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- Herausgeber: Icon Books
- Kategorie: Geisteswissenschaft
- Serie: Hot Science
- Sprache: Englisch
The controversial science that claims to have revolutionised economics. For centuries, economics was dominated by the idea that we are rational individuals who optimise our own 'utility'. Then, in the 1970s, psychologists demonstrated that the reality is a lot messier. We don't really know what our utility is, and we care about people other than ourselves. We are susceptible to external nudges. And far from being perfectly rational we are prone to 'cognitive biases' with complex effects on decision-making, such as forgetting to prepare for retirement. David Orrell explores the findings from psychology and neuroscience that are shaking up economics - and that are being exploited by policy-makers and marketers alike, to shape everything from how we shop for food, to how we tackle societal happiness or climate change. Finally, he asks: is behavioural economics a scientific revolution, or just a scientific form of marketing?
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Hot Science is a series exploring the cutting edge of science and technology. With topics from big data to rewilding, dark matter to gene editing, these are books for popular science readers who like to go that little bit deeper …
AVAILABLE NOW AND COMING SOON:
Destination Mars: The Story of Our Quest to Conquer the Red Planet
Big Data: How the Information Revolution is Transforming Our Lives
Gravitational Waves: How Einstein’s Spacetime Ripples Reveal the Secrets of the Universe
The Graphene Revolution: The Weird Science of the Ultrathin
CERN and the Higgs Boson: The Global Quest for the Building Blocks of Reality
Cosmic Impact: Understanding the Threat to Earth from Asteroids and Comets
Artificial Intelligence: Modern Magic or Dangerous Future? ii
Astrobiology: The Search for Life Elsewhere in the Universe
Dark Matter & Dark Energy: The Hidden 95% of the Universe
Outbreaks & Epidemics: Battling Infection From Measles to Coronavirus
Rewilding: The Radical New Science of Ecological Recovery
Hacking the Code of Life: How Gene Editing Will Rewrite Our Futures
Origins of the Universe: The Cosmic Microwave Background and the Search for Quantum Gravity
Behavioural Economics: Psychology, Neuroscience, and the Human Side of Economics
Quantum Computing: The Transformative Technology of the Qubit Revolution
Hot Science series editor: Brian Clegg
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BEHAVIOURAL ECONOMICS
Psychology, neuroscience, and the human side of economics
DAVID ORRELL
CONTENTS
INTRODUCTION
This volume forms part of the ‘Hot Science’ series of books, and if there is one area of economics which would seem to qualify for that descriptor it is behavioural economics. Both because it is ‘hot’ – according to the American Economic Association, since 1995 the number of academic meetings on the topic has expanded by about a factor of ten – and because it is based on empirical science. The marriage of psychology, neuroscience, and economics, behavioural economics is an attempt to put the study of economic decision-making onto a firm scientific basis.
Economists had long assumed, if only to simplify their models, that people make decisions rationally in order to optimise their utility (i.e. happiness or pleasure). Here ‘rational’ doesn’t mean sensible or reasonable, it just means acting in a way that is internally consistent. Psychologists, after many decades of the close study of actual human behaviour, had come to a rather different conclusion.
For example, far from being perfectly clear-sighted and rational, we are subject to numerous cognitive biases. In fact, 2identifying such biases has become something of a growth industry – Wikipedia currently lists about 200 of them, ranging from general ones like the default effect (given a number of options we tend to select the default one) to more specific ones such as the IKEA effect, which refers to ‘The tendency for people to place a disproportionately high value on objects that they partially assembled themselves, such as furniture from IKEA, regardless of the quality of the end result’ (a similar effect explains why cake mixes ask you to add an egg). Often these are combined, as when IKEA becomes the default option for home furnishing.
