The case for be­havioural eco­nom­ics

Down to Earth - - CONTENTS -

Will be­havioural eco­nom­ics shape pub­lic pol­icy now that one of its ad­vo­cates has won the No­bel Prize?

Main­stream eco­nom­ics as­sumes that hu­mans take into ac­count all the avail­able knowl­edge to make de­ci­sions and thus iden­ti­fies them as ra­tio­nal de­ci­sion-mak­ers. All of its the­o­ries are based on this core as­sump­tion. How­ever, econ­o­mists like Daniel Kah­ne­man and Richard H Thaler have long chal­lenged this par­a­digm, both winning the No­bel Prize in eco­nom­ics for their dis­sent. Kah­ne­man won the award in 2002 for in­te­grat­ing psy­cho­log­i­cal prin­ci­ples into eco­nomic the­ory and Thaler's award was an­nounced by the No­bel Com­mit­tee on Oc­to­ber 9, 2017 for "his con­tri­bu­tions to be­havioural eco­nom­ics".

Eco­nomic thinkers ap­pro­pri­at­ing be­havioural eco­nom­ics say hu­mans are ir­ra­tional and that poli­cies need to be de­signed in a way that they choose to make ra­tio­nal de­ci­sions. Some main­stream econ­o­mists though con­sider be­havioural eco­nom­ics as a quirky field and do not re­late to it. There are also some from within the field, like econ­o­mists Robert Sug­den and Nathan Berg, who have ques­tioned the em­pir­i­cal and eth­i­cal ground­ing of Thaler's work.

Now as the No­bel Com­mit­tee has recog­nised Thaler's work, many econ­o­mists, in­clud­ing Kah­ne­man, have wel­comed this shift in global at­ti­tude to­wards be­havioural eco­nom­ics.

AK­SHIT SAN­GOMLA speaks to three ex­perts to dis­cuss the sig­nif­i­cance of be­havioural eco­nom­ics and its im­pli­ca­tions for cre­at­ing ef­fec­tive pub­lic pol­icy

"What other eco­nom­ics is there?"

THE 2017 No­bel Prize for Richard H Thaler is a sig­nif­i­cant mo­ment in eco­nom­ics. Neo-clas­si­cal eco­nom­ics as­sumes un­bounded ra­tio­nal­ity and emo­tion­less de­lib­er­a­tion. Be­havioural eco­nom­ics uses an ex­plic­itly eco­nomic frame­work, yet bor­rows freely from psy­chol­ogy, so­ci­ol­ogy and neu­ro­science. Its ex­plana­tory power is vastly su­pe­rior to any cur­rently avail­able al­ter­na­tive.

Thaler used “loss aver­sion” (losses bite 2.5 times as com­pared to the ela­tion from equiv­a­lent gains) to ex­plain the fol­low­ing two im­por­tant puzzles. First, the mere own­er­ship of an ob­ject in­creases the value to the owner (en­dow­ment ef­fect); part­ing with the ob­ject trig­gers loss aver­sion. This ex­plains why hu­mans and an­i­mals fight ag­gres­sively to de­fend their re­spec­tive ter­ri­to­ries.

Sec­ond, the re­turn on eq­ui­ties rel­a­tive to bonds is too high, even af­ter ac­count­ing for the ex­tra risk on eq­ui­ties (eq­uity pre­mium puzzle). Thaler showed that loss aver­sion causes the down­side move­ment in fluc­tu­at­ing eq­uity prices to be mag­ni­fied 2.5 times, re­quir­ing a pre­mium rel­a­tive to bonds. In 1980s, Thaler did ex­per­i­ments with Daniel Kah­ne­man which showed that hu­mans have so­cial pref­er­ences that also take ac­count of fair­ness con­cerns.

In a set of col­umns ti­tled “Anom­alies” (of the neo-clas­si­cal model) in the Jour­nal of Eco­nomic Per­spec­tives, Thaler pop­u­larised be­havioural eco­nom­ics. He showed that when peo­ple make choices over time, losses are dis­counted less than gains as are larger out­comes rel­a­tive to smaller out­comes. He also showed that when bid­ders bid in auc­tions for an ob­ject with un­cer­tain costs, then the bid­der who es­ti­mates the low­est cost, bids the high­est, but an un­pleas­ant win­ner’s curse awaits the win­ner.

In a path break­ing idea, Thaler showed that peo­ple have men­tal ac­counts across which money is not fun­gi­ble (men­tal ac­count­ing). Fur­ther, peo­ple are averse to men­tal ac­counts go­ing in red (net neg­a­tive bal­ance). Hence sunk costs, by push­ing men­tal ac­counts into red can in­flu­ence be­hav­iour; un­der neo-clas­si­cal eco­nom­ics sunk costs don’t mat­ter. Thaler in­tro­duced emo­tions and self-con­trol is­sues into eco­nomic mod­els by mod­el­ling hu­man de­ci­sions as a game be­tween a long-run plan­ner try­ing to con­trol a se­ries of short-run do­ers in his plan­ner-doer frame­work. This can ex­plain ad­dic­tions, in­ad­e­quate sav­ings and pro­cras­ti­na­tion.

