Summary
Rizzo and Whitman now devote two chapters to critiquing (a) the underlying empirics of behavorial economics, plus (b) the way behavioral economists market these empirics. In Chapter 4, RW go after “defective” preferences; in Chapter 5, they reconsider “biased” beliefs.
RW repeatedly stress the modesty of their project. They aren’t saying that behavioral economics is worthless, just oversold. If only behavioral economists had vetted their own work with the same (motivated?) skepticism they’ve honed for standard economics! RW take up this neglected task, and claim to “show that the preferences deemed better or more ‘true’ by paternalists are often just as questionable on behavioral grounds, if not more so.”
Chapter 4’s main applied topics are: (a) hyperbolic discounting, including preference reversals and intransitivities; (b) endowment effects, including loss aversion and status quo bias; (c) and poor affective forecasting (failure to correctly predict how outcomes will make you feel).
Some highlights:
1. RW argue that hyperbolic discounting could arise because of our subjective perception of time:
People do not necessarily perceive time in the way that the calendar or the number-line portrays it. When asked, “How long do you consider the duration between today and a day some distance in the future,” with the interval ranging from three months to thirty-six months, people answer in a nonlinear fashion. For example, while the time horizon from three months to one year grows 300 percent by calendar measure, it grows only 35 percent in subjective duration…
2. In any case, preference reversals for intertemporal choice are rather rare – and often in the opposite of the expected direction:
In recent research there have been experiments that elicit preferences by questioning participants over the passage of actual time, and not simply at a point in time as in the process just described. These are called “longitudinal” studies. A large majority of individuals do not actually switch over time: those who are patient with regard to the distant decision remain patient and those who are impatient remain impatient (Read et al. 2012). Relatedly, Halevy (2015) finds that only 10 percent of participants are actually time inconsistent in a longitudinal study. Furthermore, the ubiquity of impatient preference reversals is in doubt. The longitudinal experiments (Read et al. 2012; Sayman and Öncüler 2009) have found a very large number of shifts from SS to LL – that is, patient reversals – as the distant decision becomes more nearly immediate.12 In fact, in two experiments conducted by Read and coauthors (2012) the numbers of impatient and patient reversals were roughly equal.
3. Does time inconsistency actually hurt individuals? The evidence is thin, but RW discuss some fascinating results:
In [Berg et al.]’s own study of 881 participants, they find that time-inconsistent individuals earn substantially more than time-consistent ones across the forty time trade-off payoff options in the experiment. This is because the time-consistent individuals are, for whatever reason, consistently more impatient in the choices…
[…]
Therefore, if time inconsistency is to be deemed irrational in more than a presumptive neoclassical sense, the comparison cannot be relative to just any time-consistent agent. It must be with a suitably patient time-consistent agent. Impatience in whatever form can depress lifetime earnings or wealth. Why single out inconsistency as the problem?
4. When endowment effects matter, Willingness to Pay (WTP) is less than Willingness to Accept (WTA). Behavioral economists tend to want to treat WTP as the suspect measure. But this raises a host of issues. Case in point:
[A]dopting WTP rather than WTA as the appropriate norm for “true” preferences would mean abandoning the case for many paternalist interventions, such as new labor-friendly default rules that offer workers additional contractual benefits. The alleged superiority of such rules rests on the implicit assumption that WTA is the right valuation.
An exquisitely clever point:
[I]f status quo bias is the true explanation for the endowment effect, it casts doubt on the validity of paternalist nudges whose “sticking power” depends on it. Suppose a new default rule entitles workers to paid vacation time (presumably funded by lower wages). Now endowed with this new benefit, workers resist giving it up during contract negotiations. But why? Simply because the new rule is now the status quo. If status quo bias is indeed irrational, then the persistence of the new status quo offers no grounds for thinking the new rule is an improvement.
And another!
