Posts Tagged ‘behavioral economics’

Michael Sandel has a fascinating new book out called What Money Can’t Buy: The Moral Limits of MarketsSandel makes an old argument, that economics cannot be divorced from its roots in moral philosophy, but he makes it in a fresh light from the perspective of the 21st century. Two transformations, he writes, have made this argument more compelling and important than ever before: our world has changed towards a market orientation, and the boundaries of the economics discipline have expanded.

I do not intend to provide a summary, but want to point out one argument of the book that I found particularly fascinating and persuasive. Sandel describes the commercialization effect – which refers to when markets change the character of the good and the social practices they govern. That is, a good’s characteristics will change depending on how it is exchanged/provided, whether through market exchange or another form such as through gift, informal exchange, altruism, love, or feeling of responsibility or loyalty. Thus, the value of a commodity will depend on how it was provided. The exact same commodity may have one value if I buy it commercially and another if it is given as a gift by a friend.

Though it seems very obvious, the vast majority of economics ignores this commercialization effect. (Some behavioral experimenters such as Dan Ariely have found evidence of this effect, no surprise, and have commented on it.) This highlights how mainstream economics is an analysis of a very special case of economic activity, that done through market exchange, and this theory falls apart with respect to other forms of economic activity. A truly general theory of economic behavior of humans must recognize and deal with these aspects of human psychology and moral philosophy which give rise to the commercialization effect and throw a wrench into the standard microeconomic theory of choice and exchange.

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The blog Sleepykid posts an essay from a 2007 issue of Harper’s, by David Graeber, an anthropologist. I found the following section striking:


First of all, I should make clear that I do not believe that either egoism or altruism is somehow inherent in human nature. Human motives are rarely that simple. Rather, egoism and altruism are ideas we have about human nature. Historically, one has tended to arise in response to the other…

Even today, when we operate outside the domain of the market or of religion, very few of our actions could be said to be motivated by anything so simple as untrammeled greed or utterly selfless generosity. When we are dealing not with strangers but with friends, relatives, or enemies, a much more complicated set of motivations will generally come into play: envy, solidarity, pride, self-destructive grief, loyalty, romantic obsession, resentment, spite, shame, conviviality, the anticipation of shared enjoyment, the desire to show up a rival, and so on, These are the motivations impelling the major dramas of our lives that great novelists like Tolstoy and Dostoevsky immortalize but that social theorists, for some reason, tend to ignore, if one travels to parts of the world where money and markets do not exist–say, to certain parts of New Guinea or Amazonia–such complicated webs of motivation are precisely what one still finds. In societies based around small communities, where almost everyone is either a friend, a relative, or an enemy of everyone else, the languages spoken tend even to lack words that correspond to “self-interest” or “altruism” but include very subtle vocabularies for describing envy, solidarity, pride, and the like. Their economic dealings with one another likewise tend to he based on much more subtle principles. Anthropologists have created a vast literature to try to fathom the dynamics of these apparently exotic “gift economies,” but if it seems odd to us to see, for instance, important men conniving with their cousins to finagle vast wealth, which they then present as gifts to bitter enemies in order to publicly humiliate them, it is because we are so used to operating inside impersonal markets that it never occurs to us to think how we would act if we had an economic system in which we treated people based on how we actually felt about them.

The sentence in bold particularly resonates with me. I feel like I’ve written this same thing before, but no matter. I think a lot of neoclassical economists have a creation story that starts, “in the beginning there were markets and market-oriented people.” This attitude has become the norm, and thus any activity that deviates from it is considered extra-normal. Behaviors that are altruistic or charitable are considered to be less economic in character. But what is an economy, if not a confluence of decisions on how to allocate resources, and the social substrate that binds these decisions together? If alternative economies arise, one would naturally expect behavior to change, because we are not simply hard-wired to behave as we do in a market economy.

It’s good to keep these alternative interpretations in mind as we think about what our economy is and what it could be.

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David Brooks was interviewed on National Public Radio this week, not for the usual political commentary, but to discuss his new book, The Social Animal, which in fact does look worth checking out. When asked by Robert Siegel what sparked his interest in probing the human mind, he responded:

Mr. BROOKS: Failure. I covered a bunch of policy failures, so in – and when the Soviet Union fell, we sent all these economists into Russia, when what they really lacked was social trust. We invaded Iraq totally oblivious to the psychological trauma and the cultural realities of Iraq. We had financial regulatory policies based on the idea that bankers were sort of rational creatures who would make smart decisions.

