Mainstreaming behavioral economics…

Profs. Beryl Chang and Fabrizio Ghisellin say we need to simplify behavioral economics:

At the moment, behavioural economics suffers from confusing definitions, unanswered questions and conceptual gaps that need to be filled. It is reminiscent of a person who needs a diet both for a detox and a weight loss.

We need a ‘vertical’ streamlining process that will:

  • Clarify core issues: What is the ‘correct’ definition of rationality? When an alleged bias, such as loss aversion, is found to be part of human nature as designed by evolutionary processes, can it still be considered a ‘distortion’?
  • Fill existing conceptual gaps: behavioural economics deals abundantly with biases, but how are expectations formed? Are expectations ‘rational’?
  • And most importantly, generate a tractable reduced form for behavioural economics models. Today we have hundreds of different behavioural factors. They should eventually be translated into a smaller set of primitive factors.

In order to establish behavioural economics’ status, we hardly need the ‘discovery’ of yet another behavioural bias. At this stage, we need parsimony and an effort to synthesise what already exists into a general mainstream model as an alternative to conventional models.

They cite an example from Mullainathan and Thaler:

As an example of the kind of work that should (and could) be done, consider again the quote by Mullainathan and Thaler (2001):

“The standard economic model of human behavior includes three unrealistic traits – unbounded rationality, unbounded willpower, and unbounded selfishness – all of which behavioral economics modifies.”

These three unrealistic traits have typically been dealt with by behavioural economics one at a time, each in isolation from the others, partly because the conceptual reference remains utility as defined in conventional economics (wealth maximisation).

But what if utility is associated instead with emotional wellbeing? Assume that I am an investor, and my utility function is such that it derives more from feeling good socially (in the family, with colleagues, and so on) than from wealth maximisation.

The investment implications of such a utility function are likely to generate what is considered the biased behaviour known as herding, by which I replicate the investment choices of people in my community. Would that be irrational? Not if I subscribed to Herbert Simon’s definition of rationality:

“Behaviour is rational in so far as it selects alternatives that are conductive to the achievement of the previously selected goals”.

Following this approach, the statement by Mullainathan and Thaler could be reformulated as: The economic model of human behaviour is based on a definition of rationality, which in turn is based on consistency between actions and goals. This is much more compact, much more tractable, and positive, rather than negative. This is what we need if behavioural economics is to become something more than a set of exceptions to the rule.

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