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John Cochrane On Thaler
See
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."
Here is a letter I had published in the Chronicle of Higher Education back in 2008:
"I enjoyed Evan R. Goldstein's "The New Paternalism" (The Chronicle
Review, May 9) about Richard H. Thaler and Cass R. Sunstein, authors of
Nudge. Who could disagree that "human perception is flawed," or that we
all have "cognitive limitations"? This suggests enacting policies that
"nudge" people in the right direction.
But it seems like a straw man is being used when Thaler and Sunstein
say that policy makers previously assumed that all people can think like
Albert Einstein and can exercise the patience of Mahatma Gandhi. Surely
no neoclassical economist would believe that. Even Milton Friedman, in
Capitalism and Freedom, said that "there is no avoiding the need for
some measure of paternalism." But he also said that the principle that
"some shall decide for others" is very troubling and that "there is no
formula that can tell us where to stop."
Coincidentally, Alan Wolfe summarized John Stuart Mill's view in the
same issue: "The purpose of liberty is not to give us what we want but
to help us grow so that we can best understand our wants" ("The
Forgotten Philosopher," The Chronicle Review). Let us hope that the "new
paternalism" does not end up stifling such human growth. In
understanding our wants, we get to know ourselves. If someone else is
always nudging us in the right direction, we will never figure anything
out on our own."
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