Sunday, June 28, 2015

The Economics of George Orwell

Diane Coyle has a nice review of Richard Thaler's new book, Misbehaving. Diane's review is, for the most part, appropriately laudatory. But she does voice a concern that I share. Here is Diane...
"Behavioural economics is now one of the most popular areas of the subject, ... but the new embrace by economists makes me uneasy. This is not just because of the well-known debate about paternalism (as discussed by Gilles St Paul in The Tyranny of Utility or Julian LeGrand and Bill New in Government Paternalism: Nanny State or helpful Friend?) It is because the sight of economists delighting in a new tool to engineer society is alarming –"
I agree. Here is a quote from my review of Akerlof and Shiller's 2009 book Animal Spirits, another piece that draws on behavioural economics to engage in social engineering. Akerlof and Shiller want to replace rational choice with behavioural economics. And here is what they mean by that...

Behavioural economists assert that what makes individuals truly happy can be different from what they in fact choose to do. In Akerlof and Shiller’s words, ‘...capitalism...does not automatically produce what people really need; it produces what they think they need...’ (p. 26). 
To a classical liberal like me, this is a scary proposition since it gives a licence to someone else, someone who knows my true preferences, to act on my behalf. Is this the government or the church? Both institutions have claimed that right in the past, with disturbing outcomes.
The idea that the government knows my preference better than I do is a little too Orwellian for me. 

I went on to criticize Akerlof and Shiller for tearing down too much of classical theory and failing to replace it with a credible alternative. You can read my full review here

In my view, we can understand all of the failures of classical macroeconomics without giving up on rational choice. Heres what I said in 2009

I personally find it much more credible to believe that markets may sometimes misallocate resources and that this misallocation is directed by self-fulfilling crises of confidence. There is an existing agenda (part of neo- classical economics) that integrates psychology with economics by constructing economic models in which market fundamentals do not uniquely determine outcomes. In these models, it is the self-fulfilling beliefs of market participants that fill the gap. In my view, this idea of a self-fulfilling belief is a more appropriate candidate for what one should mean by animal spirits than the ... alternative meanings proposed by the authors. This narrower established definition is already widely used by a large existing body of researchers.
Here is a link to a survey paper that discusses this alternative approach.


  1. Hi Roger,

    You always present a refreshing blend of ideas, though I think some of these are a little over the top. Your post is entitled, "The Economics of George Orwell," which suggests some kind of 1984 regime. And yet, the most consequential thing to come out of behavioral economics has probably been its success in changing the "default option" for employee retirement accounts from a zero contribution to a modest contribution. “If you don't want to save, just say no”; as opposed to, “if you want to save, just say yes.” Not really Orwell’s 1984, but I’m open to persuasion.

    The policymakers who advocated changing the "default option" from don't save to save (which is discussed in Thaler's book) weren't thinking that people wrongly prefer "fun in their 50s and penury in their 70s" to "a bit less fun now and a more comfort later." Rather, they did some research and concluded that many middle-aged workers either 1) have made no forecast of their income in retirement or 2) are more optimistic than, say, 95% of impartial experts would be given the same data.

    Changing the default option for retirement contributions from "no save" to "save" lowers the cost of latter, and raises the cost of the former, by the amount of effort it takes to reject the default option. Suppose this minimal change in the cost of "saving" vs. "not saving" results in, say, 20% of non-savers becoming savers. Now, you really have to ask yourself whether the kind of rationality involved in this case, where a minimal change in cost results in a significant change of behavior, is same kind of rationality Lucas and Sargent have in mind.

    On the question of whether Capitalism produces the things we actually want or only the things we think we want, let me simply note that if it's more profitable to create wants than to satisfy "autonomous" wants, well, I needn't say more. If you watch some TV commercials, you'll quickly notice that luxury car makers are selling status goods (watch John Hamm's commercials for Cadillac, which are not, I think, an isolated case). The trouble is that if utility functions include an item for my-status-in-relation-to-others, then the optimizing choices that follow will very likely produce different outcomes than the ones celebrated by the New Classical School.

    I'm also sympathetic to "classical liberalism," but you must remember that John Stuart Mill drew a distinction between “pushpin and poetry,” and he didn’t regard women’s “preferences” for housework as a “natural preference,” but as a cultural artifact.

    Finally, you insist that “we can understand all of the failures of classical macroeconomics without giving up on rational choice.” Question for you, “can we understand all the failures of classical macroeconomics without giving up both rational choice and the premise that all markets clear?” If anyone can make a persuasive case for the “yes” answer, I believe you can.

    1. Greg
      There are some deep and interesting issues involved in the debate over behavioral economics. The most interesting issue is whether we should continue to accept the neoclassical assumption that preferences are fixed. Let's go with that assumption for a moment.

      If preferences are fixed, then we face a second question. What form do they take? For a long time, macroeconomists assumed that people maximize the discounted present value of a time and state separable von Neumann Morgenstern expected utility function. The narrow version of behavioral economics asserts that that assumption is wrong; but people are still utility maximizers.

      Finance economists have already taken up that challenge. The dominant view in finance theory is that people maximize the present discounted value of a subclass of preferences first formalized by Epstein and Zin. These preferences drop one of the key assumptions of Von-Neumann Morgenstern; that the date at which information is revealed is irrelevant. There are also more radical possibilities. The original version of the Epstein Zin assumption also allows for dropping a more fundamental assumption, called the independence axiom.

      My point here, is that neoclassical economics can absorb the criticisms of the behaviorists without a major shift in its underlying assumptions. The 'anomalies' pointed out by psychologists are completely consistent with maximizing behavior, as long as we do not impose any assumptions on the form of the utility function defined over goods that are dated and indexed by state of nature.

      There is a deeper, more fundamental critique. If we assert that the form of the utility function is influenced by 'persuasion', then we lose the intellectual foundation for much of welfare economics. That is a much more interesting project that requires us to rethink what we mean by individualism.

      On your last point. Yes we can and should maintain rational expectations and market clearing: but that requires a radical change in the equilibrium concept.

  2. Nice post. Behavioral economists don't take into account that the general public doesn't want decisions made for them and that freedom to make our own choices is what makes people truly happy

    1. "freedom to make our own choices is what makes people truly happy"

      What concrete evidence would be sufficient for you to change your mind about that?

    2. Pfleishmoney
      Thank: I do of course agree

    3. Roger, "None?".... So you're saying that you're not open to belief revision based on objective evidence?

      I can think of objective evidence that would be convincing that this claim is NOT generally true of all humans: we could simply ask them "Is freedom to make your own choices what makes you truly happy?" If ANY of them respond "No" you're saying we should ignore them? Lol.


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