Public policies, especially economic policies, tend to fall short of expectations due to one inescapable reality: their success depends on the actions of people. Because economics is a field, which traditionally bases all of its theories, models, and paradigms on the assumption that humans are “rational actors who make rationale economic decisions,” there is often a mismatch between theoretical expectations and reality. Given a large enough population, sound economic theories will be accurate over a long enough period of time. These criteria, however, make it very difficult to predict the behavior of individuals and small groups of individuals while limiting the real-world, real-time applications of economic models.
Psychologists, or at least behavioralists, fully recognize that animal and human behavior is based on immediate, versus long-term, consequences. In other words, individuals make perceived rational decisions based on what they personally feel is an appetitive or aversive consequence for a given decision or action. Planning, or the lack thereof, for the future is a consequence of whatever an individual can rationalizes, not the logical conclusion of sound economic calculations as traditional economic theory assumes. The field of economics is, however, changing to address its shortcomings. The 2017 Nobel Prize in economics, for example, has been awarded to Richard Thaler, a highly acclaimed behavioral economist who has had a major impact on his field and public policy.
Thaler’s work has explored and modeled the impact of limited rationality, social preferences, a lack of self-control, and risk aversion on economic decisions. Behavioral Economics broadly focuses on the impact of heuristics, i.e. overgeneralized rules of thumb, framing, i.e. the way people interpret all the information they encounter, and human-based market inefficiencies. As the hybrid child of economics and psychology, behavioral economics suffers from the same faults as the many fields of psychology. In psychology, there are many schools of thoughts based on many assumptions that take many different approaches to the study of human behavior, which is itself very diverse and complex. The reason economics is based on the rational actor assumption is that it helps simplify a very complex set of behavior.
Furthermore, the various schools of thoughts within the field of psychology range in nature from nonscientific philosophies, which have more in common with religion and other ideologies, to experimental sciences. The methodical approach and well-defined concepts of behavioralism, which has its own limitations, make it the most scientific in nature. That said, the field of psychological is useful, because it allows people to “intellectualize” or break down information into pieces that can be comprehend. To utilize psychology, and fields like behavioral economics, in real world situations, it is, therefore, often best to capitalize on approaches that help others communicate their thinking, not just the limited data available and the assumption-riddled research.
One valuable way of understanding it is to distinguish between between economically, emotionally, and socially motivated behavior. Decisions and actions based on emotional reactions and social pressure depend on an individual’s state of mind and the interests of those in the individual’s social circles. In contrast, economic behavior is the pursuit of an individual’s own interests. It is also the focus of behavioral economics. Unlike the traditional economist, the psychologist looking at economic behavior recognizes people both have perceived interests and perceive means of achieving their interests. Starting from an objective, near-omniscient perspective, the economist is able to identify the most beneficial arrangement for an individual and derive the most logical path to achieve an individuals interests. Like an evolutionary biologist looking back at millions to billions of years of history, the economist then attempts to match theory with practice.
This is why the economist can determine the most advantageous, or functional, decisions in various circumstances and determine what decisions a majority should make, i.e. survival of the fittest. They cannot, however, readily predict or explain dysfunctional behavior on behalf of individuals and groups. Recognizing individuals are subjective beings with highly limited knowledge, the psychologist realizes an individual’s perceived interests and perceived pursuit of their interests are determined by their personal history of reinforced and punished behavior. Psychologists can explain the individual mechanisms behind a dysfunctional, or seemingly irrational, decision, even if they struggle to develop universal models that can definitively identify what is the most advantageous behavior for an individual.
The challenge for the behavioral economist is to predict how people will change their economic behavior and change the economy based on public policy changes and changes in market conditions. The ability to understand the economy is important, which is why the field of economics has value. To understand why it works the way it does and how changes alter the way it works, however, is far more valuable. People like Richard Thaler have taken on this challenge. Their work is providing critical insights into how the human factor impacts the economy. For the private sector, the ability to make profit depends on the ability to predict the economic behavior of consumers. For government, the ability to cultivate a stable, prosperous economic environment and respond to emerging threats through sound economic policy depends on this as well.
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