Monday, June 8, 2009

Can Behavioral Economics Save Us?

NPR had a fascinating segment today on All Things Considered concerning the use of psychology to save your from yourself (generally) and applying this approach to economics (specifically) in a manner that makes a lot of sense.

It should come as no surprise that we humans don't do a very good job at analysis and decision making due to all sorts of biases and brain farts. Even when faced with evidence that our decisions are terrible, we'll continue to support our own conclusions.

For example, we tend to seek out data that supports our views while avoiding information that challenges them. That's confirmation bias and it clouds our ability to think clearly and rationally. Think of it this way - how many people watch both FOX News and MSNBC?

Anyway, a growing number of people working in the Obama administration are believers of psychological research as a basis for economic thought, or as NPR points out:
"...the human animal is hard-wired to make errors when it comes to decision-making, and therefore people need a little "nudge" to make decisions that are in their own best interests."
The NPR story delves into the genesis of behavioral economics and it's no surprise that economists are clucking while dismissing the whole thing as mumbo-jumbo. Conservatives use the topic to point out yet another way for government to insert itself into personal choice and liberty.

I think I'm on the side of behavioral economics on this one, folks. The examples make sense to me, and there have been numerous failings of previously-sacred economic models of late.

Even if fancy computers parse the data and crunch the numbers, people design the codes and algorithms that make up the models. Human psychology has to play a role.

Some of the concepts put forth in the NPR story are familiar to me, as I'm in the middle of reading The Science of Fear, by Daniel Gardner. "Anchoring bias" is one of them:
For instance, Kahneman and Tversky identified "anchoring bias." It turns out that whenever you are exposed to a number, you are influenced by that number whether you intend to be influenced or not.
Credit card companies count on this bias when they suggest a very low minimum payment on your bill. We tend to make a decision on how much to pay based on using that very figure as a point of reference.

Humans are nothing if not erratic and irrational, and we seem to be able to accept that in nearly every facet of our lives. Why not economics?

For those who worry that "nudges" are another word for expansion of government reach, consider this passage:

But Thaler argues that government policymakers don't need to be hyper-rational to help people make better choices.

He offers this example: Any American who goes to London realizes that they are endangering their lives every time they try to cross the street, because the traffic comes from the wrong direction.

Our instinct is to look left, but if you look left, you'll get run over by a double-decker bus. To help us, Thaler says, someone in the British government decided to write on the sidewalks of busy intersections filled with American tourists the words "look right."

"British bureaucrats are no smarter than American bureaucrats," says Thaler, "but they know that tourists tend to look the wrong way and could use a helpful nudge to avoid getting hit by a truck."

As I look around at our current economic situation and see the millions that have been flattened by a collapse that no economist predicted, I can't help but think that anything that keeps us from being hit by the next truck is truly welcome.

Unless economists have a better idea?

Using Psychology to Save You from Yourself , via NPR


  1. I would disagree. The British sidewalk example was a very poor one and ill-suited for this comparison.

    I never heard any comment in the radio spot to truly counter the points of the behavioral economists.


    1) The assertion (by behavioral economists) that their system is the ONLY one that takes into account the flaws of human nature. I guess legal systems were developed thousands of years ago just for fun. Not to mention that the fundamental mover in capitalist theories is "self-interest", which some would label in the negative as "greed" - although that's a separate discussion.

    2) The assumption that somehow a system designed by a behavioral economist is better and democratic. I'm pretty sure that most socialist and communist countries operate according to the principles of behavioral economists.

    3) This entire realm of thought assumes that everyone is completely stupid and can't fend for themselves. Yet the whole of human history has proven otherwise. And why is it that in just a little over 200 years, the United States became the wealthiest country in the entire world?

    4) This realm of thought seems to recommend:

    1) Keeping children at home indefinitely, since humans are idiots we obviously can never let them out of the house
    2) We should have multiple computer networks checking and balancing each other to eliminate even the slighest human influence on the management of society- or hope that aliens find us and take care of us.
    3) Screw it all and just blow up the planet because we're too flawed to be saved anyway.

    By the way I just wanted to reiterate how asinine the British sidewalk example was.

    Would be happy to discuss this topic!

  2. I'm not sure I would use the term "asinine" to describe the British sidewalk analogy - I thought it was a decent example of the government doing what it should do - benefit the citizenry in a manner that's low cost and high yield. It seems to be effective, and anyone who wishes to ignore the message is still fully capable of exercising free will, taking the risk upon themselves.

    It's not that behavioral economists are the only ones taking into account inherent flaws in human nature. Far from it, as your examples point out. Rather, it's the fact the most economic models either suppress, ignore, or improperly weight such flaws, where the law (and other systems) use humanistic characteristics all the time.

    Let me ask you the same question but in a different way. If the legal system uses the concept (for thousands of years, no less), why would we want to keep select economic theories from leveraging it too? If behavioral principles are sound, wouldn't they have broad applicability?

  3. Hi Kev,

    I would only wonder, if all the other economic theories improperly weigh the flaws of human nature, by what golden standard have the behavioralists "figured it out". Every country has enacted social economic policies, it's just a matter of degree. It all comes back to the age old dilemma on whether or not we let people make decisions or "someone else" makes the decisions for them.

    On another level, if humans are flawed, and behavioralists are humans, how could they possibly make a better system without creating different problems? And how can behavioralists devise this system in the first place, without corrupting any ideas with their own flawed human nature?

    To be honest, the real frustrations I have with how the radio spot came across was:

    1) That they thought they came up with such a mind blowing discovery, humans are flawed. They also claimed that other systems assume a Spock-like logic in the human actors (their words). I have never heard that before in any of my economic studies. It was painting the rest with way too broad a brush.
    2) That humans make more wrong decisions than right (hard-wired even!). First of all, right and wrong are very often arbitrary. Who is the source that determines this? Every society has its own mores. Furthermore, if humans are hard-wired to make more wrong decisions than right, how in the world did we survive the last couple hundred thousand years and now number 6 billion, with vast resources of food, clean water, technology, information. I will readily admit that we also destroyed numerous ecosystems, killed each other, and that millions starve every day, but I think it still proves that we make good decisions at least 51% of the time based on this evidence.
    3) That somehow leaving bad decisions to individuals is a bad thing. Doesn't every parent have to let go at some point? If someone doesn't save money, or pay his bills, or train himself for a new career when the economy falls, why should those who DID prepare pay for his problems? Is it fair that because GM and Chrysler didn't prepare like Ford, that us taxpayers have to favor them and give them bailout money? Whereas Volkswagen, Kia, Toyota and other companies are opening American plants and hiring American workers.

    In answer to your original question, why don't we apply legal principles to the economy- two reasons.

    One, I don't think any legal system is one to aspire to for economic theory. Legal systems are complex, they vary by society, and we all argue over rights and laws all the time. We can never agree to a common system. We all have different perspectives. That's human nature.

    Second, I just don't see why this is necessary. I think a less regulated economy works better- by that I mean that since I believe humans in fact do make enough good decisions on their own, with little or no direction, that more resources are created for all of society. And if there's less scarcity, I believe people are less apt to make bad decisions and hurt others. And I think when government tries to regulate this process, it may mean well, but it doesn't solve the fundamental problems, and it also creates new ones in the process.

    I would ask in return, what truly are the specific flaws of a free market system that require a behavioralist interjection?


Please tell me what you think.