Thursday, July 9, 2015

The Economics of George Orwell, Not



   Roger Farmer has a couple of provocative    
   posts on behavioral economics.  The first   
   is entitled "The Economics of George 
   Orwell," where Farmer offers two 
   criticisms of behavioral economists such 
   as Richard Thaler, George Akerlof, and 
   Robert Shiller:

1. “Behavioural economists assert that what makes individuals truly happy can be different from what they in fact choose to do. In Akerlof and Shiller’s words, ‘...capitalism...does not automatically produce what people really need; it produces what they think they need...’ (p. 26).”  From these assumptions, it’s pretty easy to draw paternalistic conclusions, which lead, not to happier people, but towards Orwell’s 1984 dis-utopia; and

2. Neoclassical economics doesn’t need behavioral psychology. Instead Farmer insists, “we can understand all of the failures of classical macroeconomics without giving up on rational choice.”

Leaving Farmer’s second proposition for a future post, I do want to say something about “classical liberalism,” an outlook affirmed by Farmer and well-expressed in his critical reaction to the very idea that someone could know a person’s “true preferences” better than the person, himself, does.  

Consider one of the most effective “nudges” emerging from behavioral economics – changing the default option for employee contributions to a deferred income account from zero to, say, 5%.  In other words, instead of requiring employees to “take action” in order to defer income, they now have to “take action” to avoid deferring income.  Does this change in the default option assume that policymakers know more about employee preferences than the employees themselves do?

Not necessarily.  Suppose there’s lots of research showing that a great many middle-age workers either haven’t done any retirement planning or have wildly optimistic forecasts of their income in retirement.  By “wildly optimistic,” I mean forecasts that would be rejected by, say, 95% of certified financial planners.  So, in this case, the policymakers aren’t substituting their (assumed) preferences for “less current income and more future income,” rather they are assuming that if employees had reasonable forecasts of their own retirement income, many of them would choose to defer some their current income.

Farmer says, “The idea that the government knows my preference better than I do is a little too Orwellian for me.”  I think it’s worth distinguishing between “ill-informed” and “well-informed” preferences.  Granted, this distinction can become a pretext for paternalism.  But, in the case at hand, no one is compelling employees to save more.  Requiring employees to “check a box” to opt out of a deferred income plan doesn’t really qualify as “Orwellian,” particularly when some sort of default option is required in any case. 

The fact that a significant number of employees began to defer some of their income when deferral became the default option raises another, deeper question about Farmer’s classical liberalism, namely how do our preferences arise, persist, and change over time?  Can anyone really believe that capitalism always produces “what people really need”?  Farmer’s models include profit-maximizing firms.  Are we to assume that producing “what people really need” is always more profitable than creating new “needs”?  Should we assume that the $180 billion U.S. firms spent on advertising in 2012 merely conveys information to the public?

It’s not just advertising that shapes our preferences, but rather the whole culture.  Farmer seems to think that we freely choose our preferences, and he worries that if “the form of the utility function is influenced by 'persuasion', then we lose the intellectual foundation for much of welfare economics.”  Insofar as this “intellectual foundation” includes the conception of “preference” Farmer seems to have in mind, it has already been subjected to withering criticism by Amartya K. Sen and others (see especially Sen’s well-known papers, "Rational Fools" and "Behavior and the Concept of Preference").

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