Is ‘behavioural economics’ economics? Observations against, for & tied or Why Tim finds behavioural economics annoyi

1. Is ‘behavioural economics’ economics?Observations against, for & tiedorWhy Tim finds behavioural economics annoying, and why he might be wrong Tim Brennan Professor, Public Policy and Economics, UMBC Senior Fellow, Resources for the Future brennan@umbc.edu Australian Competition and Consumer CommissionMelbourne, VIC 24 July 2012

2. Behavioural economics as challenge to standard Broad definition: Doing economics when people fail to act “rationally” Laboratory effects Different responses to “logically” equivalent choices (framing) Inconsistency with maximizing expected utility Real world apparent failure to maximize utility Failure to adopt energy efficiency Voting, donations Taxi-cabs quitting early on busiest days Pension contributions differ between opt-in, opt-out Make par putts more often than birdies Requires external judgment that of no cost, no info Brennan, behavioural vs. standard economics 2 2

3. Today’s approach Not specifically to challenge evidence, accuracy Utility from seemingly non-maximizing behaviour (e.g., voting) Relevance of extrapolating from laboratory to market Sustainability of mistakes with repetition Rather, take an overall methodological view: What is economics, and how do we do it? Kuhnian paradigm shift or more “normal science”? Seven arguments against behavioural economics Two arguments as ties with the standard approach Six somewhat in favour; at least limits to standard Normative, empirical, philosophical issues at end Brennan, behavioural vs. standard economics 3 3

4. What is economics? What makes economics fun? Brennan, behavioural vs. standard economics • To some, it’s “data set” • What can one uncover empirically? • The IV “Freakonomics” effect; “econ” as social statistics • To me, it’s the opposite: Clever (theoretical) explanation of the factoid • The ability to learn by “thinking about it” • Math, philosophy, law • Then, connecting what one learns to policy • The self-contained efficiency norm • Thinking about its limits as well • Does behavioural economics add to MY fun? • Not really – that’s may be what this is about: ME 4 4

5. Tim fending off data [“Work, work?”] Brennan, behavioural vs. standard economics 5 5

6. The famous McKinsey CO2 abatement graph • “Negative” costs on the left • Economic interpretation: WTP to avoid unobserved quality degradation • Psychology, policy interpretation: Look at all the $20 bills on sidewalk Brennan, behavioural vs. standard economics 6 6

7. Economist 3/24/12: “Nudge nudge, think think” Even the Economist is on the BE bandwagon David Cameron sets up “Behavioural Insights Team” More pay taxes with blunt “pay your tax or lose your car” with photo Boys like “geometry;” girls like “drawing” More insulation adoption if it comes with cleaning out attic – “goal substitution” (?) US and British but not French reduce energy use if they see their neighbours doing so Force organ donor decision when getting driver’s license Brennan, behavioural vs. standard economics

8. Brennan, behavioural vs. standard economics Creeping into antitrust • Maybe blocking mergers?Stucke: "Behavioural Economists at the Gate" • But see“Behavioural Economics and Merger Enforcement: A Speculative Guide,” Threshold: American Bar Association Mergers and Acquisitions Committee, vol. 9, no. 2 (2009): 21-29 • Now, the search for something to justify anti-RPM lawTor and Rinner: "Behavioural Antitrust: A Novel Approach to the Rule of Reason after Leegin" • The tar balls are washing up on my beach! • Wright; Kovacic and Cooper: Recent critiques of BE in antitrust and regulation 8

9. Against #1: Inhibit disciplinary growth? Economics has grown by incorporating seemingly inconsistent behaviour into the paradigm Vertical restraints; resale price maintenance Capture theory of government Political economy of protectionism Imperfect information Adverse selection Moral hazard and agency issues Strategic behaviour; precommitment Farmer, Gianakopulos: hyperbolic discounting Don’t just assume people make mistakes and move on Brennan, behavioural vs. standard economics 9 9

10. Brennan, behavioural vs. standard economics Example: The famous Sunstein-Thaler “Nudge” • New hires adopt retirement plan out of wages at 20-50% if opt-in; at 80% if opt-out • Taken as indicating irrational inertia, as the costs of making the decision (opt in or opt out) negligible • Neglects rational inference from standard practice:What can one infer from something being “standard”? • Does not imply optimal outcome • Information cascades • Inertia in standards adoption • But does imply that irrationality not necessary 10

11. Against #2: Information or error? Can we tell rationality failures from too little information? Failure to adopt energy efficiency: Too “dim” to calculate benefits, or unaware of benefits? Rational choice not to acquire perfect information Expected benefits aren’t worth costs Strategic ignorance to maintain credible responses Becker-Stigler: Can’t even reject different preferences; could be information Those who don’t like classical music don’t have “information capital” necessary to derive utility from it Brennan, behavioural vs. standard economics 11 11

