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Who is Misbehaving?

By James H. Nolt

The Nobel Memorial Prize in economics for 2017, recently announced, will be awarded to Richard Thaler of the University of Chicago. Thaler’s field, behavioral economics, is often labeled as “controversial” because it disputes the assumption of standard textbook economics that people act rationally. One of his books is titled Misbehaving. Behavioralists use psychological research methods to show that many decisions of ordinary consumers and investors do not conform to textbook definitions of rationality.

There are many examples of this, but one is that people’s choices should be transitive. In other words, if an individual prefers A to B and B to C, they should prefer A to C, but laboratory behavioral studies have shown that this does not always hold. Economically rational people should prefer more choice to less, but in fact, studies have shown when presented with too many alternatives, many people become frustrated and avoid making any decision. If the choice set is reduced to two, the chance of choosing one of them is higher. Another example is that people asked to make choices are significantly influenced by extraneous data presented just prior to the choice.

Thaler is particularly hailed for "nudge theory," which is a way to dupe irrational people into making more "rational" choices in line with what economists or others in power think should in be their best interest. One common example is a reaction to the finding that people are often loath to make choices, especially about things they do not understand well, such as retirement or insurance plans. Instead of educating people about their choices, Thaler’s theory advocates nudging them in the "correct" direction. Thus employers should make it easy for people to choose “correctly” by pre-enrolling them in default retirement and insurance plans and then letting them opt out or select a different option later. If you leave it to individuals to choose, many will do nothing. This presumes of course that employers and marketers have the best interest of their employees and customers at heart. This sort of corporate paternalism takes advantage of the irrational consumer and calls the result more rational because it enhances profits.

My own recent experience with applied nudge theory came when I attempted to cancel service from my internet provider. I tried several customer service phone numbers, but each time I was “nudged” into an automated payment system that only allowed me to do the “right” thing—pay my bill—and not the “wrong” thing—talk to a human so I could disconnect my service. Ultimately I found the only way to disconnect was to physically return the equipment to a distant service store. This is how nudging often works in corporate practice.

My own assessment of behavioral economics is that at its best it is rather useful, especially for the marketing business, but it is nearly useless for understanding the big picture of economic and financial dynamics. Behavioralists suffer from the same myopia that blinds textbook neoclassical economics. Both are wedded to the idea that economic dynamics are driven by the small players, the myriad ordinary consumers and small investors. In any case, many of the marketing ideas of behavioral economics are obfuscations of points made more directly and honestly by classic pioneers of marketing and public relations, such as Edward Bernays.

My own approach to political economy applies the strategic method to divide economic actors into two broad, “polarized” categories: insiders and outsiders. Insiders with power act strategically to fix prices, decide investment priorities, overcome consumer inertia with marketing, arrange financing, change laws, deceive and defeat adversaries, and move markets. They are the entrepreneurs who break the rules and rig the games that others are induced to play. Outsiders are the great mass of generally inattentive and often confused ordinary folks who are acted upon by the insiders. No doubt behavioral economists are right that ordinary consumers and investors are not particularly rational, nor are they well informed. But behavioral economists shed no light whatsoever on the insiders who actually wield power. In fact, by more accurately portraying how to fool ordinary people, as does Thaler’s “nudge theory,” they merely assist the powerful to more readily prevail. Powerful insiders are capitalists who act strategically to shape economic dynamics; outsiders are not trivial, but they are an inertial mass, to borrow a term from physics. Outsiders, unless acting consciously and collectively through large organizations such as labor unions or political movements, are not themselves strategic actors. Strategic action presumes power.

There is an important psychological dimension to the struggles for power involving capitalists, politicians, or war leaders, but do not look to behavioral economists to shed much light on the strategic aspects of economic psychology. Theirs is a psychology of the weak and powerless, not of the strategically astute. As an introduction to the behaviorism of strategists, I suggest starting with classics of strategy like Sun Tzu’s The Art of War, Carl von Clausewitz’s On War, and even the contributions of ace fighter pilot and inventor of energy-maneuverability theory, John Boyd, described in several biographies about him. Their ideas apply not just to war, as Clausewitz himself noted, but also to commerce and politics.

One famous phrase of Sun Tzu is “All warfare is based on deception.” The same could be said of business and politics. The exercise of power depends on deception and surprise. Therefore, the psychology of misdirection—what I learned through kung fu training as a “mind hit”—is essential to the practice of power. It can be as simple as the sleight of hand of the magician or con man or as complex as political and economic ideologies that disguise power and thereby inculcate a sense of universal powerlessness. This is the standard assumption of “free-market” economics and finance: that everyone is equally powerless to move markets or influence prices. If people feel individually powerless and fearful, it is, incidentally, easier to market highly addictive opioid painkillers and assault rifles, which is why the National Rifle Association and market-fundamentalist anarcho-conservatives go hand in hand. Psychology does provide useful insights for political economy, but particularly when considered in the context of power and strategy.

Thaler’s work is only remarkable in the context of an economics that insists beyond all evidence that we live in a world of free markets and rational consumers. As I have argued, mainstream or neoclassical economics is founded on assumptions designed to show that market economies are stable, efficient, and fair. If consumers can be “nudged”—we might less charitably suggest “tricked”—into consuming products, investing, or working in ways not of their own choosing nor even for their own benefit, then the market economy ceases to be “provably” fair. This is why the mainstream treats behavioralists as suspect. They do not toe the line of textbook economics. Yet they survive since they can be useful for marketing, which exists as an academic field primarily because the core assumptions of economists are not practical or worldly, but describe a make-believe world of free markets and rational consumers.

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James H. Nolt is a senior fellow at the World Policy Institute and an adjunct associate professor at New York University.

[Photo courtesy of Pixabay]

 

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