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An Alternative View: Behavioural Economics


Economist George Akerlof, Professor at the University of California Berkeley, shared the 2001 Nobel Prize for Economics with Professor Joseph Stiglitz from Columbia University in New York. In a celebrated address in 2007 he pointed out that the omission of people’s normative behaviour from economists’ models results in quite important deviations of predictions from behaviour which is actually observed: “positive economics privileges models without norms”… He concludes “Economic decisions may not be as duplicable as biological processes, but the basic reason why science intensively studies the microscopic applies to economics as well. The individual economic unit, be it a firm, a consumer, or an employee, behaves the way it does for a reason. And if these actors behave as they do for a reason, we can expect to find those reasons from the structures that we see in close observation; and because of those structures their behavior will also tend to be duplicated.”[1]

Recent studies of behavioural economics field have attracted increasing attention.[2] People tend to be subject to mental quirks and biases including inertia, overconfidence and loss aversion. They tend to stick with what they are doing even if trying something different would not be very taxing.

Levels of cooperative behaviour and reciprocity, perception of and tolerance for inequalities in society differ amongst people, especially between Asian societies and western societies. Whilst intrinsic self esteem as expressed by association of self with positive events and feelings may not differ, extrinsic self-esteem expressed as preparedness to admit positive feelings about one’s self differ substantially, being low in east Asian societies and high in western societies.[3] Statistics compiled by the OECD and by the work of Gert Hoffstede elucidate these points.[4]

Tim Jackson, Professor of Sustainability at the University of Surrey, pointed out in his Deakin Lecture in Melbourne in 2010 “Prosperity without Growth” that the concept of prosperity as an ongoing drive for growth is inconsistent with human nature. [5]

“…  just asking people in the street tells you that prosperity has a meaningful sense that isn’t directly about income growth. What is it about? It’s about the health of our families. It’s about the trust of our friends. It’s about the security of our communities. It’s about participation in the life of society. It’s about some sense perhaps of having a meaningful life and a hope for the future…

“… there is no evidence in social psychology that we really are the narrow, materialistic, selfish, individualistic consumers that the economy would have us believe that we are. Social psychology talks much more about tensions between selfishness and other regarding behaviour. It talks about tensions between novelty seeking and conservation and tradition. All of these poles of these traditions, matter. They mattered as much in evolutionary terms. We evolved as much as social beings as we did as individual beings. We evolved as much in laying down the foundations for a stable society as we did in continually pursuing novelty.

“But what we’ve done in the consumer economy is to favour, to privilege, to preference novelty-seeking selfish behaviour because that is what we need to keep the system going.”

Reciprocity

A group of researchers at the Economics Program and the Program on Cultural and Social Dynamics at the Santa Fe Institute are amongst people studying the way people deal with the issue of reciprocity, the response to gift giving and the extent to which obligations are created through that.[6] Neoclassical economics after all is supposed to describe the exchange of goods and services! They explored the way in which self-interest works, or doesn’t, in 15 small-scale societies – most of them indigenous societies – around the World which together exhibit a wide variety of economic and cultural conditions.

The experimenters used games already widely used in other situations, especially students in developed countries, to explore levels of cooperation. For instance in one game, a ‘proposer’ was provisionally assigned an amount of money or equivalent goods equal to a day or two’s wages and makes an offer to the ‘respondent’ who may accept the proportion offered or reject it. If accepted the players receive the proposed amounts, if rejected they receive nothing.

The market economic model, based on the primacy of self interest, would predict a high rate of rejection of any offer significantly less than half the available amount; that is what had been found in experiments in ‘advanced’ societies in which rejection of such offers results in neither of the participants gaining any reward. However, in the experiments with small scale societies participants’ reactions reflected the everyday situations with which they were familiar. The majority of offers were accepted even if they were of only a quarter of that available; generous offers were rejected where it was considered that unreasonable reciprocal obligations would be created. The wide variation in the behaviour reflected the extent to which the different societies were involved in regular sharing and trading situations, that is the extent to which ‘the market’ was integrated into their activities.

