Dear Reader,
If you have examined the debate between Tim and myself over the past few weeks, you must have realized that, in fact, Tim and I agree on many things. Particularly, that our respective perspectives are not the only useful ones (although we each believe that our individual perspective is more useful than the other's).
However, one major disagreement that Tim and I do have is about the weight of the evidence that supports the other's position. In general, Tim doesn't see how the results from lab experiments translate to the "real world." In essence, he does not believe that these lab-based irrationalities become full-fledged irrationalities outside of the lab. I, on the other hand don't see how the results from many of the statistical analyses he and others report necessarily demonstrate that people are rational. I do see how these studies show that people react to incentives in a way that is compatible with economic theory, and that they are sensitive to the general structure of the economic environment (and psychologists and behavioral economists would say that people should react to these), but I don't see the evidence that people react to these in an optimal way--in a rational way. I hope that Tim can explain this to me in our next exchange, but in the meantime I want to answer the two questions he posed for me in his last post.
At the end of his YouTube video (and by the way Tim has one other great video on YouTube) Tim posed the following two questions:
- How can we take the insights from behavioral economics and apply them to economics?
- How can we the apply insights from behavioral economics to make real changes in the real world?
Let me try to give my perspective on both of these questions. In terms of applying the insights from behavioral economics to economics: I don't see this as the goal of behavioral economics, I don't expect that we will ever be able to successfully achieve this integration and in fact, I don't want to "fix" economics. I think economics is beautiful, interesting, and that it has provided us with many useful insights. So where do my objections to standard economics come from? It comes from Tim's second question about using insights to change the world. Here I think that relying blindly on standard economics is dangerous, and behavioral economics has oodles to contribute.
When it comes to making changes in the world, such as laws, policies, or even business and individual practices, standard economics assumes/claims that it can provide the correct and complete answer. The answer! After all if people are rational then what else is there to take into consideration? This is what welfare analysis and the Chicago school of economics is all about. This is also what bothers me about economics, and what I would like to change. If it were up to me, economics would remain as it is in terms of an academic discipline, but we would consider other perspectives, including behavioral economics, when making recommendations for implementing changes in the world. Moreover, I want us to take to heart one of the main lessons of behavioral economics--that our intuitions are not always correct. By doing so, instead of just implementing a policy based on our intuition, we should first experimentally test our ideas to ensure that we are getting what we expect.
To better understand the role that behavioral economics can play in the design of everyday life consider the following analogy: When we design physical products such as phones, cars, and pens, we carefully consider our physical limitations. We don't design products for Superman, and by taking our physical limitations into account we are able to design better products, and live a better life. Why not do the same for products that rely on our cognitive abilities such as mortgages, health insurance, and saving plans? Why don't we learn to recognize our cognitive limitations and by doing so, design products that better fit our actual ability? This is the promise of behavioral economics--once we recognize our cognitive limitations we can design the world in such a way that it will not demand from us the type of computations that we simply cannot do.
So Tim, if we want to live in a world with less financial crisis, better health, and higher savings, then we must apply insights from behavioral economics to make changes in the real world.
Irrationally yours,
Dan