is ‘behavioural economics’ economics? observations against, for & tied or why tim finds...

Is ‘behavioural economics’ economics?

Observations against, for & tiedor

Why Tim finds behavioural economics annoying, and why he might be wrong

Tim BrennanProfessor, Public Policy and Economics,

UMBCSenior Fellow, Resources for the Future

[email protected]

Australian Competition and Consumer Commission

Melbourne, VIC

24 July 2012

ACCC, 24-07-12Brennan, behavioural vs. standard economics

222

Behavioural economics as challenge to standard• Broad definition:

Doing economics when people fail to act “rationally”

• Laboratory effectso Different responses to “logically” equivalent choices

(framing)o Inconsistency with maximizing expected utility

• Real world apparent failure to maximize utilityo Failure to adopt energy efficiencyo Voting, donationso Taxi-cabs quitting early on busiest dayso Pension contributions differ between opt-in, opt-outo Make par putts more often than birdies

• Requires external judgment that of no cost, no info


333

Today’s approach• Not specifically to challenge evidence, accuracy

o Utility from seemingly non-maximizing behaviour (e.g., voting)

o Relevance of extrapolating from laboratory to marketo Sustainability of mistakes with repetition

• Rather, take an overall methodological view: What is economics, and how do we do it?o Kuhnian paradigm shift or more “normal science”?

• Seven arguments against behavioural economics

• Two arguments as ties with the standard approach

• Six somewhat in favour; at least limits to standard

• Normative, empirical, philosophical issues at end


444

What is economics? What makes economics fun?• To some, it’s “data set”

o What can one uncover empirically?o The IV “Freakonomics” effect; “econ” as social

statistics

• To me, it’s the opposite: Clever (theoretical) explanation of the factoid

• The ability to learn by “thinking about it”o Math, philosophy, law

• Then, connecting what one learns to policyo The self-contained efficiency normo Thinking about its limits as well

• Does behavioural economics add to MY fun?

• Not really – that’s may be what this is about: ME


555

Tim fending off data [“Work, work?”]


6

• “Negative” costs on the left

• Economic interpretation: WTP to avoid unobserved quality degradation

• Psychology, policy interpretation: Look at all the $20 bills on sidewalk

66

The famous McKinsey CO2 abatement graph


7

Economist 3/24/12: “Nudge nudge, think think”• Even the Economist is on the BE bandwagon

o David Cameron sets up “Behavioural Insights Team”

• More pay taxes with blunt “pay your tax or lose your car” with photo

• Boys like “geometry;” girls like “drawing”

• More insulation adoption if it comes with cleaning out attic – “goal substitution” (?)

• US and British but not French reduce energy use if they see their neighbours doing so

• Force organ donor decision when getting driver’s license


88

Creeping into antitrust• Maybe blocking mergers?

Stucke: "Behavioural Economists at the Gate"

• But see“Behavioural Economics and Merger Enforcement: A Speculative Guide,” Threshold: American Bar Association Mergers and Acquisitions Committee, vol. 9, no. 2 (2009): 21-29

• Now, the search for something to justify anti-RPM lawTor and Rinner: "Behavioural Antitrust: A Novel Approach to the Rule of Reason after Leegin"

• The tar balls are washing up on my beach!o Wright; Kovacic and Cooper: Recent critiques of BE in

antitrust and regulation

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=981530




999

Against #1: Inhibit disciplinary growth?• Economics has grown by incorporating

seemingly inconsistent behaviour into the paradigmo Vertical restraints; resale price maintenanceo Capture theory of governmento Political economy of protectionism

• Imperfect informationo Adverse selectiono Moral hazard and agency issues

• Strategic behaviour; precommitment

• Farmer, Gianakopulos: hyperbolic discounting

• Don’t just assume people make mistakes and move on


1010

Example: The famous Sunstein-Thaler “Nudge”• New hires adopt retirement plan out of wages

at 20-50% if opt-in; at 80% if opt-out

• Taken as indicating irrational inertia, as the costs of making the decision (opt in or opt out) negligible

• Neglects rational inference from standard practice:What can one infer from something being “standard”?

• Does not imply optimal outcomeo Information cascadeso Inertia in standards adoption

• But does imply that irrationality not necessary


111111

Against #2: Information or error?• Can we tell rationality failures from too little

information?

• Failure to adopt energy efficiency: Too “dim” to calculate benefits, or unaware of benefits?

• Rational choice not to acquire perfect informationo Expected benefits aren’t worth costs

• Strategic ignorance to maintain credible responses

• Becker-Stigler: Can’t even reject different preferences; could be informationo Those who don’t like classical music don’t have

“information capital” necessary to derive utility from it


121212

Against #3: Multiplicity of theories?

• Is there a unified theory? Prospect theory/loss aversion, or

• Jay Shogren’s list of aversions:

• It gets better:Try these cognitive biases on for size!

