Monday, May 25, 2015

Be-Having: In Defense of Behavioral Economics

In his new book "Misbehaving", Richard Thaler, who doesn’t even have a Nobel Prize yet, talks about his role in the development of behavioral economics.

It is a fun book to read. If you have read “Nudge,” his best seller with Cass Sunstein, you know that he has some verve as a storyteller. If you’ve read any of Sunstein’s books where his is the sole credited author, you know that that the verve in “Nudge” is from Thaler.

There is some chronological structure to the book, but it is a little looser than a more rigorous introduction to the subject like Kahneman's “Thinking, Fast and Slow”. Thaler is a little more focused on the anecdotal to illustrate some of the general things behind behavioral economics. Namely, people are not necessarily economic actors. In the book he makes the divide between irrational “Humans” and more rational “Econs”. People don’t seem to like Thaler’s division. Many of his critics say that they know human beings aren’t entirely rational actors but they model as if they are. (I think these are some of the same people whose models of the economy didn’t include banks, so I’m not sure if their simplifications are useful).

But here’s the thing. Behavioral econ is fun at the anecdotal level. After some people talking about Macro, the behavioral people are some of the most well known by the general public. That’s if you even accept the premise that they are even economists. Maybe they’re just psychologist trying to horn in on whatever halo effect you get by calling yourself an economist.

The problem is that being fun at the anecdotal level doesn’t mean that you can build strong theories on it. In fact, it might disrupt your theories. Say you think there’s deadweight loss in giving gifts -- but people still give gifts when the most rational economic act would be to give no gift. If you had to give something, then cash is the best gift. It doesn’t have the graphic simplicity of criss-crossing demand and supply curves.

What it can do is allow people to make the best choices. If you are in a situation where people have to make choices, you can make the decision easy for them so that they will make the one that is the best for them in the long run. This is where some other people bristle against the findings of Thaler and his school. The don't like the idea of making the default one thing or another, being afraid of paternalism by people who themselves are irrational actors. The most commonly cited “nudge” is making 401 (k) enrollment automatic. People are slackers, and instead of the default being “no,” you change it it “yes.” That way people are saving their money in a tax-favored retirement fund, when people need to have money for retirement. The point is here that a default has to be chosen and it makes sense to look at the research to determine what choices will be made with what defaults, ands what is the best default.

I don’t just give it lip service. I recently got a raise and I immediately increased my withholding. My take-home increased, but so did the amount I put away. I wouldn’t have thought to do it had I not read books like Thaler’s. It might not save the world, but it will help my retirement.