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Behavioural Economics – is it anything new?

Behav FinWhen Dan Ariely (author of “Predictably Irrational”) presented at the London School of Economics in 2008, visiting professor Larry Phillips, who introduced Ariely, said that if the lecture was given in 1982 he might have reserved a small classroom for it. The lecture took place in their main auditorium in which every seat was taken. Such has been the popularity of behavioural economics that it has been applied to various aspects of economics including optimal taxation, addiction, financial crisis, development etc. However, there is an overriding question – Is Behavioural Economics a new discipline and has it actually assisted governments in policy design?

Richard Thaler, co-author of “Nudge” has suggested that economics has always been about behaviour. Adam Smith’s first book “The Theory of Moral Sentiments” is in fact a Behavioural Economics treatise and within it Smith talks about its contribution to both psychology and ethics. Its purpose is to find a rationale for ethical judgement in human psychology. The latter is found in human nature: a human being put in a certain situation has a tendency to react in a certain way eg. includes sympathy, feelings and approval by others. It was Smith’s belief that human behaviour was impacted by emotions such as fear and anger and drives such as hunger. However according to Smith these emotions and drives were checked by an “impartial spectator”.

The impartial spectator allows one to see one’s own feelings and the pulls of immediate gratification from the perspective of an external observer.

In the domain of self-control and self-governance, the impartial spectator takes the structure of a long-term interest – “I won’t have that rich cream cake at morning tea because I can see that I will feel guilty about it later”. In the area of social interaction, the impartial spectator allows us to see things from another’s perspective rather than to be blinded by our own needs. The dissention is especially significant when you consider savings decisions – savings is a precision choice to delay immediate indulgence for a long-term interest. So we have the conflict between the voice of a short-term pull versus the voice of the impartial spectator.

Only recently has the field of economics advanced enough to have the tools to reincorporate the factors that Smith had always felt were important in human interaction: our caring about each other and about fairness, our difficulties with aligning our long-term interests with short-term pulls, etc. One of the most unexplored areas, which we are only now beginning to be able to measure, is the degree to which people are motivated by reputation and social status, something Smith thought was a crucial motivation for economic activity.

Nudge

The essence of behavioural economics stems from a concern that rational behaviour driven by self-interest will not guide many of us to health, wealth and happiness. People tend to make bad decisions whether it is not saving or eating the wrong type of food. This disturbing state of affairs arises because homo economicus tends to be in a continuous condition of information overload, and consumer makes errors because of their unfamiliarity about options and their effect. Richard Thaler and Cass Sunstein argue in ‘Nudge’ that subtle changes can influence peoples decision so that they can make choices that will improve their well-being. However, consumers use various methods in deciding their optimal consumption as the cost (time and effort) of acquiring all the information about the benefits of product/service might outweigh the benefits of consuming it.

Homo Economicus – the basis for a majority of economic models is the assumption that all human beings are rational and will always attempt to maximize their utility – whether it be from monetary or non-monetary gains

Final thought
Is Behavioural Economics a new field of economics? Adam Smith publication “The Theory of Moral Sentiments” in 1759 seems to relate what behavioural economists have been rigoursly studying ie. human behaviour and socialization

Refences

Adam Smith, Behavioural Economist? 2006 – Harvard Business School – Nava Ashraf
Nudge, Nudge …… Frown, Frown. – 2010 – Grant Scobie – Asymetric Information, New Zealand Association of Economists
Nudge: Improving Decision about Health, Wealth and Happiness. 2008 – Richard Thaler & Cass Sunstein

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