Rehabilitating the economist

Following up on my post Methodology, Ideology from a few days ago, I’ve started to dig in to Johanna Bockman’s Markets in the Name of Socialism: The Left-Wing Origins of Neoliberalism. It is a fascinating perspective on the history of economic thought and the sociology of economics. Importantly, it is explicitly concerned with separating the standard methodology of neoclassical economics from right-wing, capitalist ideology.

I have suffered from an unshakeable paranoia about being an economist ever since it looked like I was going to become one. To be an economist is, as I have written about a lot before, to be generally understood as someone concerned with finance, business, and money, a soulless being who sees human beings as automatons programmed to maximize their wealth. I began to feel—I still can’t shake the feeling—that we are forever condemned to this tragic, villainous role.

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Daniel Kahneman and the rational choice model

Daniel Kahneman has a new book, “Thinking Fast and Slow“, that is prompting a lot of excellent articles about his work. For example, Vanity Fair has a nice article by Michael Lewis. Back when I was an undergraduate, Kahneman and Amos Tversky’s Prospect Theory paper was one of the first academic papers I read that motivated me to become an economist.

The article quotes Kahneman as being astonished to learn early in his career that:

The agent of economic theory is rational, selfish, and his tastes do not change.

I just want to point out that this model of decision-makers in economic models is more innocuous than it seems. It means that when we put a decision-maker in an economic model, we assume that she

  •  has things that she cares about, and
  • will do the best she can to achieve the things she cares about. 

This is what we mean by rationality. The great thing about this assumption is that it is completely flexible – it can accommodate any preferences at all.

For example, the decision-maker might care about the wellbeing of her neighbor, and so give up some of her own material wealth to help her neighbor be better off. This is both rational and selfish!

For any decision we observe, some preferences will rationalize it. As economic theorists, the crucial assumption is therefore not rationality, but on what it is that the decision-maker cares about and what constraints there are on her making a good decision.

The great contribution of Kahneman and Tversky was to present evidence on the psychological constraints on our decision-maker’s ability to achieve the things she cares about. Making decisions is hard: even if I know what I want to achieve, “doing the best I can” is subject to how I process the options I have to choose from.

Rationality is not supposed to be a realistic model of the process by which people actually make decisions. Rather it attempts to capture the outcomes of decision-making in a plausible way, so that we can try bit by bit to analyze economic settings without simply saying “people are completely unpredictable, so let’s give up”. Kahneman and Tversky helped to show how to write models of rational choice that better reflect the decisions we observe people make.

Common sense versus science

We’ve all seen those faintly ludicrous reports of scientific studies confirming the obvious. Can something be so obvious that it doesn’t qualify as research? Where is the line across which we have to devote po-faced time and valuable cash to figure something out? That’s what I was wondering while reading Benjamin Friedman’s review of “Nudge”, the new Big Idea book (and obviously the one getting the most press, what with the Obama association) from Richard Thaler and Cass Sunstein. It begins:

Yes, there is such a thing as common sense — and thank goodness for that.

So far so good.

Few people will be surprised to learn that the setting in which individuals make decisions often influences the choices they make. How much we eat depends on what’s served on our plate, what foods we pick from the cafeteria line depends on whether the salads or the desserts are placed at eye level, and what magazines we buy depends on which ones are on display at the supermarket checkout line. But the same tendency also affects decisions with more significant consequences: how much families save and how they invest; what kind of mortgage they take out; which medical insurance they choose; what cars they drive. Behavioral economics, a new area of research combining economics and psychology, has repeatedly documented how our apparently free choices are affected by the way options are presented to us.

The knock on behavioral economics as a discipline is that it’s all a bit obvious. Even the things that are supposed to be revelatory are a bit “yeah, we know”; one classic example is the somewhat underwhelming finding that when people know they’re drinking a more expensive wine they like it better than one they know is cheaper. The two obvious questions: are we surprised that people’s enjoyment of a wine is influenced by its price? And is it research worth conducting?

Of course, sometimes “common sense” could be wrong, and the whole point of science is to confirm, reject or quantify phenomena in the world around us. For example, there was a lively debate – is it still ongoing? – about whether “institutions” or health was more important in fostering economic growth; the common sense answer is probably to say, well, neither good infrastructure or good health ever hurt anyone, did they? On the other hand, it would be nice to know, if it was possible, the hierarchy, especially if you really want growth but don’t have an infinite budget to encourage it.

Behavioral economics is asking questions on a different order of magnitude than that, but the same logic is probably applicable, that in that field, as in all in economics, we might sometimes seem to be masters of the obvious – a lot of economics is common sense with a fancy outfit on – but, I guess, someone has to do it.

Irrationality again

I resisted talking about ‘Predictably Irrational’, a book by Dan Ariely, “the Alfred P. Sloan Professor of Behavioral Economics at the MIT Sloan School of Management and director of the eRationality Group at the Media Lab”, when the first wave of columns and reviews appeared about it. I haven’t read it, but it is mining the vein of doing experiments to figure out how people behave.

The title, of course, is not palatable to me. It’s not possible to test rationality. I see why it’s attached to the work that behavioral economists do, but semantically, it’s a real pain. Let me dive right in to this article, direct from MIT News.

“Though Ariely’s book is often compared to the bestseller “Freakonomics”–both certainly share a quirky, hands-on approach to questions of everyday behavior–he says that in fact his research is almost the opposite of that book’s. Those researchers found cases where people’s behavior, even in seemingly irrational contexts, was perfectly rational and followed established economic principles. Ariely’s work, by contrast, shows the consistently irrational ways people behave in situations where traditional economics predicts they would follow a course of rational self-interest.”

Goodness me. Consider the bait taken: what’s ‘traditional economics’ and why is it different from behavioral economics (or are they the same)? What’s an ‘irrational context’? Here’s an example, from the article, of the Ariely book:

“Ariely and his students went around and left six-packs of Coke in randomly selected dorm refrigerators all over campus. When he checked back in a few days, all of the Cokes were gone.

But when he later placed plates of six loose dollar bills in those same refrigerators, not a single bill was missing when he checked back. Even though the value was comparable–and thus the situations were supposed to be equivalent–people responded in opposite ways. Why is that?”

First of all, if I see a plate of loose dollar bills in the refrigerator I’m pretty well out of my comfort zone. Can it be so hard to explain why people don’t take dollars from a plate in a dorm refrigerator? Aside from being a bit silly, it’s the first misperception of economics at work! ‘The value was comparable’. Actually, I’m being unfair: this is worse than the first misperception of economics, because the Coke-dollar game, as reported by the article, is refusing to acknowledge any preferences whatsoever, ignoring, then, the most fundamental building block of modeling in economics. Maybe that’s why it’s ‘not traditional’.

There are other examples in the article, and I’m sure the book is full of interesting experimental results. I can’t get past that title, though, and it, like Freakonomics itself and the cottage industry it spawned, is squarely in the making-economics-look-stupid camp with the Christmas stuff. I’m sure insights from behavioral experiments can be informative beyond the triviality – the Obama advisers come to mind – but the press coverage for this new book has instead reinforced the discipline’s ‘quirkiness’ and furthered, in some small and delightful way, the misunderstanding of economics.