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Behavioral Economics?

February 12, 2001

As reported in The New York Times [link requires registration] an emerging and relatively novel school of economic theorists is now making a pitch for more government regulation of the economy.  In particular, Professors David Laibson of Harvard University and Sendhil Mullainathan of MIT are making some waves with their idea that economic science ought to be merged with psychology so as to gain a better understanding of markets. 

As The Times tells it, "Behavioral economists help to explain how booms persist while busts, like the one that the United States may now be entering, are difficult to reverse."  This is accomplished by factoring in certain psychological elements of human behavior in the prediction of market trends.

Now that the US economy is experiencing a slowdown, we find some scholars who are "explaining it" with a view that makes room for certain pessimistic aspects of human behavior. For example, the scholars' "research sheds light on why identity - the traits people assign to themselves and to others - plays a huge and often damaging role in the economy." So how we see ourselves often has a bearing on what we will do.  When this is generalized over the entire population, various conclusions about the economy may be derived. 

As the report continues, "If the behaviorists are correct, shares of companies on the New York Stock Exchange are overvalued and the Dow Jones industrial average has further to fall."  Well, maybe.

But the crucial point is not this, for hardly anyone has ever believed that human psychology plays no role in economic behavior.  What is exciting The New York Times is that "if the behaviorists prevail, the mainstream view of a rational, self-regulating economy may well be amended and policies adopted to control irrational, sometimes destructive behavior. Twenty-five years of deregulation might lose its appeal." The implication is that mainstream economic social scientists have been enthusiastic defenders of the free market, laissez-faire idea of how markets ought to operate. 

While some of them have been, others have not and it is they who have prevailed in the majority of public policy debates concerning how the US economy ought to be structured.

The idea in mainstream economics has been that, indeed, people would behave rationally and pursue their own interests - meaning, basically, follow their own goals - if only they had adequate information and if the cost of making decisions were negligible.  Since, however, information is imperfect and costs of making changes in market behavior are no negligible, many mainstream public policy oriented economists have also advocated government interference with the market.  They have assumed that governments can rectify the lack of information and steer the economy in the direction it would go if only folks had enough knowledge of the facts.

This, in turn, has generated a great deal of government regulation, tinkering with the money supply and related government interventions in the operations of the market. The new bunch have in fact mainly changed the explanation for what are often called market imperfections.  Instead of lack of full information, now it is supposed to be various psychological factors about market agents that explains why markets - meaning, of course, human beings - do not behave perfectly rationally, predictably.  They have a negative self-image, indulge in "irrational exuberance" or whatever. Suffice it to say, whatever the theoretical economists are saying, the bulk of public policy theorists will recommend - you guessed it - some kind of government regulation. 

As Professor Ernest van den Haag argues in the Fall 2000 issue of The Intercollegiate Studies Review, intellectuals have a proclivity toward undermining the free market and injecting theirs so as to supplement Adam Smith's invisible hand.  They are terribly taken with their own wisdom, as they have been since the time Plato established the crucial role of the Philosopher King in his Republic.

In fact, neither lack of information nor the facts of a volatile human psychology justify government meddling with the economy. First, the government is no better informed about the crucial - mainly local - facts of the economy than are the rest of us. 

Second, there is absolutely no reason to think that the understanding of economic life needs to "be amended and policies adopted to control irrational, sometimes destructive behavior."  Government officials are by no stretch of the imagination less prone to act irrationally - one need but check the daily news to verify that fact.  They offer no promise of help at all!

The New York Times may have an ideological preference to encourage the idea that "Twenty-five years of deregulation might lose its appeal."  But nothing in behaviorists economics gives any justification for embracing the idea of a government regulated economy.  It is simply yet another excuse for championing the placing of some people in charge of others when it comes to how resources should be managed.
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Tibor R. Machan teaches business ethics at Chapman University and is an adjunct scholar of the Ludwig von Mises Institute in Auburn, Alabama. See his Mises.org Archive or send him MAIL.


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