While some of these biases arise from the way we perceive the world and structure our thoughts as individuals, many are caused by social factors. Mainstream economics has traditionally treated people as the social equivalent of individual atoms, but behavioural economists argue that everything from the way we shop at the neighbourhood mall to the workings of the global financial system is shaped by the way we interact as groups. An example is the behaviour seen in stock markets, where investors frequently stampede in and out of the market in near-perfect synchrony like a startled herd of cattle.
One reason for these biases is that, far from being the computer-like Homo economicus of traditional economics, where every decision is based on Spock-like logic, we make most decisions based on heuristics – rules-of-thumb, like going for that default option, that provide a shortcut and allow us to protect our brains from too much demanding thought. It seems we are as stingy with our mental resources as we are with the physical kind. And when faced with complex questions with payoffs that are hard to compare, we often reinterpret the question by framing it in a particular 3way to make the decision easier – or allowing someone else, like a marketer or politician, to frame it for us.
Behavioural economics also raises other questions about the core ideas of economics, such as the thorny topic of utility. In traditional economics, people were assumed to have fixed preferences. The purpose of economic exchange was to optimise utility, which was a measure of how these preferences were met. Psychologists have long known, however, that our preferences are not set in stone, but change with time and with context. Utility is therefore not a stable or well-defined quantity, which as we will see has implications for how we model economic transactions. Behavioural effects also come into play in other areas such as finance or macroeconomics (the study of the economy as a whole), which have come under increasing scrutiny since the financial crisis of 2007–8.
Although its roots go back much further, behavioural economics as we know it today began with the work of small teams of psychologists in the 1970s. They were interested not in building a grand general theory of economics but in studying how people actually make decisions, through experiments where they enlisted subjects to play games or make choices. In the last few decades the field has become increasingly popular – publicised in books such as Freakonomics (2005) by economist Steven Levitt and journalist Stephen J. Dubner, Nudge (2008) by economist Richard H. Thaler and law professor Cass R. Sunstein, and Thinking, Fast and Slow (2011) by psychologist Daniel Kahneman – and has become a regular offering in university curricula. Its founders (including Thaler and Kahneman) have been garlanded with the Nobel Memorial Prize in Economic Sciences, which is the economics version of the Nobel Prize. However, as 4we’ll see, the field also has its critics – such as forecasting expert Nassim Taleb who say it goes too far in attempting to model human psychology (he has described it as ‘bullshit science’), and others who say it doesn’t go far enough.
This book will take you on a guided tour of some of the murkier aspects of economic behaviour, and show how behavioural economics is putting the study of human nature back into economics, including shaping our response to some of our most pressing issues such as climate change and pandemics. The rest of the book can be divided roughly into three parts. Chapters 1 and 2 show how behavioural economics is affecting us today, and goes back to revisit how it first emerged as a contender to mainstream approaches. Chapters 3 to 6 focus on how people make decisions as individuals. We explore the various cognitive effects that sometimes confuse us, and the heuristics that get us through the day. Finally, Chapters 7 and 8 broaden the view to consider social behaviours such as herding and altruism, and show how these effects scale up to affect areas such as the stock market and the macroeconomy.
Along the way, we will look at some of the ways behavioural economics is used and abused by companies and governments, assess the strengths and weaknesses of the field, consider its effectiveness as a policy tool, and ask whether it represents a revolution in economics, or is best seen as an adjustment to existing practice. We begin in the next chapter by considering an archetypal illustration of the power, the challenges, and the limitations of behavioural economics.
STAY OR GO? 1
Many of the results in behavioural psychology are based, as we’ll see, on the results of psychological experiments, in which human subjects are asked to reveal their preferences by answering a kind of survey. In June 2016 the UK population was asked, in a large and binding version of such a survey, to answer the following economics-related question: ‘Should the United Kingdom remain a member of the European Union or leave the European Union?’
The choice was stark – as The Clash once sang, ‘should I stay or should I go?’ – but the potential payoffs were complex and hard to compare. And the event, including its build-up and aftermath, either involved or illustrated behavioural economics at almost every level. (British readers may be tired of the topic, but be assured that the focus here is on the behavioural aspects, not rehashing the politics!)
