Performativity

What Is Performativity in Economics?

The performativity thesis suggests that economic or financial models, rather than objectively measuring some aspect of reality, instead help fashion that aspect of reality to the form that they describe. That is, performativity describes the notion that economic theory does not merely
describe the world as it appears but has the capacity to act upon the world and in doing so make the economy—and the agents within it—appear more like the theory itself.

Key Takeaways

  • Performativity refers to the potential for economic theory or financial models to change the world and the individuals within it to better reflect the theory itself.
  • This suggests that, rather than passively describing some aspect of the economy, financial models have the power to change those parts of the social world.
  • Counterperformativity, in contrast, is the concept that the ubiquitous use of an economic model instead makes the world appear less like the theory.

Understanding Performativity

Performativity broadly describes the social process by which an utterance, inscription, model, etc., possesses the capacity to influence the world that it intends to describe. The linguistic philosopher J. L. Austin coined this term in the context of a "performative utterance" to distinguish expressions that do something from those that report on an already-existing state of affairs.

Performative utterances are those words that change or alter the state of the world. For example, "I now pronounce you man and wife" spoken by an ordained minister transforms "bride" and "groom" into "husband" and "wife," not only symbolically but also in social reality in terms of cultural and religious recognition, treatment by the law, and modifications to taxation and household finances, to name just a few.

When an economic model describing, for example, market efficiency or how to price some asset makes its way into the world, it has the force to change those structures such that the market begins to fit the model instead of the model passively portraying the market. Economic sociologist
Donald MacKenzie proposes three manners of economic performativity, with the strongest and most interesting type referred to as "Barnesian" (after the sociologist and technology scholar Barry Barnes). In Barnesian performativity, "the practical use of an aspect of economics makes economic processes more like their depiction by economics."

This idea stands in contrast to the model-making done by researchers in the natural sciences. To use the formulas of Newtonian physics does not in any meaningful way influence the behavior of gravity on massive bodies, nor does the widespread use of the laws of thermodynamics change any practical measure of entropy.  Economics (as well as the other social sciences) is different in that what it "measures" does not exist outside of society—there is no economy to study if there is nobody producing, consuming, borrowing, or investing.

Evidence of Performativity

One well-researched example of an economic model becoming performative is the Black-Scholes-Merton (BSM) model for pricing options contracts, which rationalized the derivatives markets in Chicago when it was introduced to traders in the 1970s an '80s.

Equipped with this particular equation, calculated by computer servers and inscribed as "theoretical" prices on paper sheets or terminal screens, options traders were changed from carrying out what amounted to educated guesswork when pricing and trading options into calculative arbitrageurs, buying up options contracts when they were priced too low and selling them where they were priced too dear. The options market itself came to persistently fulfill the prices "revealed" by the model.  As MacKenzie argues, "financial economics … did more than analyze markets; it altered them." This influence suggests that financial and economic models do have the potential to shape markets at the structural level.

Other examples of performativity have been identified in the construction of auction markets (e.g., by the FCC to auction bandwidth rights from TV stations to mobile phone networks) to appear like rational and efficient Walrasian auctions.

Counterperformativity

While performativity argues that the pervasive use of an economic model can influence the world to appear more like the theory itself over time, the opposite concept of counterperformativity argues that use of a model instead makes the world appear less like the theory would predict.

While this may seem counterintuitive, several examples do exist. One is the pervasive use of modern portfolio theory (MPT) among passive index investing strategies. MPT uses a mean-variance optimization technique to arrive at the most "efficient" portfolio for an investor, maximizing their expected return given their level of risk tolerance. The result is a portfolio with an optimal set of asset class allocation weights.

This model, however, assumes that markets are efficient and, as a result, does not take asset prices into account; instead, it simply informs you what percentage of your portfolio should be invest in which asset classes (e.g., 40% domestic stocks, 25% foreign stocks, 25% corporate bonds, and 10% Treasuries). An index investor following MPT would simply purchase an index mutual fund or exchange traded fund (ETF) representing those asset classes at the market price. If, however, in the limiting case that everybody in the market follows the recommendations of MPT, nobody is left to price the components of those indexes, and the markets become inefficient due to lack of price discovery.

A second example of counterperformativity is with the use of behavioral economics to "nudge" people to make more rational influence behavior to make for optimal outcomes. According to the theory of behavioral economics, human beings are not rational actors but make systematic errors in judgment based on cognitive and emotional errors and biases. These psychological faults include loss aversion, time-inconsistent preferences, anchoring, and the endowment effect, among several other phenomena.

The recognition of these missteps and the use of corrective nudges that are informed by the findings of behavioral economics, however, steer individuals to make better choices and achieve more rational outcomes. Thus, the pervasive use of behavioral economics to nudge or discipline makes people appear less like behavioral economics predicts (and instead more like mainstream economic models that assume rational actors predict).

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