## Monday, May 23, 2011

### “As-if behavioral economics” – puzzle: How can an as-if theory be normative?

Although I enjoyed it, I’ve spent the last few days on this blog noting some issues where I disagree with the paper ”As-if behavioral economics”. Today I want to reflect on something they touch upon without fully resolving.

Some economists argue that their assumptions cant be questioned because their models are “as-if” - they are merely tools that allow you to successfully predict market data, and the realism of the assumptions is irrelevant. If that is so - why are there so many norms and criteria apart from prediction that a “good” model should fulfill? And why - if they are mere “as-if” prediction-generating machines - are the neoclassical models held up as a normative ideal we should strive to aim for in our own decision making?

Berg and Gigerenzer touch on this puzzle in a couple of places. For one thing, two of the points they emphasize is that

• behavioral economics suffers from subscribing to the as-if method, which ignores the realism of the assumptions (similarity of model to the real-world mechanism/process), and that
• behavioral economics has grown to see behavioral “heuristics” as “biases” that violate the normatively correct neoclassical rules

Later, they also note that the

the normative interpretation of deviations as mistakes does not follow from an empirical investigation linking deviations to negative outcomes. The empirical investigation is limited to testing whether behavior conforms to a neoclassical normative ideal.

Consider - if the model is nothing but a black box that spits out impressive predictions:

• Why is it important that agents inside the model are optimizing and rational?
• Why is it important that the agents are well informed?
• Why is it important that preferences are “standard” (thus generating well behaved utility functions and nice indifference curves)?
• Why does it matter whether or not your prediction is based on an “equilibrium” inside the model?
• How can the utility and welfare effects of a model imply anything about real peoples welfare?

This is particularly odd since, as far as I can tell, rational optimizers can behave in all sorts of ways depending on their preferences and the choice problem they face. When assumptionsdon’t need to be supported by empirical evidence, this means that any observable behavior pattern can be modelled as rational behavior given some hypothetical choice problem. If you don't believe me, ask yourself whether you can describe any specific behavior pattern that could not be the result of rational choice. Note that this has to be a pattern, that is to say that it has to be stated in terms of observables without reference to “underlying” but non-observable preferences. You can refer to prices, consumption goods, patterns across time and between goods, etc., and using such categories I dont think it is possible to find any “non-rationalizable consumption pattern” that would be accepted as that by most economists.

So what?

Well - if anything can be rationalized by such a theory, and assumptions can be as unrealistic as you want - then any stable pattern can be “explained” by such a “theory.” In actuality, though, you would just be describing the pattern using a different format (the “rational choice model” format). Which raises the question of why it is so important to use that format.

After all - if all you want to do is to predict, then it shouldnt matter whether you assumed people to behave “as if” they were maximizers or not. Any model would be just as good if it predicted equally well.

Also - if the rational choice model is just a format - a way of describing behavior by identifying some “story” that would generate it - then why should it have normative power?

This is extra puzzling if you consider the old-school style Chicago-economics that sees all behavior as rational. If this is so, then there is no normative power beyond “do whatever you do cause that’s what’s optimal.” Taken at face value, this view of the world would also lead to apathy: There’s

no point in criticizing politicians or engaging with the world, because everyone knows what they’re doing and are doing what’s best for themselves. Politicians – that’s public choice. Regulators - theyve been captured by special interests. Economists? Well - I guess their doings could be made endogenous as well.

I don’t have an answer to this puzzle - but I wonder if it may have something to do with politics. By both claiming that everyone is rational  and that this rationality represents the normative ideal for action, then a world of unfettered markets seems like a good idea: It would be a world of informed, self-interested people generating huge benefits to each other through their selfish doings. If so - then behavioral economics becomes the “interventionist” response: Yes - a neoclassical paradise would be great – however, unfortunately, we’re just evolved apes with lots of biases and flaws. With a little carefully designed policy, though, we can regulate and nudge people in the direction of the truly rational agent.

Does anyone know of a survey that would make it possible to correlate policy views and politics with economistsattitudes towards behavioral and old-school rational choice theory?