Today I stumbled across the podcast series Social Science Bites. Led by David Edmonds and Nigel Warburton, it is a series of interviews with leading social scientists about their perspectives on society and the contribution of social sciences to enhance our understanding of it. In August 2012, Edmonds and Warburton interviewed Robert Shiller on Behavioural Economics. The interview is only a quarter of an hour long, yet it is a real jewel for getting the bigger picture why the movement has revolutionised the field of Economics over the last twenty years and why it is going to become even more important in the future.
Nigel Warburton starts the interview by asking Shiller for a rough definition of behavioural economics. Shiller explains that behavioural economics is a merger of economics with other social sciences. A major benefit of this is that by introducing psychology, sociology, and political science into economics, the field has moved closer toward reality. In contrast, standard economics relies on rational optimisation which describes actual human behaviour rather poorly. Hence it is not surprising that conventional economics cannot seem to explain coherently why we ended up in a global financial crisis in the late 2000s.
Shiller describes bluntly that in the economics profession of twenty years ago speculative bubbles could not exist because economists treated markets as collectively rational and ‘smart’. Yet this rationality continued at individual level. In consumer theory economists assumed that humans always maximise their consumption. Shiller points out that the elegance and simplicity of economists’ models were also their shortfalls. Recognising that human behaviour is far more complex has led to the behavioural economics movement. It is in some sense interdisciplinary because it makes use of many discoveries of psychologists. Shiller illustrates this with the example of fairness. While economists assume that people act in pure self-interest, human behaviour is governed by a sense of fairness and equity. In his research Shiller has shown that fairness even enters the area of labour contracts. Nevertheless, standard economics does not consider it to be part of the contract between employees and employers.
I must say that I especially like the second half of the interview in which Robert Shiller debunks the assertion that economics is a science and economists are ‘hard-scientists’. In doing so, Shiller refers to the renowned British economist Alfred Marshall who already said that “economics cannot be compared with the exact physical sciences: for it deals with the ever changing and subtle forces of human nature” (Marshall, 1920, p.12). Likewise, Shiller advocates that the study of how humans are thinking cannot be hard science but requires intuition, human judgement and a broader perspective on human behaviour guided by psychology and sociology. Yet he points out that the economics profession is currently suffering from “physics-envy”, but the Einstein model is not going to fit with real world thinking. What adds to this problem is the shortage of data, especially in Macroeconomics, which makes any scientific method inappropriate for predicting major macroeconomic fluctuations like the last global financial crisis.
Nigel Warburton ends the interview asking about the value of behavioural economics. Clearly, for Shiller the value lies in being able to model human behaviour more realistically. He takes the medical school as example. Incorporating what is going on inside the brain allows behavioural economists to move away from “revealed preferences”. This is why behavioural economics, including neuro-economics, is going to become more and more important in the future. With the help of other social sciences, the profession can move away from restricting assumptions like rational optimisation or revealed preferences. Shiller stresses that the insights from the field of behavioural economics are likely to benefit our society at large. At the forefront this includes better public policy-making and reducing the occurrence of crashes. With the use of behavioural economics, Shiller envisions the future role of economists to be one of “prevention”, a bit like the street planners which nobody observes but without whom traffic wouldn’t run smoothly or not at all.
If you have 15 spare minutes, the full interview ant transcript can be found here. It is more than worth it!
Marshall, A. (1920). Principles of Economics. An introductory volume. 8th ed. Macmillan & Co, London.
Shiller, A. (2012). Robert Shiller on Behavioral Economics. Interview by Nigel Warburton, Social Sciences Bites, 1 August 2012 [Online]. Available at: http://www.socialsciencespace.com/2012/08/robert-shiller-on-behavioral-economics/ [Accessed 25 September 2016]