There are few books critiquing behavioural economics that I find compelling. David Levine’s Is Behavioral Economics Doomed? attacks too many straw men. Gilles Saint-Paul’s The Tyranny of Utility: Behavioral Science and the Rise of Paternalism is more an attack of the normative foundations of economics than of behavioural science. And in most of Gerd Gigerenzer’s books, while making a strong case that many of the so-called “biases” are better described as good decision-making under uncertainty, Gigerenzer often extends his defence of human decision making too far.
In The Community of Advantage: A Behavioural Economist’s Defence of the Market, Robert Sugden finds a nice balance in his critique. Sugden starts by taking the evidence of behavioural anomalies seriously, reflecting his four decades working in the field. His critique focuses on how the behavioural research has been interpreted and used as part of the “nudge” movement to develop recommendations for the “planner”, “benevolent autocrat” or “choice architect”.
Sugden’s critique has two main thrusts. The first relates to how behavioural economists have interpreted the experimental evidence that our decisions don’t conform with rational choice theory. In the preface, Sugden writes:
I have to say that I have been surprised by the readiness of behavioural economists to interpret contraventions of rational choice theory as evidence of decision-making error. In the pioneering era of the 1980s and 1990s, this was exactly the interpretation of anomalies that mainstream economists typically favoured, and that we behavioural economists disputed. As some of us used to say, it is as if decision-makers are held to be at fault for failing to behave as the received theory predicts, rather than that theory being faulted for failing to make correct predictions.
In particular, Sugden sees behavioural economists as having adopted an approach whereby they see people as having inner-preferences that conform with the rational choice model (“latent preferences”), contained within a “psychological shell”. This shell distorts our decisions through lack of attention, limited cognitive abilities and incomplete self control. As Sugden points out, this approach has almost no relationship with actual psychological processes, and it is questionable whether these latent preferences exist.
The second thrust of Sugden’s critique relates to how the behavioural findings have triggered a public policy response that is largely paternalistic. In the preface, he continues:
I have been less surprised, but still disappointed, by the willingness of behavioural economists to embrace paternalism. And I have felt increasingly uneasy that, in public discourse, ideas from behavioural welfare economics are appealing to a sensibility that is hostile to principles of economic freedom—principles that, for two and a half centuries, have been central to the liberal tradition of economics.
Here Sugden undertakes the rather large task of seeking to displace the dominant normative basis of economics - utilitarianism - with “contractarianism”.
I’ll now cover each of these two arguments in the depth they deserve.
The concept of latent preferences
Decades of behavioural research have presented a challenge to neoclassical economics. Many of its underpinning assumptions about human preferences and decision making simply do not hold. So how can we reconcile the two?
Sugden makes the case that behavioural economists typically approach this problem by thinking of humans as rational beings wrapped in a layer of irrationality. (He draws heavily on his work with Gerardo Infante and Guilhem Lecouteux in Preference purification and the inner rational agent: A critique of the conventional wisdom of behavioural welfare economics (working paper pdf) in making this case.) Sugden pulls apart a number of the seminal papers on nudging, including Thaler and Sunstein’s Libertarian Paternalism (pdf) (the precursor to Nudge) and Colin Camerer, Samuel Issacharoff, George Loewenstein, Ted O’Donaghue, and Matthew Rabin’s Regulation for Conservatives (pdf), in arguing that there is this common approach. For each of them, the underlying “latent preferences” are the benchmark that against which utility is measured, with decisions that do not meet this criteria attributed to error.
Given this, the role of the planner (or “choice architect” as Thaler and Sunstein rebranded the planner in Nudge) is to try to reconstruct a person’s latent preferences. These latent preferences would have been revealed if they had not been affected by limitations of attention, information, cognitive ability or self-control. Sugden calls this reconstruction of latent preferences “preference purification”.
One of Sugden’s central points concerns whether preference purification is possible. For instance, it is only possible if the latent preferences are context independent.
