Wednesday, December 1, 2010

Economic Irrationalism

A study by the Australia Institute has shown that a majority of Australians are costing themselves money by not keeping track of a range of financial details like what interest rate they are paying on their home loan, whether or not they have the best mobile phone plan, and keeping money in low interest savings accounts instead of paying off credit card debts. When you look at it objectively, it would seem to indicate that people are either dumb, don’t care, or just plain irrational. But that’s not really a fair assessment of what is going on. Modern life has become so complicated and so overburdened with endless details to keep track of that you would really have to be some kind of human calculator to stay on top of it all.

In fact, that’s exactly what the study calls people who seem to master the challenges of modern life: human calculators. Apparently they make up 22% of the population, while the rest of us can’t seem to get on top of things like this, even though most of us believe ourselves to be “better than average money managers”. So why is that? A clue can be found in the fact that so called human calculators are more likely to be found among the older population. Other factors are not as significant as you might think. For example, those with tertiary educations were no more likely to be good money managers than those who left school early, and high income earners are actually just as likely to struggle to make ends meet as low income earners. But people over 55 are more likely to be “human calculators”.

Now this might be as a result of the benefit of experience and wisdom, but I suspect that there is another reason. In general, older people have more time to invest in making sure that they get the best deal. The rest of us are so flat out just making money in the first place that we just don’t have the time to manage it as well as we might. Despite all of the promises of the benefits of competition in the market place, all it really means is that we now have to wade through mountains of information comparing banking details, insurance policies, mobile phone plans, internet plans, electricity costs, petrol prices, health insurance, motor mechanics, grocery prices, all while holding down a job and looking after the family.

Nobody has the time to deal with it all. The idea that people are always rational beings is at the centre of most economic theory. It underpins the concept of free markets, and is supposed to guarantee that overall the economy will work itself out. But the fact is that the assumption is just plain wrong. People can be rational, but people also have a range of differing priorities. For many people it is more important to spend their time with their families, going to the beach, having barbecues and watching the football, than it is to devote their lives to counting beans. When you look at it that way, you really have to ask just what is so irrational about that.

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