For many years, I have disregarded the importance of culture in the study of economics. I always used to say that culture is like money : in the long run, its neutral. However, for the past few months, I have come to appreciate the role of culture in economics and especially in link with the role of rational expectations.
In economics, rational expectations theory is been the closest thing to “revolutionnary” that already-sliced bread brought to supermarkets and consumers. When governments make decisions, people have expectations and they can defeat the best intent of governments by adapting their behaviours. The government borrows to wage war? Wars are only temporary but we will have to pay taxes in the future, so let’s borrow to make sure we won’t get screwed ten years from now.
As much as it irritates some of my colleagues, people do plan. Like they did when the Bush Tax Cuts (temporary tax cuts) were enacted. Because they were temporary, the vast majority of investors, entrepreneurs and workers did not change their behaviour. They knew it was coming.
But how do we form expectations? I form my own expectations for behaviour on the market and at home on my knowledge of economics and knowledge about my girlfriend’s mood. But what about norms, culture and tradition?
What we consider “reasonable” does not appear out of thin air. We discovered what was “reasonable” by being told so by people with experience. We discovered that it was “reasonable” not to spit in people’s faces because our traditions do not permit this. All of these traditions and norms reduce the “transaction costs” of living in modern society because they make it cheaper to know what is coming.
What we expect from the market depends on our own experience and those that have been transmitted to us by traditions. This is where I think culture has its place in New Instutional Economics, Development Economics and Growth theory.
If for decades, you have had a slow path of growth that is uniformly distributed, expectations about the future are not rosy. Peasants in medieval England used to use scatter plotting (even though it was 10% less productive than farming one single and larger strip of land) because it was safer. They were averse to risks and prefered to farm many smaller plots even if it wasn’t too productive because they estimated that they were less likely to lose all their crop in one shot and starve tod eath.
Now imagine that one group of peasants becomes ultra rich, ultra fast. Individually, their personal identities and their culture have changed. They consume different items, have different needs and behave differently than others. Their expectations change because of cultural changes induced by economic transformations. Rather than expecting a low return rate, they might decide to take risks and innovate. They might “jump into uncertainty” (Frank Knight speaking…) and create greater value by innovating!
Hence, yes culture does play a role in the formation of expectations. In fact, I believe that it is one of the driving forces behind the formation of expectations because it is the transmission belt of information, knowledge and wisdom. Not the sole one, but a pretty important one.
(This post is a 1 of 3 posts – the second will discuss the weight of culture in economics and the third will provide an illustration of my point with my own study about Quebec’s economic growth from 1926 to 2010).