A behavioural economics primer

There are so many books about behavioural economics, including bestsellers like Kahneman’s Thinking Fast and Slow, Thaler’s Misbehaving, Ariely’s Predictably Irrational, and the original Sunstein and Thaler Nudge, you might wonder if we need another. It turns out the answer is yes. Behavioral Economics: Moving Forward by Fabrizio Ghisellini and Beryl Chang is aimed at students rather than a more general audience – it even has a few equations. Its real contribution though is to explain the distinction between the ‘American’ approach, which lists many psychological ‘biases’ and frames them as deviations from the standard rational model, and the ‘German’ approach (ie. Gerd Gigerenzer) which accounts for the well-known ‘behavioural’ behaviours as rational satisficing given a limited attention and brain energy budget.

The first half of the book discusses the shortcomings of the standard rational maximising approach (a bit overdone for my tastes), and explains the behavioural alternative, especially the ‘German’ version, which is presented here in the light of Herbert Simon’s work on satisficing and attention. The second half consists of seven open questions for behavioural research, including how to make sense of the proliferation of apparent ‘biases’, how to deal with time preference, the tensions in ‘libertarian paternalism’ and biased nudgers, and the formation of expectations.

So having started with the same question the authors use to open the book – do we really need another one – I’d agree with them that there is a gap to fill. This is a really useful book for introducing students to behavioural economics and the key research questions in the field, far more so than the pop behavioural literature, excellent as some of it is. Unfortunately, it won’t get widely used given the shocking pricing by the publisher (Palgrave Macmillan) – it must be so frustrating for authors to have a publisher who sets prices only libraries will ever pay (and decreasingly often at that).

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The Community of Advantage

I very much enjoyed reading Robert Sugden’s The Community of Advantage: A Behavioural Economist’s Defence of the Market. It tackles the aspect of behavioural economics that has always troubled me: the presumption that there’s a wise policy-maker who somehow knows better than I do what’s good for me and will act like a government version of Mad Men to non-coercively get me to choose accordingly. In other words, libertarian paternalism is a contradiction in terms, and in reality. In fact, I’m torn because – like many other “experts” –  I do think economists (or doctors, or engineers, or farmers, or nuclear physicists etc) often do know better than most of us what makes for a better outcome. Even in less expert domains, such as the provision of news, it is surely better not to give people exactly what they want, if that’s bias-confirming news rather than impartial and accurate news.

However, Lord Reith and other paternalists didn’t pretend to be ensuring people got what they *really* want, rather than what’s good for them according to the paternalist. As Sugden points out early in this excellent book, most behavioural economics implicitly assumes it’s possible to discern a set of ‘true’ but latent individual preferences, undistorted by the various psychological mechanisms identified in the literature. It addresses policy prescriptions to a benevolent social planner, the policy maker – in other words it takes what’s referred to as “the view from nowhere”, an impartial spectator outside society. This enables a normative assessment of behavioural policies. It’s an appealing idea in many ways, and an admirable effort to take this impartial perspective. But it is of course open to the standard public choice critique and has led (as I argued in my Tanner Lectures some years ago) to bad economic policy choices. Sugden also criticises Sen’s alternative of finding impartiality in the ability of a proposition to withstand reasoned public debate; “I cannot see why I am morally required to justify my private choices by reasoned arguments and to expose those arguments to public scrutiny,” he writes.

Sugden advocates instead a contractarian approach, so rather than asking is aggregate welfare maximized, the question is: “is it in the interest of each individual to accept the rules of that institution, on the condition that everyone else does the same”. The behavioural challenge is devising economic institutions satisfying this condition with respect to individuals who do not know what their preferences are. To translate this into a normative criterion useful for policy, Sugden proposes that: “It is in each individual’s interest to have more opportunity rather than less.” In other words, there is an an analogue to the invisible hand theorem: “The guiding idea is that a well-ordered economy is an institutional framework that allows individuals to co-operate with one another in the pursuit of what they perceive as their common interests.” He traces the approach to Hume’s view of good institutions in a well-ordered society as self-reproducing and self-enforcing conventions – self-enforcing because of mutual advantage, albeit emerging in an evolutionary way in society. Moral reasoning is addressed to individuals rather than a nebulous ‘policymaker’ outside of society.

