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Where to Now for Behavioural Economics?

New Scientist has an article that features Ernst Fehr and experimental behavioural economics. It’s a good article that covers a good idea. However, we need to be aware of a few points. The first is the context in which the behavioural paradigm has risen to prominence.

One explanation, perhaps now the dominant one, for the global financial crisis relies on the irrationality of economic agents in the market place, a notion contrary to the standard conceptions of economic theory, such as “animal spirits” and the “madness of crowds” etc.

I don’t like these behavioural explanations.

Systemic risk should be seen as an externality. The players on Wall Street were quite rational; it was their task, an institutionally mandated task, to pursue short term profit maximisation. This they did on a grand scale. Shifting the explanation towards such matters as “animal spirits”, in my opinion, is a way of hiding these underlying institutional imperatives and thereby the underlying rational basis for the crisis.

That’s why we see a lot of discussion in the mainstream about behavioural economics. The constitution of humanity itself becomes in a sense responsible for the crisis, for the irrational behaviour exhibited by Wall Street is an intrinsic part of human nature.

That’s too cute by half.

It’s also very important because it leads to reform measures that largely leave the financial power structure in place. Whatever we might think of Simon Johnson’s too overt focus on “too big to fail”, leaving in place this power structure matters if we seek to prevent future crises. The behavioural explanation helps, because it tends to obscure the power structure.

That is not a reflection on behavioural economics itself. It is a reflection on how it is being used in the current context. Behavioural economics boasts good experimental results that do tell us something quite profound about human economic behaviour. There seems to be a link between notions of fairness and justice and economic behaviour. That result is important, not least because it undermines the crass conception of man that underlies standard economic theory.

But this then brings in a second qualm we might have about behavioural economics. Consider the article linked above

Such responses, Fehr suspects, arise from a deep-seated resistance in many people to the idea that something as apparently complex and unique to humans as our social instincts could find a relatively simple basis in chemical changes in brain activity….

…Fehr’s most recent work focuses on so-called neuroeconomics, which explores the roots of our social instincts and emotions. That our precious moral values may ultimately be biologically based upsets some people, Fehr admits, but science is science. “I’m quite happy with whatever I find,” he says. “You have to accept what the data tell you”

As a committed card carrying naturalist I cannot but agree with Fehr’s sentiments. However, a few issues need to be raised. I speak of the increasing shift to neuroeconomics. The idea here is to look at neuronal and brain activity as experimental subjects perform the economic games that Fehr constructs. That’s OK, but very, very limited when what we are after are rich naturalisitic explanations that account for human behaviour.

I think what Fehr and others are doing is spot on, but they should be channelling this at the cognitive not neuronal level. We should be speaking of a “cognitive economics” rather more than we do of a “neuronal economics.”

A good way of looking at this is with reference to the computer. We have software and we have hardware. What Fehr is doing is like looking at what lights up and how electrons move in the Central Processing Unit and other hardware components of the computer as it is running various types of software.

His emphasis however should be on the software. That means focusing on the cognitive level.

Economic theory, like social and moral theory more broadly, should be a part of cognitive science. A settled, experimentally well supported, theory of economic cognition will be the theory of economics. A theory of economics will not be a theory of the economy. We must be “inward bound.”

So Fehr is on the right track, but the emphasis on the hardware could be better redirected to the software i.e. cognitive level.

In a way we would be going back to the way the great David Hume conceived of what in his day was called “moral philosophy.”

I think Hume was right. Since his day we have been riding on the wrong side of the track, and not just in economics.

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Categories: Economic Theory
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