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Stefan Heidl, Philosophical Problems of Behavioural Economics

Guilhem Lecouteux
p. 143-148
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Stefan Heidl, Philosophical Problems of Behavioural Economics, London: Routledge, 2016, 164 pages, ISBN: 978-113863919-5.

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1In his 2016 Presidential address at the American Economic Association, Richard Thaler predicted “that behavioral economics will eventually disappear” (Thaler, 2016, 1578). Thaler indeed argues that “it is time to fully embrace what [he] would call evidence-based economics” (ibid., 1597, emphasis in original): in this perspective, all economics will become behavioural, and “we will have an approach to economics that yields a higher R²” (ibid.). Behavioural economics (henceforth “BE”) is indeed usually perceived as an attempt to “[increase] the explanatory power of economics by providing it with more realistic psychological foundations” (Camerer and Loewenstein, 2004, 3). This “reunification [of economics and psychology] should lead to better predictions about economic behavior and better policy prescriptions” (Camerer, 1999, 10575).

2In Philosophical Problems of Behavioural Economics—a revised version of his PhD dissertation (University of Bonn, 2014)—Stefan Heidl investigates how behavioural economists use psychology to build their economic theories, and discusses the intertheoretical relations between standard economics and psychology in BE. Far from seeing a “reunification”, Heidl convincingly argues that the project of BE is a deidealisation of standard economic theory. It is neither a genuine combination of economic and psychological theories nor an economic theory derived from a psychological theory: psychology is treated as a mere add-on to standard economics, through the introduction in standard economic models of psychological factors that were thought to be irrelevant for economic analysis. Heidl argues that deidealising the standard economic man is necessary if we want to improve the explanatory and predictive power of economics, but BE models are still built in the same way as “standard” economic models, and thus face the same methodological limitations.

3The first chapter presents a brief overview of BE and discusses the intertheoretical relation between economics and psychology. Heidl suggests that there is no reduction of one of the disciplines to the other, because BE uses psychology to explain empirical deviations from the standard model, and then introduces elements of psychology to improve the predictive power of the theory. The object of BE is therefore to deidealise the standard model of the economic man. Chapters 2 to 5 address the main criticisms raised against this project of deidealisation. Chapters 6 to 8 then investigate how behavioural economists build their models and introduce elements of psychology in economic theories. Chapter 9 summarises the main arguments.

4Chapter 2 discusses the ontological nature of economic preferences, and highlights a behaviouristic and a mentalistic interpretation of preferences. According to the mentalistic interpretation, “preferences are understood as scientific refinements of the folk psychological concepts of desire and preference” (26), while the behaviouristic interpretation is that “preferences are not mental entities but consistent patterns of choices” (27). If preferences are understood behaviouristically, the object of economics is not the study of preferences as mental states, but the study of individual choices—the mental states and reasoning processes leading to the choice are not relevant for the theory. Heidl however argues that the behaviouristic interpretation cannot properly explain economic phenomena because of its circularity (preferences are indeed the representation of the choice, and cannot therefore be its cause). Explaining behaviour thus requires a mentalistic account of preferences, and it is legitimate to integrate the results of behavioural decision research to model how different psychological factors shape individual preferences.

5 Chapter 3 then deals with a related argument: according to the view that Heidl labels “selectionism”, economic theory does not describe the deliberation process of the agent, but the selection processes that operate on markets. Friedman (1953, 22) famously argued that “it seems unlikely that [businessmen whose behaviour is not consistent with the maximisation-of-returns hypothesis] would remain in business for long”. Even though firms do not decide as described by the theory, economic theory accurately describes how they behave (because only the firms who behave as if they were deciding as in the theory could survive). A serious issue of selectionism is that the theory describes the behaviour of whole economic systems such as competitive markets in the long run, but has nothing to say on the behaviour of individual firms—only that a certain type of firms has a higher probability of surviving and dominating the market in the long run (Alchian, 1950, 216). Economists however also study the behaviour of individual firms (in the case of oligopolistic competition for instance), for which a deliberation-based rather than selection-based theory is needed. Secondly—and also more problematically—the intuition that only payoff-maximising behaviours could survive in the long run is erroneous (see e.g. Winter, 1964 in the case of market competition, and Lecouteux, 2015, chapter 7 for strategic interactions).