[T]he experimental evidence we do have is for an “instant endowment effect.” This means that the experimenters test for WTA–WTP gaps and reluctance to exchange within a few minutes after the subjects are given a mug or some other good (Ericson and Fuster 2014, 557). How these subjects react after they have possessed the good for some time (a day, week, month, or more) is unknown. Does the novelty of the gift wear off, or do they become more attached?
Chapter 5’s main applied topics are: (a) the functions of beliefs and learning; (b) violations of classical logic; (c) the conjunctive effect; (d) Bayes’ Rule, base-rate neglect, and belief revision; (e) availability bias; (f) salience; and (g) overconfidence. A few highlights:
1. Biased beliefs can offset confused preferences, or even other biased beliefs.
Varki (2009), among others, argues that optimistic illusions may have had adaptive value for early humans because it counterbalanced the fear of death and oblivion that came with the emergence of conscious foresight. In short, the “best” beliefs for attention, motivational, and even survival purposes may not be the most correct from the standpoint of truth.
2. Logical consistency is overrated:
From a pragmatic perspective, the case for limiting the role of logic is even stronger. It is uneconomic for the agent who wants to attain his goals efficiently to worry about the consistency of all of his beliefs.1 The inconsistency of an entire system of beliefs is likely to be vast.
Trying to make all your beliefs consistent is as foolish as trying to keep your house perfectly clean.
3. Experimental subjects often make “mistakes” because the experimenters expect the subjects to interpret all instructions literally. In real life, you’re not supposed to do so!
The behavior of the experimenters violates the expected norms of conversational interaction (Grice 1989). Among these norms is the maxim of relevance, which says that in a cooperative setting, people assume that their interlocutors present them with the information required for current purposes and no more.
4. In real life, people often neglect base rates because they should:
Consider the case of a doctor who takes a job in a new clinic… A significant number of her patients test positive for HIV. Now, if the doctor applied Bayes’ rule using base rates from the national population – where the fraction of people with HIV is small – she would have to conclude that most of these are false positives. Fortunately, the doctor is smarter than that… So she adjusts her priors away from the base rates, and thus concludes that many of the positive test results are probably true positives.
5. Availability bias doesn’t matter much when you have lots of first-hand experience:
[W]hen economics students and nursing students were asked to estimate the frequency of deaths from various causes in their own age cohorts, the whole picture changed – in fact, the bias vanished (Benjamin et al. 2001).39 The logic of this result is compelling. In a world of scarce resources, people have a tendency to learn what is in their interest to learn. The students, by and large, did not need to know population figures, but they did find it useful to have a decent idea of the hazards they actually face in their age groups.
6. The standard evidence of overconfidence is largely artifactual. People seem overconfident if you ask them their confidence question-by-question. But if you ask them for their overall accuracy, there is often no sign of overconfidence. Format matters.
What all this format dependence ultimately means for an understanding of “overconfidence” phenomena is unclear. This is because there is no good theory to guide us in determining which measures are most relevant to pragmatic concerns. In other words, we do not know which formats mirror the process by which real-world individuals evaluate their own knowledge and, most importantly, make decisions about significant matters.
Analysis
Chapters 4 and 5 are packed with good points. Behavioral economists should be more self-critical. There is considerable contrary empirical evidence they should take to heart. Most remarkably, RW manage to simultaneously provide a careful survey of the conventional view with insightful critique.
Yet ultimately, the main results of behavioral economics seem pretty solid to me. In particular:
1. The whole idea of time inconsistency is that people predictably change their minds. If this is not a strong sign of irrationality, what is? As I claimed last week, the time consistency literature doesn’t go far enough. Discounting the future purely because it is in the future should be classified as irrational even if you do so with perfect consistency.
2. The evidence RW present on the subjectivity of time is credible. However, we should interpret it as a further sign of irrationality rather than use it to rationalize time inconsistent choices.
3. RW flatly deny the irrationality of loss aversion (and, by extension, endowment effects):
Loss aversion would then seem to be a taste variable no different from the nonpecuniary aspects of labor that economics has recognized from early on. Loss-averse agents happen to attach value to changes in wealth, with greater value attached to a loss than to the equivalent gain.