The referendum was famously announced by then-Prime Minister David Cameron in early 2016. Cameron was no stranger to behavioural economics. Members of his Conservative Party leadership team had met with economist 6Richard Thaler in 2008, and decided, according to Thaler, that his behavioural approach to public policy ‘was one that the party could support as part of a rebranding … to make the party more progressive and pro-environment’. And perhaps it could help to smooth the effects of the austerity measures which had been imposed by his government following the financial crisis.
In 2010 Cameron set up the Behavioural Insights Team, otherwise known as the Nudge Unit, in an effort to incorporate its insights into government policy. One of the Nudge Unit’s first wins was to reword tax collection letters to include a phrase saying that ‘the great majority of people in the UK pay their taxes on time’, which shamed people into paying and increased the compliance rate by about 5 per cent. Sending reminders by text message helped too. (Though as Levitt and Stephen Dubner note in their book Think Like a Freak, Cameron’s interest in their ideas didn’t extend to healthcare – when they suggested in a meeting that the NHS shouldn’t be free, he walked out.)
Cameron at the time had a problem with Eurosceptics in his party, who maintained a Thatcherite distrust of what former leader Margaret Thatcher had called a ‘European super-state’ and favoured traditional free-market economics with minimal state intervention. On the other hand, he was also in political trouble with the electorate because of the unpopular austerity measures, which involved shrinking government services.
Rather than confront the Eurosceptics directly, Cameron promised during the run-up to the 2015 general election that, if the Conservatives were elected with a majority, then he would hold a referendum on EU membership. This was what behavioural scientists call a risky decision under7uncertainty but it seemed like a relatively safe gamble, since the Conservatives were then in a coalition government and few political forecasters expected them to win a majority. It was also an illustration of what behavioural economists call present bias, where Cameron chose a short-term solution for boosting his support in the party over the long-term risk that the whole thing might blow up in his face.
When to the surprise of most forecasters and commentators the Conservatives won a majority, Cameron had to hold the referendum, but campaigned for the Remain side, which was a little confusing since he had previously presented himself as being somewhat of a sceptic (behavioural economists call this preference reversal, which is particularly popular with politicians). Like most of the Europhiles, he also seemed optimistic that Remain would comfortably prevail (as we will see, optimism bias affects not just our political leaders). This was backed by political forecasters and commentators who confidently predicted a Remain victory (we also experience an overconfidence effect when it comes to our ability to predict the future). And of course, the population was always susceptible to a bit of nudging.
Project Fear
In order to help cement the anticipated result, the Chancellor George Osborne penned his own forecast of the possible outcomes, presenting the choice in starkly simple economic terms. In a Treasury analysis on the economic impact of leaving the EU, he wrote that were the country to vote Leave, the ‘central estimate was that Britain would be permanently poorer by the equivalent of £4,300 per household by 2030 8and every year thereafter’. In the short term, ‘a vote to leave would represent an immediate and profound shock to our economy. That shock would push our economy into a recession and lead to an increase in unemployment of around 500,000, GDP would be 3.6% smaller, average real wages would be lower, inflation higher, sterling weaker, house prices would be hit and public borrowing would rise compared with a vote to remain.’ (Framing the issue in this way appealed directly to the electorate’s loss aversion, which is our tendency to overweight potential losses as compared to gains when making decisions.)
In contrast, Osborne wrote, a vote to remain ‘would be the best way to ensure continued growth and safeguard jobs, providing security for working people now and opportunity for the next generation. This document,’ he wrote, ‘provides the facts that I hope the people of Britain will consider when they make this historic decision one month from today.’ Or as Cameron summarised, ‘Stay in and you know what you’ll get.’
This in turn was an appeal to status quo bias which is our tendency to stay with the devil we know rather than the one we don’t. As the behavioural economist Michael Sherman explained, ‘There’s a very large irrational bias people have called status quo bias … And Prime Minister Cameron knows that.’ In an interview, Thaler said, ‘I am not a prognosticator, but I would bet on them staying. And I think that there is a tendency, when push comes to shove, to stick with the status quo.’
