Revisiting the Behavioral Revolution in Economics

CAMBRIDGE – In 2008, University of Chicago economist (and future Nobel laureate) Richard Thaler and Harvard law professor Cass Sunstein published their book Nudge, which popularized the idea that subtle design changes in the architecture of choice (“nudges”) can influence our behavior. The book became a global phenomenon and marked an intellectual watershed. But 15 years after its publication, the question remains: Has behavioral economics lived up to the hype?

Thaler and Sunstein based their thesis on the research and insights of psychologists Daniel Kahneman and Amos Tversky, which they had previously applied to the field of law and economics in a Stanford Law Review article (co-authored with Christine Jolls). While the paper was one of the most cited law-review articles ever, it remained virtually unknown outside the discipline.

But following the publication of Nudge, and against the backdrop of the global financial crisis, behavioral economics burst into the mainstream, turning Thaler and Sunstein into superstars. Thaler received the Nobel Prize in economics in 2017. Sunstein was recruited by the Obama administration to head the White House Office of Information and Regulatory Affairs and translate the book’s findings into policy, spawning more than 200 “nudge units” around the world.

Acclaimed author Michael Lewis fueled further interest in behavioral science with his books Moneyball and The Big Short (the latter’s screen adaptation featured a cameo by Thaler). In just a few short years, behavioral economics went from niche specialization to cultural phenomenon.

Beyond the buzz, the behavioral breakthrough also promised to usher in a full-fledged epistemic revolution, fundamentally altering the sources of knowledge deemed valuable. In particular, behavioral economists underscored the importance of psychological factors, in addition to econometric analysis, in understanding how economic institutions work.

The integration of behavioral sciences into microeconomics, which focuses on the decisions and actions of individual actors, has led to a growing recognition that consumers’ and firms’ own heuristics and biases may cause their behavior to deviate from the economic model of rationality. Nowadays, most major universities incorporate behavioral economics into their curricula, and the majority of mainstream textbooks cite behavioral approaches (even if cursorily). Moreover, by exposing the flaws in the prevailing rational-actor approach, behavioral economics has amplified other perspectives, such as Ernst Fehr’s work on “strong reciprocity,” Robert Shiller’s Narrative Economics, and Nathan Nunn’s scholarship on cultural economics.

But the impact of the behavioral revolution outside of microeconomics remains modest. Many scholars are still skeptical about incorporating psychological insights into economics, a field that often models itself after the natural sciences, particularly physics. This skepticism has been further compounded by the widely publicized crisis of replication in psychology.

Macroeconomists, who study the aggregate functioning of economies and explore the impact of factors such as output, inflation, exchange rates, and monetary and fiscal policy, have, in particular, largely ignored the behavioral trend. Their indifference seems to reflect the belief that individual idiosyncrasies balance out, and that the quirky departures from rationality identified by behavioral economists must offset each other. A direct implication of this approach is that quantitative analyses predicated on value-maximizing behavior, such as the dynamic stochastic general equilibrium models that dominate policymaking, need not be improved.

The validity of these assumptions, however, remains uncertain. During banking crises such as the Great Recession of 2008 or the ongoing crisis triggered by the recent collapse of Silicon Valley Bank, the reactions of economic actors – particularly financial institutions and investors – appear to be driven by herd mentality and what John Maynard Keynes referred to as “animal spirits.”

Even without a financial panic, as Keynes notes in The General Theory of Employment, Interest, and Money, “anticipating what average opinion expects the average opinion to be” is fraught with error and uncertainty. But, despite George Akerlof’s persistent advocacy for a behavioral macroeconomics that considers “cognitive bias, reciprocity, fairness, herding, and social status,” the real-world foundations of macroeconomic theory remain shaky, and the scope of efforts to systemize our understanding of contagion-type phenomena through tools like network analysis remains limited.

The roots of economics’ resistance to the behavioral sciences run deep. Over the past few decades, the field has acknowledged exceptions to the prevailing neoclassical paradigm, such as Elinor Ostrom’s solutions to the tragedy of the commons and Akerlof, Michael Spence, and Joseph E. Stiglitz’s work on asymmetric information (all four won the Nobel Prize). At the same time, economists have refused to update the discipline’s core assumptions.

This state of affairs can be likened to an imperial government that claims to uphold the rule of law in its colonies. By allowing for a limited release of pressure at the periphery of the paradigm, economists have managed to prevent significant changes that might undermine the entire system. Meanwhile, the core principles of the prevailing economic model remain largely unchanged.

For economics to reflect human behavior, much less influence it, the discipline must actively engage with human psychology. But as the list of acknowledged exceptions to the neoclassical framework grows, each subsequent breakthrough becomes a potentially existential challenge to the field’s established paradigm, undermining the seductive parsimony that has been the source of its power.

By limiting their interventions to nudges, behavioral economists hoped to align themselves with the discipline. But in doing so, they delivered a ratings-conscious “made for TV” version of a revolution. As Gil Scott-Heron famously reminded us, the real thing will not be televised.

Antara Haldar, Associate Professor of Empirical Legal Studies at the University of Cambridge, is a visiting faculty member at Harvard University and the principal investigator on a European Research Council grant on law and cognition.

Copyright: Project Syndicate, 2023.
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