• Risk aversion• Loss aversion• Myopic loss aversion• Ambiguity aversion• Inequality aversion• Lying aversion• Guilt aversion

• Regret aversion • Disappointment aversion• Stress aversion• Extremeness aversion• Delay aversion• Recession aversion• Innovation aversion• And so on…

http://en.wikipedia.org/wiki/List_of_cognitive_biases


131313

Against #4: Publish or perish?• Is the demand for behavioural economics

arising from the need for:o More accurate explanations of the evidence?o A simpler, easier to apply theory?o Better conformity to intuition?

• Or a response to the demand for a new source of publications needed to secure academic positions?

• Post-modernist literary criticism of the classics?

• Not the first in economics, to be fair o General equilibrium? 1960s – 1970so Game theory? 1980s – 1990so IV studies, the “Freakonomics effect”? – 2000s


141414

Against #5: What’s the normative standard?• Standard economics supplies policy norm

• Valuation as area under empirical demand curveo “Consumer surplus without apology”

• What if demand curve can’t be trusted?o Revealed WTP isn’t “real” WTP?

• “Negative cost” climate adaptation as exampleo Energy efficiency erroro People better off with forcing them to take an option

to which a better one was revealed

• How do we do CBA? What goes in its place?o “Optimal Energy Efficiency” Energy Policy – maybe?


151515

Against #6: Elites or the public?• If not revealed preference, then which

preference?o Full information?o No cognitive impairment?o No “bias”?

• Who determines information, cognitive skill, bias?

• As Al Franken once asked, “Why not ME?”

• Cooper/Kovacic: Behavioural biases of policy makers?

• Also a problem if preference change is a policy toolo Which preferences to use to evaluate policy?o Ex ante, ex post, or the policy maker’s?o “Green Preferences,” Ecological Economics


161616

Against #7: Ex post anti-economic policy?• Which comes first –

the policy preference or the justification?

• Mistrust of markets for lots of reasonso Doubts regarding competitiono Non-economic normso Unwillingness to defer normatively to revealed

preference

• Does behavioural economics fulfil demand for anti-economic policy prescription?

• Why can’t one argue directly from normative principle?o Utilitarianism, qualifiedo Rawls, Harsanyi, Seno Inalienability theory of ethical rights


171717

Tie #1: Standard economics shares similar flaws• Economics also has long list of adaptations

• Rationality as logical re means, not substantive re ends

• Utility maximization as unrejectable tautologyo From “self-interest” (narrow) to “present-aim”o Voting: Preference to voteo “Warm glow”

• The “auctioneer” in general equilibrium theory

• “Transaction costs” as ex post rationalization for institutional organization, common law

• Folk theorem in repeated games

• Dozens, hundreds (?) of strategic games


181818

Tie #2: Bad sales job to standard economists• Why not call this “imperfectly performing

investments to reduce costs of thinking”?o Decision rules-of-thumb that can be fooled

• No worries in standard economics with modelling imperfect investments to reduce costs of physical labouro Irrational to wait for an elevator rather than take the

stairs?

• Internal “transaction costs” make baseline important o Usual ones make property rights assignment important o Standard economics => inside head, Coase theorem

applies

• But do behavioural economists want to convince standard economists, or get others to reject them?o Complement or substitute?


191919

Example: Foreseeable misuse(Credit: Severin Borenstein’s defence of policies to promote energy efficiency)

•Legal doctrines to assign choice responsibility away from consumer – foreseeable misuse

•Holding lawnmower company liable for no foot protector—even when someone mows lawn in bare feet

•Is the cost to the lawnmower company of avoiding the accident lower than “cost” to the consumer?

•Cost of “thinking about it”? [Also Economist examples]

o Explain “behavioural” anomalies as costs we can model?o Is “behavioural economics” really nothing new?o BUT: Can these costs be independently measured?


202020

For #1: Relative vs. absolute preferences• Not necessarily outside the standard paradigm,

but close

• My utility depends on your consumption, adversely

• Robert Frank: Can competition to win be wasteful? o Just drives up the cost of being first

• May be efficient in some endeavourso Sports contests – don’t worry about wasted effort by

losers

• Progressive taxes don’t reduce social welfareo Just reduce price of unique goods pursued by wealthyo Big fish, small pond – wage explanations


212121

For #2: Preferences over preferences• “Metapreferences”

• Can prefer X to Y, but also prefer “I’d prefer Y to X” to “I’d prefer X to Y”

• Wish I were different than I am … … hard to imagine as that may be … ;-)

• Smoking, dieting, exercisingo Also weakness of will, coming up

• Investment in preference changeo Education, travel, moving, jobo Advertising as “preference pollution” (David

George)

• Bring some preference change inside the paradigm?


