What Does a Faux-Nobel Prize Tell Us About Economic Policy?

by Neil H. Buchanan

"You can't beat something with nothing."  That adage is usually trotted out when someone wants to say that a purely negative argument is not enough to win, that is, that "merely" showing that someone else is wrong is somehow never sufficient to win a debate.

As such, the saying ought to be the opposite of a truism.  If someone makes a bad argument, the only thing necessary to beat that argument should be a clear refutation.  "I am a great deal maker," says a man.  "No, you make bad deals," you respond.  "Oh yeah?  Show me someone who makes better deals!"

As illogical as that is, it is surprisingly common for people to continue to accept bad claims until someone proves an alternative claim.  Criminal lawyers will tell you that sowing reasonable doubt in a jury's mind is almost never enough, because jurors want "a better story."  If the defendant is not the murderer, then who is?

One would hope that such mindlessness would not infect arguments among academic experts, but it does.  In particular, the field of economics has been dominated for decades by people who proffer a bad theory but who have thrived by saying, "Oh yeah, you say our theory's bad?  Where's yours?"

It is no small matter that that dominant theory is rigged to generate right-leaning policy prescriptions.  Combined with serious financial backing from conservative sugar daddies, the field of economics has been built upon a default theory that purports to prove Ronald Reagan's assertion that government is always the problem and never the solution.

There have, of course, been plenty of economists with orthodox training who have argued in favor or both micro- and macroeconomic theories that lead to centrist and liberal policies.  But it has always been true that such theories and policies are viewed with suspicion and must be ten times as strong to receive even one-tenth of the credibility that standard right-wing dogma receives by default.

Thankfully, economists have in recent years started to relent, and the world is becoming better for it.  The orthodoxy is at last starting to crack.  The interesting question is whether the orthodox theory is dying because of its own inherent weakness or because something came to replace it.  Did nothing beat something, or did something beat something?

I am thinking about this question because the Swedish Royal Bank has just completed its annual ritual of conferring its economics award, an award that is not a Nobel Prize but that carries high prestige.  Every year, conservatives and liberals look for validation in an award that is not a Nobel and really should not even exist.

This year, liberals are the ones who are smiling, because Richard Thaler won the award.  Why is that happy news for liberals?  Because Thaler has for years been a leading theorist and a popularizing voice of a field that is now known as behavioral economics.  Although the true pioneers of behavioralism were Daniel Kahnemann and Amos Tversky, Thaler's importance cannot be overstated.

What is the difference between behavioral economics and plain-vanilla (orthodox) economics?  Not to be too cute about it, but behavioral economics is different because it takes behavior into account.  But surely, one might say, that cannot be right.  How could regular old orthodox economics make predictions about economic activity without having a theory about human behavior?

The simple answer is that orthodox economics does start from a behavioral theory, known as "rational actor" theory, but that theory is ridiculous.  The theory is so ridiculous, in fact, that orthodox economists rarely even bother to claim that it is right.  "I'm not saying that people truly act as hyper-rationally as I must assume for purposes of building my economic model.  I'm just saying that it's a better unrealistic theory than all of the others."

In other words, "You can't beat something with nothing."  Orthodox economists want to claim that theirs is the default "something," and unless something else comes along that clearly dominates their theory, they win.

Is the behavioral economics school that new something?  As the business columnist for The New York Times put it in describing Thaler's work, behavioral economists have shown that people "consistently behave in ways that defy economic theory."  (That the columnist did not feel the need even to add "orthodox" before the words "economic theory" tells us everything we need to know about the dominance of the hyper-rational theory that behavorialists are criticizing.)

Thaler and the behavioralists have offered a large number of interesting insights, all of which are based on the "well duh" truth that people are not hyper-rational.  What makes those insights nontrivial is both that they are grounded in psychological principles (individual and social) and that they can lead to very different policy prescriptions -- prescriptions that often (though not always) are politically non-conservative.

Liberals are therefore pleased with this year's prize.  Both Paul Krugman (himself a prior winner of the faux-Nobel, whose award delighted liberals) and David Leonhardt (a non-economist who has carved out a career as an economics journalist and is now a columnist for the op-ed page of The New York Times) expressed delight at Thaler's award.

