Tuesday, February 20, 2007

On Behavioral Economics

Jane says and Greg agrees that

. . . the left seems to believe [behavioral economics] is a magical proof of the benevolence of government intervention, because after all, people are stupid, so they need the government to protect them from themselves. My take is a little subtler than that:

1) People are often stupid
2) Bureaucrats are the same stupid people, with bad incentives

My interepretation is that behavioral economics is two things

1) It’s a wake-up call to those who took the neo-classical models to heart. It doesn’t say that people are stupid. It just says that simplistic modeling is not apt to catch everything.

2) And more importantly. It’s a statement that the discipline cannot wait. It cannot wait for formal models of thinking costs, and guilt costs, and cognitive consumption. It cannot wait for us to fit nice neat curves to everything because there are policy issues that need to be addressed now

Coming from a lower ranked school I always assumed that the big-boys in the other schools were not silly enough to fall into the trap of thinking that if it comes out of a simple model it must be true. Afterall, models are abstractions and are good for what they are designed to model and often bad for what they are not. Alas, I am often wrong.

Deadweight loss triangles, for example, give you an estimate of the loss in single market in terms of consumer surplus. They say little about what happens in general equilibrium, even less about what happens to measured economic aggregates and virtually nothing at all about economic growth.

Yet, many will assume if the deadweight loss is large then economic growth will suffer. Its entirely possible for the deadweight loss to be huge and the tax to increase economic growth. [Suppose I taxed having a child before age 27]

Anyway, I don’t think that behavioral and neo-classical are that far apart, unless you thought that neo-classical described the world with perfect precision. I certainly don’t think that behavioral says that people are stupid, just that they are human.


Anonymous said...

Behavioral econ is currently quite sexy but neoclassical economics has been attacked since its inception and has stood strong.

I think people are too quick to dismiss neo-classical thinking in favor of behavioral approaches.

For instance I think John List of Uchicago (PhD from Wyoming) has some very interesting work regarding prospect theory & behavioral econ generally in well functioning markets.

According to List, neoclassical predictions seem to hold with experienced market participants. See here
So behavioral econ may not possess the ability to overturn neoclassical approaches just yet as some have hoped.