A unified behavioural theory of economic activity
John Brockman has wheeled out another good bunch of experts for the newest Edge question “What’s the question about your field that you dread being asked?”
One response by Richard Thaler is particularly interesting, who fears being asked “When will there be a single unified ‘behavioral’ theory of economic activity?” For those who know Thaler’s work in behavioural economics, his reason might be surprising:
If you want a single, unified theory of economic behavior we already have the best one available, the selfish, rational agent model. For simplicity and elegance this cannot be beat. Expected utility theory is a great example of such a theory. von Neumann was no dummy! And if you want to teach someone how to make good decisions under uncertainty, you should teach them to maximize expected utility.
Obviously, Thaler knows that this model is not perfect:
The problem comes if, instead of trying to advise them how to make decisions, you are trying to predict what they will actually do. Expected utility theory is not as good for this task.
However, Thaler is not convinced that alternatives such as prospect theory are up for the task, and he suggests that there will ultimately be a multitude of theories:
Just as psychology has no unified theory but rather a multitude of findings and theories, so behavioral economics will have a multitude of theories and variations on those theories. You need to know both physics and engineering to be able to build a structurally sound bridge, and as far as I know there is no general theory of structural engineering. But (most) bridges are still standing. As economics becomes more like engineering, it will become more useful, but it will not have a unified theory.
Thaler is being overly pessimistic - and I’m not sure that there are many theories of bridge building that can ignore the unifying framework of physics. He is right that the rational agent model is simple, elegant and powerful. The problem is that while behavioural economics can pick holes in the model on the basis of predicting how people make decisions, there has been limited attempt to generate a unified theory. Prospect theory is a useful tool for predicting behaviour, but the question that is rarely asked is why people act in that way.
I am optimistic about the role that evolutionary biology will play in filling this gap. Evolution is the ultimate rationality machine, and any actions that are not rational will be ruthlessly eliminated. This is what lies behind the power of the rational agent model. But evolution can only work with the material at hand, leading to a constrained rationality. Heuristics that use less energy and time can be favoured. Many adaptations are path dependent (Robert Frank’s Passions Within Reason gives one excellent account of how path dependence might have shaped human emotions). A changed environment can result in decisions that were once rational no longer being optimal.
Thaler points to the multitude of theories in psychology as an example, but psychology is now being reconstructed by evolutionary psychology, with many of the available theories unable to withstand the light of evolutionary theory. Economics, and more particularly behavioural economics, is slowly being examined using evolutionary theory and the unifying basis of human decision-making as an evolved trait. Those theories inconsistent with our evolved past will be discarded, and the commonality between those that remain will provide considerable unification across the field.