Wednesday, October 30, 2019

Misbehaving: The Making of Behavioral Economics II

The second half of the book was not particularly exciting to me, but it was interesting in the sense of learning how a new academic discipline came into existence. Debate about behavioral economics within the economics profession began at a meeting at the University of Chicago, a hotbed of rationalist economists, in 1985. Thaler and a few others started to organize seminars and recruit new researchers, and by the 1990's behavioral economics had become a recognized field. Early topics focused on finance, where research indicated that the efficient market hypothesis, which had been academic dogma for several decades, was incorrect. Later, Thaler's research moved to irrational behavior in NFL draft selections, game shows and other areas. Finally, there was an intersection between behavioral economics and behavioral law when Thaler teamed up with Cass Sunstein, the law professor, and wrote the book Nudge, which was published in 2008 and became a bestseller. The thesis of Nudge is that behavioral research can be used to produce better public policies and improve individual behavior in ways that are beneficial to the public at large.

Perhaps what interests me the most about the book is the late admission by economists that human behavior is not rational. I had always held the economics profession in low regard, and that was one of the reasons. Another reason was that, while I was an undergraduate student in the late 1960's and early 1970's, the default major for unimaginative upper-middle-class males seemed to be economics, while my friends tended to major in philosophy and the arts, and I considered them more intelligent and less conformist. Then, while I was in graduate business school in the 1980's, the two economics classes that I took made no sense to me, because the rational agent basis for economics was still accepted without question and no allowance was made for the considerations later addressed by behavioral economists. Even though the M.B.A. program that I was in was highly rated, I thought that the faculty lacked real intellectual talent. As I became involved in my own investments, it became apparent to me, based on observation of the stock market, that financial markets could not possibly be efficient. To this day the efficient market hypothesis is still widely accepted by economists, and it provides part of the conceptual basis for index funds. Sabine Hossenfelder, the theoretical physicist whose book I discussed a year ago, confirmed my opinion of economists when she said that economics is a fallback field for physicists, because the math is easier and the pay is higher.

Although I am not a great fan of Richard Thaler, I thought that he acquitted himself very well in the final chapter. Given the dogmatic nature of his field, it took some doing to introduce behavioral concepts, and this may never have happened without Thaler, Kahneman and Tversky. In the end, unlike most economists, Thaler is a strong advocate of empirical research in economics and hopes to extend behavioral research into macroeconomics. When you review the circumstances that produced the Great Recession, it is easy to see how the misguided triumphalism of well-known economists such as Alan Greenspan facilitated a major economic disaster only eleven years ago. Nevertheless, behavioral economics is nowhere near providing a comprehensive economic program. Perhaps my main criticism of Thaler is that, while he is modest and self-deprecating and has helped expand his field, he still pays homage and fealty to the status quo in his advocacy of "libertarian paternalism," which, though it encourages rational behavior, seems implicitly to preserve elements of a hierarchy which places so-called rational agents, i.e., economists, at the top of the pecking order. Libertarian paternalism incorporates distinctly American pro-capitalist elements and presumes that a meritocracy of superior individuals, who would by definition become wealthy, would work to help less-capable people by designing systems to make them behave more rationally.

In this vein, I was surprised that the book made no mention of Thomas Piketty, who is a macroeconomist whose work is also based on empirical data. Although at times Thaler shows some socialistic affinities, he usually tows the line as a loyal capitalist. Capitalism, in my view, is an ideological fantasy that is on its way out. Socialism is another ideology with its own set of problems and a history of failure, but I think that some version of it will become inevitable as technology renders human labor obsolete. I don't know whether Piketty or other economists will collectively come up with a system that works well for future generations, but at the moment the wealth tax proposed by Piketty seems like a sensible approach. In the real world, a system such as libertarian paternalism is more likely to produce a plutocracy than a well-balanced democracy. At the moment, populist movements throughout the world seem to be fueled in part by public resentment of "elites" such as Barack Obama and Hillary Clinton. In the case of Obama, racism no doubt plays a role, but it is noteworthy that Obama is a friend of Cass Sunstein and seems to like the idea of libertarian paternalism. One might argue that those who adopt libertarian paternalism are engaging in a current form of politically correct social climbing and in reality may not have much to offer the public. Obama's political career, in my view, was mostly a failure.

