Home > Uncategorized > Nobel economics: the behaviorism of economic decisions and its secret

Nobel economics: the behaviorism of economic decisions and its secret

from David Ruccio

Lots of folks have been asking me about the significance of the so-called Nobel Prize in economics that was awarded yesterday to Richard Thaler.

They’re interested because they’ve read or heard about the large catalog of exceptions to the usual neoclassical rule of rational decision-making that has been compiled by Thaler and other behavioral economists.

One of my favorites is the “ultimatum game,” in which a player proposes an allocation of an endowment (say $5) and the second player can accept or reject the proposal. If the proposal is accepted, both players get paid according to the proposal; if the proposal is rejected, both players get nothing. What Thaler and his coauthors found is that most of the second players would reject proposals that would give them less than 25 percent of the endowment—even though, rationally, they’d be better off with even one penny in the initial offer. In other words, many individuals are willing to pay a cost (i.e., get nothing) in order to punish individuals who make an “unfair” proposal to them. Such a notion of fairness is anathema to the kind of self-interested, rational decision-making that is central to neoclassical economic theory. 

Other exceptions include the “endowment effect” (for the tendency of individuals to value items more just because they own them), the theory of “mental accounting” (according to which individuals can overcome cognitive limitations by simplifying the economic environment in systematic ways, such as using separate funds for different household expenditures), the planner-doer model (in which individuals are both myopic doers for short-term decisions and farsighted planners for decisions that have long-run implications), and so on—all of which have implications for a wide variety of economic behavior and institutions, from consumption to financial markets.

So, what is the significance of Thaler’s approach economics?

As I see it, there are three stories that can be told about behavioral economics. The first one is the official story, as told by the Nobel committee, which starts from the proposition that “economics involves understanding human behaviour in economic decision-making situations and in markets.” But, since “people are complicated beings,” and even though the neoclassical model “provided solutions to important and complicated economic problems,” Thaler’s work (alone and with his coauthors) has contributed to expanding and refining economic analysis by considering psychological traits that systematically influence economic decisions—thus creating a “a flourishing area of research” and providing “economists with a richer set of analytical and experimental tools for understanding and predicting human behavior.”

A second story is provided by Yahya Madra (in Contending Economic Theories, with Richard Wolff and Stephen Resnick): behavioral economics forms part of what he calls “late neoclassical theory” that both poses critical questions about neoclassical homo economicus and threatens to overrun the limits of neoclassical theory by offering “a completely new vision of how to specify the economic behavior of individuals.” Thus,

Based on its psychological explorations, behavioral economics confronts a choice: will it remain a research field that merely catalogs various shortcomings of the traditional neoclassical model and account of human behavior or will it break from neoclassical theory to formulate a new theory of human behavior?

A third story stems from a recognition that behavioral economics challenges some aspects of neoclassical economics—by pointing out many of the ways individuals are guided by forms of decisionmaking that violate the rule of self-interested rationality presumed by traditional neoclassical economists—and yet remains within the strictures of neoclassical economics—by focusing on individual behavior and using rational decision-making as the goal.

Thus, Thaler’s work and the work of most behavioral economists focuses on the limits to individual rationality and not on the perverse incentives and structures that plague contemporary capitalism. There’s no mention of the ways wealthy individuals and large corporations, precisely because of their high incomes and profits, are able to make individually rational decisions that—as in the crash of 2007-08—have negative social ramifications for everyone else. Nor is there a discussion of the different kinds of rationalities that are implicit in different ways of organizing the economy. As I wroteback in 2011, “is there a difference between how capitalists (who appropriate the surplus for doing nothing) and workers (who actually produce the surplus) might decide to distribute the surplus to others?”

Moreover, while behavioral economics have compiled a long list of exceptions to neoclassical rationality, they still use the neoclassical ideal as the horizon of their work. This can be seen in what is probably the best known of Thaler’s writings (with coauthor Cass Sunstein), the idea of “libertarian paternalism.” According to this view, “beneficial changes in behavior can be achieved by minimally invasive policies that nudge people to make the right decisions for themselves.” Thus, for example, Thaler proposed changing the default option in defined-contribution pension plans from having to actively sign up for the plan (which leads to suboptimal outcomes) to automatically joining the plan at some default savings rate and in some default investment strategy (which approximates rational decision-making).

The problem is, there’s no discussion of the idea that workers would benefit from an alternative to defined-contribution plans—whether defined-benefit plans or the expansion of Social Security. It’s all about taking the institutional structure as given and “nudging” individuals, via the appropriate design of mechanisms, to make the kinds of rational decisions that are presumed within neoclassical economics.

