David R. Henderson  

Thaler and Caplan on Homo Economicus

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I have in my pile Richard Thaler's latest book, Misbehaving: The Making of Behavioral Economics. I'm reviewing it later this month for a quarterly publication.

But this morning I had time, while doing other things, to listen to a delightful Freakonomics podcast on the topic. It addresses whether it would even be desirable for us to behave as homo economicus. It featured Richard Thaler and also contained a shorter interview with co-blogger Bryan Caplan.

I can't do justice to the show in a few words. But, in a word, I found it delightful. Thaler pokes holes in the idea that we are all rational calculators following our self-interest. And, while he is often thought of as someone who believes in government solutions to problems, he points out that it is the very fact that we are not totally self-interested that solves, or at least, mitigates some free-rider problems. He also argues that it wouldn't be desirable in some ways for us to be homo economicus.

Bryan Caplan is his typical charming and endearing self also. And I won't steal his thunder by telling how he answers the inquiring reporter who wants to know if he should vote. Obviously, the answer is no, but Caplan lays out the exception nicely.

I do want to make one criticism of Thaler's view. You might regard it as picky--it might even be picky. But here goes.

Thaler argues that the homo economicus would not take only one to four pennies from the "Take a Penny" tray at checkout counters, but would take them all. I don't think so. And the reason is simple: the person on the other side of the counter would regard him as a thief. Would the retailer call the cops? Not likely. But his reputation with that particular retailer would be damaged. And homo economicus would, because he maximizes over a long period, worry about this reputation. Charley Hooper and I have written about this at some length in our chapter on ethics in Making Great Decisions in Business and Life. One excerpt:

As hard as this may be for many to believe, P.T. Barnum actually deserves credit, not for knowing the birth rate of suckers, but for discovering that it is easier to make money honestly than dishonestly. Barnum went so far as to write, "Poor fool! Not to know that the most difficult thing in life is to make money dishonestly!" To take advantage of P.T. Barnum's experience, we suggest two techniques. One comes from the pharmaceutical powerhouse Merck & Co., named as America's Most Admired Corporation seven years in a row by Fortune magazine. Merck had an informal policy for avoiding ethical mishaps while I (CLH) worked there. "Ask yourself how you would feel to see your latest policy or behavior on the front page of the New York Times. If you don't feel proud knowing this, don't do it." Try this yourself and you'll see how much more clearly you think about questionable practices.

Of course, homo economicus doesn't have feelings, so the feeling part of the quote above is not a good guide. Still, homo economicus does care about reputation.

Bryan also points out two huge upsides of people being homo economicus:
(1) No terrorism (he should have said no suicide terrorism). Why blow yourself up for other people's benefit?
(2) No war. The optimal strategy for homo economicus is what I call the Monty Python strategy: Run away.

Listening to Richard Thaler reminded me of the "good old days" at the University of Rochester Graduate School of Management where we were both young assistant professors. His work was largely dissed by his U. of R. colleagues, but what I always admired about him was that he persisted in the face of a fair amount of hostility.

It reminds me one other thing too. Although it might be hard to understand why a 26-year-old without tenure (me) was put in charge of recruiting an economist in the winter of 1976-77 or 1977-78 (I've forgotten which), I was. That winter, the American Economic Association had its employment/interview meetings at the Chicago O'Hare Hilton. Dick, the late Bill Meckling (the dean), and I went to interview people. At lunch in the middle of one long day of interviews, we were all kind of playing "ain't it awful" about how mathematical and uninteresting even the group we had selected to interview were on average. I think it was Dick who said, "I would love it if someone would say 'Here's an interesting thing I'm thinking about and here's why it matters.'" Bill and I grinned and laughed in agreement.


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COMMENTS (13 to date)
AlexR writes:

David,

I very much enjoyed John Cochrane's irascible review of Thaler, available at:

http://johnhcochrane.blogspot.com/2015/05/homo-economicus-or-homo-paleas.html

Grumpy but commonsensical, as usual.

David R. Henderson writes:

@AlexR,.
Good review. And I’m guessing that you’ve seen my critical reviews of Thaler’s work.

Scott Sumner writes:

Very nice post. The pennies example is exactly the sort of thing that made me lose interest in behavioral econ. The behavioral economists kept saying "behavior X is not rational" and I kept thinking that they had too a narrow a view of life.

That's not to say they don't have some good examples, but overall the field is greatly oversold in my view.

Tom West writes:

But his reputation with that particular retailer would be damaged. And homo economicus would, because he maximizes over a long period, worry about this reputation.

Except that most reputational damage is cultural. There are many countries where taking all the pennies would be common sense, and the damage to reputation would be nil because anyone with common sense would do the same.

Indeed, one of the larger changes I think we've seen over the decades is an attitude that there is no moral duty beyond adherence to the law.

And I think part of that is attributable to the fact that economics, which implicitly accepts homo economicus, has become the dominant discipline behind many policies adopted by the public and private world. And those implicit assumptions just slide on in.

Sadly, I'm pretty certain a society of human beings trying to pretend that they're homo economicus is miserable at best and collapses at worst.

Levi Russell writes:

I think Pete Boettke's distinction between mainline and mainstream economics is extremely useful for understanding where behavioral econ fits. I think Thaler, Kahneman and others go too far, just like the "mainstream" does, albeit in different directions.

The "mainline" seems to strike a good balance between the two, giving us an understanding of how social norms and institutions influence us to divert from homo economicus.

