THE BLOG
12/11/2013 07:52 am ET Updated Feb 10, 2014

The Bottom Line of Classical Economics: The Missing 20 Percent

Classic economics presents a simplistic view of how companies operate. It expresses the view, using simple diagrams and mathematical models, that corporate actions are guided by rational self-interest; that companies and their executives make decisions that they believe will maximize the line at the bottom of the balance sheet. They contend that in a truly free market, all the choices they make are to be rationally aimed at enhancing this line.

There is value, and power, in this belief. In a crude way, it is roughly right. But to make it a true description of corporate behavior, they have to accept a very loose definition of at least one of three terms: rational choice, maximize, or bottom line.

The formula works, more or less, if you accept that "rational choice" includes a complex and incomprehensible mix of impulse, emotion, selfishness, selflessness, self-delusion, favoritism, self-fulfilling prophecy and other drivers. Or, the formula works if you accept that "maximizing the bottom line" refers not to the net quantity expressed (the literal bottom line), but to a complex market basket of assets that include everything from corporate income, personal income, and relationship capital, to cultural and legal understandings of unintended consequences, the approval of friends, and the accumulation of power to counteract deep feelings of incompetence or insignificance.

One problem arises when true believers in the simplistic formula attempt to enforce, often by law, the literal interpretation of their bible, without the complications imposed by reality. When they force companies to behave as if they are actually maximizing the number at the bottom of the balance sheet, they prevent them from considering the long-term consequences, externalities and even illegalities that they must foist on others, in order to stay true to this fiction. When they force companies to pretend that the impulses, emotions, and passions that they and their customers, employees, and stakeholders act on are actually all bland, vanilla, "rational choices," they turn their whole world into a heartless, soulless machine with none of the qualities that make life worth living.

Neoclassical economics is a powerful tool, which emphasizes the role that self-interest and impulsivity play in driving relatively selfless behavior. But it is only around 80 percent accurate. If we can accept it not as a rule of nature, but as a rule of thumb, then we can use it to advance our higher and deeper purposes. Because that missing 20 percent, the part of our nature not explained by the formula, is what makes life worthwhile.