Behavioral economics under attack.

Stories from the Financial Times. 
Jan. 30 2011 7:00 AM

Why We Do What We Do

Behavioral economics under attack.

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"Nudge."

Behavioral economics has never been hotter. It's not just the success of books such as Nudge, Predictably Irrational, and Basic Instincts, but the political influence of the field: One of Nudge's authors, Cass Sunstein, runs the Office of Information and Regulatory Affairs for Barack Obama, and his co-author Richard Thaler has been advising David Cameron's new Behavioral Insight Team, based in the Cabinet Office.

A simple summary of behavioral economics——I've borrowed this one from the Guardian—is that it is the study of "how people actually make decisions rather than how the classic economic models say they make them." But this approach is now under attack, from Gerd Gigerenzer, a psychologist, and Nathan Berg, an economist, and they argue that behavioral economics is not nearly as realistic as its boosters claim. While it does study what decisions we make, the very last thing it does is study how we make them—and as a result it is even more wedded to silly accounts of the way human beings think than its neoclassical rival.

Neoclassical economics has often relied on the "as if" defense, published in 1953 by Milton Friedman, who argued that while people don't actually solve complex neoclassical optimization problems in real time, they still behave as if they do, somehow making rational decisions thanks to a combination of experience and cognitive short-cuts. But economists have been strikingly incurious about what those cognitive short-cuts actually are. Gigerenzer is not.

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Behavioral economists point out cases in which our decisions don't match neoclassical theory, and thus the "as if" defense fails. But Gigerenzer and Berg complain that behavioral economists have retained the neoclassical incuriosity about why we act as we do. Instead, they have modified the neoclassical model until its predictions fit our observed choices, and then fallen back on the same "as if" story.

Consider the human response to risk. Neoclassical economics says that we act as if considering all possible outcomes, figuring out the probability and utility of each outcome, multiplying the probabilities with the utilities, and maximizing expected utility. Clearly we do not in fact do this—nor do we act as if we do.

Behavioral economics offers prospect theory instead, which gives more weight to losses than gains and provides a better fit for the choices observed in the laboratory. But, say Berg and Gigerenzer, it is even more unrealistic as a description of the decision-making progress, because it still requires weighing up every possible outcome, but then deploys even harder sums to produce a decision. It may describe what we choose, but not how we choose.

Gigerenzer prefers to look for actual decision processes. Take the simple act of catching a ball in flight. The spirit of neoclassical economics would say that people act "as if" swiftly calculating the parabolic arc of the ball. The spirit of behavioral economics would explain dropped catches with references to some systematic errors in the way we perform that calculation. But in fact, ball-catchers use a cognitive short-cut called the "gaze heuristic," running forward and back while keeping constant the angle of sight up to the ball as it descends. No amount of "nudging" towards faster differential calculus will help prevent dropped catches.

This is tough on behavioral economists, because in order to be taken seriously by other economists they have had to play the optimizing game. Switching to Gigerenzer's rules would mean the end of economics as we know it.

Yet the critique is sobering. If behavioral economists do not really understand why we do what we do, there are surely limits and dangers to the project of nudging us to do it better.

This article originally appeared in Financial Times. Click here to read more coverage from the Weekend FT.

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