Homo economicus or homo paleas?

Or at least that's how Google translate renders "straw man."

Dick Thaler is in the news, with a long review of his book in the Wall Street Journal  and a thoughtful opinion piece in the New York Times, earning plaudits from Greg Mankiw no less.

The pieces are nice reference points to think about just where psychological economics is. (That's a better adjective than "behavioral" since we are all students of behavior.)

Bottom line: People do a lot of nutty things. But when you raise the price of tomatoes, they buy fewer tomatoes, just as if utility maximizers had walked into the grocery store.

Homo paleas

Dick spends the first half of his precious space in the New York Times and much of the WSJ review complaining about homo economicus, the dispassionate rational maximizer of economic theory.

Economists discount any factors that would not influence the thinking of a rational person

Econs do not have passions; they are cold-blooded optimizers

This is a straw man, and we all know it. As the joke goes, physics studies massless elephants on frictionless sandpaper. All sciences and engineering make simplifying assumptions appropriate to the problem at hand. If you want to figure out the effect of prices on tomato demand, the absurdly simplified rational maximizer approach gives a darn good answer. If you want to figure out where to put the signs advertising a tomato sale, or what color to draw them, let me suggest some psychology.

To jump from the fact that economists often study simplified models focusing on "rational" decision making, to say that economists uniformly deny that any other principle is useful for understanding any human behavior is absurd. And where in rational maximizing does it state that rational maximizers have no feelings about what they're doing? The experience of rational maximization carries immense feeling.

And even if we are all wrong, that doesn't make Thaler right.

One could just as easily make fun of psychologists and sociologists for ignoring the rationality of much human decision-making, and price incentives in particular. Gary Becker made a splendid career out of that fact.  We could easily write parallel opeds saying all of psychlogy is wrong because they omit the fact that sometimes people do in fact add two and two to get four. But "rationalists" respect logic and their reader's intelligence too much to do that: Psychologists' omissions and simplifications likewise do not invalidate their observations about other aspects of behavior.

Stories vs. achievements

Dick tells good stories. Of 20 paragraphs in the New York Times piece, Dick spends 6 on how his students were happier by rebasing exams to 137 points. Just happier, there is no actual behavior here other than a reduction in "grumbling." Then 5 more paragraphs of stories, like why do non-economist spouses want presents on anniversaries.

Only on paragraph 16 do we get a real observation about real behavior: Employers have found that people tend to take the default retirement plan, so if that default plan includes more saving, people are likely to save more. And that this incentive works better than some complex tax deduction that even economics professors often can't figure out. One might complain that it shouldn't take a PhD in psychology to figure this out, but peace, it's a good observation.

Paragraph 19 has a second real-world observation: The Obama administration chose to send taxpayers a $100 per month extra rather than a lump sum $1200, in an effort to nudge the taxpayers to spend it rather than pay down debt.  This one is also concrete, but he doesn't give us any evidence that it actually worked as claimed.  More deeply, is psychological economics about changing taxpayers' behavior or about selling programs to government officials?

Most of the Wall Street Journal review passes along Thaler's of complaining about how people resisted his early ideas. Really, now, complaining about being ignored and mistreated is a bit unseemly for a Distinguished Service professor with a multiple-group low-teaching appointment at the very University of Chicago he derides, partner in an  asset management company running $3 billion dollars, recipient of numerous awards including AEA vice president,  and so on.

Note that the inflammatory quotes:  “pure heresy” "blood boiling” "Chicago School’s libertarian beliefs" are his. "This was `treacherous, inflammatory territory,' he writes." He writes.  An objective history of behavioral finance this is not. And news flash, we ask sharp questions at Fama's seminars too.

The nudge for saving experience is good and solid. But the skeptical reader, who does not sing in the choir,  wonders: you've been at it three decades, and this is all you've got?

Decisions

Actually, no, and it's a shame Dick spent all this bandwidth on straw men, stories, and whining about his early reception. Psychological insights are quite useful for helping people to make more rational decisions.

This may surprise some blog readers, but I'm actually quite a "behavioralist," in my hobby life as a competition soaring pilot. We read a lot of sports psychology, and it makes a big difference. When pilots are low over inhospitable terrain in a glider, we are prey to all sorts of unhelpful emotions. "Darn why can't I fly anymore" is common; self-pity combined with ego defense. We train by visualizing a healthy set of emotions, a mental patter, as well as the actual series of decisions that must be made quickly. Better racing performance and better safety demonstrably result.

Psychology has a lot to say about how people make quick decisions in environments of information overload and scarce time.  Traditional economics is not really at fault for assuming "rationality" whatever that may mean. Traditional economics ignores information gathering and processing costs, because they are usually second-order.  Homo economicus got devoured by a lion while working out the dynamic program of how fast to run away.

Behavioral marketing, for example, is a cornerstone of the business school curriculum. I presume Dick's class "Managerial decision making" (syllabus sadly not available) covers a lot of how to use psychology to become more rational. Behavioral finance is excellent marketing for active investment strategies, that's for sure.

Cuteonomics?

