Some of the most interesting economic research being undertaken these days draws on the disciplines of cognitive science and psychology, and these two books are highly readable contributions to behavioural economics and neuroeconomics respectively. The interest arises out of this research at several levels. One is the pure entertainment of reading about experimental results which amusingly demonstrate the lack of rationality which so often affects human decision-taking – and conversely, the pure economic rationality demonstrated in other experiments by rats or monkeys. Sometimes one gets the impression the economy would be far better run by our furry friends. A second, and more serious, source of interest is the relevance of the different types of experimental result for policy design. More on this later.
Dan Ariely’s book describes the conclusions he draws from the range of psychological experiments which have been the focus of his research as an economist based at MIT. Some of the examples he gives have become familiar, for example the way the presence of an irrelevant alternative (such as a very expensive bottle of wine on a restaurant menu) can affect our choice between two realistic alternatives (leading us to choose the more expensive of these, rather than the cheapest). Other examples concern the framing of choices, anchoring effects (even when the anchor is random such as the turn of a roulette wheel or a social security number), loss aversion, or the lack of independence between supply and demand (because of the way retailers can shape demand through how they present their prices, or through promotions and advertising). However, there are plenty of less familiar results as well. One striking section discusses the importance of memory for elasticities of demand. Ariely’s argument is that our sensitivity to price changes is determined by our memory of what we paid in the past and our desire for the psychological coherence of past and current decisions.
The author’s discussions of practical implications for policy – whether for a business making pricing decisions or for a government – are the best feature of this book. However, he draws conclusions which are pretty much diametrically opposed to those derived by Michael Shermer from his description of recent result in neuroeconomics. Neuroeconomics monitors brain activity of participants in experiments directly through MRI scans, rather than indirectly through observing behaviour. On the face of it, the results of both approaches are very similar. I was particularly struck by a description of the way certain brands, such as Coca Cola, stimulate dopamine delivery to certain parts of the brain and rewire our neurons. The author quotes Pascal: “The heart has its reasons, of which reason knows nothing” – but for ‘heart’, read ‘brain’.
However, where Ariely concludes that the non-rationality of much decision-making points away from reliance on market outcomes – how can they be claimed to have any strong welfare properties? – and towards specific paternalistic policies, Shermer concludes that the experimental results shed no new light on the old trade-off between individual freedom and collective outcomes. He will concede only that there is a role for ‘libertarian paternalism’, the shaping of incentives drawing on what we know about the human brain; but, in the main, human nature does not undermine the merits of markets.
The contrast between these two interesting books reveals the challenge for advocates of behavioural or neuroeconomics: when should we abandon the powerful, systematic results of conventional economics in favour of the accumulation of behavioural insights? Some behavioural conclusions seem unquestionable. For instance, it is widely accepted that opt-out savings schemes will increase savings rates as compared with opt-in schemes. But equally conventional economic models successfully predict behaviour in many other contexts. As yet, we know next to nothing about when conventional models based on rational agents apply, and when instead to apply what we have learned about irrational choices.
Diane Coyle
Enlightenment Economics |