To illustrate the problem of context independence, Sugden asks us to consider Thaler and Sunstein’s famous cafeteria story. Imagine that the relevant prominence or ordering of food in a cafeteria affects people’s choices (and experimental evidence suggests that it does). The cafeteria director could place the fruit more prominently, with the cakes at the back, increasing purchases of fruit and “nudging” the customers to the healthy option.
Suppose the cake is at the front of the display. When the ordinary human “Joe” goes to the cafe, he selects the cake. If the fruit had been at the front, he would have selected the fruit. Has Joe made an error in his choice? We need to ask what his latent preference is. But suppose Joe is indifferent between cake and fruit. He is not misled by labelling or any false beliefs about the products or their effects on their health. He simply feels a desire to eat whatever is at the front of the display. What is the nature of the error?
To help answer this, imagine that SuperReasoner also goes to the cafe. SuperReasoner is just like Joe except that he “has the intelligence of Einstein, the memory of Deep Blue, and the self-control of Gandhi”. (Sugden borrows this combination of traits from Nudge). What happens when SuperReasoner encounters cake and fruit that vary in prominence? Since he is just like Joe, he is indifferent between the two. He also has the same feelings as Joe, so feels a desire to eat whatever is at the front. This is not a failing of intelligence, memory or self-control. There is no error. Rather, the latent preference itself is context dependent. But if latent preferences themselves are context dependent, how do you ever determine what a latent preference is? What is the right context?
When I first read this example, I was unclear how important it was. It was clear that Sugden had found a weakness in the latent preferences approach, but was this something practically important?
I think the answer to that question is yes, and it comes down to the disconnect between the latent preferences approach and the actual decision making processes of humans. Context independent latent preferences in many cases simply do not exist. They only come into existence in certain contexts. And whatever the psychological approach actually is, latent preferences in an inner shell isn’t it.
Even if there were an inner rational agent, advocates of the preference purification approach don’t attempt to understand or explain the decision making process of this inner agent. There is simply an assumption that there is some mode of latent reasoning that satisfies the economists' principles of rationality, free from the imperfections created by the external psychological shell. (This is also a problem with rational choice theory. As Sugden writes “rational choice is not self-explanatory: if there are circumstances in which human beings behave in accordance with the theory of rational choice, that behaviour still requires a psychological explanation.")
(As an aside that I won’t go further into today, Sugden and Sunstein continue this debate in a series of papers that are worth reading. See Sugden’s Do people really want to be nudged towards healthy lifestyles?, Sunstein’s response (pdf) and Sugdens rejoinder. Sugden’s rejoinder has another great example of the problems created by context dependent latent preferences that I’ll discuss in another post.)
Sugden does see that one possible defence of the latent preference approach is to define latent preferences as the preferences that this same person will endorse in independently definable circumstances. People will acknowledge these latent preferences even when a lack of self control (akrasia) leads them to act against their better judgment.
Sunstein and Thaler draw on this interpretation in Nudge in their New Year’s resolution test. How many people vow to drink or smoke more when making their resolutions?
As Sugden points out, this is a context dependent preference. People are using the cue of the New Year to make their resolution. In the same way, if they decide later to have an extra glass of wine in a restaurant, they are responding to that particular context.
The issue then becomes which of these are the true preference. I presume Sunstein and Thaler would take the New Year’s resolution. Sugden is less sure. As he writes:
[J]ust as the restaurant gives cues that point in the direction of drinking, so the traditions of New Year give cues that point in the direction of resolutions for future temperance. If an argument based on akrasia is to work, we need to be shown that in the restaurant, the individual acknowledges that her true preferences are the ones that led to her New Year’s resolution and not the ones she is now acting on. In many cases that fit the story of the resolution and the restaurant, the individual in the restaurant will be thinking that resolutions should not be followed too slavishly, that there is a place in life for spontaneity, and that having an extra glass of wine would be an appropriately spontaneous response to the circumstances. A person who thinks like this as she breaks a previous resolution is not acting contrary to what, at the moment of choice, she acknowledges as her true preferences.
