Richard Thaler’s Nobel Prize

by Mario Rizzo

Richard Thaler has won the Nobel Prize for initiating the behavioral moment in economics.

My view of the Nobel Prize in economics is much like Time magazine’s view of its “Person of the Year.” It is awarded to the economist who “for better or for worse… has done the most to influence” the course of economic thinking – at least in certain respects. It also, like Time magazine, operates under the constraint that an award must be given every year. Continue reading

A Crisis in Economics?

by Mario Rizzo

Periodically, people warn about the “crisis in economics.” I have heard about several of these over my professional career. Somehow the mainstream or orthodox economists never seem to notice these crises or take them seriously. They continue doing what they were doing.

Today the crisis, if there is one, is due to behavioral economics. The traditional rationality assumptions of economics are under assault. Why should we care? After all, they were unrealistic in the first place. And yet they did lead us to some definite conclusions about a wide variety of matters regarding economic theory, applied economics, and policy economics. A consensus seemed to be forming that markets, if not efficient in the strong sense, were at least subject to strong corrective pressures. Now the collection of biases we have accumulated makes it seem like a miracle that markets work at all. We must now not only worry about market failure but we must think about “decisionmaking failure.” People cannot be relied upon to pursue their own interests effectively in matters from deciding how many potato chips to eat to whether to join an employer-sponsored retirement savings program. They might also choose the wrong bank account because of fees for add-on services (like overdraft protection) that are not made salient enough. People cannot be simply given information about the dangers of smoking; they must be subject to worse-case scenarios (biased in themselves) to offset other biases that plague decisionmaking. But many biases move in opposite directions. Others cannot be quantified very accurately. More importantly, biases are being sought. Many researchers stop when they have found one or more.

All this is fueled by several factors. Young economists want to make a name for themselves. The most direct way is to overturn some conventional wisdom. Much of that is based on models that assume agent rationality. So now we get results in public economics that if you don’t make sales taxes salient, that is, don’t add the tax on to the price label before checkout, the taxes will not have much of an effect on demand. When you do, demand for the product will fall. (I wonder what happens if tomorrow all price labels for all products include the tax – will the demand to hold money increase and a recession start?) Another factor is the demand for policy measures by politicians who need to keep providing services. If new (behavioral) problems can be found then new solutions can be proposed. This demand and incentive to respond to it must be great because even articles that are primarily theoretical have some discussion of the possible policy relevance of the model. A third factor is the decades-old mindset of fine-tuning. For example, in a world of scores of biases, all sorts of things can go wrong in financial markets. So why not have regulators with a broad mandate to curb systemically problematic behavior? There can be no end to the possible perverse biased behavior that these regulators need to monitor and control. The approach that Milton Friedman and others preferred was to establish clear general rules. Because behavioral biases are so contextual (that is, they come and go depending on the concrete details of the particular case) it is not feasible to rely simply on general rules.

Out of all this comes two problems. First, are they any general lessons we can teach Principles of Economics students or members of the general public? I still think we can teach basic concepts like opportunity cost – unless of course people fall victim to the “sunk costs fallacy” which behavioral economists say they do. Oh well. There must be something… Second, the normative standard of economists has not changed. The ideal is still neoclassically rational behavior. But now that behavior has become so seemingly preposterous that deviations from ideal behavior almost find themselves. Perspective is lost. We wonder how things can ever go right, even though “Paris gets fed.”

I am afraid that the days of the straightforward Economics in One Lesson of Henry Hazlitt or the direct implications of University Economics of Armen Alchian and William Allen are over. You can have almost any set of beliefs about how the economic world operates and have an economic theory to support it.

I do not suggest a solution. None is possible yet because not enough people have faced the problem squarely.

Military Service and the New Paternalism

by Mario Rizzo

In the last few years there has been a small expansion in the number of universities that are reinstating ROTC (Reserve Officer Training Corps) after the cancellation of such programs due to protests against the war in Vietnam. I express no opinion here about whether universities should have ROTC programs. My points here have equal applicability to military recruiting of all kinds.

My concern here is a relatively wonkish one. Why have not the new paternalists (those who base their paternalistic policies on the findings of behavioral economics) sought to apply their ideas to young college students signing up for ROTC? Or to other young people going to their neighborhood military recruitment center.