6 Even if preferences are interpreted mentalistically, and that economics is treated as a theory of deliberation and individual choice, it can still be argued that economics does not need psychology, because those two disciplines do not have the same object of study. Indeed, the general view within the economic discipline (and which is implicit in selectionism) is that the psychological factors that influence individual behaviours are not relevant for market outcomes (55). In chapter 4, Heidl presents several theoretical and experimental contributions that question this argument: under certain circumstances, individual psychological factors do influence market outcomes. Sonneman et al. (2013) for instance find that partition dependence (a framing effect that biases the judged likelihoods of events with the partitioning of the event space—the perceived probability of one event among N alternatives is biased towards 1/N) persists over time in both experimental and actual prediction markets, and significantly affects the market price. Even if economists restrict their analysis to market outcomes, deidealising the standard model might be necessary to increase the scope of validity of economic theory.

7 In the direct continuation of chapter 4, Heidl discusses in chapter 5 the argument that the role of psychology is precisely to delimit the scope of economic theory. According to this view, a large class of social phenomena can be explained as the result of an instrumentally rational reasoning, and experimental deviations from the theory only occur in situations for which the theory is not supposed to apply, for instance if the agents did not have enough time to learn how to best respond, such as in the first rounds of repeated market experiments (Plott, 1996). The experimental findings of behavioural decision research thus do not question the validity of economic theory, but merely identify domains that are not in the scope of economic theory (Binmore, 1999). This requires restricting the scope of economic theory to cases in which individuals have sufficient time to become best responders: however, since there are many economic choice problems (e.g. education choices) for which the individuals do not have the opportunity to learn from their past mistakes, it seems sensible to use insights from psychology to explain individual economic behaviours.

8 After having presented and questioned the arguments against the use of psychology in economic analysis, Heidl turns to the actual practice of building behavioural economic theories of choice. Deidealising economic theory requires (i) localising the anomalies in the theory, (ii) introducing elements from psychology in the standard model to improve its predictive power, and (iii) justifying why the “behavioural” explanation is more relevant than an alternative “standard” explanation.

9 Chapter 6 shows how behavioural economists use experiments to “localize” anomalies in specific parts of the theory. Rather than invalidating all the theory, experimental deviations are ascribed to specific assumptions. Behavioural economists then try to correct those assumptions, while keeping core elements of the theory, such as utility maximisation.

10 Chapter 7 then analyses how BE theories are built once the anomaly has been localised. Heidl suggests that building a BE theory mainly consists in introducing new parameters in the utility function so as to account for psychological factors that were ignored by standard economics. The danger of such an approach is that those parameters could be calibrated in an ad hoc way to fit experimental data (Binmore and Shaked, 2010). This means that BE requires additional theories explaining the value of those parameters, such as the level of the reference point in prospect theory. Another difficulty of the deidealisation approach is that the core of the standard theory—utility maximisation—is maintained: BE theories thus do not describe individuals’ cognitive processes, and are still committed to an as-if methodology (Berg and Gigerenzer, 2010). This is because, like other standard economists, behavioural economists are ultimately interested in market outcomes and not in individual decision processes.