So why do behavioural economists tend to see problems such as this as self-control problems? Sugden suggests this is because of their commitment to the model of the inner-rational agent. Any context dependent choice needs to be seen as an error. Sugden has a different view:
If one has no prior commitment to the idea of latent preferences, there is no reason to suppose that Jane has made any mistake at all. The question of how much she should drink may have no uniquely rational answer. Both when she was making New Year’s resolutions and when she was in the restaurant, she had to a strike a balance between considerations that pointed in favour of alcohol and considerations that pointed against it. The simplest explanation of her behaviour is that she struck one balance in the first case and a different balance in the second. This is not a self-control problem; it is a change of mind.
The contractarian perspective
While I have opened with Sugden’s critique of the nudging approach that emerged from his own field of behavioural economics, his agenda is The Community of Advantage is much broader - an alternative normative basis for economics that is consistent with the psychological evidence.
This normative basis is not new. At the beginning of the book Sugden sources it to John Stuart Mill - the book’s title comes from Mill’s description of the market as a “community of advantage”. Mill considered that economic life is, or should be, built on mutually beneficial cooperation. If people participate in relationships of mutual benefit, they will come to understand that they are cooperative partners, not rivals.
Sugden’s uses the term “contractarianism” to describe this normative foundation. Sugden is inspired by James Buchanan in this approach. Buchanan saw economics as not being about how the market should achieve certain means, but rather how the market is a forum by which people can enter into voluntary exchange.
The question for the economist thus becomes what institutional arrangements will maximise the opportunity for mutually beneficial cooperation, or more specifically, what institutional arrangements are in the interest of each individual to accept if everyone else accepts the same. As Sugden shows (through some rather technical proofs), markets tend to intermediate mutually beneficial transactions, so like neoclassical economics, contractarianism provides support for the use of markets. In this argument, he does not rely on the preferences of the agents being integrated, so he avoids the problems of the inadequacy of rational choice theory. In fact, opportunity is defined independently of people’s preferences, so it does not rely on preferences at all.
The contractarian approach does not result in a blunt call for no government action. Possibly the most stark example of this is Sugden’s suggestion that retirement savings might be mandated. Sugden is sceptical that savings shortages are driven by short-term desires to spend, and asks whether the large economic, political and personal uncertainties involved in saving for a retirement decades away are more important. Among other things, people may simply believe that their collective voting power might enable them to secure sufficient transfers from the working population whatever they do.
In this case, Sugden suggests the problem is a collective action problem. What is the credibility of a policy regime in which private savings play a major part if a large proportion of people simply won’t play ball? In a society where the imprudent have votes, some form of mandatory saving might be required to create the sustainable institutional structure to guarantee some minimum living standard.
I struggled through my first read of the book to understand exactly what a contractarian would think about nudging (I am no philosopher), but there was one passage that I felt gave me the closest glimpse:
A typical questioner will describe some case in which (as judged by the questioner) a mild but unchosen nudge would be very beneficial to its nudgees. Perhaps the nudgees are morbidly obese, and the nudge is a government policy that will make unhealthy fast food less readily available. The questioner asks me: What would you do in this case? To which my reply is: What do you mean, what would I do? What is the hypothetical scenario in which I am supposed to be capable of doing something about the diets of my morbidly obese fellow-citizens?
If the scenario is one in which Robert Sugden is in a roadside restaurant and a morbidly obese stranger is sitting at another table ordering a huge all-day breakfast as a mid-afternoon snack, the answer is that I would do nothing. I would think it was not my business as a diner in a restaurant to make gratuitous interventions into other diners’ decisions about what to eat. But of course, this is not the kind of scenario the questioner has in mind. What is really being asked is what I would do, were I a benevolent autocrat. My answer is that I am not a benevolent autocrat, nor the adviser to one. As a contractarian economist, I am not imagining myself in either of those roles. I am advising individuals about how to pursue their common interests, and paternalism has no place in such advice.
