What is the benefit of using economics to assess policy recommendations amid a global pandemic or a prolonged economic stagnation? I would like to consider this question from the viewpoint that the rational expectations theory mindset, which is a characteristic of economics, democratizes policy debate.
The rational expectations theory posits that humans rationally determine their behavior based on future expectations. Rationality has the following two meanings:
First, it ordinarily means being rational. A rational person can conduct mathematical or logical thinking without superstitions.
The other meaning of rationality refers to the human ability to assess another person’s thinking and expectations. This differs from whether a person can conduct mathematical or logical thinking.
The rationality that allows one to assess another person’s thinking is a basic element of human nature. Under this meaning of rationality, the other person assesses my expectations and I assess the other person’s expectations. Then, the other person thinks that I assess his or her expectations in a certain way. I then think that the other thinks that I assess his or her expectations in a certain way. Thus, I and the other mutually read each other’s thinking in an endless loop. As a result, we develop self-reference or recursiveness in which my expectations depend on my expectations of another person’s understanding/expectations.
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Regarding the world as a system that includes such self-reference is a unique feature of economic thinking derived from the rationality of assessing another person’s thinking. In physics, quantum mechanical theories have a similar concept of self-reference: in the physical system, there is an observer and he or she affects his or her observational target.
Classical physics, which came before quantum mechanics, has no self-reference concept. One difference between the present rational expectations theory of economics and earlier economics may be equivalent to the development from classical physics to quantum mechanics (see the figure below).
The capacity to understand another person’s thinking has important ethical implications in policy debate. The capacity is the basis for a fundamental criticism of paternalism (patriarchal authoritarianism). Assessing another person’s thinking means thinking about what one would think if in another person’s position.
According to the rational expectations theory, policymakers should think, “How would I think and react if I were in their shoes.” Conversely, the citizens also think about issues from the standpoint of the other party, asking what the policymaker’s intentions are. Policymakers and citizens equally have the rationality or capacity to understand what the other is thinking. Given that policymakers and citizens are equally intelligent, discussing policies within the framework of the rational expectations theory may amount to democratizing policy debate.
In contrast, the paternalism into which policymakers tend to fall assumes that the wise elites lead the foolish citizens. A tacit premise here is that citizens do not think as much as policymakers do. Paternalism is based on a stereotype that citizens are foolish. Under such a stereotype, policymakers do not seriously consider what citizens would think about policies. Policymakers, if falling into paternalism, lose their rationality in terms of their ability to understand the thinking of the other party.
I would call this loss of rationality due to paternalism an ethical inconsistency. This assumption is inconsistent because the policymakers assume that the citizens will not consider what policymakers would think about if they were in the citizens’ positions. This assumption is also unethical in that it regards the citizens as foolish. In this sense, paternalistic policymakers are ethically inconsistent.
When policymakers have fallen into such an ethical inconsistency, unanticipated actions of citizens can cause their policies to fail unexpectedly. A typical example is the postponement of non-performing loan write-offs. Massive loans became non-performing due to the burst of asset bubbles in the 1990s in Japan, but those non-performing loans failed to be written off immediately. Their write-offs were postponed for years. Then, bank administrators enacted a typical paternalism in which elite experts used a convoy system to control the banking system.
Elite experts thought that the postponement of non-performing loans write-offs was necessary for preventing the banking system from failing. They concluded that to securely maintain order in the banking industry, they had no choice but to phase out non-performing loans without hurting banks’ financial soundness. They failed to seriously consider how consumers and companies outside the banking industry would react.
As non-performing loans continued to increase without being written off, in fact, citizens were left uncertain about companies plagued with non-performing loans and about when their customers or banks would fail. There was a general contraction of economic activities amid such insecurity and mutual distrust. The contraction represented a giant economic cost that arose outside the banking industry. The cost would have been mitigated if policymakers had the rationality or capacity to assess citizens’ thinking.
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An apparent policy failure of a similar type has been seen in restrictive policies for PCR (polymerase chain reaction) and other COVID-19 tests.
Healthcare and public health policymakers think that as infectious disease tests are designed to efficiently find infected people who require medical treatments, tests should be limited to people who are more likely to test positive (including those who had close contact with infected persons). They may have concluded that random testing of asymptomatic citizens would be less likely to find infections, wasting time and resources. This conclusion has led to the policy of limiting the scope of people targeted for testing and restricting the number of tests.
As a result, citizens might have become uncertain about who is infected, falling into mutual distrust which may have restricted social and economic activities. As policymakers have failed to seriously assess citizens’ thinking processes, the social and economic cost of test restrictions has been underestimated.
However, the social and economic function of relieving public anxiety is not the original function of infectious disease testing. This was an unfortunate incident in which policy decisions were confused because infectious disease testing functioned, in effect, as an economic policy.
As vaccination is less effective for preventing infections amid the Omicron variant, for the time being, the only way to achieve a balance between social and economic activities and COVID-19 countermeasures is to ease restrictions on employment and travel on the condition of a negative test result. The expansion of tests has been a challenge since the outset of the COVID-19 pandemic and is presenting a new, key policy challenge. Policymakers are required to make policy decisions with the rationality or capacity to assess citizens’ thinking, without falling into ethical inconsistency.
* Translated by RIETI.