A couple of technical chapters demonstrate that the contractarian approach is a generalisation of the usual welfare theorems in an exchange economy. The book then turns to policy questions: what kind of regulation can be justified in normative terms if the criterion is expanding individual opportunity (rather than satisfying their ‘true’ latent preferences)? For example, what about someone choosing how much to save for their retirement, a well-known behavioural policy example. Sugden suggests: “Behavioural economists’ propensity to interpret context-dependent preferences [like the opt-out/in pattern] as evidence of self-control problems may be a side-effect of their commitment to the model of the inner rational agent.” He argues that the policy drive to increase personal retirement savings is driven by policy regimes in which pensions are privately provided – so the behavioural policy is there to serve the regime rather than the individual. “A contractarian solution to this problem may require some form of compulsory saving.” In short, the nudge is a fig leaf and the better policy (increasing individuals’ opportunity sets) would be a straightforward regulated contribution.

The term ‘community of advantage’ comes from Mill. Sugden is making an ardent liberal case, while recognising the realities of human psychology. I remain somewhat torn. To go back to Lord Reith, British TV viewers, when asked, are very clear that they prefer watching sport, comedy, movies and soap operas, but they also definitely want their licence fee to support the provision of impartial news, children’s programmes, educational material and other wholemeal stuff. Those preferences are not latent, but rather acknowledge explicitly the mutual as well as the individual benefit. However, Sugden’s approach is very attractive & I’d say The Community of Advantage is a must-read for those interested in behavioural and welfare economics.

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Randomistas through the ages

A jolly history of the experimental in economics and social science, Randomistas: How radical researchers are changing our world by Andrew Leigh, is a good general introduction to the RCT method for readers unfamiliar with it. The book starts with a 1747 experiment to find a cure for scurvy, an affliction causing mass death and illness among sailors. Medicine was of course a pioneering arena for the experimental method as applied to ourselves. Subsequent chapters roam through psychology and education to more recent applications in ‘nudge’ policies, A/B testing by digital companies, and of course the famous ‘randomistas’ (so named by Angus Deaton) working in development economics.

The book is a jolly description of experimental discoveries in these domains ever since the scurvy experiment of ship’s surgeon James Lind. It notes that the randomista methods have their critics but doesn’t linger on the methodological debate. The author (an Australian MP and former economics professor), though well-informed and citing the extensive literature, is clearly an ardent enthusiast.

The final chapter, ‘Building A Better Feedback Loop’, indeed makes a strong case that it would make for better outcomes if policymakers and politicians were able to change course on the basis of evidence. One of the practical advantages of RCTs is perhaps that they leave open the decision – they can be described as pilot schemes in the policy context. There is far too little evaluation in policymaking – it can be too embarrassing, the decisions are water under the bridge –  so setting up an evaluation in advance by design, as it were, is attractive.

Experimental approaches are surely welcome as one more addition to the toolbox of policy evaluation, more useful in some contexts than others, vulnerable (like all empirical methods) to not being well carried out or interpreted. They can easily become a means of manipulating people – as in the behavioural testing done by online marketers – so should always be deployed with caution in the world of policy and politics. After all, people are wising up to the testing methods used by Facebook, Amazon, etc and not necessarily liking them. So I would be less of a randomista enthusiast than Andrew Leigh; other methods of evaluation are available.

Still, this is a very lively, well written book with lots of examples (some familiar like the Perry Preschool trial, others not). Experimental approaches are being more widely used, not least because of the spread of ‘nudge’ units (as pioneered by the UK’s Behavioural lnsights Team)  around the world.

And its basic point is essential: the scientific method should apply to the study of human society just as much as to the natural world. The more tools available, the better.

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When Michael Lewis came to dinner

That Michael Lewis came to dinner at our house once. This was about 30 years ago, when he was dating a friend of mine for a while, and before Liar’s Poker made him famous. He was charming – working in finance – but if only I’d known who he’d turn into, I’d have quizzed him closely about his stellar writing technique.

I’ve just devoured The Undoing Project, his much-trailed book about Daniel Kahneman and Amos Tversky, and their launching of the behavioural revolution in economics, over two evenings. It’s a wonderful book. I heartily recommend it as a Christmas gift for the economists in your life, or a treat for yourself over the holiday.

The book weaves together the personal and intellectual biographies of its protagonists. It explains the ideas, including the paradoxes requiring one to think about probabilities, beautifully clearly. It’s also just a terrific human story about an intense creative friendship as it flowed, and ebbed, over the decades and continents. If they’re not always totally likeable, the two characters are always immensely sympathetic.

