Misbehavioral Economics?

May 2001 -- A new school of economic thought, called "behavioral economics," is beginning to take hold in much of America's academic community. One measure of the movement's growth is a bibliography of the field by Matthew Rabin: it comprises more than two thousand "significant" articles and books. Another measure of growth is the number of behavioralists (as they are called) who have been hired by top schools, including the University of Chicago, Yale, Harvard, M.I. T., Stanford, and the University of California-Berkeley.

Recently, to mark the field's coming of age, the New York Times has run two feature-length articles on the discipline. Unfortunately, the growing acceptance of behavioral economics could lead to a host of unintended political consequences, such as laws banning actions judged—not harmful—but merely irrational.

What is behavioral economics? The catch-phrase explanation is that it focuses on the area where psychology and economics overlap. Thus, current topics in the field include people's seemingly irrational aversion to certain types of risks; this is an area where Rabin is developing new models. More specific questions in behavioral economics include: Why do consumers shop for hours to save pennies and then make snap decisions on big-ticket items? And: Why do people accumulate large sums of credit-card debt when more sensible borrowing options are available? Or again: How do addiction and self-control affect economic decisions? But, at present, applications of behavioral economics seem to be most prevalent in finance: already, prominent behaviorialists such as the University of Chicago's Richard Thaler are developing plans to help individuals increase their retirement account savings.

Undoubtedly, this work will help expand the discipline of economics. Yet it is not utterly original; behavioral economics has roots in many other branches of the field, especially game theory and certain aspects of Public Choice theory. Many citations in Rabin's mammoth bibliography refer to the works of the renowned neoclassical economist Kenneth Arrow; game theorist Barry J. Nalebuff; and a plethora of other figures in game theory. Though some of John Maynard Keynes's major works are included, The General Theory of Employment, Interest, and Money is missing, even though it echoes one sentiment found among the behavioralists: that a certain "herd mentality" often causes people to make irrational decisions in investing, purchasing large-ticket items, or whatnot. Also, the works of many major Austrians and Public Choice theorists are conspicuous by their absence; after all, both schools share with the behavioralists an intellectual grounding in psychology and many common concerns as to how economics and human behavior ought to be understood.

Thus, one begins to wonder: The idea that human psychology interacts with economic actions is not new. So, what is all the fuss about?

Perhaps one motive behind the publicity given to behavioral economics can be found in the far-reaching policy prescriptions it suggests to journalists. "If the behaviorists prevail," says the Times, "the mainstream view of a rational, self-regulating economy may well be amended and policies adopted to control irrational, sometimes destructive behavior." Such policy prescriptions, the Times suggests, would include maintaining regulations in certain industries in order to protect man from his so-called irrational actions. And following this line of logic, one can imagine such policies as more regulations on the stock market (to curb investors' impulses); greater government controls on alcohol, tobacco, and other drugs (to lower addiction rates); and the development of a tax code that is even more pitted with incentives and disincentives (to guide Americans into proper spending and investment behavior).

Of course, all schools of economics—from the Keynesians to the Austrians—have a notion of how the government ought to involve itself in economic activities. But what they generally agree upon is that, at the individual level, most people are better able to recognize their preferences and act to attain them than any government official, however benign and benevolent. And therein lies what is worrisome about behavioral economics. Though the behavioralists themselves are cautious about basing public policy on their theories, politicians will not be. If some men act in a way that the behavioralists argue is irrational—as in the case of succumbing to certain temptations or plunging into foolhardy investment strategies—politicians will feel justified in having government infantilize all citizens by subjecting them to regulations designed to protect the few from their own misbehavior.

This article was originally published in the May 2001 issue of Navigator magazine, The Atlas Society precursor to The New Individualist.

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