12. Against #3: Multiplicity of theories? Is there a unified theory? Prospect theory/loss aversion, or Jay Shogren’s list of aversions: It gets better:Try these cognitive biases on for size! Brennan, behavioural vs. standard economics 12 12

13. Against #4: Publish or perish? Is the demand for behavioural economics arising from the need for: More accurate explanations of the evidence? A simpler, easier to apply theory? Better conformity to intuition? Or a response to the demand for a new source of publications needed to secure academic positions? Post-modernist literary criticism of the classics? Not the first in economics, to be fair General equilibrium? 1960s – 1970s Game theory? 1980s – 1990s IV studies, the “Freakonomics effect”? – 2000s Brennan, behavioural vs. standard economics 13 13

14. Against #5: What’s the normative standard? Standard economics supplies policy norm Valuation as area under empirical demand curve “Consumer surplus without apology” What if demand curve can’t be trusted? Revealed WTP isn’t “real” WTP? “Negative cost” climate adaptation as example Energy efficiency error People better off with forcing them to take an option to which a better one was revealed How do we do CBA? What goes in its place? “Optimal Energy Efficiency” Energy Policy – maybe? Brennan, behavioural vs. standard economics 14 14

15. Against #6: Elites or the public? If not revealed preference, then which preference? Full information? No cognitive impairment? No “bias”? Who determines information, cognitive skill, bias? As Al Franken once asked, “Why not ME?” Cooper/Kovacic: Behavioural biases of policy makers? Also a problem if preference change is a policy tool Which preferences to use to evaluate policy? Ex ante, ex post, or the policy maker’s? “Green Preferences,” Ecological Economics Brennan, behavioural vs. standard economics 15 15

16. Against #7: Ex post anti-economic policy? Which comes first – the policy preference or the justification? Mistrust of markets for lots of reasons Doubts regarding competition Non-economic norms Unwillingness to defer normatively to revealed preference Does behavioural economics fulfil demand for anti-economic policy prescription? Why can’t one argue directly from normative principle? Utilitarianism, qualified Rawls, Harsanyi, Sen Inalienability theory of ethical rights Brennan, behavioural vs. standard economics 16 16

17. Tie #1: Standard economics shares similar flaws Economics also has long list of adaptations Rationality as logical re means, not substantive re ends Utility maximization as unrejectable tautology From “self-interest” (narrow) to “present-aim” Voting: Preference to vote “Warm glow” The “auctioneer” in general equilibrium theory “Transaction costs” as ex post rationalization for institutional organization, common law Folk theorem in repeated games Dozens, hundreds (?) of strategic games Brennan, behavioural vs. standard economics 17 17

18. Tie #2: Bad sales job to standard economists Why not call this “imperfectly performing investments to reduce costs of thinking”? Decision rules-of-thumb that can be fooled No worries in standard economics with modelling imperfect investments to reduce costs of physical labour Irrational to wait for an elevator rather than take the stairs? Internal “transaction costs” make baseline important Usual ones make property rights assignment important Standard economics => inside head, Coase theorem applies But do behavioural economists want to convince standard economists, or get others to reject them? Complement or substitute? Brennan, behavioural vs. standard economics 18 18

19. Example: Foreseeable misuse Brennan, behavioural vs. standard economics (Credit: Severin Borenstein’s defence of policies to promote energy efficiency) • Legal doctrines to assign choice responsibility away from consumer – foreseeable misuse • Holding lawnmower company liable for no foot protector—even when someone mows lawn in bare feet • Is the cost to the lawnmower company of avoiding the accident lower than “cost” to the consumer? • Cost of “thinking about it”? [Also Economist examples] • Explain “behavioural” anomalies as costs we can model? • Is “behavioural economics” really nothing new? • BUT: Can these costs be independently measured? 19 19

20. For #1: Relative vs. absolute preferences Not necessarily outside the standard paradigm, but close My utility depends on your consumption, adversely Robert Frank: Can competition to win be wasteful? Just drives up the cost of being first May be efficient in some endeavours Sports contests – don’t worry about wasted effort by losers Progressive taxes don’t reduce social welfare Just reduce price of unique goods pursued by wealthy Big fish, small pond – wage explanations Brennan, behavioural vs. standard economics 20 20

21. For #2: Preferences over preferences “Metapreferences” Can prefer X to Y, but also prefer “I’d prefer Y to X” to “I’d prefer X to Y” Wish I were different than I am … … hard to imagine as that may be … ;-) Smoking, dieting, exercising Also weakness of will, coming up Investment in preference change Education, travel, moving, job Advertising as “preference pollution” (David George) Bring some preference change inside the paradigm? Brennan, behavioural vs. standard economics 21 21