Of course, I've had to read/watch/hear Boettke and others on this topic on my own because very few of us are exposed to this more "sociological" perspective in grad school.

David R. Henderson writes:

@Scott Sumner,
Thanks.
@Tom West,
Interesting take. So you’re saying, essentially, that Thaler is wrong and standard neoclassical economics is right: not morally right, but right insofar as it describes and predicts behavior.
@Levi Russell,
Well said. And, in Pete Boettke’s sense, I’ve been a “mainliner” for about 45 years.

Hasdrubal writes:
Except that most reputational damage is cultural. There are many countries where taking all the pennies would be common sense, and the damage to reputation would be nil because anyone with common sense would do the same.

But, at best that doesn't favor either the rational or the behavioral model: In places where there's no reputational harm for taking all the pennies out of the "take a penny, leave a penny" tray, you simply don't find pennies laid out in a tray. Rational actors would take them all (therefore rational vendors don't make them available). At the same time, cultural norms don't prevent non-rational actors from taking them, either.

A lot of behavioral economics' insights seem to be like this: The behavior only violates rational assumptions if you narrow your range of what you're looking at to just money or first order effects. You can come up with models of rational actors behaving the same way if you look at utility from other sources (such as reputation) without even violating the basic assumptions of rationality. And you can cover a lot more ground if you loosen up some of the assumptions in justifiable manners, such as shifting from perfect information to costly information.

In the end, models based on homo economicus do a pretty darned good job of describing how the world works. Incentives _do_ matter.

Michael Byrnes writes:

What Scott Sumner said.

I do think that some people are too quick to assume rationality (in the homo economus sense) but a lot of the examples of supposedly irrational behavior are pretty bad.

Joe did X. Joe is rational. Therefore X must have been a rational decision is awful logic.

But it is crazy to assume that all decisions that are contra to the decider's ultra short term financial interests are irrational.

If you want to look at irrational decisions, look at investor behavior. The persistence of high cost mutual funds and the tendency of investors to "chase" past returns.

Robert Schadler writes:

The limitations of reason and "rational man" needs to be more fully incorporated into economics. Humans have reflexes, some of which can be shaped or controlled and some that can't. Perhaps the "rational" human can anticipate and include those reactions ... or at least somewhat so.
The time horizon is also not easily incorporated. Someone may take all the pennies -- if he never plans to come back to the store. There is usually a considerable uncertainty about when we will die --- and many may care about their reputation long after they die. When the alternatives are simplistic, the choices are obvious. When highly complex, try to find the truly rational choice may accrue a high opportunity cost -- thereby becoming irrational to pursue fully.

Unlearning writes:

Surely most people would not take too many pennies even if they were never going to visit the store again?

Danno755 writes:

Back when items for sale at Woolworth's 5 & 10 actually cost a nickle or a dime, taking all of the pennies in a tray may have been rational. But now, a homo economicus would realize that the cost of taking those pennies to the coin counting machine in the supermarket (or saving the cut the machine/supermarket takes, wrapping the coins and taking them to the bank) is greater than the benefit of taking the coins.

Tom West writes:

There's a lot of play in the term "self-interest" or even "financial self-interest". Does homo economicus always play "betray" in the prisoner game? Does he short-term or long-term optimize, etc.

So arguments about what H.E. would do are not well defined.

That said, for purposes of argument, I'd agree that H.E. would do as you suggest, as reputation has economic importance.

As for which better describes human behaviour? Well, obviously classical economics does a pretty good job the vast majority of the time. I feel that people only really start to go really wrong when, because it works well most of the time, they feel it *must* predict behaviour *all* of the time, no matter the possible confounding factors.

I think we see this most commonly in the minimum wage debate where we see the occasional poster point out how any results that doesn't correspond with ECO 101 *must* be wrong, when of course, there are thousands of factors at play, not just economic ones.

I feel a lot about economics the way I feel about climate science. Mostly right, but anyone who claims that they can perfectly predict a system that is unimaginably complex has already broken basic credibility. (And yes, I find the similarity between mindsets of those who believe there is a conspiracy of economists and those who believe in a conspiracy of climate scientists to be darkly amusing.)

As for behavioural economics, I find it interesting, but I feel it's more often used as a club to attack economics than for its possible benefits. I like the nudge idea (and businesses have used it for decades), but I'm generally for things that I see as improving people's lives, regardless of whether it's for business or government.

Joe Topp writes:

@Tom West:
Amen to the comparison of Economics with Climate Science. Neither field has advanced to the point where it can make perfect predictions, nor are they likely to. The difference between the two is that for some reason we know to take a meteorologists advice with a grain (or two) of salt, whereas most people see economic predictions in black and white.

As for the take-a-penny debate, here's my two cents. I think Scott, Hasdrubal, and others are right when they say that one can easily fit the penny-leaving behavior into a rational framework, either by changing the utility function to include reputation or by considering the problem in a long run, repeated game. Indeed, you can explain almost any behavior in a rational framework. Even Heuristics (a la Kahneman) can be fit into a rational framework if one considers the opportunity cost of time spent calculating the optimal choice.

I think that the point of Behavioral Economics is that the rational 'Homo Economicus' models are not sophisticated enough to include things like culture and reputation. When they say "behavior X is irrational," what I hear is "those guys can't model behavior X yet." Behavioral economics is only valuable while rational economics fails to incorporate these important determinants of human behavior, which seems like it's going to be a long time.

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