It will surely send many readers on to Kahneman’s Thinking Fast and Slow, which requires some mental effort but everybody who fancies themselves an intelligent, educated person ought to have read. Although I’ve read loads of behavioural economics books and papers, and so think I know about a lot of the insights the literature has given us about how our decision-making processes function, there were still some new (to me) ones in The Undoing Project. These are two I found. Tversky had a rule that you must wait a day before replying to any invitation, even one you wanted to accept. It becoms much easier to decline the ones you don’t want. This is advice I definitely need to follow.

The other comes from thinking about reversion to the mean. An exceptionally (beyond average) good or bad performance is usually followed by one that is less good or less bad (closer to average).  Yet coaches and teachers and bosses often hold that if you praise someone for doing well, they do less well next time, and if you shout at someone for doing badly, they do better next time.  “Because we tend to reward others when they do well and punish them when they do badly, and because there is regression to the mean, it is part of the human condition that we are statistically punished for rewarding others and rewarded for punishing them,” wrote Kahneman. This strikes me as profound and something one ought to act on.

It was surprising to learn that at the height of his fame, in the years before his death, Tversky was bugged by the criticism of their work by Gerd Gigerenzer. I’ve never seen Gigernenzer’s argument that heuristic rules of thumb were rational because they economized on brain energy as a fundamental attack on Kahneman and Tversky, more an extension. There’s surely loads still to be discovered about decision making (especially under uncertainty), not least when decisions are conventionally ‘rational’ versus when ‘behavioural’ behaviour kicks in.

As economics is all about decision-making in the domain of resource use and allocation, this overlap with psychology and cognitive science is an exciting area – even though I’m deeply uneasy about the eagerness with which some economists and policy makers are leaping to adopt ‘nudges’ as another handy tool for social engineers to get the people to behave as they ought. We certainly ought to be teaching this at A level and in universities. The Undoing Project is a great book to introduce behavioural economics – and a cracking good story, told by a master.

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Not the smartest animals

The title of Frans de Waal’s latest book is a rhetorical question: Are We Smart Enough to Know How Smart Animals Are? I thoroughly enjoyed reading it. De Waal’s deep knowledge shines through every sentence, as does his delight in all the creatures (especially other primates) he has spent his career studying. The book is about the evolution of cognition and emotion in animals (including humans). It particularly debunks Skinner’s behaviourism – mental processes as a black box, but manipulable using reward and punishment. (This of course the approach behind the present fashion for behavioural economics, a fashion I find troubling because some of its enthusiasts do so clearly see themselves as omniscient scientists ordering society for the better by manipulating the choices of their less intelligent subjects.)

I learned a lot from the book, including that the elephant brain is the one with the most neurons (about 3 times as many as we do). The neural differences between humans and other primates are not sufficient to make us unique in all aspects (although we clearly are in some, notably language). De Waal argues we should assume continuity, a spectrum of cognitive abilities between different animals, rather than sharp and wide distinctions. He notes that psychology is moving to accept this assumption, but the social sciences tend to assume human discontinuity – “But what does it mean to be human?” he reports social scientists asking him. “I usually answer with the iceberg metaphor, according to which there is a vast mass of cognitive, emotional and behavioural similarities between us and our primate kin. But there is also a tip containing a few dozen differences. The natural sciences try to come to grips with the whole iceberg, whereas the rest of academia is happy to stare at the tip.”

The scientific project must therefore be to develop a unitary theory of different cognitions, how cognition operates in general, and then in the case of each particular species. The book emphasises two important contributors: sense perceptions (is vision the most important to the species? or hearing, or smell?); and social relations (is it a species with strict social hierarchies, like chimpanzees, or solitary, like the octopus?) “Cognition and perception cannot be separated… they go hand in hand,” he writes. (Interesting to reflect on what this means for AI. The question is not so much what androids dream of as what they see or hear.)

To crown a wonderful book, it ends with a quotation from David Hume: “Tis from the resemblance of the external actions of animals to those we ourselves perform, that we judget their internal likewise to resemble ours; and the same principle of reasoning, carried one step farther, will make us conclude that since our internal actions resemble each other, the causes, from which they are derived, must also be resembling. When any hypothesis, therefore, is advanced to explain a mental operation, which is common to men and beasts, we must apply the same hypothesis to both.” As Hume summed it up, “No truth appears to me more evident than that beasts are endowed with thought and reason as well as men.”

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