On Behavioral Economics

Scott Sumner had a wonderful post on Econlog last week. He was responding to an Atlantic article lamenting behavioral economics not taking a prominent role in introductory economics courses.

Scott’s key point was that many insights in behavioral economics are intuitive, while important economic concepts are not. In a world in which there is so much misunderstanding about trade, migration, the price mechanism and much else, the real value added of introductory economics comes in giving students the toolkit to “think like an economist.” Hence, it makes sense to spend more time teaching standard micro over human heuristics and biases.

I couldn’t agree more. But there is perhaps another point Scott could have made.

Though behavioral economics is interesting and can have beneficial applications to our own life and in policy areas where clear defaults must be set, leaning so heavily on human irrationality in introductory courses risks behavioral economics becoming a kind of “Market Failure version 2.”

What I mean by that is that, absent a thorough treatment in courses with applications about trade-offs, unintended consequences, or case studies, the risk of throwing out basic economics so early in favor of declaring “humans are irrational” is that policy debates become even more heavily weighted towards unthinking intervention to “correct” for our supposed biases.

As with market failure, the undercurrent of lots of behavioral economic contributions – the throwaway implications – are that government intervention is needed to fix the biases of behavioral consumers. Intervention is often thought implicitly pareto improving over non-intervention (helping behavioral consumers without harming others.) But there are at least six reasons why this may not be the case (even if we see what we consider evidence of behavioralism):

1)      Behavioral consumers (BCs) might themselves respond “behaviorally” to interventions or nudges designed to help them, potentially leaving them worse off (e.g. drug prohibition, payday loan restrictions, some smart disclosures on credit costs).

2)      Seemingly behavioral decision-makers may, in fact, be acting rationally, especially given the costs associated with accessing information or switching (e.g. in credit card markets and in relation to fuel economy).

3)      Interventions to correct for irrational decision-making by BCs may impose substantial costs on others, maybe even failing a reasonable overall welfare evaluation (e.g. autoenrollment often comes with lower default savings rates, caps on payday loan interest rates can reduce services for non-BCs too).

4)      Developing policies to correct the biases of BCs may distract attention from policy approaches that are welfare-improving for all groups (e.g. opt-out organ donation vs. organ markets, environmental behavioral approaches vs. more direct tax incentives).

5)      Interventions can increase the complexity of economic decision making or worsen inaccurate perceptions of risk (e.g. disclosure laws, overdraft protection).

6)      Interventions can undermine the “ecological rationality” of the market, dampening incentives to learn from mistakes or for entrepreneurs to deliver new protections for BCs.

Yes, behavioral economics is an important body of economic knowledge. But putting irrationality front and center of very introductory economic courses would both constrain time from teaching more difficult economic concepts, and worsen economic policy debates absent teaching the difficulties associated with correcting perceived biases through interventions or nudges.