Bryan Caplan  

A Verdict on Mindless Economics

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During my four years at Princeton I can't recall anyone other than myself having the slightest interest in methodology. How the times have changed! Princeton's Faruk Gul and Wolfgang Pesendorfer have put out a lengthy methodological tract, "The Case for Mindless Economics," challenging Psychology & Economics in general and neuroeconomics in particular.

The best parts of this piece build on the perfectly sensible observation that if two fields are talking about totally different things, results from one cannot contradict results from another. If someone claims that a new study about the common cat disproves a theorem about prime numbers, we can dismiss his claim out of hand. Unfortunately, like many Austrian economists, Gul and Pesendorfer almost act as if economics is by definition totally different from everything else:

Contrary to the view expressed in the quoted paragraph, economics and psychology do not offer competing, all-purpose models of human nature. Nor do they offer all-purpose tools. Rather, each discipline uses specialized abstractions that have proven useful for that discipline. Not only is the word trust much less likely to come up in an economics exam than in a psychology exam, but when it does appear in an economics exam, it means something different and is associated with a different question, not just a different answer.

But in fact, there are a lot of issues where economists and psychologists are studying exactly the same thing. Take subjective probabilities. Economists make assumptions about subjective probabilities in their models. Psychologists test assumptions about subjective probabilities in their experiments. If the psychologists find that economists' assumptions are false, then their models are built on foundations of sand. To say "That's psychology, not economics" is to play the ostrich.

Gul and Pesendorfer are on firmer ground when they criticize neuroeconomics:

Suppose that we find that drug addicts generally satisfy the strong axiom of revealed preference in their demand behavior. Can we argue that since addicts maximize some utility function, there are no separate brain functions and conclude then that the “limbic system” does not exist? This line of reasoning is, of course, absurd because brain science takes no position on whether choices satisfy the strong axiom of revealed preference or not. The argument that evidence from brain science can falsify economic theories is equally absurd.

Gul and Pesendorfer don't seem to see a fundamental difference between psychological evidence and neurological evidence, but I do. The difference is rooted in philosophy of mind. Both psychology and economics discuss mental states, such as subjective probabilities and willingnesses to pay. Neuroscience, in sharp contrast, tries to link mental states to physical states.

For psychologists and economists to disagree, then, they merely have to reach different conclusions about questions that both fields study. For economists and neuroscientists to disagree, however, requires one of two kinds of quackery. Either economists would have to make novel claims about the brain or related physiological processes ("Immediate fear is not traceable to the amygdala."), or neuroscientists to make novel claims about what mental states exist. ("There's no such thing as willingness to pay.")

Even on neuroscience, however, Gul and Pesendorfer go too far. It's true that neuroscience can't contradict basic economics. But it can still help advance the details. Do people directly value money or not? Economic theory doesn't answer. Brain scans examining whether people react to money the same way they react to immediate consumption can help.

Thus, while I'm tempted to say that economics should be "brainless, but not mindless" - open to psychology but closed to neuroscience - that's going to far. Evidence about the mind is intrinsically relevant to economics; evidence about the brain might be relevant on a case-by-case basis.

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Dan Landau writes:

I may be a bit neanderthal about this issue, but I see the study of individual behavior in economics as only a way to predict the behavior of the group. I don’t think the models of economics stand or fall on the realism of their assumptions about individual behavior. They stand or fall on the empirical accuracy of their predictions about the effects of group behavior. If the prices of factors of production fall, the price of the product will fall and the quantity sold will increase. I still believe economic models are “as if.” The economy behaves as if people were maximizing utility. It is not required or very helpful to test if people really do maximize utility, unless you have a complete economic alternative model that better predicts what happens to prices and quantities.

Barkley Rosser writes:

Dan Landau,

Your argument would appear to depend on either a law of large numbers argument or an Alchian-Friedman evolutionary argument. The first would say that individuals can be raving irrational maniacs, but the errors/stupidity of one are balanced off by the errors/stupidity of another in the large. The second says that even if people don't know how to optimize, or that many are raving irrational maniacs, those that are behaving more rationally will "survive" economically and reproduce, hence mindless rationality still predicts economic reality.