Fi­nally, in his most re­cent work with Cass Sun­stein of Har­vard, well de­scribed in their book Nudge, they have bro­ken new ground in wel­fare eco­nom­ics. Their idea—lib­er­tar­ian pa­ter­nal­ism—gives a gen­tle nudge to ra­tio­nal peo­ple to im­prove their wel­fare, yet has no ef­fect on fully-ra­tio­nal peo­ple. Ex­am­ples of nudges are de­fault op­tions, such as opt-in or opt-out, which have had a mas­sive ef­fect on sav­ings, pen­sions, and or­gan do­na­tions.

Thaler’s recog­ni­tion with the No­bel should fi­nally eclipse the fic­tional crea­tures, Econs, in neo-clas­si­cal eco­nom­ics and, usher a new era of a eclec­tic and em­pir­i­cally-founded science of eco­nom­ics based on be­havioural eco­nom­ics.

"Every­thing else is not al­ways equal"

CETERIS PARIBUS" or kev­ery­thing else is equaly is the uni­ver­sal as­sump­tion in eco­nomic the­o­ries. For so­ci­ol­o­gists and psy­chol­o­gists, Thaler’s No­bel is a mo­ment of glory, for it em­pha­sises why eco­nom­ics is be­com­ing more khu­many with in­cor­po­ra­tion of psy­cho­log­i­cal and so­ci­o­log­i­cal con­sid­er­a­tions.

How­ever, does nudg­ing al­ways work in de­vel­op­ing coun­tries? Nudge the­ory presents us with be­havioural in­ter­ven­tions that are ben­e­fi­cial. Econ­o­mists ar­gue that peo­ple choose the most con­ve­nient op­tion than what may be kwis­esty to them, thereby suc­cumb­ing to ir­ra­tional temp­ta­tions. This premise may ex­plain the be­havioural in­er­tia ex­pe­ri­enced with Swachh Bharat Mis­sion, where chang­ing mind­sets be­came the re­cent zeit­geist sup­ple­ment­ing mak­ing toi­lets.

How­ever, ka one size fits ally cen­tralised ap­pli­ca­tion of nudge may go against the very idea of a bot­tom up de­cen­tralised par­a­digm, which the nudge es­pouses— that of en­abling in­di­vid­u­als.

A case in point to over­haul­ing pub­lic pol­icy dis­sem­i­na­tion was the an­nul­ment of the Plan­ning Com­mis­sion in 2015, and res­ur­rec­tion of de­cen­tralised prin­ci­ples of kco­op­er­a­tive fed­er­al­ismy through the niti Aayog. The think tank was formed with a vi­sion to lend au­ton­omy to states. How­ever, it in­sti­tuted a knudge unity in col­lab­o­ra­tion with Bill and Melinda Gates Foun­da­tion later, to pro­pose solutions to be­havioural im­ped­i­ments en­coun­tered in gov­ern­ment schemes.

kIn­flu­enc­ingy be­hav­iour by propos­ing solutions, so that com­mu­ni­ties steer to­wards di­rected out­comes is not demo­cratic per­sua­sion, rather akin to co­er­cion and man­u­fac­tur­ing con­sent.

In­ter­ven­tions guised as nudg­ing re­quire ef­fec­tive sup­ple­men­ta­tion of ef­forts with ad­e­quate so­cial, cul­tural and po­lit­i­cal where­withal. Such holistic ap­proach at­tempts at min­imis­ing bi­na­ries be­tween kplan­nersy and kben­e­fi­cia­riesy. Lim­ited ap­pli­ca­tion of klib­er­tar­ian pa­ter­nal­ismy where peo­ple are not de­nied a choice, yet nudged in a di­rec­tion may, how­ever, re­sult in chore­ographed out­comes to ful­fil tar­gets, with­out any re­gard for the au­ton­omy of an in­di­vid­ual.

For ex­am­ple, the sud­den change in­duced by declar­ing 86 per cent cur­rency null and void last Novem­ber, to grav­i­tate to­wards a cash­less so­ci­ety, while pe­nal­is­ing those with un­ac­count­able cash, caused grave dis­com­fort to ru­ral and tribal pop­u­la­tions.

While the in­tent of this scheme was noble, a sud­den ex­pec­ta­tion in be­havioural change re­sulted in a com­plete break­down of ecosys­tems. kDigi­tis­ing be­hav­iour,y by en­cour­ag­ing peo­ple to use ke-mon­eyy, re­quired deeper em­pa­thy with peo­ple’s ag­o­nies; un­der­stand­ing the el­derly’s plight, dif­fer­ently-abled’s hard­ships and poor’s marginal­i­sa­tion. Ef­fec­tive im­ple­men­ta­tion in this case first re­quired cre­ation of crit­i­cal in­fra­struc­ture and aware­ness on use of dig­i­tal pay­ments. Such kIn­di­an­i­sa­tion of nudgey re­sulted in a catas­tro­phe with rip­ple ef­fects paralysing the un­or­gan­ised sec­tor that ac­counts for over 90 per cent of our work­force.

A suc­cess­ful ex­am­ple of nudge by the gov­ern­ment is PM Ujjwala Yo­jana through which bpl house­holds switch from fire­wood to

SANJIT DHAMI Pro­fes­sor of Eco­nom­ics at the Univer­sity of Le­ices­ter and a Fel­low of CESinfo, Mu­nich

SWASTI PACHAURI

so­cial sec­tor pro­fes­sional. Was a Prime Min­is­ter's Ru­ral Devel­op­ment Fel­low dur­ing 2012-2014

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