Milwaukee come to mind. 

Commons says that all three types have “futurity”, that is, they require some security that future outcomes occur as expected by the participants, so that expectations can operate as working rules.  He sees the three types as functionally interdependent.  The Institutionalist perspective focuses on the second and third types of transactions, because these represent “collective action in control of individual action”, which is Commons’ explicit statement of the central thesis of Institutionalism.  Commons was particularly interested in the social control exercised by courts over the working rules in bargaining transactions.  Perhaps it is not coincidental to Commons’ interests that in the 1930’s prior to the Roosevelt Administration, the courts viewed collective bargaining by labor unions as an illegal conspiracy in restraint of trade.  The second and third types of transactions, however, are also relevant to Simon’s interests.

Simon elaborates on the relation of institutions to his thesis of satisficing bounded rationality in his “Rationality as Process and as Product of Thought” (1978) reprinted in his Models of Bounded Rationality.  He does not explicitly refer to the academic literatures of either pragmatist philosophy or Institutionalist economics, but instead draws upon the “functionalist” type of explanation often found in the sociological literature.  He references Encyclopedia of the Social Sciences (1968) in which “functionalism” is defined as an explanation of how major social patterns operate to maintain the integration or adaptation of larger social systems.  More formally stated functionalist explanations are about movements of a system toward stable self-maintaining equilibria.  Most notably Simon states that there is no reason to suppose that the attained equilibria are global maxima.  Thus functionalist explanation describes satisficing behavior.

In this paper he furthermore notes that functionalist analyses are not focused on quantitative magnitudes as are found in price theory, but are focused on qualitative and structural questions, and typically on the choice among a small number of discrete institutional alternatives.  Particular institutional structures or practices are seen to entail certain desirable or undesirable consequences.  A shift in the balance of consequences, or in the awareness of them, may motivate a change in institutional arrangements.  This qualitative functionalism is represented in the sociological literature.  Like economic sociologists, who recognize the underlying rôle of economic institutions, Simon argues that economists have in fact not actually limited themselves to maximization analyses, but have utilized qualitative functionalist analyses when they seek to explain institutions and behavior that lie outside the domain of price theory, distribution, and production.  In his autobiography he says most of the conclusions drawn by neoclassical economists do not depend on the assumption of perfect rationality, but derive from auxiliary institutional assumptions that are required, in order to reach any conclusions at all.  And in his Reason in Human Affairs (1983) he says that markets do not operate in a vacuum, but are part of a larger framework of social institutions, which provide the stable environment that makes rationality possible by supplying reliable patterns of events.

In “Rationality as Process...” Simon states that the characterization of an institution is almost never arrived at deductively from consideration of the function that it must perform for system survival.  Functionalist analysis is not deductive like theoretical neoclassical economics.  Rather an institution is a behavior pattern that is empirically observed, and existence of the pattern occasions the question of why it persists, that is, what function it performs.  Institutions can be observed in every society, and their existence is then rationalized by the argument that its function is requisite.  But Simon comments that this kind of reasoning may demonstrate that a particular behavioral pattern is a sufficient condition for performing an essential social function, but cannot demonstrate that the particular pattern is a necessary condition.  Alternative patterns may be functionally equivalent, since they serve the same need.  In other words there may be many alternative satisficing institutional patterns for accomplishing the same social goal.

There have been more recent dissenters than the Institutionalists to conventional academic economics, and the reason for dissent as always has been the empirical inadequacy and simplistic unrealism of the neoclassical theory with its heroically imputed rationality postulates.  More recently a new empirical psychological style of economic research has emerged that is called “behavioral economics”.  One pioneer in this new style at the University if Chicago, Booth School of Business is Richard H. Thaler, who published a book titled Misbehaving: The Making of Behavioral Economics (2015). Thaler wrote an article in New York Times (10 May 2015) Business Section front page titled “The Importance of Irrelevance”.  Thaler notes in the article that an important problem for neoclassical economic theory is economists’ discounting as irrelevant any factor that does not influence the maximizing rational thinking of a person.  Like Veblen, Thaler rejects economists’ insistence on studying mythical maximizing creatures often known as Homo Economicus, creatures that Thaler ridicules with the name “Econs”.  Thaler says that for his theory many supposedly irrelevant factors such as emotions do matter.  In a The Wall Street Journal (16-17 May 2015) review of Thaler’s book titled “How Homo Economicus Went Extinct” and subtitled “Making Economics Irrational”, Carol Tavris expresses incredulity at how delusional academic economists are with rational economic “theory”.

But while behavioral economics relies on survey research instruments often used by social psychologists like Tavris and by modern market researchers for businesses, Simon proposes “cognitive psychology” based on his imputed bounded rationality postulate of satisficing behavior.

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