IDENTIFYING BOUNDED RATIONALITY WITH PANEL DATA: ITALY’S LABOR MARKET AND A COMPARISON WITH THE GERMAN CASE

In this paper I question the hypothesis of bounded rationality against full rationality in the context of job changing behaviour, via simple econometric explorations on microdata drawn from WHIP (Worker Histories Italian Panel). The task requires to face a deep identification problem, as many of the observable data are coherent with both hypotheses of rationality. The identification strategy builds on a quasicounterfactual experiment in which the performance of each voluntary mover’s performance is compared to the average performance of a peer-group of stayers of the same skill group, co-workers in the firm from which the movers' job switch originated. Voluntary movers are identifiable in the WHIP dataset, while it is not possible to do the same among the stayers. Full rationality suggests that the performance of voluntary movers should be superior to the stayers’ (both voluntary and involuntary) as the involuntary stayers have a smaller decision set from which to choose. In this exploration I find a clear opposite result, which I take as evidence of bounded rationality of the movers. 1. Motivation This paper is not on job changing behaviour per se. Nor do I explain the process by which choices take place. It is a novel empirical exploration on field data attempting to test bounded rationality against full rationality. As will be evident in what follows, this task is riddled with difficulties and methodological problems. In a different, unpublished paper of few years ago I attempted to solve the identification problem using an analytical strategy that turned out to be unsuccessful: many of the results were in line with hypotheses of bounded rationality, but, although unlikely, they could have been generated also by fully rational individuals. 1 I am grateful to D. Card for his encouraging comments on a very old version of this paper (2008), and to C. Flinn for a casual observation at lunch table that led me to readdress from scratch the identification strategy of this study. I also thank an unknown referee for useful comments. 2 Emeritus, University of Torino, Dipartimento di Economia e Statistica “Cognetti De Martiis” and Honorary Fellow, Collegio Carlo Alberto. 3 B. Contini and M. Morini (2007) 2 In this study I am not suggesting a specific theory of job change behaviour. Nor, I believe, is precision essential if the aim is to show that some forms of bounded rationality provide a more plausible explanation of behaviour than full rationality. Recognizing the specific decision rules that lead individual choices is not my scope, nor is it within my reach. I accept the notion that choice ought to produce a “satisficing” option (à la H. Simon), where the driving forces of job change are future real wages and expected job quality. In a sense, what I propose is a fuzzy interpretation of bounded rationality: fuzziness reflects the fact that bounded rationality may embody different factors, none of which is mutually exclusive. 2. Job changing and bounded rationality Job changing is the context in which economic agents operate: worker histories are observed after a relatively long time since the decision to move or stay, and on such basis an ex post assessment on the agents’ rationality is formulated. In order to make analysis operational, I assume a simple model à la Simon where workers set themselves aspirations (reference points) y*, where y* is a two-dimensional vector of future wage growth and risk-on-the-job. Similar examples may be drawn from different settings: buying a house, opening a new plant, writing a sentence involving tragic choices (à la G. Calabresi), and so on. The scope of this exploration is a hard one, confronting a deep issue of identification. The choice of a reference point within an appropriate local environment may be perfectly reasonable, but no less arbitrary than the decision of where an efficiency frontier should lie in the context of full rationality. Both decisions are driven by assumptions and not by empirically observations of reality. The test proposed here consists of a quasi-counterfactual comparison where the performance of voluntary movers is compared to that of a peer group of co-worker stayers at the end of a three-year time window that starts when choices are expressed, under the accepted notion that the main driving forces of job change are future real wages and expected job quality. As will be explained, full rationality theory predicts that the voluntary movers ought to perform better than the stayers, but the opposite seems to hold. With all the necessary caveats, my conclusion is that workers seem to behave according to principles of rationality that differ from those of “full rationality” assumed in the vast majority of contemporary empirical (and theoretical) studies. “Bounded rationality” seems to prevail, although this exploration falls short of indicating which model of bounded rationality drives the job changers’ decisions. In recent years various papers have provided evidence of bounded rationality in experimental studies as well as a variety of specific case studies reviewed below. The underlying idea here is along similar lines. The novelty of this paper is that I investigate the presence of bounded rationality on panel data that are currently used to test standard theories of job changing behaviour. 4 B. Contini and C. Villosio (2005), in B. Contini, U. Trivellato (eds.) "Eppur si muove. Dinamiche e persistenze nel mercato del lavoro italiano", Il Mulino, pp. 567-595.