When it gets to economics, though -- market outcomes, not individual decisions --  a common complaint is that "behavioral" approaches study small-potatoes effects. OK, some asset might have a price 10 basis points off. OK, Dick knows how to rebase exams to get a bit better teaching ratings. OK, so your non-economist spouse wants roses on Valentine's day. But really, in the big picture of growth, unemployment, inequality, climate -- you name it -- has this risen past cuteonomics? How do I use psychology to study the practical problems of everyday economics, say How much does progressive taxation hinder innovation and growth; How do I separate the risk premium from expected inflation in reading long-term bonds; How much carbon would a tax reduce, and so on?

That's an interesting debate. We could have it. We should have it. There are good points on both sides. Too bad Dick chose not to address it at all.

That is why “economic models make a lot of bad predictions”: some small and trivial, some monumental and devastating.  

says the Wall Street Journal. Too bad it does not list a single "monumental and devastating" prediction, made wrong by conventional economics, and convincingly made by psychological economics. I underline prediction: explanations after the fact ("there was a 'bubble' which you guys can't explain) which could go either way don't count.

Libertarian Paternalism

You know why the Times loves this stuff.

One article directly attacked the “core principle underlying the Chicago School’s libertarian beliefs,” namely consumer sovereignty: “the notion that people make good choices, and certainly better choices than anyone else could make for them.” By empirically demonstrating that consumers often do precisely the opposite, because rationality and self-control are bounded by human perceptual distortions, their paper undercut this principle. This was “treacherous, inflammatory territory,”

The first is flatly untrue. The case for the free market is not that each individual's choices are perfect. The case for the free market is long and sorry experience that government bureuacracies are pretty awful at making choices for people. "Empirically demonstrating" that some people do silly things does not empirically demonstrate that other people, organized into the US regulatory agencies, can make better choices for them. This is another simple failure of basic logic.

And psychological, social-psychological, sociological, anthropological, and sociological study of bureaucracies and regulatory agencies, trying to understand their manifest "irrationality," rather than just bemoan it as libertarians tend to do, ought to be a tremendously interesting inquiry. Where is behavioral public choice? (More in a previous post.)

(And accusing your colleagues of "beliefs" and viewing a paper as "treacherous" is ungracious at least. The Chicago school's prime belief, if there is one, is to let data speak, and hire quality and impact no matter what the answers. That's why that very Chicago school hired him.  Attacking motivations of those who disagree with you is not particularly scientific or "rational," though it is common behavior, especially at the Times. )

The hard nut: Government bureaucracies are staffed by the same homo psychologicus that makes bad private decisions. Except that social psychology is full of lessons ("groupthink" for example) on just how people, organized into committees, not subject to the discipline of competition, make truly awful decisions. And if you want stories of awful bureaucratic decisions, just open the pages of the Wall Street Journal, or the Cato or Hoover webpages.

Let's go back to that great success, the Obama administration's choice to send taxpayers a $100 per month extra rather than a lump sum $1200, in an effort to nudge the taxpayers to spend it rather than pay down debt.  Hmm, is getting the average consumer to go down to Walmart and buy a bunch of stuff they don't need, rather than pay down some debt, put off foreclosure or car reposession, such a great idea? Didn't the last paragraph just tell us how effective enrollment defaults are at getting people to increase savings? Along with a host of other Federal incentives like IRAs and 401(k)s? Just how infinitely rational is all this nudging?

There is a little offering here:

No matter how often they added that bureaucrats are Humans, with their own biases, their critics wouldn’t listen, even when Mr. Sunstein kept repeating that they were not pro-paternalism but rather “anti-anti-paternalism.”

This critic has been listening a lot, and not hearing or seeing any serious psychological study of the perfect rationality of government bureaucracies.

The central problem with Libertarian Paternalism as an alternative to Homo Economicus, is ubi est pater? Where is this hyper-rational Pater who will guide things for us better than the admittedly shoddy job we often do for our selves, and the somewhat less shoddy job that private institutions designed to help us make decisions can do?

The WSJ article takes up the issue

“Could we use behavioral economics to make the world a better place? And could we do so without confirming the deeply held suspicions of our biggest critics: that we were closet socialists, if not communists, who wanted to replace markets with bureaucrats?” Yes, he argues, and yes. Because people make predictable errors, we can create policies and rules that lower the error rate, whether it has to do with reducing driving accidents, getting men who use public urinals to aim better or enticing people to save for retirement—and do it in a way that makes people themselves happier with the results.

"We." Well, at least it is better than the usual passive, "people can be made better off." But just who is this "we, " and how did that "we" avoid all the chaos coming from federal bureaucracies trying to regulate behavior?

The problem, Mr. Thaler argues, is that although economists “hold a virtual monopoly” on giving policy advice, ...

Ah, the benevolent bureaucrat is just getting bad advice. This isn't socialism or communism. It is aristocratism; us the bien-pensant experts, immune from behaviorism and over emotional decision-making (a trait not terribly on display in these articles) can guide the benighted masses, if only the government would listen to us.

Always just over the hill

One would think that after 30 years, one would be looking back at a long string of solid successes. But despite 30 years of trying, both pieces keep promising a golden future, just over the next hill.

By injecting economics with “good psychology and other social sciences” and by including real people in economic theory, economists will improve predictions of human behavior,

Any day now. Well, keep trying. And I'll keep listening. I hope 30 years from now there is a string of solid successes to report, and less  straw men, antagonist-vilification, and funny classroom stories.