behavioral economics and ill-behaved economists

September 28, 2008

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Lessons in economics (photo by "Grim Reaper With a Lawnmower" - cc-by-sa)

The current issue of The Prospect magazine contains a “debate” between Tim Harford and Pete Lunn on the significance of behavioral economics to economic theory as a whole.

The two authors succeed in putting on a friendly show of insult-swapping; in the process they somehow manage to endorse divergent perspectives on the latest research in their field.

Lunn contends that behavioral research is nothing less than a revolution in the making, uprooting the rotten foundations of the discipline in favor of a more nuanced, empirically accurate models of human action and motivation.

Harford puts forward a contrary view, in which behavioral theories and methods take their place among the tools of mainstream economics, but fall far short of transforming the field in a radical fashion.

FWIW, I find many of Harford’s claims quite compelling. I suspect that many economists can freely admit the limitations of theories grounded in a narrowly-selfish model of motivation; I recall reading something by Milton Friedman himself in which he points out that the accuracy of the assumptions is irrelevant, it is only the accuracy of the predictions that matters. In other words, Friedman agreed that it was obvious that narrowly-selfish “rationality” was a mere shadow of the depth and complexity of the human psyche. He merely claimed that it was the most reliable assumption anyone had yet found to model economic behavior on a large scale.

An interesting problem with Harford’s argument crops up in the following passage, though:

…the orthodox, rational-choice approach continues to work. Take a step back and look at the big picture. According to the laboratory experiments on public goods you describe, there is no such thing as the free-rider problem. If only that were true. It would mean that there was no climate change problem, because people would voluntarily restrict their carbon emissions to preserve the planet for strangers and the children of strangers. It would mean that fish stocks were healthy because fishing crews realised they were dealing with a common resource. London’s congestion charge would be counterproductive, because people do not respond to individual incentives: drivers would have willingly left their cars at home in order to leave the roads congestion-free for others.

No matter how many experiments you allude to, the discomfiting rational self-interested model explains our environmental predicament perfectly. It is also the inspiration for solutions such as a carbon tax or a cap-and-trade scheme.

Harford argues that orthodox models of narrowly-selfish rationality still work, but he neglects to point out that orthodox economists may have something to do with that fact.

As Michel Callon (1998) has theorized and Donald MacKenzie (2006) has demonstrated, if you look under the hood of every carbon-producing, fish-catching, and emissions-releasing industry, you find classically trained economists!. This is not a surprise, but it means that economic theorists can no longer turn to the world of already existing industries and firms as empirical “proof” of the accuracy of their predictions. Why not? It’s like betting on the outcome of a baseball game when you’re the starting pitcher. Economists and their theories play such a large role in shaping contemporary industries that it is no longer possible to distinguish clearly their theories from those industries. They have actively gone out and propagated the theory to such a degree that they can be said, in some cases, to have made it come true.

How does this relate to behavioral economics? That remains to be seen. Analytic models and business plans constructed on assumptions of altruism, cooperation, sharing, and social wealth are only beginning to emerge. Nevertheless, I wonder what kinds of industries would emerge out of more empirically accurate models of behavior?

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