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Fudenberg on Behavioral Economics

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Drew Fudenberg [2] has a superb, constructively critical review of some recent work in behavioral economics [3].  It appears in the September 2006 issue of the Journal of Economic Literature [4].  In particular, it’s a review of a collection of articles gathered under the title Advances in Behavioral Economics [5] (2003).

My sense is that the findings of behavioral economists are important.  If individuals consistently act differently enough from the way they are assumed to act in standard economic models, the usefulness of these models for promoting our understanding of reality must be questioned.

The jury is still out, in my view, on how robust are the findings of behavioral economists.  But that there is something potentially important here cannot, I believe, be doubted.  No less a light than Hayek worried about the consequences of the fact that we human beings, who today live in a global economy marked by an indescribably deep division of labor, are evolved to survive in small hunter-gatherer groups.  (See, for example, Hayek’s last book, The Fatal Conceit [6](1988).)  Why suppose that our basic psychological make-up is especially well-suited to a modern economy?

Of course, even if we conclude that each of us is much less rational than mainstream economists typically assume us to be, it is hardly true that a strong case is thereby made for government intervention or even for abandoning the assumption — for purposes of evaluating public policy — that people’s actions reveal their preferences.  Here’s Fudenberg, from page 707 of his review essay, on this point:

Even if we believe people do make systematic errors in evaluating how various choices will influence the appropriately defined measure of their "welfare," we might not trust that the government or policy analysts would make better evaluations.  For this reason, it is consistent to believe both that people make mistakes and that government policy should (with a few exceptions) be based on the assumption that people’s actions and ex-ante predictions are the best guide to what is in their own interests.

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