I am a liberal, too, and as far as it goes, I am perfectly happy to celebrate Thaler's justifiable renown.  Using behavioral concepts to devise policies that overcome myopia, framing biases, and other less-than-rational human psychological defaults, Thaler and his associates have improved our retirement savings incentives and offered other useful ways to move people toward better outcomes than they might otherwise achieve.

As an aside, I should mention that some conservatives still insist that there is no such thing as non-rational economic behavior.  Everything that people do can be rationalized after the fact, such that what looks like irrational behavior can always be explained as merely "rationally optimizing a different set of target variables."  The most infamous example of this is the theory of "rational suicide" (criticized here).

That tautological approach is merely a different way of saying that everything always happens for the best in this best of all possible worlds.  If it is not already happening, says the theory, people must not want it to happen.  The government can only make things worse -- but again, that is by assumption, not the result of rigorous proof.

For those who prefer not to assume the problem away, however, behavioral insights are a welcome addition to the field of economics and especially to discussions about possible policy choices.  We are certainly enhancing the range of possible actions once we allow ourselves to notice that human beings are human.

Even so, it is far too easy to overstate the significance of behavioral economics.  Four years ago, I wondered aloud (here and here) whether behavioral economics had "jumped the shark" and amounted to little more than a collection of interesting observations.  The possible implications of behavioral economics are so nonspecific -- often pointing in radically different directions -- that it has become difficult to draw general lessons from particular behavioral insights.  (OK, people have loss aversion.  What does that tell me about the minimum wage, or interest rates?)

The short answer was that we are better off in a world with behavioral economics than in a world without it.  Even though it is true that behavioral economics is not adding up to much as a theory, it is at least a collection of convincing objections to orthodox assertions of hyper-rationality and the conservative conclusions that flow therefrom.

It is, therefore, not quite right to say that behavioral economics is a "nothing" in the context of "beating something with nothing."  Thaler's faux-Nobel is a recognition of quite a large number of things that have enhanced our knowledge of the policy universe.

Even so, the success of behavioral economics still boils down to a critique of the orthodox theory.  It is not a theory of its own.  Indeed, as Michael Dorf insightfully argued about Thaler's work, behavioral economics is not truly a challenge to economic orthodoxy at all, because it does not challenge the notion of what counts as economic rationality.

The behavioralists, after all, argue that there is a "right" -- or at least a better -- way for people to behave, and that right way is to be in some sense less human and more rational in the orthodox sense.  Only then will people overcome their irrational defaults and, for example, save enough money for retirement.

So perhaps the question is not whether behavioral economics is a something or a nothing that has beaten the something of orthodox economics, but instead the question is whether orthodox economics has truly been beaten.  It certainly seems battered, and there are plenty of holes in the orthodox facade that we did not see before Thaler and his crowd came along, but how badly has orthodoxy been hurt?

As Dorf's column reminded us, Thaler's frequent co-author Cass Sunstein has done a great deal of work that undermines economic theory in a fundamental way.  As I have also written in many, many columns, economic theory (especially in its politically conservative manifestation) justifies its outcomes by taking as given a set of arbitrary choices about the proper baselines of legal rules, the distribution of wealth and other advantages, and so on.

To use one of the more extreme examples, if slavery is legal, then banning slavery will be inefficient; but if slavery is illegal, then enslaving a person will be inefficient.  That logic carries over to questions about the default baselines for contract law, property protections, and on and on.

And that is a much deeper way in which a nothing can beat a something.  If a person says, "I can use government to move us to the 'efficient' policy outcome that we would (and should) see if everyone were rational," she is a behavioralist.  If, on the other hand, a person says, "There is no such thing as efficiency because a 'no government' baseline cannot exist," she is saying something much deeper.

As a theory, orthodox economics did not need to be beaten, because it is not a theory at all.  It is built on a shifting and opportunistic set of baselines that (by design) pushed us relentlessly toward a "laissez-faire" default.  As a dominant paradigm, however, orthodox economics needed to be beaten, because its policy conclusions were thought to be obviously correct.

There is a lot to like about behavioral economics.  Even though it does not add up to much in the way of a theory, it has done a lot of damage to a non-theory that never should have been elevated to its position of primacy in the first place.  Perhaps the lesson is that you can beat something with nothing, so long as you have a whole lot of it.