I get where they’re coming from. I whole-heartedly love the kids I have, even though I recognize that I would have felt the same way about very different offspring. In common-sense terms, I see nothing “irrational” about this. On the other hand, I would deem it highly irrational to fall in love with the peaches I bought yesterday, knowing full-well that I would have felt the same love for whatever peaches I purchased. Can I formally model this distinction? No, but it seems dogmatic to deny the silliness of getting attached to a specific bag of peaches.
4. RW’s discussion of the “maxim of relevance” is thought-provoking. Still, how much does it really buy them? Suppose experimenters loudly and clearly announced, “Focus on the literal meaning of all our instructions.” Would that really lead anyone to avoid the conjunctive fallacy? Similarly, think about how long it took humans to apply the experimental method. Thinking in clear-cut, literal terms yields enormous gains – but the experimental method has only been around for a few centuries, and only a few people really understand it even today.
5. RW sternly remind us:
In a Bayesian framework, all probabilities are conditional. The priors are conditional on everything the agent believes as background knowledge. This knowledge may include base rates, but not exclusively. In the subjectivist version of Bayesianism, any prior probability would be allowable. The rationality of Bayes’ theorem begins after the agent has chosen his priors.
In most experiments, however, the descriptions are so austere that using any prior probability other than the base rates is bizarre. Suppose, for example, experimenters tell you that the balls in an urn are half blue, half green. Next they ask, “What is the probability that you draw a green ball?” Sure, you could say, “My prior probability says that experimenters always stack green balls on top, so the chance that the first ball I draw will be green is 100%.” Isn’t that absurd, though?
In a sense, RW accidentally show that behavioral economics sets the bar of rationality much too low. Rationality is actually a matter of substance, not form alone.
6. For availability bias and overconfidence, the reasonable prior is that they’re serious. Ponder all you’ve seen. Human beings overweight rare, vivid events. Human beings are overconfident and ubiquitous cognitive flaws. We should have believed this before any experimental evidence arrived, because daily life overwhelmingly affirms these patterns. And we should continue to believe these problems are severe even if the scientific evidence of these biases is fragile. So while RW do a fine job of exposing researchers’ overconfidence in their own research, we should only marginally change our minds about human psychology itself.
READER COMMENTS
Elijah
Jul 22 2020 at 7:37am
You said:
I fail to see why this is the case at the individual level. I could die of a heart attack tomorrow rendering all future consumption moot. Because I am only certain I will be able to consume in the present, some amount of discounting seems eminently reasonable.
Josh
Jul 22 2020 at 9:36am
The reasons for discounting money and consumption are numerous and real. There is inflation, economic growth and the declining marginal value of money, uncertainty about the future etc. The issue is that economists frequently include pure time preference (preferences for things that occur sooner for the mere fact that they do occur sooner, separate from the other things I listed.) into discount rates. That is controversial and what Bryan disagrees with in the post. For what it is worth, most philosophers find it unmotivated as well. “Discounting” is a loose term.
Philo
Jul 22 2020 at 1:27pm
Discounting some future state-of-affairs because it is uncertain is rational. Discounting it just because it is future is irrational.
Elijah
Jul 22 2020 at 1:43pm
Maybe I am missing some context on Bryan’s point, but the future is inherently uncertain in my view. Any decision about future utility involves the consideration that I may not be around at that horizon. Is there a way to get around this basic reality?
B K
Jul 23 2020 at 7:48am
Don’t the problems in philosophy of personal identity mean that discounting the future purely because its the future can be totally rational? Your future selves may not ultimately be ‘you’. They may be people very similar to you, like the person who is ‘you’ tomorrow may be slightly different than you now, but the person who is ‘you’ 50 years from now may be drastically different in nearly every way.
Discounting utility for other people probably isn’t irrational (consequentialists may call it immoral, but its probably not irrational), so one can imagine a rational discount rate for utility between persons being dependent on how much you identify with a person (compare how much you would value utility to a total stranger compared to your child or parents).