The former is not countered by neuroecon, but may be by experimental econ, in particular all the studies of herding and bubbles and such like. So, it is quite possible that if one person starts behaving non-rationally, they may well infect others to imitate them. One cannot assume that the others will offset them in some randomly convenient way.

The second argument is harder to deal with, but seems more distant from this whole issue. Maybe the more rational will outsurvive the less rational. But if pretty much everybody is somewhat irrational, or more precisely boundedly rational, then what we may see at best is some reasonable degree of bounded rationality.

My own take on the whole thing is that indeed Gur and Pesendorfer are overly defensive. My sense is that Pesendorfer in particular is viewed by his fellow game theorists as defending and extreme and ultimately indefensible position.

Dan Landau writes:

Experimental economics may only be proving the experiments are flawed. In the real world bubbles are the exception and the bubbles that do happen always burst. So the theories of the market and the economy based on people on average behaving as if they were rational are in general correct.

Barkley Rosser writes:


That actual bubbles burst proves the law of large numbers? Only if there are offsetting bubbles so that the average long run price equals the long run rational price. However, we see very few negative bubbles in contrast with lots of positive bubbles. They do not offset. The law of large numbers is violated. Rational expectations does not hold generally.

Dan Landau writes:

It is not so certain there are not negative bubbles. What about the Great Depression?

More fundamentally, rationality is a better predictor of real world market behavior than any alternative. That doesn’t mean people are 100% rational and it certainly doesn’t mean they work with perfect information.

Economic got along quite well without rational expectations and behavioral economics for a long time. My view is both are not very useful for understanding reality.

Colin Camerer writes:

Your take is exactly right. Economics is about predicting decisions, games and markets and their consequences for welfare. If knowing psychology and neuroscience (a highly speculative, at this point, but rapidly growing subset of psychology) helps make predictions then it is useful. It would be foolish to bet against neuroscience generating insight. Economic agents have brains, and use them. The only question is when the insights will come and how they can be integrated into or constrain powerful formal theories. Yes, Dan, you are a neanderthal. To say that "behavioral not very useful for understanding reality" is putting too much faith in c 1920-90 economics which did very well, admittedly, abstracting from psychological reality. The issue now c 2006 is not, can we do good things with the rational choice approach-- yes, we can-- but can we do substantially better? Now we have tools that can measure things we could safely ignore previously without such tools. Even Ramsey, Fisher and Edgeworth speculated about "psychogalvonometer" (Ramsey's term) and "hedonometers" (Edgeworth) to measure utility directly (see David Colander's nice essay on this topic). So they actually were neuroeconomists but without the tools we have today.

Keep in mind, in digesting above, that the right way to think about behavioral economics is as a general theory of human behavior ranging from new complex decisions to highly practiced ones, and from amateurs to experts. Rational choice theory is a useful limiting case when people have learned a lot and become expert. But that leaves a hole about inexperienced people or those who make simple mistakes.

On a methodological topic, Dan, you write that "Experimental economics may only be proving the experiments are flawed." May be. But how do you decide? Do you infer evidence of a flawed experiment from the fact that subjects do not obey a theory? Then the theory is immunized from disproof. Those of us who have done many, many experiments are actually hypersensitive to this concern; I have probably spent 5 years of my life running extra experiments etc. trying to speak to concerns about incentives, comprehension etc. so that experimental evidence of rationality limits will be taken seriously. If you have a tautological view that any experimental evidence of rationality limits is prima facie proof that the experiment was flawed, I can't convince you and you are not a convinceable scientist. But if you have a criticism of a specific experiment and a conjecture about how a methodological change would affect the results {yes, we have done dozens of high-monetary stakes studies} that would be a very useful part of a dialogue.

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