What Is Performativity in Economics?

The performativity thesis suggests that economic or financial models, rather than objectively measuring some aspect of reality, instead help shape that aspect of reality to the form that the model describes. 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.

Understanding Performativity

Performativity broadly describes the social process by which an utterance, inscription, or model 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.

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 so that the market begins to fit the model instead of the model passively portraying the market. In this context, performativity holds massive power as it not only serves as a predictor but an influencer of an outcome.

This idea stands in contrast to the models researchers in the natural sciences make. 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. 

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 and '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.

Counterperformativity

Though 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 the use of a model instead makes the world appear less like the theory would predict.

Though 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 invested 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 a lack of price discovery.

A second example of counterperformativity is 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).

Performativity vs. Traditional Economic Modeling

There's several key ways in which performativity in economics
differs from traditional economic modeling.

• Descriptive vs. Constructive: Traditional economic models primarily serve a descriptive or explanatory role. They are used to understand and explain economic behavior based on certain assumptions and data. Performativity goes a step further, suggesting that models can actively construct economic realities by influencing the decisions and actions of economic agents.
• Reactive vs. Constitutive: Traditional models are often seen as reacting to observed economic behavior. They attempt to explain and predict actions based on historical data. Performativity suggests that models can also be constitutive, meaning they actively participate in creating the behaviors they describe.
• Simple vs. Complex: Performativity acknowledges the complex interplay between economic models, institutions, and social practices. It recognizes that models are embedded in social, political, and cultural contexts, and their effects extend beyond economic decision-making.
• Hypothetical vs. Real-World: Economic performativity theory underscores that the adoption of particular models can have tangible real-world consequences. This includes shaping market dynamics, financial bubbles, regulatory decisions, and income distribution.
• Recognition of Heterogeneity: Performativity theory is open to the idea that economic agents may not always behave according to the rational, utility-maximizing assumptions of traditional economics. It allows for the incorporation of behavioral economics insights and acknowledges that agents can be influenced by a range of factors, including social norms and expectations.

Limitations and Downsides of Performativity

The concept of performativity in economic modeling has generated some criticism. Some of the larger concerns are listed below, though this list is not meant to be exhaustive.

Empirical Validity

While the idea of performativity is appealing, demonstrating a direct and causal link between the adoption of economic models and real-world economic behavior can be challenging. Establishing empirical validity requires rigorous empirical research, and it is often difficult to isolate the influence of models from other factors that drive economic behavior.

Endogeneity Problem

The endogeneity problem arises because economic models can simultaneously describe and shape behavior. This makes it difficult to untangle whether models directly influence actions or if they are simply reflecting pre-existing behaviors. The endogeneity problem can complicate efforts to establish a clear causal relationship.

Oversimplication

Critics argue that performativity can sometimes lead to an oversimplification of economic behavior. Economic models often assume rationality and efficient markets which may not capture the full complexity of human behavior. Real-world decision-making is influenced by numerous psychological, social, and contextual factors that economic models may overlook.

Misrepresented Homogeneity

Many economic models assume that economic agents are homogeneous and act in similar ways. Performativity may not adequately account for variations in behavior among different groups and individuals. Failing to consider these variations can limit the accuracy and usefulness of economic models.

Lack of Transparency

The influence of economic models is often subtle and indirect. This lack of transparency can make it difficult to pinpoint when and how models shape behavior. The mechanisms through which performativity occurs may be unclear, making it challenging to identify and measure its effects and thus make further adjustments to the model to further impact outcomes.

Limited Scope

Performativity is particularly relevant in financial markets and certain contexts, but it may not explain all economic behaviors. It may be less applicable in areas like labor markets, public goods provision, or macroeconomic policy. Critics argue that performativity may have a limited scope of application.

Ethical Considerations

The use of economic models to shape economic behavior raises ethical and moral concerns. If models disproportionately benefit certain income groups, harm vulnerable populations, or perpetuate social inequalities, it can lead to ethical dilemmas should that model be able to influence real-world impacts.

The Bottom Line

Performativity in economic modeling is the concept that economic models have the capacity to actively shape economic behavior and outcomes, beyond their traditional role of describing or explaining phenomena. These models can become self-fulfilling prophecies by influencing the decisions, expectations, and actions of economic agents. Performativity suggests that models are not passive observers of economic reality but participants in constructing that reality.