11 Chapter 8 discusses how BE theories of choice are used to model economic phenomena. After a brief overview of the methodological debate about the unrealism of assumptions in economic models, Heidl focuses on Benartzi and Thaler’s (1995) explanation of the “equity premium puzzle” to discuss whether the introduction of BE theories of choice—which improve the psychological realism of the theory of choice—does improve the realism of the assumptions of BE models. His conclusion is that BE models are constructed in a similar way as standard economic models, because of their use of abductive reasoning, and of a set of highly unrealistic “background” assumptions (e.g. homogeneity of the agents). However, although BE cannot model economic phenomena with realistic assumptions, Heidl suggests that its explanations of economic phenomena are still more plausible than the explanations of the same phenomena by standard economic models—many economists indeed consider that explaining a phenomenon with a standard model is scientifically preferable to explaining it with a behavioural model, but the “rationalization” of the phenomena explained by BE models generally requires introducing ad hoc assumptions.

12 Heidl’s book is a very welcome contribution, because it clarifies the objectives and practices of behavioural economists, i.e. to deidealise the standard model of the economic man. BE is neither a revolutionary change nor a reunification of economics and psychology, because behavioural economists aim at iterative improvements of economic theory. Since BE keeps some of the core features of standard economics, it would not be so surprising that BE eventually becomes the “standard” form of economics, as predicted by Thaler: behavioural economics could indeed be, in the words of Berg and Gigerenzer (2010), “neoclassical economics in disguise”.

13Beyond the main line of argument developed throughout the book, Heidl’s discussion in chapters 2 to 5—about the object of economic theory and the main arguments against the introduction of psychology in economics—illuminates the notions of “preferences” and “rationality”: although those notions are central in economic theory, little is generally said about what those notions actually mean. Heidl however offers a clear and detailed presentation of the two main interpretations of “preferences” (behaviouristic or mentalistic) and of the different justifications of the assumption of rationality (as a normative benchmark, the representation of aggregate behaviours, or as a long-run tendency).

14My only regret is however the limited discussion of the normativity of the standard model, and the sharp contrast regarding the role of psychology in economics between the “new” BE discussed in the book and the “old” BE that emerged in the 1950s and 1960s with, among others, Herbert Simon. Indeed, a key reason of the success of new BE (compared to the limited impact of old BE) is probably that Kahneman, Tversky, and their followers explicitly endorsed expected utility theory as a normative theory, and treated observed behaviours as deviations from this benchmark (Sent, 2004, 747, Heukelom, 2014, 124-131). Human psychology is represented as a set of forces that interferes with the reasoning of the individual, but the latent rationality of the agent is not given any psychological explanation (Infante et al., 2016, 14-15). A difficulty of the deidealisation approach is thus that looking for incremental improvements of the theory requires assuming that individuals are at least approximately acting like in the standard theory. Rather interestingly, the justification of this assumption by behavioural economists is similar to the argument put forward by the opponents to BE, i.e. that economics deals with environments in which the assumption might be justifiable (123). If we follow the argument of chapter 5, this could mean that the deidealisation approach will probably not be sufficient to properly explain economic behaviours, and would eventually require a more radical change in the theoretical framework of economics, of a similar nature than the changes suggested by old BE.

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Alchian, Armen. 1950. Uncertainty, Evolution, and Economic Theory. Journal of Political Economy, 58(3): 211-221.

Berg, Nathan and Gerd Gigerenzer. 2010. As-if Behavioral Economics: Neoclassical Economics in Disguise? History of Economic Ideas, 18(1): 133-166.

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Binmore, Ken and Avner Shaked. 2010. Experimental Economics: Where Next? Journal of Economic Behavior & Organization, 73(1): 87-100.

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Infante, Gerardo, Guilhem Lecouteux and Robert Sugden. 2016. Preference Purification and the Inner Rational Agent: A Critique of the Conventional Wisdom of Behavioural Welfare Economics. Journal of Economic Methodology, 23(1), 1-25.

Lecouteux, Guilhem. 2015. Reconciling Normative and Behavioural Economics. PhD Dissertation, École Polytechnique.

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Winter, Sidney. 1964. Economic “Natural Selection” and the Theory of the Firm. Yale Economic Essays, 4: 225-272.

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Guilhem Lecouteux

Université Côte d’Azur, GREDEG.

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