If there is no continuous ‘you’ across time, then you may very well not value the utility of the person who is ‘you’ 50 years from now as equally as you value yourself right now in the present moment. But you may value the utility of ‘you’ from tomorrow or a week from now very highly, perhaps equal to or maybe even greater than the utility of the present ‘you’.
Mario J Rizzo
Jul 24 2020 at 10:46am
BK: “If there is no continuous ‘you’ across time, then you may very well not value the utility of the person who is ‘you’ 50 years from now as equally as you value yourself right now in the present moment.”
This is a very difficult issue. I am currently thinking about what is means for the self to endure through time. In the multiple selves literature, as employed by some behavioral economists, each temporal self is modelled as if it were a separate person. This is convenient because it enables them to take forms of analysis that were created to deal with interpersonal relations and apply them to intrapersonal relations. (The analogy with externalities provided by the concept of “internalities” is a prime example.)
I think it is clear that if the selves are completely separate then discounting at a positive rate is rational and could be interpreted as our degree of “altruism.” Even in the intermediate case where we are partially the same as our future selves, the same basic analysis applies — although we might expect a lower rate of discount, ceteris paribus.
I should add here that I find the notion of discounting *utility* problematic. What is this “utility” that is being discounted? It seems to be an abstract feeling of something good (pleasure, happiness, satisfaction, etc.). But this is just a mental construct. It does not mean anything concrete. Our “happiness” is always linked to particular experiences (engagements with the world) in a given context. And it is these contextual factors that may cause us to discount. Anyway, I have no particular beef with using some form of utility discounting as a simple predictive construct. What will people do under certain circumstances? But I am quite suspicious of the idea of a *normative* use of discounting utility and, especially, at a zero rate. No one ever discounts pure utility because no one knows it outside of concrete goods.
Going back to the issue of the enduring self. I am fairly confident that the usual analysis of discrete selves treated analogously to different people is wrong. The idea of treating them as partially different but still discrete is just an ad hoc way of patching up the full separation view. I tend toward a view that the self is some complex of memory, current experience, and expectation. All of these elements affect each other. The complex self changes over time but not in discontinuous ways. It learns as expectations are not corroborated — both expectations about the world and about its own behavior. So I think of a learning and changing self — a self in disequilibrium or internal tension. As a consequence, I would not expect consistent on constant attitudes toward the future. Some of this is implicit in the book but most goes beyond it. I recommend two articles: (1) Rizzo, M., & Whitman, G. (2018). Rationality as a Process. Review of Behavioral Economics, 5(3-4), 201-219; (2) Rizzo, M. J. (2016). Behavioral economics and deficient willpower: Searching for akrasia. Geo. JL & Pub. Pol’y, 14, 789. These are really “ideas in process” in more than one sense.
Thank you for your comments.
SaveyourSelf
Jul 22 2020 at 10:11am
Escaping Paternalism is both a critique of interventionism and in particular interventionism justified by “behavioral economics.” I think the word, paternalism, is an inspired choice. It communicates much more information than a similar word like “interventionism”. On the other hand, I have deep problems with the way “behavioral economics” is interpreted in this book.
“Behaviorism, also known as behavioral psychology, is a theory of learning based on the idea that all behaviors are acquired through conditioning.” It is an entire field of study spawned by Pavlov’s dog experiments. The foundation of behavioral psychology is the simple observation that behaviors followed within 0-3 seconds are more likely to reoccur in the future and behaviors followed within 0-3 seconds by discomfort are less likely to reoccur in the future. Behavioral psychology, therefore, is the study of human behavior based on the realization that organisms respond to incentives. The fact that people respond to incentives fits quite nicely in standard economic models, in particular those of utility maximization. Thus a behavioral economist, by definition, would be and economist who models and studies the effects of incentives on rationing decisions made by economic agents. From a behavioral psychology perspective, the definition of “rational”, which gets much attention in Escaping Paternalism, would likely simply be, “responds to incentives”. Importantly, that is an observational, external judgment. What is more, that definition is a generality. As in, people generally respond to incentives in a somewhat predictable manner, at least in the long run.
