Calling Behavioral Economics a Fad

Josh Hendrickson and Brian Albrecht have a Substack called Economic Forces that is a source of economics news and examples. We have linked to EF before at EWED.

Albrecht just published an op-ed titled “Behavioral Economics Is Fine. Just Keep It Away from Our Kids”. I’ll to respond to this, just as I responded to that other blog. I think the group of people who are pitting themselves against “behavioral economics” is small. They might even think of themselves as a minority embattled against the mainstream. So, why bother responding? That’s what blogs are good for.

I agree with Albrecht’s main point. The first thing an undergraduate should learn in economics classes is the classic theory of supply and demand. Even in its simplest form, the idea that demand curves slope down and supply curves slope up is powerful and important.*

Albrecht points out that there are some results that have been published in the behavioral economics literature that turned out not to replicate or, in the recent case of Dan Ariely, might be fraudulent. Then he makes a jump from there by calling the behavioral field of inquiry a “fad”. That’s not accurate. (See Scott Alexander on Ariely and related complaints.)

In his op-ed, Albrecht names the asset bubble as a faddish behavioral idea. Vernon Smith (with Suchanek and Williams) published “Bubbles, Crashes and Endogenous Expectations in Experimental Spot Asset Markets” in Econometrica in 1988. Bubbles have been replicated all around the world many times.  There is no doubt in anyone’s mind that the “dot com” bubble had an element of speculation that became irrational at a certain point. This is not a niche topic or a very rare occurrence. Bubbles are observed in the lab and out in the naturally occurring economy.

Should we start undergrads on bubbles before explaining the normal function of capital markets? No. Lots of people think that stock markets generally work well, communicate reliable information, and should be allowed to function with minimal regulation.  Behavioral Finance is usually right where it should be in the college curriculum, which is to be offered as an upper-division elective class for finance and economics majors. I am not going to do research on this, but I looked up courses at Cornell, and there it is: Behavioral Economics is one of many advanced elective classes offered for economics students. I don’t know how they teach ECON101 at Cornell, but it would seem like they are binning most of the behavioral content into later optional courses.

In a social media exchange, Albrecht pointed me to one of the posts by Hendrickson on how they handle the situations where it seems like economic forces are not explaining everything. Currently, for example, it seems like the labor market is not clearing right now because firms want to hire but wages are not rising. The quantity supplied seems lower than the quantity demanded at the market wage. Hendrickson claims that this market condition is temporary. He says that firms are cleverly paying bonuses to attract workers so that they won’t have to lower wages in the future when conditions return to normal post-Covid. This would be a perfect time to discuss downward nominal wage rigidity, a pervasive behavioral phenomenon.** It has been studied extensively in lab settings. Nominal wage rigidity has implications for monetary policy. Wage rigidity might be a “temporary” thing, but it helps to explain unemployment. Some of the research done by behavioral economists in this area follow the Akerlof 1982 paper on the gift exchange model. It was published 40 years ago by a Nobel prize winner and cited extensively.*** The seminal lab study of that theory is Fehr et al. 1993. There have been hundreds of replications of the main result that people will trade out of equilibrium due to positive reciprocity.

This summer, I blogged about new research on gift exchange. By studying gift exchange in a controlled setting, the authors can compare how an employer-employee unit negotiates during changing economics conditions. Cooperation is more difficult to maintain when economic conditions are changing because of fairness concerns.

Adam Smith wrote in the 1700’s that, “Pain…is in almost all cases, a more pungent sensation than the opposite and correspondent pleasure. The one almost always depresses us much more below the ordinary, or what may be called the natural state of our happiness, than the other ever raises us above it.” However, I wouldn’t start with loss aversion if I was introducing Adam Smith to undergraduates. I would start with his insights on self-interest and the invisible hand. Adam Smith showed us that, within markets, people who are self-interested and imperfect can be incentivized to provide a lot of valuable help to each other.

*If you don’t know what I mean by that, start here, or check out more regular content from Economic Forces.

**A great study on wage rigidity is “How Wages Change” by Dickens et al. (2007). They show that nominal wage cuts are uncommon around the world. However, there also seem to be a lot of variation and room for context.

***Albrecht is polite in his tone toward behavioral economists. He seems like a nice guy and don’t we all need more of that right now? I hope he thinks I’m nice, too. He says that he understands there is good work in this field and people have won Nobel Prizes who work on behavioral economics. It’s hard to reconcile those words with him also writing, “Across the board, when teaching the basics, we should leave the fads out.”

One thought on “Calling Behavioral Economics a Fad

  1. Scott Buchanan October 12, 2021 / 12:32 pm

    “…This is not a niche topic or a very rare occurrence. Bubbles are observed in the lab and out in the naturally occurring economy….” Good point.

    Liked by 1 person

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