The argument was therefore a combination of traditional economic reasoning, with a good dose of fear – its alarmist claims of economic calamity soon earned the Remain campaign the name ‘Project Fear’ – and a reminder of the 9relative safety and security of keeping things as they are. Decision-making has two components, the objective and the subjective, and Cameron and his team were targeting both.
However, in many ways Cameron and Osborne – representing a certain type of Conservative whose political viewpoint was pretty much based on the concepts of loss aversion and status quo bias – were out-of-touch with the electorate. Not everyone worried about a weaker sterling, or London house prices, or public borrowing, or abstract measures of economic growth like gross domestic product (GDP), especially when they had little apparent local relevance. As one heckler told a Europe expert, ‘That’s your bloody GDP. Not ours.’ Loss aversion and status quo bias are less effective when you don’t feel like you are winning under the status quo. And while Cameron et al were busy framing the referendum in terms of money and economics, the Leave campaign was framing it in terms of something even more basic, which is identity.
The experts
The Leave campaign did make some loss-framed economic arguments, for example in claiming that £350 million was being sent to the EU every week. This number sounded bigger than Osborne’s £4,300 per household per year, even though it was actually six times smaller (the way that numbers are presented affects how we judge them). However, a number of polls conducted just after the referendum showed that, while Remainers listed the main reason for their vote as ‘the economy’, those who voted Leave listed ‘sovereignty’ and ‘immigration’ as their main concerns. For these Leavers, 10the referendum tapped into fundamental questions about what Britain represented, which politicians and others were happy to exploit. The government was about to be out-nudged.
In a May 2016 article for the Telegraph, future Prime Minister Boris Johnson argued that the end goal of the European Union was to create a European superstate ‘just as Hitler did’, while in contrast Churchill’s ‘vision for Britain was not subsumed within a European superstate’. The Leave argument was summed up in the slogan ‘Take Back Control’ which similarly seemed to hark back to the days of the British Empire. Dominic Cummings, who oversaw the campaign, later said that he began with ‘Take Control’ but changed it to ‘Take Back Control’ because it ‘plays into a strong evolved instinct – we hate losing things, especially control’.
Experts on the Remain side could throw scary statistics around with abandon, but as Michael Gove, who campaigned for Leave, put it, ‘I think people in this country have had enough of experts.’ And while few voters would claim to be able to follow the economic calculations of either side, it was much easier to say whether you were for or against immigration. Faced with a complicated comparison where there is no easy answer, we often resort to shorthand responses, such as substituting the original question with another one (behavioural psychologists call this the attribute substitution heuristic).
However, while the people may have had enough of experts, another kind of expert – the behavioural sort – had plenty of time for them. As we will see in this book, while behavioural economics is often associated with government interventions, in many ways it is like a particularly scientific-looking version of marketing theory – and unless 11perhaps you live in China, where the Communist Party controls much of the news and social media, and is developing a social credit system to reward good behaviour and punish bad, private companies are often much more adept at nudging people than the state is.
Triggered
The now-defunct firm Cambridge Analytica, for example, took behavioural approaches to a whole new level. The company was part-owned by Robert Mercer, the billionaire CEO of hedge fund Renaissance Technologies, who had turned his talents from predicting markets to shaping them through organisations and causes including Breitbart News, Donald Trump’s presidential campaign, and Brexit. Cambridge Analytica used an online psychological profile app to get profiles of tens of millions of Facebook users, via a university researcher who had claimed to be using the data for academic purposes. The app was designed to assess people on the basis of five personality traits known as OCEAN: Openness, Conscientiousness, Extroversion, Agreeableness, and Neuroticism. Users were asked to read a series of statements like ‘I am the life of the party’ and rate them on a scale from very inaccurate to very accurate.
