Laibson summarizes the results of two decades of nudges in the table at the top of this post, which is excerpted from his 2020 AEA talk. Two features stand out: 1) the short-run impact of nudges is often larger than the long-run impact because habits, societal pressures, etc. pull people back to their pre-nudge behavior and 2) large welfare effects from nudges are rare. However, small effect sizes can still imply cost effectiveness, since the costs of nudges are small. Both extreme optimism and pessimism for nudges seem unwarranted.
A unifying theory for behavioral economics to replace EU theory?
One of the main critiques against behavioral economics is that is has no unifying theory.
Anyone familiar with KT’s heuristics-and-biases program will know the slew of biases and errors they found: the availability heuristic, the representativeness heuristic, the conjunction fallacy, etc. These biases often conflict and there is no underlying theory that makes predictions about when one dominates over another.
For example, suppose I’m asked to estimate the percentage of people in Florida who are over 55, after having just visited friends in Florida. The representativeness heuristic suggests I’d overestimate this percentage, since Florida has more older people than other states, and thus being over 55 is representative of being from Florida. But the availability heuristic implies I’d mainly recall the young people who I just saw in Florida, causing me to underestimate the share of older people in the state. What does behavioral economics predict?
Rational actor models sidestep these issues by having a small set of assumptions that—even if not exactly true – are reasonable enough that most economists view them as good approximations. This had led to rational choice serving as a common language among economists – when theories are written using this language, their assumptions can be transparently criticized. But when behavioral biases are introduced ad hoc, it makes comparing theories difficult.
The inertia of a unifying theory means that even if it’s not perfect, rational actor models will probably remain the primary way economists talk to each other unless a replacement comes along.
In a series of recent papers, BGS and co-authors have begun to outline such a replacement. In papers such as Memory and Representativeness, Memory, Attention and Choice, and Memory and Probability, they micro-found decision-making in the psychology of attention and of memory. This research program predicts the existence of many biases originally discovered piecemeal by psychologists, as well as new ones. Rather than making small tweaks to existing models, they start with a biological foundation for predicting how people judge probabilities and value goods, and see where it goes.
For example, Memory and Probability assumes people (a) estimate probabilities by sampling from memory, and (b) are more likely to recall events that are similar to a cue, even if those events are irrelevant. Granting these assumptions predicts the availability heuristic, the representativeness heuristic, and the conjunction fallacy. The advantage of this unified approach is that researchers don’t need to weigh one bias against another, rather, many biases are nested in a theory that makes a single prediction.
The paper also predicts a new bias, which the authors validate experimentally. The bias is over-estimation of the probability of “homogenous” classes of events, i.e. classes where all the events are self-similar, for example, “death from a flood”. Similarly, they underestimate the likelihood of “heterogenous” classes, e.g. “death from causes other than a flood.”
In closing, one of the most important challenges in making economics models more accurate will be to develop a theory that incorporates the quirks of how our brains actually work while remaining mathematically tractable enough to be adopted by the economics profession.
[1] Some studies, however, have shown that loss aversion is reduced with training and proper incentives. The original PT paper was also ambiguous about how the reference point from which gains/losses are assessed is formed.