Consider that these potential recruits seem to meet all of the behavioral red flags. First, they are young with little experience of the world and so their decision is would be one in which their data base is deficient. They would seem to be similar to first-time home buyers who are alleged to be easily subject to fraud and manipulation. Continue reading

Top Young Economists Consider Their Future

by Roger Koppl

Ali Wyne of the big think  blog “Power Games”  recently posted an interesting set of comments on the theme “Empirics and Psychology: Eight of the World’s Top Young Economists Discuss Where Their Field Is Going.”  George Mason’s own Peter Leeson  was among the eight “top young economists” sharing their views.

Over at New APPS, the philosopher Eric Schliesser  summarizes the eight comments. “Bottom line: due to low cost computing and a data rich environment the future of economics is data-mining (this was clear from at least four of the comments). This is especially so because the young stars have lost faith in homo economicus (due to behavioral work and the crisis).”

Eric’s summary seems about right to me. There were eight fine minds sharing eight different visions, but two related themes dominated the comments. 1) The old rationality assumption is in trouble and we don’t quite know what to do about it. 2) Economics should be more data-driven now that we have what William Brock has labeled “dirt-cheap computing.” Continue reading

“Rationality” isn’t always Rational

by Mario Rizzo

Over the past two years I have been reading more than I ever dreamed about rationality in economics, especially in the standard neoclassical theory of choice. I have done this because I want to get at the root of the controversies concerning whether people’s behavior is, in particular contexts, rational or not.  Claims about the rationality of individual behavior are very closely linked to important policy questions about state paternalism. The highly abstract is working its way down the line to practical policy issues.

In all of this I am well-aware of the argument that “rationality” is the result of market processes and of decisionmaking institutions. I have nothing per se against this line of reasoning. Nevertheless, I want to approach the issue on the terms espoused by many choice theorists and behavioral economists themselves. This is the idea that the axioms of rational choice have a normative importance in and of themselves. By and large, behavioral economists accept the normativity of standard rational choice even as they reject the descriptive reality of rational choice.

The funny thing about all of this is that, initially, the axioms of rational choice were supposed to shed light on how people actually made choices. Then a sleight of hand occurred. It was claimed that they shed light on how rational individuals would choose – without addressing the issue of whether people were in fact rational in the sense of the axioms. Finally, it was alleged – in the face of empirical evidence that people often did not choose rationally – that the axioms defined the norms of choice. They told us how rational individuals should choose. More than that. Since being rational is taken as “good,” they show us how people should behave – full stop. Continue reading

Behavioral Economics and Rationality

by Mario Rizzo

One of the very good things about the blogosphere is that academics have been uploading their syllabuses for various courses. For the past couple of years, I have been teaching a graduate course taking a detailed and critical look at modern behavioral economics, including its normative and policy aspects.

More and more, I am thinking about this area in terms of the normative vision of the world it presupposes. Most amazingly, behavioral economists tend to accept the normative stance of neoclassical or standard economics (that is, the axioms of rationality). They “simply” do not believe that people behave in accordance with these axioms. Thus they find decisionmaking failure (akin to market failure). All sorts of state interventions may be warranted to correct for the suboptimalities that defective or biased decisions imply.

There are many issues here. (1) What is the status of neoclassical rationality as a normative standard? I think the technical idea of rationality gains acceptance to the extent that it is viewed as the instantiation of a broader rationality — or simply the instantiation of sensible decisionmaking. This is a not very defensible point. (2) Even assuming that is defensible, is “rationality” where economists ought to begin or where perhaps they should end up? Economists such as Philip Wicksteed argued, in effect, that irrationalities were disequilibrium phenomena that would tend to dissappear or be reduced under the pressure of the costs of bearing the consequences of irrationality. (3) Even assuming the empirical stubborness of biases or irrationality, is it possible or feasible to discover what unbiased behavior would be, especially in a world of multiple biases and differential degrees of these biases accross individuals and contexts?

Behavioral economics is one of the many areas of economics that could benefit with a little more fundamental thinking even at the expense of  yet another experiment or psychological study or “innovative” model. Let’s slow down and take a breather.

Here is my syllabus. Behavioral Economics Syllabus 2012

What is Economics Today?

by Mario Rizzo

I was recently at the Summer University in Aix-en-Provence. I heard more than once about the need to educate people in economics in order to get better public policy.