And I’ve covered education for 20 years, and we’ve reorganized all the boxes to very little effect. And the reality of education is that people learn from people they love. But if you mention the word love at a congressional hearing, they look at you like you’re Oprah.

And so all these policy failures were more or less based on a false view of human nature: that we’re cold, rationalistic individuals who respond to incentives. And so while all these failures based on this bad view of human nature were over in one side of my life, all these scientists, philosophers and others were developing a more accurate view of human nature, which is that emotion is more important than reason, that we’re not individuals, we’re deeply interconnected. And most importantly, that most of our thinking happens below the level of awareness.

This cold, rationalistic, atomistic agent is exactly the agent that inhabits economic models and plays game theory. It is because this is the type of agent that can be modeled neatly using the techniques borrowed from physics and engineering. In order to theorize about a more useful economic agent, the neoclassical economists standard tools of dynamic optimization and dynamic programming would have to be thrown out the window; economists are most unwilling to throw their entire toolkit out the window, for fear of being reduced to level of other, “soft” and “non-rigorous” social sciences.

Brooks also makes an interesting point about how this research has changed his view of markets:

And it’s made me much more suspicious, actually, of the free market, because we have to have – you know, the free market produces a lot of wealth, but it’s embedded. It’s embedded in a series of understandings. And if you don’t have those relationships, then people can’t thrive in that free market.

Do they have an ability to control their impulses? Do they have an ability to work in groups?

Groups are much smarter than individuals. And the groups that do well, it’s not shaped by how smart the people are in the group, it’s shaped by how well they signal each other. Do they take turns when they’re having a conversation? And so, even when you see something like the free market, you don’t see like Ayn Rand rationale individuals. You see groups and competing groups and collaborating groups deeply intertwined with one another.

It is becoming increasingly clear that a more useful economic theory will be one that is holistic, rather than atomistic, and more humbly interdisciplinary, rather than disdainful of other fields of study.

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Tim Harford had a great column in the FT last weekend in which he discussed some of the limits of what I’ll call micro-behavioural economics (in general I think micro/macro splits are problematic, but this branch is operating as such). Basically, Harford describes the Thaler-Sunstein policy nexus, wherein minor policies will have large impacts because humans behave in ways violating assumptions of neoclassical economics:

Behavioural economists point out cases in which our decisions don’t match neoclassical theory, and thus the “as if” defence fails…

Consider the human response to risk. Neoclassical economics says that we act as if considering all possible outcomes, figuring out the probability and utility of each outcome, multiplying the probabilities with the utilities, and maximising expected utility. Clearly we do not in fact do this – nor do we act as if we do.

Behavioural economics offers prospect theory instead, which gives more weight to losses than gains and provides a better fit for the choices observed in the laboratory…

But, say Berg and Gigerenzer, it is even more unrealistic as a description of the decision-making progress, because it still requires weighing up every possible outcome, but then deploys even harder sums to produce a decision. It may describe what we choose, but not how we choose…

This is tough on behavioural economists, because in order to be taken seriously by other economists they have had to play the optimising game. Switching to Gigerenzer’s rules would mean the end of economics as we know it.

Yet the critique is sobering. If behavioural economists do not really understand why we do what we do, there are surely limits and dangers to the project of nudging us to do it better.

Indeed, it’s unlikely if behavioral economics will ever get at the “why” (perhaps neuroeconomics will some day, but it’s hard to envision how that branch will unfold). The whole nudge policy nexus aims for low-hanging fruit- policies that, for a variety of reasons, will likely work in getting whatever goal is sought. However, this type of behavioral economics will not help us better model an economy, predict crises, et al. In part, it’s because decision-making is fluid, and changes in interaction with other agents in the world. And in part, it’s because decision-making doesn’t necessarily tend to maximize anything in particular.

Indeed, I think we’re better off looking in a direction that Daniel Little points to, wherein real, macro-level complexity reigns supreme.

Axelrod and Cohen make use of three high-level concepts to describe the development of complex adaptive systems: variation, interaction, and selection.  Variation is critical here, as it is in evolutionary biology, because it provides a source of potentially successful innovation — in strategies, in organizations, in rules of action.  The idea of adaptation is central to their analysis — in this case, adaptation and modification of strategies by agents in light of current and past success.  Interaction occurs when agents and organizations intersect in the application of their strategies — often producing unforeseen consequences.

