Abstract
Behavioral economists and psychologists feel confident, if not cocky, that they have substantively undermined the methodological approach to neoclassical economics identified in modern times with the two branches of the Chicago school associated with Milton Friedman and, more pointedly, Gary Becker. Certainly, the behavioralists have contributed to our understanding of people’s decision-making abilities, especially their limits, and have caused neoclassical economists (including me) to rethink their (my) methodologies. This in turn has led me to a new understanding of the role of the rationality premise in economics and of a budding economic theory of the human brain. There are, however, several good reasons for caution in siding with the behavioralists on all critical fronts, even if their research findings on people’s decision biases and irrationalities are confirmed time and again. Let me count the ways.
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Notes
- 1.
Indeed, they might come to hope that there would be more students choosing A so that there would be more money to be made, but then with some thought and experience with the options, they might expect fewer of their classmates to choose A.
- 2.
Ariely’s research on candy prices needs to be considered with some skepticism for two reasons. First, he doesn’t say whether the group of subjects remains the same when the prices of the chocolates are lowered by a penny. Because he undertook his candy sales on a college campus, I suspect that percentages are for different groups of students. Second, Ariely doesn’t give the number of students in the two samples. It could be that few people switched from buying the truffle to buying the kiss when both goods’ prices were lowered by a penny. There could have been simply far more people picking up the kiss when its price was lower, leading to a higher percentage. After all, when the kiss was priced at zero, people did not have to spend time searching for change or waiting for change to “buy” one. “Free” might still have an effect, but the point is that the effect might not have been for the reasons Ariely suggests.
- 3.
Consider the findings from other experiments, my own and others reported above, that are at odds with the findings of behavioralists, and that do not mirror the incentives that may emerge when the nudges are applied to the real world.
- 4.
For example, a reporter for The New York Times editorialized in a news report in a matter of fact manner, “If nothing were done, the banking system could collapse, and bring down much of the economy with it. That’s what happened in the Great Depression, when a shortage of money led to a steep downward spiral of wages and production. But that episode taught a clear lesson: Governments have a responsibility to keep the financial system going” (Hadas, October 13, 2008).
- 5.
Bernanke made the case for the aggressive fiscal actions the federal government had taken through the bailouts in a column for The Wall Street Journal: “History teaches us that government engagement in times of severe financial crisis often arrives very late, usually at the point at which most financial institutions are insolvent or nearly so. In these conditions, the consequences and costs of inertia and inaction can be staggering. Fortunately, that has not been the situation we face today.” Bernanke goes on to assure readers, “Americans can be confident that every resource is being brought to bear: historical understanding, technical expertise, economic analysis and political leadership” (Bernanke 2008). Perhaps understandably, he made no mention of possible downside to the policy course he was helping to direct.
The House of Representatives turned down solidly the first bailout proposal, surprisingly to many. Subsequently, the original $700-billion bailout proposal quickly became a political Christmas tree, covered with bailout ornaments – tax cuts and a variety of bailouts for other past bad credit decisions (for example, $25 billion for bad car loans and billions more federal funding for Hurricane Katrina) – all designed to achieve the requisite number of votes. The bailout bill as passed had at least $140 billion of bailout “sweeteners” that benefited specific congressional districts (McClam 2008).
There appeared at this writing to be truly no natural or political limit to the expansion of “bailout thinking,” which totally denied or set aside the downside risk to expanded bailouts, or the “bailout bubble.” The fact of the matter is that the proponents of the bailout really could not be as confident as they seemed that the bailout would work as advertised, or even that the bailout will not make the country’s economic problems worse, which no one had even hinted at. The moral hazards the country will face in the future because of the current likely escalating growth in bailouts to an ever-expanding circle of economic sectors could be real and substantial, and those future problems could be captured in people’s current expectations about the future health of the country, thus undercutting the country’s economic vitality today, and worsening today’s financial mess. But then, Shiller’s “social contagion” in policy thinking seems to have taken hold, with the bailout becoming the proverbial “free lunch.” This future burden from bad decisions could throttle current economic incentives and, thus, the economic recovery in the short term, a point that the bailout advocates have never acknowledged at this point, to my knowledge.
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McKenzie, R.B. (2010). Problems with Behavioral Economics. In: Predictably Rational?. Springer, Berlin, Heidelberg. https://doi.org/10.1007/978-3-642-01586-1_10
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