My purpose in this post is not to go over the issue of the relative power of ideas about the “general welfare” as compared to special interests in determining public policy. Instead, I want to raise the question of whether today’s economics is homogeneous enough to teach basic lessons about the desirability of free markets. Let us put aside the old socialism and central planning issue. We can say that “economics” defeated that. Continue reading

The Attack on Dignity and Moral Autonomy: The Case of Cigarettes

by Mario Rizzo

The latest in the paternalistic actions of the federal government are a kind of reductio ad absurdum.  At least this is how it might have seemed ten or fifteen years ago if someone would have said that cigarette-pack health warnings would become graphic pictures designed to horrify the public into not smoking.  Continue reading

Policy Makers and Irrational Exuberance

by Chidem Kurdas

Robert Shiller says the speculative bubble in real estate was driven by “a contagion of optimism” that pushed up prices and expectations in a feed-back loop. This epidemic apparently engulfed regulators as well.  “Government policy makers breathed in the same optimism, which no doubt encouraged them to be lax on regulatory restraint,” he writes in a NYT column.

This is a plausible explanation of the psychological mechanism that operates in any bubble. It eventually collapsed and led to the property slump that underpins the current economic malaise And Professor Shiller is right that public officials are not immune. But federal entities breathing in heady fumes is different from anybody else breathing in the same. Continue reading

Attributing Agency

by Gene Callahan

In C. Mantzavinos’s Philosophy of the Social Sciences there is a paper by Philip Pettit entitled “The Reality of Group Agents.” (He decides, by the way, that sometimes it makes perfect sense to attribute agency to a group, but that’s a topic for a different day.) What I wish to talk about today is the following passage, a preliminary to the issue of group agency, which discusses when it is sensible to posit agency for an individual creature such as, say, a wasp: Continue reading

The Blinders of Behavioral Economics

by Mario Rizzo 

At the turn of the new-year the Financial Times published two small articles about why people often do not adhere to their new year’s resolutions. One article was by a philosopher (Julian Baggini) and the other by a psychiatrist (Antonia Macaro). Interestingly, they each seem to focus on whether people really want what they resolve to do or not do. More fundamentally, the authors say, if people understood themselves better they would know more fully what their personal goals are and not have so difficult a time achieving them.   Continue reading

Behavioral Economics: Rocking the Boat

by Mario Rizzo  

It seems as if it has become increasingly common for bloggers who are also academics to post the syllabi of courses that may elicit some general interest. In that spirit I post my syllabus for a graduate course in behavioral economics here.  Behavioral Economics 2011 Course 

Despite some rhetoric to the contrary, academics are a very conservative group. They (me too?) hate disruption of their research agendas by young upstarts who rock the boat. Where is the respect for their elders who have given the best years of their lives to orthodoxy? From the orthodox perspective, behavioral economics is, I should think, especially unpleasant. Luckily, I do not consider myself a part of an economics orthodoxy.  Continue reading

When Nudging Isn’t Enough

by Glen Whitman

In a New York Times op-ed, George Loewenstein and Peter Ubel argue that policymakers are relying too heavily on behavioral economics, when traditional — that is, rational choice — economics would often serve them better.

On cursory reading, you might think this op-ed repudiates the facile use of behavioral economics to guide policy. But in fact, the authors encourage us to go further down that road. They do so by questioning the efficacy of behavioral policies while implicitly accepting behavioral welfare analysis. Continue reading

New Paternalism, Regulation and Cass Sunstein

by Mario Rizzo

The New York Times magazine has an interesting, if somewhat uncritical, article on Cass Sunstein, the Obama regulation czar. The “best” part is the section about me:

Some scholars dislike the strong, if subtle, governmental hand that is embedded in this last proposal. It seems more forceful than a nudge. “Once you get to a point where you have automatic enrollment, you raise the question, What kind of fund?” Mario Rizzo, a professor of economics at New York University, says. “The problem is that if you were enrolled automatically, you could complain later that you’d been put into either a too-risky or a too-conservative fund. So then you micromanage that and you say you have to have a balanced fund. But pretty soon you’re on a slippery slope, where you’re dictating people’s retirement choices.” Rizzo told me about an academic study of gift-giving that found that most people would value cash more highly than the gifts they get for holidays; if even your friends and family can’t figure out what you want, he asked, how can a distant bureaucrat? “Sunstein is very taken with the need for experts,” Rizzo says. “But it turns out experts are subject to these cognitive quirks, too.” Continue reading

All Decisionmaking is Doomed to Failure: Questions for the Bias Industry

by Mario Rizzo  

Behavioral economists have an embarrassment of biases. They have discovered many cognitive and behavioral biases which plague human decisionmaking. By one count there are nearly a hundred of them.  