Paraphrasing that nineteenth-century critic of political economy, we can say that economic decision-making appears, at first sight, a very trivial thing, and easily understood. Its analysis shows that it is, in reality, a very queer thing, abounding in metaphysical subtleties and theological niceties. We might credit Thaler and other behavioral economists, then, for having taken a first step in challenging the traditional neoclassical account of rational decision-making. But they stop far short of examining the perverse incentives that are built into the current economic system or the alternative rationalities that could serve as the basis for a different way of organizing economic and social life. And, in terms of economic theory, they appear not to be able to imagine another way of thinking about the economy, as a process without an individual subject.

However, taking any of those steps would never be recognized with a Nobel Prize in economics.

  1. spender7
    October 12, 2017 at 3:11 pm

    Thanks – very clarifying.

  2. Alan
    October 12, 2017 at 4:15 pm

    These three stories about behavioral economics are stories internal to the discipline of economics. For me the money line from David above is:

    while behavioral economics have compiled a long list of exceptions to neoclassical rationality, they still use the neoclassical ideal as the horizon of their work.

    This is the critique that is made by historians, philosophers and those in other social sciences (see for example here, here and here). It’s what I’d call the lipstick on a pig story.

    And, in terms of economic theory, they appear not to be able to imagine another way of thinking about the economy, as a process without an individual subject. However, taking any of those steps would never be recognized with a Nobel Prize in economics.

    If they wanted to shake things up rather than merely tinker round the edges in order to maintain the status quo, they’d give the Nobel Prize in economics to someone outside the disciple of economics, say to someone in social or cultural anthropology. But that’s not going to happen.

    • spender7
      October 15, 2017 at 9:09 pm

      the third ‘here’ link does not seem to work.

  3. charlie
    October 12, 2017 at 9:51 pm

    … or to Ecologists like Odum we have been sooo skrwed by the economists our to Chicago and elsewhere when i think about … our dire situation

  4. charlie
    October 12, 2017 at 9:53 pm

    ‘our to’ should read out of

  5. Jorge Vianna Monteiro
    October 12, 2017 at 10:07 pm

    At last someone said something that it is usually said much latter after the Nobel Priza is awarded!

  6. Jan Milch
    October 12, 2017 at 10:58 pm

    Dear David! Wonderful piece of mind!!

    Great piece, but
    of mine.But i i got
    it all right, in my thught, this is nec
    assicall eco,with some diversitions?
    i Behavourel Eco, is tighten up with Neoclassist,
    of personall,tradition reason, i think
    Their Corporate, in my view?

    greetings,Jan in Sweden

  7. Nick
    October 13, 2017 at 10:00 am

    why do elites inevitably do evil? is evil a coherent concept? or even a useful or fruitful one? Think Allende and the Chicago school real-time experiment under Pinochet to ground these abstractions…

    • October 13, 2017 at 5:33 pm

      Nick, let us agree that evil is not a thing, it is characteristic of something done: a process. Consider, then, the four ways in which the things we do can go wrong:

      lack of skill – errors
      mistaken understanding – mistakes
      deliberately wronging others – wickedness
      deliberately persuading others that known wrongs are right – evil.

      The ones who do evil are thus usually those who have been persuaded to; the real evil is in the thought processes of the persuaders: those who have deliberately entered into Faustian contracts with the Devil (the handsome guy they see in their mirror)..

  8. October 14, 2017 at 1:24 am

    And then there’s the simple fact that the economy is always far from equilibrium, due to
    pervasive increasing returns to scale,
    comprehensive failures to predict the future,
    pervasively insufficient information,
    herd behaviours in financial markets,
    herd behaviours cultivated by marketing,
    new technologies and firms bubbling up all the time …

    So anyone who tries to jam actual human behaviour (or anything else) into the neoclassical near-equilibrium is wasting the world’s time.

    The Nature of the Beast https://betternature.wordpress.com/my-books/nature-of-the-beast/

  9. October 19, 2017 at 9:48 am

    First, let’s make one item clear. Rationality – what it is and how it works – is historically and culturally relational. It fluctuates with time and cultural setting. Investigating its origins is the first step in understanding rationality.

    The theories and vocabulary of the behavioral sciences are everywhere today. They penetrate every aspect of our lives. We use them to explain lots of things. And the fundamental theory in all of this is “behavior,” “human behavior.” But this situation is historically speaking relatively recent. The social sciences did not exist prior to the 18th century. The behavioral sciences are even more recent in origin. Not knowing how and why behavioral sciences were and are invented, and how these inventions end up in our daily conversation has not stopped the indiscriminate and naive use of behavioral science. Just look at how the notion of behavior is casually tossed about to allegedly explain things like buying, selling, wealth, poverty, etc. Richard Thaler’s behavioral economics is just one of the current abusers and misusers of behavioral science. Particularly, its historical circumstances.