Many people, contrary to what would be expected from the economic model, respond to nice behaviour of others by being nice to them and more cooperative. “Conversely, in response to hostile actions they are frequently much more nasty and even brutal”.[7] The consequences for the structure of organisations and incentives must be obvious. Moreover, “free riding generally causes very strong negative emotions among cooperators and that there is a widespread willingness to punish the free riders. … this holds true even if punishment is costly and does not provide any material benefits for the punisher. In … free riders are punished the more heavily the more they deviate from the cooperation levels of the cooperators. … free riders, therefore, can avoid or at least reduce punishment by increasing their cooperation levels. .. in the presence of punishment opportunities there will be less free riding.”[8]

Studies of the behaviour of Capuchin monkeys reveal loss aversion, a tendency to choose strategies which result in minimal loss over those which result in greater losses even if they also result in greater gains.[9] This behaviour is part of Prospect Theory as developed by Amos Tversky and Daniel Kahneman.

Social democracy and neoclassical economics

Neoclassical economics posits that financial incentives drive improved performance. However, this is not so in all domains in all situations. It is fair to say that billions of dollars have been wasted by governments and business in paying bonuses to executives.[10] The huge increase in the pay of senior executives in the private sector has become a matter of serious concern in many countries with governments in some attempting to limit them, including by empowering shareholders to refuse authorization.

In an extensive critique of the way in which contemporary economics has diminished modern humanity, historian the late Tony Judt noted, “Americans would like things to be better.[11] According to public opinion surveys in recent years, everyone would like their child to have improved life chances at birth. They would prefer it if their wife or daughter had the same odds of surviving maternity as women in other advanced countries. They would appreciate full medical coverage at lower cost, longer life expectancy, better public services, and less crime.

“When told that these things are available in Austria, Scandinavia, or the Netherlands, but that they come with higher taxes and an “interventionary” state, many of those same Americans respond: “’But that is socialism! We do not want the state interfering in our affairs. And above all, we do not wish to pay more taxes… it is incontrovertible that social democracy and the welfare states face serious practical challenges today.’”

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No society which organizes the economy to benefit just 10% of the population will generate prosperity. To grow and become prosperous the most critical thing a society must do is to harness its talent and human potential which is widely disbursed in the population.

Daron Acemoglu & James Robinson, Why Nations Fail, 2011

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The increasing inequality in many societies is the return on investment in neoclassical economics, the notion that the freedom of the individual is paramount and that the role of government must be limited. It is ironic that the very reforms which were touted as improving freedom have turned out to do just the opposite. In a scathing analysis of public management in Britain 17 years ago Professor Ron Amann, onetime Professor of Comparative Politics at the University of Birmingham and later founding Director General (Permanent Secretary) of the Centre for Management and Policy Studies in the British Cabinet Office, compared the practices required in the civil service to those which applied in the highly centralised and inefficient system of the Soviet Union. In that system, “The key point was that no level of the administration really knew what the level below it was actually doing or was capable of doing. The periphery knew that the centre didn’t know and the centre knew that they knew. Around this fundamental core of dishonesty grew a series of ever more elaborate controls and stratagems which brought an entire social system to its knees.” This system has been applied particularly to the higher education sector in the U.K.[12]

The Consequences for Education

The school system in the US and the UK and a few other countries suffers because of a failure to recognise the severe limitations of an economic system that pays no attention to the realities of human behaviour and what influences it. Countries such as the UK and Australia, and some others, where more socially conservative political forces have influence, have nothing to learn from the US so far as the promoted reforms to education are concerned. There are however many lessons to be learned from the research upon the education system!

The lessons are to be learned from education practice in the democratic governments of Scandinavia and much of mainland Europe as well as some Asian countries where support for and respect of teachers is high and where high standards are set in a context of general concern over the long term for the community. The lessons need to be learned from situations that can demonstrate actual achievement, not ones relying merely on theory.

