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The Unfolding Landscape of Behavioral Economics: from the Past to the Future

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The Unfolding Landscape of Behavioral Economics: from the Past to the Future Journal of Behavioral Economics for Policy, Vol. 3, No. 1, pp. 5-11, 2019 The Unfolding Landscape of Behavioral Economics: from the past to the future Michelle Baddeley1,2,3 Abstract Consolidated by the award of the 2017 Economics Nobel Prize to behavioral economist Richard Thaler, behavioral economics is enjoying a golden age. It combines a diverse range of insights from across the social sciences – including economists’ powerful analytical tools, alongside rich evidence about real human behavior from other social sciences – especially psychology and sociology. This article explores the evolution of behavioral economics and some key behavioral insights about incentives and motivations; social influences and social learning, peer pressure, and group-think; heuristics and biases; decision-making under risk and uncertainty; present bias and procrastination; and nudging policy tools. These all illustrate how behavioral economics provides businesses and policy makers with a rich understanding of how real people think, choose, and decide. Keywords Behavioral Economics — Behavioral public policy — History of economic thought 1Institute for Choice, University of South Australia Business School; Institute for Global Prosperity, University College London. 2Email: [email protected] 3Reprinted with kind permission from BBVA Open Mind publishing. Originally published as ”Behavioral Economics: Past, Present and Future”, in Towards and New Enlightenment? A Transcedent Decade, BBVA OpenMind, 2018. https://www.bbvaopenmind.com/wp- content/uploads/2018/12/BBVA-OpenMind-Michelle-Baddeley-Behavioral-Economics-Past-Present-and-Future.pdf Introduction economics nor the psychology can stand alone. Without eco- nomics, psychology lacks analytical structure and direction, Today, it seems as though everyone is talking about behavioral especially in describing everyday decision-making. Without economics. Governments are embedding behavioral insights psychology, economics lacks external consistency and intu- into policy. Commercial businesses are using it to inform their itive appeal. Together, the subjects are uniquely insightful. marketing strategies. Lessons from behavioral economics are Together, they enable us powerfully to understand what and informing relationships between employers and employees. how real people think, choose, and decide in ways that no sin- Even in the silos of academia, most applied research teams – gle academic discipline has managed before, generating not most obviously other social scientists but also natural scien- only new theoretical insights but also new practical and policy tists, from neuroscientists through to behavioral ecologists, insights that, at best, have the power to change livelihoods, computer scientists and engineers – are keen to bring behav- prosperity, and well-being across a range of dimensions. ioral economists into the multidisciplinary teams so that they can connect their research with insights from behavioral eco- nomics. Why? Because behavioral economics combines a The Past unique collection of insights from social science. It brings Behavioral economics may seem to many observers to be a together economists’ powerful analytical tools, traditionally new thing, for better or worse. Most of the excitement about applied in a restricted way to unraveling the economic incen- behavioral economics has bubbled-up in the past ten or so tives and motivations driving us all. But it also addresses years. The first milestone was the award of the 2002 Nobel the fundamental flaw in non-behavioral economics: its highly Prize jointly to economic psychologist Daniel Kahneman and restrictive conception of rationality, based on assumptions of Vernon L. Smith the latter an experimental economist whose agents able easily to apply mathematical tools in identifying insights and tools inspired behavioral economists even though the best solutions for themselves or their businesses. experimental economics and behavioral economics are not the Herbert Simon made some early progress in re-conceptualizingsame. The second was the award of the 2017 Nobel Prize to rationality in economics via his concept of “bounded ratio- behavioral economist Richard Thaler, who has written color- nality”, that is, rationality bounded by constraints in infor- fully about his contributions in his book Misbehaving (Thaler, mation available or in cognitive processing ability (Simon, 2106). Thaler is most famous for his work on behavioral 1955). Modern behavioral economists have taken this further finance and behavioral public policy – commonly known as by bringing together rich insights from psychology to capture nudging – a term coined from the title of Thaler’s best-selling how economic incentives and motivations are changed, of- book with legal scholar Cass Sunstein. Nudge celebrated its ten fundamentally, by psychological influences. Neither the tenth anniversary last year (Thaler and Sunstein, 2008). These The Unfolding Landscape of Behavioral Economics: from the past to the future — 6/11 thinkers have had enormous influence on modern policy, not actually do. In understanding this more deeply, we can look at least through advising the policy-making teams of the then a range of themes which behavioral economists explore so to US President Barak Obama and the then UK Prime Minis- illustrate the power and relevance of their insights. Behavioral ter David Cameron. The establishment of a “nudge” unit in economics is now an enormous literature and doing justice to Cameron’s Cabinet Office spawned the growth of similar units it all in one short paper is impossible, but a few key themes around the world – from Australia to Lebanon to Mexico, to dominate and we will focus here on those insights from be- name just a few. havioral economics that are most powerful and enduring in The progress of behavioral economics between the two illuminating real-world decision-making problems. These milestones of the 2002 and 2017 Nobel Prizes mirrors the include behavioral analyses of incentives/motivations; social emergence of behavioral economics from a largely theoretical influences; heuristics, bias, and risk; time and planning; and subject through to a subject that now has enormous real-world impacts of personality and emotions on decision-making 1 policy relevance—for public and commercial policy makers alike. It also has much to offer ordinary people in understand- Incentives and Motivations ing some of the decision-making challenges they face. But be- As we noted above, economics is essentially about incen- havioral economics is a much older discipline than these two tives and motivations, traditionally focusing on money as twenty-first-century milestones might suggest. Some could an incentive. A key example is workers’ decision to work, argue that all economics should be about behavior if behavior represented in economic theory as a balancing act whereby is what drives choices and decision-making. Economics is the workers are persuaded by the wages they are offered to give study of decisions after all. But, from the nineteenth century up some leisure time. Psychologists bring a broader under- onward, economics started to move away from behavior as standing of motivation into behavioral economics specifically it might be richly understood in terms of the psychology of by disentangling extrinsic motivations from intrinsic moti- choice toward a much narrower subject, focussing observed vations. Extrinsic motivations include all the rewards and choices as a measure of revealed preferences. punishments external to us. Money is the most obvious, but In providing a neat and simple story about these prefer- physical punishments would be another example. Alongside ences revealed when we make our choices, this story can these are intrinsic motivations such as pride in a job done well, only be made sufficiently simple if economists assume that dutifulness, and intellectual engagement. economic decision-makers are constrained by strict behav- Some of the most famous behavioral motivation experi- ioral rules, for example in assuming that consumers aim to ments were conducted by psychologist Dan Ariely and his maximize their utility (satisfaction) and businesses aim to team (see Ariely, 2008). These experimental studies show that maximize profits. In mainstream economics, consumers and experimental participants’ decisions to contribute to a char- firms are assumed to do this in the best way they can by im- ity or public good are partly driven by social factors: people plementing mathematical rules to identify the best solutions. donating to charity are more generous when their donations Modern economists, in the process of building these neat math- are revealed than when information about their donations is ematical models that captured these behavioral rules, stripped kept private. Intrinsic motivations drive effort, often as much out all the socio-psychological complexities of real-world as (and sometimes more than) external monetary incentives. decision-making. Students, for example, are often prepared to work harder for Historically, however, and before modern economics math- an intellectual challenge than for money. This illustrates that ematicized the analysis of choice, economists spent plenty of we are not driven just by external incentives and disincentives time thinking about how the incentives and motivations that whether these be money, physical rewards/punishments or so- are the stuff of economic analysis are affected by psychologi- cial consequences.
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