Monday, July 19, 2010

The problem with the problem with behavioral economics

There's a lot to like in George Loewenstein and Peter Ubel's op-ed in the New York Times on the limits of behavioral economics and it's possible to draw various conclusions from it.  But the piece is at heart just a good old-fashioned moral criticism of government (and the Democratic Party)  for not doing the "right" thing and indirectly, also of democratic politics in general.

Loewenstein and Ubel’s op-ed is mostly aimed at warning people that behavioral solutions are no panacea. I am only a modest consumer of this research so I cannot evaluate all their claims. Yet, it strikes me that if they are right, their argument is really quite damning for the behavioral economics revolution. Essentially, they assert that traditional economic analysis has ultimately much more relevance for the analysis of major social problems and for finding solutions to them. Behavioral economics can complement this but cannot be a viable alternative. Within political science and other social sciences the insights of behavioral economics are sometimes interpreted as undermining the very foundations of classical economic analysis and warranting an entirely different approach to social problems. At the very least, the op-ed is a useful reminder that careful scrutiny of effect sizes matters greatly. 
I suspect this is right.  But this has far more to do with the disciplinary matrix of economics than it has to do with the insights of the behavioral revolution.  I am no economist but as I understand it, the idea that  human beings use a certain form of cost-benefit analysis to make economic decisions (homo economicus) forms the cornerstone of traditional economics.  According to this theory, people make decisions that maximize benefits and minimize costs.  But this, of course,  all depends on what counts as a cost and what counts as a benefit, about which the homo economicus model says nothing.

Initially at least, costs and benefits were thought to be monetary.  Increasingly, we are beginning to realize that we need to factor in culture into these costs and benefits.  And while behavioral economics has helped us understand that there are costs and benefits that are not monetary in nature, it has not changed the cost-benefit model itself.  In that respect, it has in no way undermined the foundations of economic theory.

As an reviewer puts it (scroll down to read):
At root, the rational actor model says "people act to maximize utility." Utility is left more or less undefined.
Thus, the model really says "people act to maximize something." Or put differently, "There exists a way to interpret human behavior as a maximization of something."  Although it does not look like it, this is a statement about our ability to simulate a human using an algorithm. It is on par with the statement that humans are Turing machines.
This model will never lose, because it is very flexible. A challenge to the model will always take the form of a systematic or nonsystematic deviation between some specific "rational actor" model and the true actions of a human. But the challenge will always fail:
- A systematic deviation will by definition always be combatted by enriching the rational actor model to eliminate the deviation.
- A nonsystematic deviation is explainable as "noise" or "something we don't understand yet."

[...] There is really no way to beat the rational actor model, because it is really the outline of a research program, it is not a fleshed-out model. And the research program is the correct one, by the way.
Being a Kuhnian, I wouldn't say that this research program is the "correct" one.  But it's an extraordinarily productive one, that gives its practitioners the ability  to construct a variety of problems and solve them.  In that respect behavioral economics cannot be -- and never was -- an alternative to it.

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