This has led to significant changes in the way the education sector is viewed. In countries such as England and the U.S. and to an extent Australia, as well as some European countries, most of the stakeholders in the education sector – teachers, textbook publishers, school boards and so on – are considered by proponents of neoclassical economic reforms more likely to act in their own self interest rather than in the best interests of the ‘customers’ – that is the students – as judged by the parents (and later their employers). Therefore business enterprise conditions should be applied.

That means performance indicators in the form of test scores, teachers paid for their performance (as measured by the test scores) and oversight by community representatives on school boards. In some instances it is considered appropriate that business enterprise should manage schools and provide services. Teachers’ unions are considered to limit adequate reform. The focus of education reform is the school. Little attention is paid to other places where learning might occur before schooling and in later years.

Further education, in universities and technical colleges, is considered to be principally an individual benefit and the cost therefore appropriately charged to the individual, at least in part. Universities themselves are likewise considered to be in essence a business and therefore appropriately operated like a business.[13] That means staffing and structure should reflect demand and the university should be encouraged to be more entrepreneurial by focusing on efficiency and innovation and by seeking support of business and granting agencies rather than relying on government funding. In Australia this has meant attracting students from various countries to fee paying courses and even establishing campuses in other countries. It has also meant, in many countries, ‘corporatisation’ as part of which increasing numbers of people with expertise in marketing and commercial endeavours are recruited. Academic staff are expected to gain research funding from outside the university including by forming partnerships with commercial enterprises that can apply the ‘outcomes’ of their research.[14]

Such exhortation ignores the benefits to the community at large; it also ignores the fact that development of expertise needed by the community through tertiary education takes time to develop and is not acquired in a few months or years from the time the need for such expertise is acknowledged – if it is acknowledged at all.

 



[1] ‘The Missing Motivation in Economics’ Presidential Address to the American Economic Association, Chicago, January 6 2007

[2] John Cassidy, ‘Economics: Which Way for Obama?’ New York Review of Books 55 (10), June 12, 2008 ( a review of Nudge: Improving Decisions About Health, Wealth, and Happiness by Richard H. Thaler and Cass R. Sunstein, Yale University Press, 2008). Ian McAuley reviews recent findings of these studies in a presentation to the 2010 Australian Economic Forum, “When does behavioural economics really matter”: amongst other things McAuley shows that various thinkers from the time of eighteenth century Scottish philosopher David Hume accommodated psychology into theories of decision-making.

[3] “Challenging Stereotypes: culture, psychology and the Asian Self” All in the Mind, ABC Radio National 7 August 2010; go to

[4] Society at a Glance 2009 – OECD Social Indicators Geert Hofstede™ Cultural Dimensions.

[5] Given in Melbourne 6 July 2010.

[6] Joseph Henrich et al, ‘Economic Man’ in Cross-cultural Perspective: Behavioural Experiments in 15 Small-scale Societies, Behavioral and Brain Sciences, 28 (6), p 795-815, 2005.

[7] Ernst Fehr & Simon Gachter, ‘Fairness and retaliation: the economics of reciprocity’, CESifo Working Paper 336, 2000.

[8] Ernst Fehr & Simon Gachter, ‘Cooperation and Punishment in Public Goods Experiments’, American Economic Review 90 (4), p 980-994, 2000.

[9] M Keith Chen et al, ‘How basic are behavioural biases? Evidence from Capuchin Monkey Trading Behaviour’, Journal of Political Economy 114(3), p 517-537.

[10] See essay ‘Pay and Performance’ [to come]

[11] ‘What Is Living and What Is Dead in Social Democracy?’, New York Review of Books December 17, 2009

[12] See essay ‘Learning outside and beyond school’ [to come]

[13] Amongst the harsh critics of this view, which in Australia was applied by then Education Minister John Dawkins, are former Minster for Science Barry Jones and former Prime Minister Malcolm Fraser.

[14] See the essay, ‘Education outside and beyond school’ [to come]