The power of behavioral psychology is at least twofold. First, to the extent the axiom that people respond to incentives is true, it provides some predictability regarding how people will behave in the long run if the rewards and punishments in the environment are known. And, second, because the relationship is claimed as causal, the reverse should also be true—altering the environmental stimuli around people should result in a change in their behavior in the long run. It is that second application of behavioral psychology that Rizzo and Whitman call paternalism, at least when such changes to the environment are instigated through government policy and backed by coercion.
The problem with Escaping Paternalism is it treats behavioral economics as something other than a study of incentives and their effects on economic models. It treats behaviorism more like Freudian psychology, “which looks to unconscious drives to explain human behavior.” Thus the book includes extensive explorations of biases and logic relative to individual’s stated or implied desires and expectations. A major problem with the Freudian psychology approach is that Freudian models are poor predictors of individuals’ actual behaviors. Applying psychological drives to economic models will, therefore, also produce poor predictions. Applying the assumptions of behavioral psychology to economic models, on the other hand, will have some predictive power because it is demonstrable that people, on the whole, actually do respond to incentives.
I don’t blame Rizzo or Whitman for missing this important nuance. I get the impression they are dealing with the literature as it stands, not as it should stand based on a careful understanding of the definitions involved in the different branches of psychology. That being the case, much of their critique of the literature is actually a critique of the psychoanalytic approach. And that is old news. Studies of psychoanalysis in medicine are plentiful and, for the most part, say the same thing—it doesn’t work. It doesn’t work in models in medicine. It is not going to work in models of economics. What is likely to work, in contrast, is applying actual behavioral psychology to economic models. For example, if the benefits of smoking are experienced immediately but the costs experienced 30-50 years later in the form of lung cancer, lung scarring, heart attack, stroke, and death, does that mean the costs are not appropriately weighted by our brains because they only take into account rewards and punishments experienced within 0-3 seconds of an action? Are those dire costs ignored because they are outside that 3 second window of influence? And if they are ignored, does that lead people to smoke more than they would if they had experienced the costs at the same moment as the benefits? And is there a method of conveying those costs to people in a meaningful way at the moment of smoking such that they would make better decisions? And would they agree their decisions to stop smoking, avoid smoking, or smoke less is a better decision? That is behavioral economics. And to the extent that Escaping Paternalism deals with the power of incentives in economic models and economic modeling in general, I think it is a fantastic book. My worry, though, is that, by applying an inaccurate understanding of behaviorism and behavioral economics, they are essentially making a straw man argument—criticizing (justly) psychoanalytic economics but labeling it, instead, behavioral economics.
Mario J Rizzo
Jul 23 2020 at 9:05pm
Freudianism, as I understand it, is not at issue here. The literature we discuss is the behavioral — both in the hands of psychologists and economists. Whether there is some deep Freudianism in the behavioral literature is not something I am competent to discuss.
There may be good reason for people to avoid relationships with people who have very high rates of discount. Consider a promisor who has a very high rate. He may be satisfied to renege on some deal with me even if his business reputation gets ruined because that is in the future and the gain the now. I think Adam Smith discussed this. BUT this is not what begavioralists are getting at. They do not consider high rates “irrational” — only inconsistent rates are. Inconsistent rates can be high, low or something in between.
“Which is a worse problem overall: people discounting the future too much or not discounting the future enough? ” It depends. There is no “discounting in the air” — there is discounting with respect to particular things, at particular times and places. “Too much” or too little is a subjective judgment. Again, the issue is not the height of discounting but the inconsistency. Or , as I would prefer to say, “inconstancy.” What others think of your discounting may or may not be important. It depends on the context.
