In: Uncategorized1 Oct 2012
This Perspective column was first published in today’s edition of Fund Strategy.
It is hard to imagine many things more annoying than someone who thinks their ideas are deep and original when in reality they are banal and derivative. Purveyors of behavioural economics generally fit the bill.
Although behavioural economics has several high profile exponents, their pitches are remarkably similar. Typically they start by noting that mainstream economics assumes that people behave rationally. They point out that it models human behaviour by examining how rational people react to forces such as supply and demand.
The next step is to observe, as if it is a great insight, that people do not always behave rationally. Several examples are given, usually from psychological studies, to show that individuals have many cognitive biases.
Such observations are the basis for the introduction of auto-enrolment into work-based pension schemes. The idea is that far more people will choose not to opt out of such schemes rather than actively to opt in. In the world of personal finance, as in many other areas, inertia rules.
Often the behaviouralists use the metaphors of Mr Spock from Star Trek and Homer Simpson to illustrate their point. Economists, they say, assume that people behave like Spock: in a logical, calculating manner. In reality most humans are more like Homer Simpson: driven by emotion and irrational impulses.
Many best-selling books have been sold and careers have been made on the basis of such arguments. For example, Nudge: Improving Decisions about Health, Wealth, and Happiness (2008) helped bring fame to its authors Cass Sunstein and Richard Thaler.
It also brought them into positions of influence. Sunstein, a law professor, became a senior official in the Obama administration while Thaler, a finance academic, has advised David Cameron. Their books is one of several which uses the Spock-Simpson analogy to make its point.
There are many flaws in the Nudge argument, and a poor knowledge of Star Trek is the least important, but worth noting: Anyone who has watched the original series of Star Trek should know that Spock is half human and half Vulcan: he is torn between his logical Vulcan side and his emotional human side.
Many episodes of the science fiction series feature this tension between Spock’s logic and his emotion. Perhaps Thaler and Sunstein’s own cognitive biases caused them to miss this point. Indeed it is arguable that one reason Spock emphasises his logical side so much is to compensate for his vulnerability to human emotions.
In any case the idea that everyone behaves logically all the time, like some sort of calculating machine, is a caricature. Only the most crass economist, and admittedly there are some around, would argue such a thing. The more common argument is that rationality is a reasonable working assumption for those who want to construct models of how the economy works.
As it happens the behaviouralists are far too quick to accuse people of being irrational. Take the argument about retirement provision as an example. It is possible to make an entirely rational case for not saving. Many people are unlikely to be able to save enough to enjoy a comfortable retirement. Saving also involves inherent uncertainties such as the possibility of poor investment returns and dying before retirement.
Under such circumstances individuals might rationally decide it is better to make the most of their limited resources in the present rather than wait for an uncertain future. It might not be the conclusion the pensions industry wants to hear but that does not necessarily make it irrational.
At its heart, the discussion of rationality is not about economics. Indeed it arguably predates the emergence of the discipline by about two centuries.
From the mid-seventeenth century to the late eighteenth century Enlightenment thinkers emphasised the human capacity for reason. Their argument was not that everyone always behaved rationally but that reason gave human beings the capacity to reshape the world for the better. It was also rationality that gave humanity the ability to understand the world.
Adam Smith, often wrongly described as an economist, was a central figure in this trend. His The Wealth of Nations (1776) was an attempt to apply the rational principles of the Enlightenment to the material world. But he was a professor of logic and moral philosophy rather than economics. It was only in the second half of the nineteenth century that economics emerged as a disciple.
The Enlightenment was followed by the romantic reaction of the counter-Enlightenment from the end of the eighteenth century onwards. In broad terms the romantics rejected the possibility of attempting to understand and reshape the world through the application of reason.
In many respects today’s behaviouralists promote crude versions of romantic thinking. They imagine they are capable of understanding the world but they believe the rest of us, with our apparently Homer Simpson like dumbness, cannot.
Instead of trying to reshape the world for the better the behaviouralists’ main project is to manipulate our behaviour. Not only do they reject reason but they have created an elitist justification for interfering in our lives.
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