    The story of behavioral science and human behavior begins with a committee that undertook a study for the Ford Foundation in the late 1940s, when the foundation was about to enter on the enlarged program that made it, overnight, the largest private foundation in the world. This study committee, given the task of recommending how “the Ford Foundation can most effectively and intelligently put its resources to work for human welfare,” concluded that “the most important problems of human welfare now lie in the realm of democratic society, in man’s relation to man, in human relations and social organizations” and it recommended that the over-all objective be pursued in five “program areas—the establishment of peace, the strengthening of democracy, the strengthening of the economy, education in a democratic society, and individual behavior and human relations.” Among the social science disciplines, political science became involved in the first and second programs, economics in the third, and, anthropology, psychology, and sociology in the fifth. The study committee’s report summarized all this in a term that soon spread to all parts of academia, government, and business, “the behavioral sciences,” defined thusly to distinguish them from the social sciences: “We have in the social sciences scientifically-minded research workers who are both interested in, and equipped for, the use of such techniques. Among these are the psychologists, sociologists, and anthropologists. In addition, there are psychiatrists and psychoanalysts, as well as natural scientists, including geneticists and other biologists” (Ford Foundation 1949, p. 92). The subject matter of the behavioral sciences is human behavior, which says the Ford Foundation includes not only overt acts but also such subjective behavior as attitudes, beliefs, expectations, motivations, and aspirations. The aim is a scientific understanding of why people behave as they do. (Page 404.) The behavioral sciences rest on the assumption that there are uniformities or laws of individual, group, and organizational behavior that can be discovered through research. If behavior is only an “art,” without any “central body of theory or principles,” then it follows that behavioral scientists who feel they can discover laws of behavior are simply pursuing crackpot notions. The Ford Foundation report emphasizes in its view this is not the case.

    Academic departments staked out their own versions of human behavior, with theories and statistics to make them sound important. “Economic” behavior is callous, cold, calculating pursuit of profit and utility. “Social” behavior is collective and reciprocal. Political behavior is coalition building and compromise oriented. Psychological behavior is cognitive and emotional in many forms.

    • robert locke
      October 20, 2017 at 7:44 am

      Ken, what you call rationality, seems to me to be close to what Peter Drucker calls THINKING in his letter to Russell Ackoff, inserted in my comment, 19 October to my posting of 14 October. Drucker wrote that Quanitative thinking is what occurs AFTER THINKING, not before. Moreover, it goes on, this THINKING, in a different part of the brain than quantitative thinking.
      Jeffrey K Liker in “Building CI habits through practices: Lean is about a fundamental change in thinking. How do we teach our brains to make the change,” (Target, AME, Fall 1917) reaches back to quotes from William James’ 1890 essay “Habit,” to make his point: “A tendency to act only becomes effectively ingrained in us in proportion to the uninterrupted frequency with which the actions actually occur, and the brain ‘grows’ to their use.”
      Liker is talking about how the teaching of Toyota production systems, the Toyota KATA, discussed generally under the rubric “lean production,” engages a different part of the brain from the usual classroom instruction, and he quotes brain scientist Carl Wieman: “high school science teachers who learned from lectures often have not mastered the skills to solve problems and therefore are not equipped to coach students through experimental learning.”
      My point, is that these insights apply to the teaching of economics, which must engage parts of the brain that includes historical and cultural thinking as well as mathematical-quantitative, so that the thinking Drucker talks about goes on BEFORE the quantification. The old dichotomies we are daily taught, orthodox, neoclassical vs heterodoxy, microeconomics vs macro, etc would disappear and the history of economics emerge as unified field of inquiry that would abolish the neoclassical economists attempt to exclude those outside their camp from the discipline.

      • October 23, 2017 at 10:22 am

        Robert, brain mapping has shown that varied parts of the brain connect to certain forms of decision making and activity. For example, learning to carry out experiment by performing the experiment vs. reading about the experiment in a textbook involve certain parts of the brain and limbic system in common while other parts are only associated with performing and others with reading the experiment. My comment goes to which of these, or maybe neither is considered rational. Are we rational in performing or reading experiments, or is it both, or neither? How about conflict situations. Are humans rational when they run away or when they fight, or is it some combination? My point is that the answers for these questions are historically and cultural situational. Changing over time and cultural circumstances. In 12th century Italy, a knight would be unlikely to flee combat. In 20th century Italy most police officers would avoid combat if possible. Why is one choice rational and the other not, or are both rational, just not for the same reasons and the same periods in history?

        The James quote it apt. But habitual actions can be rational or irrational. Or both depending on circumstances. How is this determined? It’s not the formation of the action that’s in question, but rather how it is judged rational vs. irrational.

        I agree with Drucker that the human brain is not inherently quantitative. It can become quantitative, however, once humans invent quantification. Humans teach themselves to quantify by inventing mathematics and all that goes with it. Once able to quantify then humans can create the dichotomies you mention and many others. As you suggest such dichotomies are tools humans use to separate themselves into camps – economist vs. non-economist, microeconomics vs. macroeconomics, classical vs. neoclassical, etc. The differences between camps are real because humans invented them to be actual differences. And humans divide themselves or are divided by their differences. Differences that humans invented. The two camps I’m interested in here are the rational and irrational.

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