Daniel
Jul 22 2020 at 3:08pm
Loss aversion is not irrational in a meta-cognitive sense. People expect to keep what they have unless they choose to trade it or throw it away. Losing something that you expected to hold on to means having to revise your plans, which were made with the expectation of a certain amount of resources being available. Having to constantly readjust your expectations and plans is mentally taxing.
If you were planning to build a house tomorrow, is it rational to symmetrically weight the values of 100% more or 100% fewer bricks? It’s the same number of bricks with the same market price. If you faced a 50/50 probability of “double or nothing” on your bricks, is it reasonable to be indifferent?
Phil H
Jul 23 2020 at 6:51am
Huh. I was just about to agree with BC that loss aversion must be irrational, but this is a good point.
If the utility of money decreases with increasing wealth, then at any point, the utility loss involved in losing 100 bucks will in fact be slightly greater than the utility gain from gaining 100 bucks.
Whether this is enough to explain loss aversion as observed in real life, I don’t know, but it’s certainly an interesting point.
Jason Ford
Jul 22 2020 at 5:03pm
Which is a worse problem overall: people discounting the future too much or not discounting the future enough? A lot of people have trouble optimizing for the present and thus put a great deal of weight on the future. They sacrifice happiness in the present for the promise of happiness in the future. For many people, this makes sense: The pains of pregnancy are worth it for the joy of a child. if you want a career in the military, the few months in boot camp make a lot of sense even if you’re miserable for that brief time.
Consider, however, someone who spends 40 years on a job they hate because of the promise of a wonderful retirement. Many of these people would be better off if they perhaps took a lower-paying but more satisfying job in the present and thus accepted somewhat smaller retirement savings in the future.
What’s interesting—and RW’s book alludes to this point—is that people tend to react negatively toward others who discount the future too much but often react positively toward those who don’t discount the future enough.
Consider the following two examples:
Someone smokes and loses the last five years of their life because of it.
After college, someone goes into a graduate school program they hate and they have a miserable existence for five to ten years of life. They do so with the hope that the rest of their career will be happier because of their present sacrifice.
Others will probably condemn the first person as being foolish and praise the second person for being persistent. But if the second person doesn’t realize an increase in happiness in their career and life after their sacrifice, one could argue it’s a bigger tragedy than the smoker in example #1 faced.
Do people have a consistent bias when judging the actions of others? If so, that would indicate a great risk to paternalistic policies.
Incidentally, my rule of advice for anyone wondering whether they should continue an arduous experience for promises of future gains is to consider what percentage of the experience they hate. 100 percent? 50 percent? People I know who hated boot camp with a passion never reenlisted. People I know who hated academic graduate school with a passion never went on to long-term academic careers. On the other hand, people who said of such experiences something along of the lines of “well, it’s a challenge, of course, and some days were really tough, but I liked parts of it” are the ones who often went on to flourishing careers.
Mario J Rizzo
Jul 23 2020 at 9:18pm
Jason, I apologize for inadvertently including a reply to your comments in the second and third paragraphs to my reply to SaveyourSelf. And similarly I apologize to SaveyourSelf.
Jason Ford
Jul 23 2020 at 9:42pm
No problem! I greatly appreciate your insights and wisdom wherever I find it! Thanks so much for being part of this. Your point helped me understand this complex issue.
Glen Whitman
Jul 25 2020 at 12:27am
These are good insights, John. It’s true that people tend to be asymmetrical in their judgments of others’ time discounting. In general, people tend to exhibit a “social desirability bias” that in most cases goes in exactly the direction you would imagine. I’m not sure it makes sense to regard this as a genuine “bias” as opposed to a preference, but it is certainly a preference about *other* people’s behavior, which is quite different from a preference about one’s own behavior. The fact that I want other people to behave a certain way is not the same as wanting myself to behave that way. In chapter 8 of the book, we talk about how moralistic attitudes can tend to skew public policy in a paternalistic direction.
Glen Whitman
Jul 25 2020 at 12:28am
I meant Jason, not John. My apologies.
Jason Ford
Jul 25 2020 at 11:41pm
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