It’s likely that models of the real-world economy with these characteristics will be unsolvable, because these features are difficult to turn into datapoints. Nevertheless, the more ambitious project of seeing how real, unpredictable behavior aggregates into a socially-embedded, uncertain economy, is far more interesting than 401(k) nudges.



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There’s been a bit of discussion on a Rajiv Sethi post about Duncan Foley’s attempts to bring strong microfoundations into macro. Mark Thoma first had comment and then Leigh Caldwell chimed in. If you have time, start with Rajiv’s post. Thoma sums up a key problem well:

That is, you need to make the representative agent assumption in order to aggregate individuals up to the macroeconomic level and still be able to guarantee uniqueness, stability, or many other properties we need to have a reasonable model.

Caldwell goes a little bit deeper into smoothing out the problem. He argues that we should abstract models of the economy into systems of agents and goods, mediated by beliefs and values. I think the problem is that Caldwell over-abstracts, though. He seems most excited that, “the model has the potential to be simple enough to be tractable.” Even though he acknowledges that, “the actual mathematics of this theory will look like is not yet obvious,” I don’t think Caldwell moves the ball forward much. What he wants boils down to:

But a simple model of choice arising from values, mediated by beliefs, under constraints on attention, accuracy and myopia provides a parsimonious and expressive description of reality. By implementing a realistic theory of decision-making into the model, we will have a closer match to the real world than current theories.

However, he eschews agent-based models which require too many assumptions. However, I think we have two choices if we want to formally model the economy. We either observe behavior on measurables and fit the model, or we make abstract assumptions about how agents behaves on squishier concepts like beliefs and values and then apply them throughout. I don’t think, though, we can get by based on observing these hard-to-measure concepts. Even if we can measure beliefs and values in some dimensions, I’m not sure how we implement them in these models without making further assumptions. And finally, if we want micro-foundations, they have to be agent-based, with a full slew of interactions. For now I side with Thoma’s third option:

give up the idea of providing microeconomic foundations for macroeconomic models and begin modeling the aggregate level directly (e.g. see Kirman’s discussion of network models)

And of course, in modeling this aggregated activity, we should be mindful that there are a variety of questions we can ask besides “what will GDP growth look like?”

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I love these RSA animated lectures. This one by Dan Pink on his new book, Drive: the surprising truth about what motivates us.

I especially like the idea of the purpose motive, and the caveat about unmooring the profit motive from it. If someone does come up with a way to keep organizations anchored in the purpose motive, I think that would make the world a better place.

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Stephanie Rosenbloom at the New York Times challenges the foundational economic assumption that more is always better in a recent article, “But Will It Make You Happy?” Research has shown that people are happier when they spend money on experiences rather than on acquiring more stuff:

On the bright side, the practices that consumers have adopted in response to the economic crisis ultimately could — as a raft of new research suggests — make them happier. New studies of consumption and happiness show, for instance, that people are happier when they spend money on experiences instead of material objects, when they relish what they plan to buy long before they buy it, and when they stop trying to outdo the Joneses.

If consumers end up sticking with their newfound spending habits, some tactics that retailers and marketers began deploying during the recession could become lasting business strategies. Among those strategies are proffering merchandise that makes being at home more entertaining and trying to make consumers feel special by giving them access to exclusive events and more personal customer service.

As a response to these trends, business have been trying to sell more “experiences” than just stuff. For example, Wal-Mart has responded by grouping items that families can use to share experiences at home: cooking out, home theaters, and games. They are really selling experiences. Research shows that other experiences such as vacations and sporting events yield a better “bang for the buck” than buying stuff.

Some argue that this is because we can reminisce about experiences, while new things quickly lose their allure. Also, it might be due to competing for status:

Alternatively, spending money on an event, like camping or a wine tasting with friends, leaves people less likely to compare their experiences with those of others — and, therefore, happier.

Conspicuous consumption certainly does seem to have a huge effect on happiness. However, the commodification of leisure and experiences can lead them to be vehicles for comparison also. How close are your seats to the stage or to the field? Which exotic beaches did you vacation to? How expensive was that wine you tasted?

In the film Happy, Roko Belic shows that “the one single trait that’s common among every single person who is happy is strong relationships.” Does building strong relationships require the commodification of leisure and “experiences” that we have to buy at Wal-Mart? Perhaps not.  But it can help.

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