Tuesday, May 17, 2011

"As if behavioral economics" - flaw 2: "Neglecting the process is always wrong"

I´m writing through some issues raised by the paper As-if behavioral economics. It´s a sprawling paper with some very good arguments and some… not so good ones. I´m hoping to get through both good and bad this week.

The paper opens with a reasonable goal - evaluating whether behavioral economics has achieved its (sometimes) stated goal of improved empirical realism:

Insofar as the goal of replacing these idealized assumptions with more realistic ones accurately summarizes the behavioral economics program, we can attempt to evaluate its success by assessing the extent to which empirical realism has been achieved.

This is an OK idea for a paper: Some tradition has aimed to achieve X, and we want to see how successful they´ve been in this. However, Berg and Gigerenzer also imply in much of the paper that this aim (empirical realism in the assumed decision making process) is always an important aim, and that any economic theory that fails in this regard is wrong. They call behavioral economics a “repair program” for the flaws of neoclassical “rational choice” economics, and have a long section on how “empirical realism” was sold, bought and re-sold (i.e. they had it in mainstream economics, lost it due to Pareto and his friends, started getting it back with behavioral economics, but then lost it as these strayed from the path):

perhaps after discovering that the easiest path toward broader acceptance into the mainstream was to put forward slightly modified neoclassical models based on constrained optimization, the behavioral economics program shed its ambition to empirically describe psychological process, adopting Friedman‘s as-if doctrine.

So why is this empirically accurate process description so important in Berg and Gigerenzer´s view? The reason seems to be that they give different implications for how we can aid and improve human choice. After an (interesting) explanation of how ball-players catch balls through a simple heuristic (“run so that the ball up in the air is at a constant angle to you”) rather than through “intuitive” application of Newtonian mechanics, they write:

Thus, process and as-if models make distinct predictions (e.g., running in a pattern that keeps the angle between the player and ball fixed versus running directly toward the ball and waiting for it under the spot where it will land; and being able to point to the landing spot) and lead to distinct policy implications about interventions, or designing new institutions, to aid and improve human performance.

This is a good and valid argument in its relevant context but it surely fails to apply to all types of economics. It seems particularly relevant as a criticism of welfare economics, which often involves nothing more substantial than the argument that “all choices are always welfare-maximizing, so any new choice option that is chosen improved welfare.” However, not all of economics is (or should be) dealing with this.

To my mind, at least part of what economics is about is the study of interactions: What happens when many people interact in a given institutional context (market, negotiation or whatever) and there are mechanisms (prices, norms, whatever) that introduce various positive and negative feedback effects? To study this you need a method, and one such method is to create a “toy world” where “toy people” act in a way that captures relevant behavioral regularities in real people. If people tend to buy less of a good when the prices rises, then you need a toy person who responds like this. If you think it may be important that people in some market want to buy the same thing as some other person or group (e.g. fashion), then you need a toy person who exhibits this response. However, you don´t need a psychologically realistic model of a person because all you want (in this context) is to see what the outcome of various interaction effects would be.

Sometimes (usually, I would guess), economists will do this in a closed, simple mathematical model with utility maximizing agents and profit maximizing firms. However, since utility maximizing agents can behave in almost any conceivable way (just change their preferences and introduce state variables as in Becker´s extended utility approach), this “rationality postulate” doesn´t really constrain the kinds of behavior you can study that much. You are likely more constrained by the expectations of other economists that the toy people and firms in the model should have “model consistent expectations” (i.e., they should expect the consequences of their actions that actually occur), and that it is important and interesting to study the subtle mechanisms that are created when these toy agents consequently marginally adjust their behavior for all sorts of reasons (Hotelling´s rule, the green paradox, smokers responding to expectations of future tax hikes by smoking less today, etc.).

Another way of doing this is agent based modelling, where you create small “ant people” in a computer program and let them interact based on simple rules. You do this again and again and see what “typically happens” and so on. This is related to evolutionary game theory where the shares of “agents” living by some simple strategy grows or shrinks depending on the average payoff it produces given the current mix of strategies in the population.

Anyway - though none of these ways of studying interaction are sufficient to credibly examine the social world around us, they don´t seem completely valueless. Granted - some (many?) economists do take the welfare of the toy people a bit too seriously as a proxy for real world consumer welfare, and some seem to think that tweaking a toy person to act like a real person means that the real person “is similar” pscyhologically to the toy person. But these are errors in interpretation and use, not in the method as such.

In short: If you want to show how simple behavioral patterns at the individual level could combine to create various higher-level patterns in groups and markets and other contexts, then what you want is the simplest, most tractable representation of those behavior patterns. Psychological realism is irrelevant - because your argument is “several people interacting in this specific way, each of whom exhibit this simple behavior patterns, would generate these and these aggregate patterns and would - in aggregate - respond in this and this way to various external shocks in the environment”.

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