22. Brennan, behavioural vs. standard economics For #3: Preference formation and change • Preferences: Raw data, or something to be explained? • Presumably, they come from somewhere: blue jeans • Sagoff, others: Do preferences exist prior to choice? • Interpretation of “preference reversals,” framing • “Authentic” vs. “manipulated”, e.g., advertising • “False consciousness”; e.g., dissatisfaction with political outcome • “Going green”: Manipulating preferences as policy tool • Why not manipulate preferences to make “problem” go away, e.g., get people to not care about environment • Elites, powerful dominate 22

23. For #4: Hyper-rationality • (Thanks to Bob Majure and Joe Farrell) • Is it reasonable to assume “rational” outcome with complex repeated sequential games? • Especially with perverse outcomes—Backward induction example • Farrell critique of articles claiming no exclusive dealing that’s renegotiation-proof • Does anyone really think price fixing is supported (or countered) by the folk theorem? • Act “as if” they understand Myerson, Tirole, Milgrom, etc.? • But is it cognition cost, or transaction costs? • The problem with renegotiation equilibria is that one can’t endlessly renegotiate Brennan, behavioural vs. standard economics ACCC, 24-07-12 23

24. Brennan, behavioural vs. standard economics For #5: Economics “welfare” vs. normal welfare • No genuine “welfare” test in normal sense of the word • May be reasonable to presume harm from lost opportunity to get to higher indifference curve • Neoclassical requires unstated psychological assumption that revealed preference is meaningful • Assume plants have “utility” from light--does that create obligation to give them light? • Economists can’t understand question; philosophers can’t imagine why one would presume meaning • Happiness studies? • Risk of paternalism, elitism, remains • Behavioural economics as questioning inference of “real” willingness to pay from revealed preference

25. For #6: Weakness of will What does it mean to act against one’s will? “Freedom of will and the concept of a person” – Harry Frankfurt; conundrum in philosophy Jon Elster, Thomas Schelling Ulysses and the Sirens; “The Intimate Contest for Self-Command” Multiple selves and the problem of precommitment The roommate/refrigerator story Elster: Failure to exercise as “free riding” by multiple selves Knowing I’ll buy a car on impulse, support regulations requiring minimal quality – with no other “market failure” Rationale for drug laws? Whose preferences count? Can’t get away from that! Brennan, behavioural vs. standard economics 25 25

26. Brennan, behavioural vs. standard economics Big picture #1: What is economics—theory or data? • We all know junior high school “scientific method”: If conflict between data and theory, choose data • But conflicts between data and theory should be decided in favour of one with greater a priori confidence • Quantum mechanics forced rejection of Newtonian categories (instant action at a distance, uncertainty) • Feynman: “If quantum mechanics makes any sense, I haven’t explained it correctly” • Eddington: “It is also a good rule not to put overmuch confidence in the observational results that are put forward until they are confirmed by theory” • Economics differs? Theory could win because confidence in data weaker (standard compromises) • Acting on the basis of theory: US v. AT&T 26

27. Brennan, behavioural vs. standard economics Big picture #2: Is this a paradigm shift? • Kuhn: “Science” doesn’t just incrementally build • It can, of course: What he calls “normal science” • Punctuated by revolution • Incompatible paradigms, not accretion of knowledge • Definitional changes, e.g., Newtonian vs. relativistic mass • Change may be generational • Einstein refusal to accept quantum mechanics • Many refused to call quantum mechanics “physics” • Behavioural economics “normal” or “revolutionary”? • Shift from economic theory to empirical psychology? • Looks like an attempted paradigm shift to me: Lead, follow or get out the way?

28. Big picture #3: Help or impede other disciplines? Brennan, behavioural vs. standard economics • What to do about mistakes – and how do we know? • Normative? Cognitive? • Philosophy: • Substituting logical categories (“multiple utility”) for independent normative assessment? • Are consumers empirically mistaken or ethically mistaken? • Psychology: • Does this get you at the policy/research table? • Does something have to be called “economics” to matter? • Would/should I care if one said “economics covers this, psychology covers that?” • If not economic imperialism, “economists imperialism” 28 28

29. Big picture #4: Not just energy efficiency Increasing research based on “barriers” to energy efficiency adoption To make credible and non-elitist, need to be general, not just energy efficiency: Explain why we pick the wrong: Doctors Houses Cars Jobs Investments These are WAY more complicated than CFLs, caulking Shows one is throwing out more than the bath water Brennan, behavioural vs. standard economics 29

30. Brennan, behavioural vs. standard economics The bottom line • [If cost-benefit analysis is still permissible] • Benefits of behavioural economics • Perhaps better empirical confirmation • To many, more salient explanations • Costs of behavioural economics • Sacrificing an internally consistent policy norm: Aggregate revealed preference • Justifying paternalistic rationalization over revealed preference • Giving up “thinking like an economist” – Interpretive theory vs. empirical description • Do the benefits exceed the costs?

31. If consumer sovereignty still matters,you tell me ? Brennan, behavioural vs. standard economics 31 31