A cognitive bias is a systematic departure from rational decisionmaking. For example, a person may react differently if he is told that a drug has a 90% cure rate or that it has a 10% failure rate. A behavioral bias is the systematic inability to act in accordance with one’s true preferences. For example, I resolve to stop drinking but I don’t have the willpower.  

But what does all of this add up to? Continue reading

New Paternalism on the Slippery Slopes, Part 8: Hyperbolic Discounting in Public Policy

by Glen Whitman

As discussed in a previous post in this series, the new paternalists often use the concept of hyperbolic discounting (roughly, excessive impatience) to show that people make systematic errors that could, in principle, be corrected by government intervention. But what if policymakers, too, are prone to hyperbolic discounting? That is the question raised in the next section of the paper (p. 724-725):

Policymakers can have short time horizons for various reasons. They might no longer hold office when future costs and benefits of their policies occur. Insofar as voters have imperfect memories, they might fail to fault policymakers for the ill effects (or credit them with the good effects) of policies they supported. Both of these effects give fully rational policymakers an incentive to discount future consequences.If policymakers are hyperbolic discounters, there is yet another reason they will tend to discount the future: because they apply especially high rates of discount when some costs or benefits are in the present (or near future). Continue reading

Why Kant Was Smarter Than Behavioral Economists

by Mario Rizzo  

Behavioral economists who like to indulge in normative pronouncements have decided that quasi-hyperbolic discounting violates rationality. In other words, suppose a person decides today that he will give up the hamburgers he loves beginning in 2010 (because of the high fat content). But then when 2010 arrives he reverses his decision and continues to eat them.  To stress the point, let’s suppose that he repeats this preference-reversal one or two more times during 2010.  

The poor fellow is, in addition to all his other troubles, violating standard economic rationality. Continue reading

Behavioral Economics As Self-Help

by Mario Rizzo  

For quite a number of years I have been saying that I have no objection to behavioral economics per se, aside from the legal paternalism wing. After all, why shouldn’t people use science to make their lives better?  

So now MIT economist Dan Ariely has adapted some of the findings of behavioral economics to helping people regulate their own behavior. This is his advice on how to avoid eating too much on Thanksgiving, but it is applicable more generally to avoiding poor eating.  

Yes, this is where the legal paternalists should shift their considerable skills: self-help books.

 

The New Interventionist Economics

by Roger Koppl

Two recent posts on this blog (here and here) raise the issue of animal spirits and where macro is headed.  I’ve recently completed a draft manuscript saying we are headed for “BRACE” economics.  I say the “New Interventionist Economics” will be characterized by five features:

Bubbles

Radical Uncertainty

Animal Spirits

Complexity Dynamics

Extra-Market Control

(giving the BRACE acronym). Continue reading

New Paternalism on the Slippery Slopes, Part 4: Context Dependence

by Glen Whitman

New paternalists have also relied on the notion of context dependence to justify their policies. But as with hyperbolic discounting, they unjustifiably assume the existence of an inconsistency of preferences gives the policymaker license to choose among the inconsistent preferences. That assumption is the paper’s next target (pp. 703-704):

For a variety of decisions, people are subject to what behavioral economists call context-dependence. This means that how they choose among two or more options depends on seemingly irrelevant aspects of how the situation is described. For example, medical patients are more likely to assent to a treatment with a 90% survival rate than one with a 10% death rate, even though these are the same. In this case, people seem to favor “positive” over “negative” framing. People also seem to prefer options framed as the existing or a baseline position; this may be called status-quo bias. Another example of the power of framing is the persistent difference between willingness-to-pay (WTP) and willingness-to-accept (WTA), meaning that people will demand more money to part with an item than they will pay to acquire it, even when the item’s value is a trivial portion of their wealth or income. Continue reading