I’m still reading Lionel Robbins’ classic An Essay on the Nature and Significance of Economic Science. His definition of economics remains widely used: “Economics is the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses.” (Chapter 1, Section 3)
Later in the book, he asks whether the resulting focus on relative valuations depends on particular psychological assumptions. The answer is a firm ‘no’:
“The borderlands of Economics are the happy hunting ground of minds averse to the effort of exact thought, and in these ambiguous regions, in recent years, endless time has been devoted to attacks on the alleged psychological assumptions of Economic Science. … Economics needs ‘rewriting from the foundations up’. As might be expected, the opportunity has not been neglected.” (Chapter 4, section 4)
This of course brought the present interest in behavioural economics to mind. There’s no shortage of people now claiming that economics needs rewriting utterly. Now, I’m as interested as the next economist in Daniel Kahneman’s new book, Thinking, Fast and Slow. Recently, I attended a fascinating workshop at the Toulouse School of Economics which brought together psychologists/cognitive scientists and economists precisely because the economic crisis has underlined the need for us to evaluate the compatibility of the assumptions we make in economics with the ever-growing knowledge of how the brain works (a summary of this workshop will be published soon & I’ll link to it then). Any economist who works, as I did for 8 years, on competition inquiries will know that the rules of thumb emerging from behavioural economics do reflect behaviour in some markets better than the standard rational choice models.
However, the Robbins challenge is a good one. There are some big issues about behavioural economics and the psychological experiments on which it is based, and these shouldn’t be overlooked in the current enthusiasm. One is that sometimes behavioural models are empirically more robust, but sometimes absolutely orthodox models do better with the data – why, and when? A related point is that the behavioural rules of thumb are no less arbitrary that the conventional assumptions about aspects of psychology, an argument made forcefully by Roman Frydman and Michael Goldberg in their recent book, Beyond Mechanical Markets.
Equally, some of the phenomena described in every book on behavioural economics may not be as empirically robust as supposed, as so many reflect relatively small scale experiments among groups of US college students. For example, the results of the famous ultimatum game seem to vary from culture to culture, albeit in none does homo economicus reign.
So Robbins is too sweeping in his denunciation of fashionable psychology – indeed, he sets out some psychological assumptions in the book without appearing to be aware that they are assumptions that could potentially be disproved. But those quotable lines are a useful reminder not to get to carried away by fashion.
Thinking, Fast and Slow
Beyond Mechanical Markets: Asset Price Swings, Risk, and the Role of the State