Bounded Rationality and Challenges of Liberalism

Human behavior is intendedly rational, but only boundedly so! — Herbert Simon

The concept of Bounded Rationality, introduced by Herbert Simon, suggests that people attempt to make rational decisions but are constrained by several factors. Unlike the notion of a perfectly rational “Homo Economicus,” humans cannot achieve perfect rationality due to cognitive (mental) and practical limitations. This imperfection challenges the very foundation of Liberalism. The human limitations in achieving rationality include:

1. Cognitive limitations: Humans can only process a certain amount of information at once.
2. Incomplete information: People never have a complete picture of every possible scenario.
3. Time constraints: In real life, people have limited time to analyze every option.
4. Contextual decision making: People consider the context of their decisions, unlike a perfectly rational actor.

Due to these constraints, people settle for a “good enough” choice, a process Simon calls satisficing. Instead of evaluating every option, decision-makers often choose the first available option that seems appropriate.

Bounded rationality can be used to model more realistic economics, taking human limitations into account. It can also be used to design policies that recognize how people actually make decisions, rather than how they theoretically should make them. For instance, a consumer might choose a product based on brand recognition instead of researching every possible option. Similarly, when choosing a job, a person may consider work-life balance and alignment with their values, rather than solely focusing on salary.

The Rational Man (Homo Economicus)

The concept of a rational man or Homo Economicus emerged from the works of John Locke, John Stuart Mill and Adam Smith. It posits that humans are capable of making perfectly rational decisions to maximize their profit or utility. This model assumes that a rational man answers three key questions when making a decision:

1. What is possible?
2. What can be achieved?
3. Given the constraints, what are the best options to align with the desired outcome?

A rational man will pick the optimal option by applying a mathematical relation to every possible choice. This decision can be modeled as a choice problem, where the rational man chooses one element from a set of options. For example, when choosing food at a restaurant, the rational man picks one option from the menu that maximizes their utility.

Assumptions of the Rational Man Model:

• Complete knowledge: The rational man has absolute knowledge of the problem.
• Clear preferences: The rational man knows what they are supposed to choose.
• Complex calculations: The rational man can make complicated calculations.
• Independent choices: Choices and preferences are independent, meaning a rational man will make the same choice in different scenarios.
• Logically equivalent alternatives: Replacing a choice with another that is logically equivalent will not affect the rational man’s selection.
• Calculation of consequences: A rational man calculates the consequences of each decision.

The rational man model, although based on perfect rationality, is not realistic. Traditional economics is often more interested in the behavior of the decision-maker than in the process leading to the decision. For example, consumer theory suggests that a rational consumer will maximize their utility given their budget and the prices of goods.

Critiques of the Rational Man Model

The rational man model faces several critiques, noting that real-world decision-making is not always rational:

• Framing effect: Choices are affected by how they are presented or framed. For example, people are more likely to undergo a needed surgery if chance of success is presented as 99.9% vs chance of failure is 0.1%.
• “As if” approach: Real-world decisions are affected by past experience. For example: Instead of properly evaluating price and features of new smart phones, we buy it because Samsung has a reliable product.
• Tendency to simplify problems: People simplify problems instead of analyzing every option. Example: A product will be repurchased even in the presence of better products in a market the last purchase was good enough .
• Search for reasons: People choose options based on factors like values instead of solely on rational factors. Example: People will buy product from their homeland instead of looking for the best combination of quality and price and people will reject products from countries which are involved in Genocide.

Assumption of Rationality in Game Theory

Game theory is a field to study strategies involving entities who interact with each other to maximize their gain and minimize their pain (we have discussed Game Theory at some details in our previous post). It demonstrates that people do not act perfectly rational in real life. Key components of game theory include:

• Players: Multiple decision-makers or participants.
• Strategies: Actions that players employ.
• Payoff: The outcome or result of the interactions.

Traditional Game Theory assumes that entities always act rationally when making decisions. However, this doesn’t always align with real-world behavior. Consider the Ultimatum Game, an economic experiment involving two players who decide how to split a sum of money. The first player proposes a division, and the second player can either accept or reject it. If the second player accepts, both players receive the proposed amounts. If rejected, neither player gets anything.

If humans acted as Homo Economicus, the second player would accept any offer, no matter how unfair, since receiving something is better than nothing. However, in practice, unfair offers often lead to rejection. For instance, if the first player proposes keeping $85 out of $100 while giving the second player only $15, the second player is much more likely to reject the deal out of a sense of fairness, resulting in both players receiving nothing. In contrast, a more equitable division, such as $50-$50, is far more likely to be accepted. This experiment demonstrates that strict rationality isn’t always the most effective strategy, as emotional and social factors like fairness and reciprocity heavily influence real-world decision-making.

Liberalism and Boundary Rationality

Liberalism, like the rational man model, assumes that individuals act rationally in making decision which will both benefit themselves and the society at large. Liberalism can be traced back to the Enlightenment, where philosophers advocated for individual freedom over biblical laws. The basic tenets of Liberalism include:

• Freedom: Individuals have the right to choose from various options.
• Equality: Everyone should have equal opportunities.
• Personal liberty: The freedom to make individual choices.
• Free market and competition: Businesses and agents compete with each other to maximize profit.

Key thinkers in liberalism include John Locke, who advocated for individual rights and limited government, John Stuart Mill, who enhanced the philosophy by emphasizing Utilitarian side of human being, and John Rawls, who made major contributions to the concept of Justice. Locke’s “Two Treatises of Government” criticized divine rights (especially associated with Monarchy) and advocated for individual rights, asserting that people are born equal and independent. The U.S. founding fathers, adopted this philosophy which is evident from the Declaration of Human Rights, which echoes this idea, stating that all men are created equal with inalienable rights to life, liberty, and the pursuit of happiness.

Challenges to Liberalism

Liberalism faces challenges because it relies on the idea of rational individuals with complete information. These challenges include:

• Incomplete information: Individuals often lack complete information to make rational decisions such as to elect the most eligible leader in an election.
• Lack of collective good: Liberalism emphasizes individual benefit, potentially overlooking the good of society as a whole.
• Self-interest: The emphasis on maximizing profit and utility may not lead to the best outcomes for the society.
• Irrationality: People cannot always maximize profit or utility due to their bounded rationality, as shown in Game Theory.

The Insufficiency of Rationality and Need for Divine Guidance

Human knowledge is based on five senses, and intellect. However, even when using both, people are still limited by bounded rationality. In Islamic framework, revelation, or wahy, provides guidance from God that completes the knowledge. Using the example of a gun, one can use senses and intellect to know how the gun works and how it came into being, but one cannot use them to know about the legal uses of the gun. This is where wahy (Divine revelation) comes in.

As stated earlier per Herbert Simon’s analysis, a perfect rational man is nothing but a fiction. But even if we assume that such a rational man exists, he will be unable to know what is the correct decision when faced with a moral question, like the proper punishment for a murderer.

The limitation of rationality, therefore, poses a serious challenge to the philosophy of Liberalism and underscores the importance of guidance from a higher authority in matters related to freedom, justice and good decision making.