Psychologists use such quizzes in order to explore how personality shapes our decisions, including on how to vote. Importantly, though, the app also extracted data including likes and personal information from the test-taker’s Facebook account. This vastly magnified the amount of data on which to train the artificial intelligence algorithms used to make predictions. The result was that Cambridge Analytica had 12a way to find ‘persuadable’ voters and identify emotional triggers. Someone who rated highly in neuroticism, say, might be easily manipulated through targeted ads featuring images of immigrants swarming into the country. According to Dominic Cummings, Vote Leave used this information to serve some 1.5 billion ads to 7 million people whom the algorithm had identified as ‘persuadable’ or ‘shy’ voters. The effort was concentrated at the end of the campaign as ‘adverts are more effective the closer to the decision moment they hit the brain’. Behavioural psychologists refer to this as the availability heuristic.
The referendum was held on Friday 24 June 2016. When the results were tallied, a 51.9 per cent majority had voted Leave versus 48.1 per cent on the side of Remain. Cameron immediately resigned as Prime Minister, the pound saw its biggest ever daily fall against the US dollar, and Scottish First Minister Nicola Sturgeon announced Scotland’s desire to remain a part of the EU (reflecting how the majority had voted north of the border). Meanwhile a Google Trends report from the day of the vote showed that ‘What is the EU?’ was the second most searched-for phrase about the European Union.
The forecasters and commentators who had continued to believe in a Remain victory until the last moment were in shock. This despite the fact that a number of polls suggested that the Leave campaign was ahead. (As we’ll see, behavioural effects continue to befuddle forecasters.)
A breakdown of the results showed that young, mobile, educated people – especially those clustered in the financial and business hub of London – were the most likely to vote Remain, which was unsurprising given that they had the most to benefit from EU integration. However, other 13results were more confusing from the perspective of traditional economics. Rational choice theory would suggest that areas such as Wales would have been pro-EU because they had received visible benefits in the form of subsidies and projects, and there were relatively few immigrants, yet the locals came out strongly for Leave. But what counts is not just absolute levels, but a sense of relative change – and even low levels of immigration can be enough to evoke resistance.
Hypernudge
While the Brexit referendum will probably be discussed and argued over for years, what is clear is that the vote both exposed and created deep divisions within the British population, and the ongoing debates caused what many commentators described as something akin to a collective mental breakdown. It also raised questions about things as basic as personal autonomy and the democratic process. With both private companies, and state actors such as Russia and China trying to manipulate us online, it has become customary today to wonder whether elections have been hacked, not so much by hacking the computers which tally the results, but by using behavioural techniques and insights to hack the brains of voters. The accuracy of the algorithms used by Vote Leave can be debated (and no amount of advertising on Facebook or elsewhere could help Michael Bloomberg in his failed bid to become the 2020 Democratic candidate in the US), but the reason Facebook is one of the most profitable companies on the planet is because of the value contained in its data, which suggests this data has some use to marketers. 14As we will see in the next chapter, the study of economic behaviour has its roots in military research, and today it has been weaponised into a tool of political and corporate manipulation.
The results of the referendum also provided a graphic illustration of how behavioural effects make the economy so difficult to predict. In the months after the referendum, the UK economy performed far better than most forecasters, including those at the Bank of England, had expected. The supposedly ‘irrational’ voters may have been right to reject expert claims of impending disaster, especially given the poor track record of economic forecasting. It was only years later, as the uncertainty wore on, that the economy seemed to be affected. One of the biggest lessons of behavioural economics may be that we need to be more humble about our understanding of the economy.