2222

For #3: Preference formation and change• Preferences: Raw data, or something to be

explained?o Presumably, they come from somewhere: blue jeans

• Sagoff, others: Do preferences exist prior to choice?o Interpretation of “preference reversals,” framing

• “Authentic” vs. “manipulated”, e.g., advertising

• “False consciousness”; e.g., dissatisfaction with political outcome

• “Going green”: Manipulating preferences as policy toolo Why not manipulate preferences to make “problem” go

away, e.g., get people to not care about environmento Elites, powerful dominate

For #4: Hyper-rationality• (Thanks to Bob Majure and Joe Farrell)

• Is it reasonable to assume “rational” outcome with complex repeated sequential games?o Especially with perverse outcomes—Backward

induction exampleo Farrell critique of articles claiming no exclusive

dealing that’s renegotiation-proof

• Does anyone really think price fixing is supported (or countered) by the folk theorem?o Act “as if” they understand Myerson, Tirole,

Milgrom, etc.?

• But is it cognition cost, or transaction costs?o The problem with renegotiation equilibria is that

one can’t endlessly renegotiate

Brennan, behavioural vs. standard economics

ACCC, 24-07-12 23


24

For #5: Economics “welfare” vs. normal welfare• No genuine “welfare” test in normal sense of the

wordo May be reasonable to presume harm from lost opportunity

to get to higher indifference curve

• Neoclassical requires unstated psychological assumption that revealed preference is meaningfulo Assume plants have “utility” from light--does that create

obligation to give them light?

• Economists can’t understand question; philosophers can’t imagine why one would presume meaning

• Happiness studies?o Risk of paternalism, elitism, remains

• Behavioural economics as questioning inference of “real” willingness to pay from revealed preference


252525

For #6: Weakness of will• What does it mean to act against one’s will?

o “Freedom of will and the concept of a person” – Harry Frankfurt; conundrum in philosophy

• Jon Elster, Thomas Schellingo Ulysses and the Sirens; “The Intimate Contest for Self-

Command”

• Multiple selves and the problem of precommitmento The roommate/refrigerator storyo Elster: Failure to exercise as “free riding” by multiple

selveso Knowing I’ll buy a car on impulse, support regulations

requiring minimal quality – with no other “market failure”o Rationale for drug laws?

• Whose preferences count? Can’t get away from that!


2626

Big picture #1: What is economics—theory or data?• We all know junior high school “scientific

method”: If conflict between data and theory, choose data

• But conflicts between data and theory should be decided in favour of one with greater a priori confidence

• Quantum mechanics forced rejection of Newtonian categories (instant action at a distance, uncertainty)o Feynman: “If quantum mechanics makes any sense, I

haven’t explained it correctly” o Eddington: “It is also a good rule not to put overmuch

confidence in the observational results that are put forward until they are confirmed by theory”

• Economics differs? Theory could win because confidence in data weaker (standard compromises)o Acting on the basis of theory: US v. AT&T


27

Big picture #2: Is this a paradigm shift?• Kuhn: “Science” doesn’t just incrementally build

o It can, of course: What he calls “normal science”

• Punctuated by revolutiono Incompatible paradigms, not accretion of knowledgeo Definitional changes, e.g., Newtonian vs. relativistic

mass o Change may be generational

• Einstein refusal to accept quantum mechanicso Many refused to call quantum mechanics “physics”

• Behavioural economics “normal” or “revolutionary”?

• Shift from economic theory to empirical psychology?

• Looks like an attempted paradigm shift to me: Lead, follow or get out the way?


282828

Big picture #3: Help or impede other disciplines?• What to do about mistakes – and how do we know?

o Normative? Cognitive?

• Philosophy: o Substituting logical categories (“multiple utility”) for

independent normative assessment?o Are consumers empirically mistaken or ethically

mistaken?

• Psychology: o Does this get you at the policy/research table? o Does something have to be called “economics” to matter?

• Would/should I care if one said “economics covers this, psychology covers that?”

• If not economic imperialism, “economists imperialism”


2929

Big picture #4: Not just energy efficiency• Increasing research based on “barriers” to

energy efficiency adoption

• To make credible and non-elitist, need to be general, not just energy efficiency: Explain why we pick the wrong:o Doctorso Houseso Carso Jobso Investments

• These are WAY more complicated than CFLs, caulking

• Shows one is throwing out more than the bath water


30

The bottom line

• [If cost-benefit analysis is still permissible]

• Benefits of behavioural economicso Perhaps better empirical confirmationo To many, more salient explanations

• Costs of behavioural economicso Sacrificing an internally consistent policy

norm: Aggregate revealed preferenceo Justifying paternalistic rationalization over

revealed preferenceo Giving up “thinking like an economist” –

Interpretive theory vs. empirical description

• Do the benefits exceed the costs?


313131

If consumer sovereignty still matters,

you tell me

?

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