Market irrationality and the environment

There are in fact at least five ways in which the rationality of markets can be challenged, and all of them have implications – not all negative - for the environment.

Firstly, sometimes people just aren’t rational by any standard. However, this is not all innocent folly or individual caprice. Not only are individuals open to irrational behaviour on their own account, but they can often be manipulated, stampeded and panicked into actions that are, from their own point of view, profoundly irrational, but that are very much in the economic interests of others.

This possibility is routinely exploited through (and often by) the mass media, of course. In the absence of a systemic account of the ways in which individuals in the economy are behaving irrationally, it is hard to say just what that means, or what it does to conventional economic theory apart from render it more or less fuzzy. But whatever the answer is, it is unlikely to figure in conventional economic theory, as it my suggest that the power to exploit and control is fundamental to our economic system, yet decidedly not the benign (or at least neutral) thing markets are supposed to be.

Secondly, if by ‘rational’ we mean, ‘pursuing economic self-interest’, it is obvious that a great deal of human behaviour can’t be forced into this particular (indeed, peculiar) mould. That does not mean that we are irrational – only that the rationality according to which we operate is not narrowly economic. I doubt that a committed church-goer tithes a significant fraction of their income out of reasons of economic self-interest, and the idea that people contribute to charities out of a very indirect calculation that they may need that charity’s services one day is surreal, to say the least. It would be doubtful to propose that a person on the streets of Manchester or San Francisco contributes to Oxfam because they expect to need Oxfam’s support any time soon. People have values, goals, interests, relationships, and any number of other motives that affect their behaviour, all of which can be pursued rationality without ever reflecting economic rationality.

This can be extremely fortunate for the environment, because it means that people are willing to pay for environmental management even when it ‘harms’ their economic self-interest. Unfortunately there are quite a few ways in which the same ability to rise above economic self-interest is likely to harm the environment – as when a certain kind of fundamentalist is persuaded that environmental problems are signs of Last Days, or that any kind of collective action is ‘communism’.

Thirdly, when we hand over the direct management of our economic interests to others (typically investment professionals, the senior management of the firms by which we are employed, our government’s treasury department, and quite a few others), this creates a dilemma for the theory of economic rationality. Either they pursue our interests on our behalf, and not their own, in which case they are not being rational from their own perspective, or they do the reverse – in which case they aren’t being rational from our perspective.

This is the problem of ‘agency’, as economists like to call it, and it had a major impact on creating the recent global economic crisis. Investment banks hotly pursuing their own interests netted themselves billions in fees for investment advice and dubious sales, not to mention outright fraud, but added little value as far as the rest of us – including their immediate customers – were concerned.

From an environmental point of view this could prove to be a serious issue, as it is crucial that environmental problems are seen as affecting all of us equally, and, conversely, that one group cannot evade the consequences by exploiting another. Unfortunately, although this may be true in the long run, especially if the problems turn out to be still more severe than most people expect, it is unlikely that such a long-term perspective will be the rule. Indeed, we can certainly expect some groups – from privileged individuals up to corporations and national governments – to do their utmost to exploit the weaknesses of others.

Fourthly, there is the more profound kind of irrationality that follows from the fact that what is rational for an individual can be counterproductive, or even outright destructive, when replicated all across a market.

From an environmental perspective this is all too common, as can be seen from the ratchet effect of many investments. To take a very parochial example, right now the London underground train system (the Tube) is being blighted with hundreds of screens that show dynamic advertisements in place of the old posters. This raises the impact of these advertisements, but they probably also represent only the thin end of the wedge, and we can certainly expect these deeply annoying devices to become the norm. But with that, all advertisements will be restored to an equal footing, so no advantage will be gained by using electronic screens. But no one will be able to go backwards either, to old fashioned paper posters. From an environmental point of view, these necessarily lead to more material resources – electronics, energy, and so on - being invested to achieve absolutely no net material benefit (as opposed to monetary) value.

Finally, there are situations – some extremely widespread – in which the economically ‘rational’ option simply isn’t available. In any market that is dominated by large-scale capital (which is to say, any area of heavy industry, any long-term commitment, and so on), rapid movements to reflect a sudden change of circumstance are simply not options.

For example, if a lower-cost operator suddenly enters the market – as often as not taking advantage of the most recent methods, processes, technologies, etc. – they can price their goods and services below more established operators, who are still committed to the old approach. The latter may have the option of moving to a lower-cost operation too – but the long-term nature of many financial commitments may mean that the old investments still have to be paid off, and the arrival of a radically new operating model may mean that the systems and resources by which they currently operate simply cannot be sold off, because no one want them.

From an environmental perspective, this is almost invariably disastrous, as it obliges the owners of that capital to carry on using it, regardless of the environmental consequences. A power station or car plant built today must be operated for decades to come if it is to be paid for, and its proprietors will lobby for the continuation of dirty energy and transport for the same period.

And all that is leaving aside the conscious exploitation of other complexities such as 'informational asymmetry' (i.e., they're lyng to you). All in all, the case for the ‘rationality’ of markets, or for the so-called ‘efficient markets hypothesis’, is not strong. As far as the environment is concerned, it is pretty disastrously flawed.