The success of behavioural economics and techniques such as social nudging has also led to a backlash. In 2019 the computer analyst whistleblower Edward Snowden warned that ‘new platforms and algorithms’ have given governments and corporations the power to ‘monitor and record private activities of people’ in such a way that ‘they’re able to shift our behavior. In some cases they’re able to predict our decisions – and also nudge them – to different outcomes. And they do this by exploiting the human need for belonging.’ He described the result as ‘the most effective means of social control in the history of our species’. Karen Yeung of Birmingham Law School coined the term ‘hypernudge’ to describe nudges based on big data analytics that ‘are extremely powerful and potent due to their networked, continuously updated, dynamic and pervasive nature’. 15
At the same time, the picture of all-knowing technocrats gently nudging, sheepdog-style, the populace into the right decisions has also taken a bit of a hit. When the legal scholar and behavioural economist Carl Sunstein served as officer of the Office of Information and Regulatory Affairs under US President Barack Obama, he encouraged ‘clear, simple, salient, and meaningful disclosures’, and recommended that ‘presentation greatly matters; if, for example, a potential outcome is framed as a loss, it may have more impact than if it is presented as a gain.’ Donald Trump took the second point at least to heart, though not perhaps in the way that Sunstein would have expected. And groups like the anti-vaccination movement thrive on complicated theories and the sowing of doubt, not clear information.
Behavioural economics exists at the nexus between psychology, politics, and money. And while the Brexit referendum was a something of a one-off event (probably), we are faced with the same kind of choice between ‘hard’ abstract prices and ‘soft’ but tangible emotions every time we make an economic transaction, whether it is buying a house, or selling an heirloom at a yard sale. In the next chapter, we take a step back, and ask how economics got along before the psychologists came on board – and why the behavioural approach was perceived as such a shock. 16
Mindspace
The MINDSPACE framework was developed in 2010 by the Cabinet Office and the Institute for Government as a way to raise awareness among UK civil servants of ‘nine of the most robust (non-coercive) influences on our behaviour’.
We reproduce it here so that, if you ever think you’re being manipulated by the government, you can just check against this list. Source: Cabinet Office/Institute for Government (2010).
THE RATIONAL(ISH) ANIMAL 2
Behavioural economics is often portrayed as being a little radical and carrying a whiff of danger. The subtitle of Freakonomics was ‘A Rogue Economist Explores the Hidden Side of Everything’. In his 2015 book Misbehaving, Richard Thaler wrote of the field’s ‘heresy’ in questioning mainstream authority, and the danger of dabbling in ‘treacherous, inflammatory territory’. Behavioural economists like to see themselves as the teen rebels of economics.
To a non-economist, though, it might seem strange that bringing psychology into economics could be viewed as a heretical pursuit or a sign of roguish tendencies. After all, isn’t economics a social science like any other, that is ultimately about human behaviour, and that should therefore be open to incorporating experimental evidence from related fields? As the investor Charlie Munger put it in a 1995 speech: ‘How could economics not be behavioral? If it isn’t behavioral, what the hell is it?’
To understand why behavioural economics has been considered so radical, it is first necessary to understand 18how economics was before it came along. This chapter will therefore give a brief overview of the traditional mainstream approach which has dominated economics for about the last 150 years, highlight some of the key differences with the behavioural perspective, and show how behavioural economics emerged as an alternative.
The calculus of economics
If there is one thing that captures the essence of the mainstream approach towards human behaviour, it is an emphasis on self-interested rationality. The idea goes back to Aristotle who saw the rational principle as the secret sauce which distinguished mankind from animals. It was satirised by Bertrand Russell in 1950 when he wrote: ‘Man is a rational animal – so at least I have been told. Throughout a long life, I have looked diligently for evidence in favour of this statement, but so far I have not had the good fortune to come across it, though I have searched in many countries spread over three continents.’ Not being prone to that kind of empirical research, the early economists did find it, in an imaginary creature called Homo economicus, or rational economic man.
The founder of economics as we know it today is usually considered to be Adam Smith. Smith was inspired by the physical theories of Isaac Newton and in his 1776 book The Wealth of Nations tried to put economics onto a similarly scientific plane. The best-known aspect of his book is what became known as the ‘invisible hand’ which acted as a kind of feedback that regulated market prices. If prices were too high, then new suppliers would enter the market, driving 19