Another section of the mindset of the contractarian was also helpful:
Sunstein and Thaler devote a chapter of Nudge to the issue of retirement savings. The content of this chapter is summarized in the final paragraph:
Saving for retirement is something that Humans [as contrasted with ideally rational agents] find difficult. They have to solve a complicated mathematical problem to know how much to save, and then they have to exert a lot of willpower for a long time to execute this plan. This is an ideal domain for nudging. In an environment in which people have to make only one decision per lifetime, we should surely try harder to help them get it right. (Thaler and Sunstein, 2008: 117)
Look at the final sentence. Sunstein and Thaler are telling their readers that we should try harder to help them get their decisions right. But who are the ‘we’ and who are the ‘they’ here? What ‘we’ are supposed to be doing is designing and implementing choice architecture that nudges individuals to save more for retirement; so presumably ‘we’ refers to government ministers, legislators, regulators, human resource directors, and their respective assistants and advisers; ‘they’ are the individuals who should be saving. As an expert adviser on the design of occupational pension schemes, Thaler is certainly entitled to categorize himself as one of the ‘we’. But where do his readers belong? Very few of them will be in any position to design savings schemes, but just about all of them will face, or will have faced, the problem of saving for retirement. From a reader’s point of view, Sunstein and Thaler’s conclusion would be much more naturally expressed as: They should try harder to help us get it right.
Sunstein and Thaler are writing from the perspective of insiders to the public decision-making process: they are writing as if they were political or economic decision-makers with discretionary power, or the trusted advisors of such decision-makers. And they are inviting their readers to imagine that they are insiders too—that they are the people in control of the nudging, not the people who are being nudged.
I suggest that the benevolent autocrat model appeals to people who like to imagine themselves as insiders in this sense.
In contrast, the contractarian approach appeals to people who take an outsider’s view of politics, thinking of public decision-makers as agents and themselves as principals. The sort of person I have in mind does not think that he has been unjustly excluded from public decision-making or debate; he is more likely to say that he has (what for him are) more important things to do with his time. He does not claim to have special skills in economics or politics, and is willing to leave the day-to-day details of public decision-making to those who do—just as he is willing to leave the day-to-day maintenance of his central heating system to a trained technician. But when public decision-makers are dealing with his affairs, he expects them to act in his interests, as he perceives them. He does not expect them to set themselves up as his guardians.
Sugden states - and I agree - that he takes the psychological evidence more seriously than most nudge advocates. But his approach - which doesn’t rely on integrated preferences - does on first glance seem to have some weaknesses. How do people identify these mutually beneficial advantages? If we increase opportunity, do we end up with choice overload?
I covered some of Sugden’s views on choice overload in a previous post, whereby he stated that much concern for choice overload was condescension towards other people’s preferences. But he does take some of the issues with choice overload seriously. For instance, he notes that long menus of retirement or insurance plans lead to poorer choices through the lack of pre-existing preferences and lack of navigational aids (partly the result of public programs needing to be impartial in the way they present options).
Sugden also sees problems with “obfuscation” in the market, whereby firms deliberately price their products or present the pricing information in overly complex ways. They might bait, whereby only a small quantity of stock is available at the advertised price, or provide exploding offers, whereby a decision must be made in a certain timeframe.
Here the contractarian does not seek to close opportunities for exchange, but rather to provide a better institutional structure. This might involve requiring transparency in pricing, such as requiring pricing to be given for complementary bundles of goods (e.g. printers and print cartridges). However, they should not be required to be purchased together. Exploding offers designed to induce quick decisions might be tempered by cooling-off periods. Other product information such as calorie counts might be required on menus. Importantly, these measures are not then taken to have failed if someone continues to purchase the high calorie food.
The question about how effective people are at identifying and capitalising on opportunities for mutual benefit, outside of the choice overload issue, was less clearly addressed. Sugden reviews some of the experimental evidence relating to fairness, and suggests it points to a preference for mutually beneficial exchange (also a subject for another post). But this does not extend to the question of our effectiveness at seeing these opportunities for exchange.
If you would prefer to get a flavour of the book in a different manner, below is a video discussion between Sugden, Henry Leveson-Gower and myself on some of the topics in the book.