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Economics Behaving Badly
IT seems that every week a new book or major newspaper article appears showing that irrational decision-making helped cause the housing bubble or the rise in health care costs.
Such insights draw on behavioral economics, an increasingly popular field that incorporates elements from psychology to explain why people make seemingly irrational decisions, at least according to traditional economic theory and its emphasis on rational choice. Behavioral economics helps to explain why, for example, people under-save for retirement, why they eat too much and exercise too little and why they buy energy-inefficient light bulbs and appliances. And, by understanding the causes of these problems, behavioral economics has spawned a number of creative interventions to deal with them.
But the field has its limits….
Prime Minister David Cameron of Britain recently promoted behavioral economics as a remedy for his country's over-use of electricity, citing what he claimed were remarkable results from a study that reduced household electricity use by informing consumers of how their use compared to that of their neighbors.
Under closer scrutiny, however, tests of the program found that better information reduced energy use by a mere 1 percent to 2.5 percent — modest relative to the hopes being pinned on it.
Compare that with the likely results of a solution rooted in traditional economics: a carbon tax would instantly bring the price of energy into line with its true cost and would unleash the creative power of the marketplace to generate cleaner energy sources.
Behavioral economics should complement, not substitute for, more substantive economic interventions. If traditional economics suggests that we should have a larger price difference between sugar-free and sugared drinks, behavioral economics could suggest whether consumers would respond better to a subsidy on unsweetened drinks or a tax on sugary drinks.
But that's the most it can do. For all of its insights, behavioral economics alone is not a viable alternative to the kinds of far-reaching policies we need to tackle our nation's challenges.