To sum up, Thaler's introduction of behavioral research to economics was positive in the sense that it added not only an emphasis on empirical evidence but also an element of altruism, both of which had been in short supply in economics. However, Thaler seems timid in his advocacy of altruism, which was and still is anathema to the thinking of many economists, particularly in the Chicago school. The fact remains that, in their profession, economists are often obfuscators and apologists for wealthy and unscrupulous benefactors. Some of them even subscribe to the idiotic ideas of Ayn Rand. There is an implicit elitism and selfishness among economists who believe that they are part of the select few who make rational choices and deserve to be rewarded accordingly.

Sunday, October 13, 2019

Misbehaving: The Making of Behavioral Economics I

I'm halfway through this book by Richard Thaler, which was published in 2015. Thaler is an economist and one of the founders of the field of behavioral economics. He won the Nobel Prize in Economics in 2017. Economics is not an especially interesting topic for me, and I generally prefer macroeconomics, such as that found in Thomas Piketty's Capital, to more circumscribed areas such as this. I am making an exception for Thaler in order to understand behavioral economics better. The book is partly autobiographical, and it describes the development of his career starting in 1970 up to the present. That adds a dimension in that you can see many of the pitfalls of academic life, which relates to my interest in the sociology of academia.

Early in his career, Thaler noticed that the actual decision-making processes used by people are often not rational in the sense that economists understand the term. There are different schools of economic thought, but the predominant one in the twentieth century entailed the idea that humans are rational agents who collectively make rational choices with respect to maximizing utility. This means that people usually make optimal choices regarding whatever it is that they value, and economists have traditionally focused on their financial decisions. From an economic standpoint, it is mathematically convenient to assume that people are rational, because that allow economists to predict collective human behavior with relatively straightforward mathematical tools.

The early behavioral economists conducted simple experiments like the ones described by Daniel Kahneman in Thinking, Fast and Slow, demonstrating unequivocally that human decisions are often not rational in a quantitative sense. Thaler collaborated with Kahneman, Amos Tversky and others, and behavioral economics arose as a bridge between the academic disciplines of economics and psychology. In Thaler's language, Kahneman's "fast" or "System 1" thinking very roughly corresponds with Thaler's "Human," and Kahneman's "slow" or "System 2" thinking very roughly corresponds with Thaler's "Econ." Humans are fuzzy thinkers and Econs are ultra-rational. There are many examples of people arriving at answers that are mathematically or logically incorrect. Thaler differs somewhat from Kahneman in his search for what might be called extenuating circumstances or non-numerical values that affect how actual decisions are made. One example involves the way that Uber's pricing algorithm can alienate consumers. Uber increases fares automatically when the number of passengers in a particular area goes up and there is an insufficient number of drivers available. It is possible for fares to become ten times the normal rate. This formula can backfire when customers believe that they were treated unfairly and when anti-gouging laws provoke lawsuits. In the past, economists favored the Econ types for all of their models, because that type makes purely rational decisions based on maximizing value, which in most cases means money. Thaler in particular helped demonstrate that factors having nothing to do with maximization go into the decisions that most people make. In other respects, Thaler's discussion covers some familiar concepts such as confirmation bias and the endowment effect, the latter indicating that people value things that are currently in their possession more highly than they ought to rationally.

Reading about Thaler's career, you get a sense of how one might fail in academia. In his early years, he was conflicted between making enough money to support his family and pursuing his area of interest in research, which, at the time, was barely on the fringes of economics and was frowned upon by most economists. If he hadn't met Kahneman and Tversky and a few others and participated in research with them, behavioral economics may have remained an undeveloped field. As it turned out, it took off and has produced several Nobels. In this book, Thaler seems like a very ordinary sort of person with plebeian interests, and one can readily imagine him finishing off his career teaching traditional economics in a humdrum economics department somewhere. It is even possible that he would never have obtained tenure and may have switched to a different career.

Though my enthusiasm for the book is limited, I am holding out for the later chapters that cover the uses of behavioral economics for social benefit. Since I have visitors arriving soon, it will take me a while to finish, but I will eventually make another post.