When the
Federal Reserve Bank of Boston
invited the leading behavioral
economists to a Cape Cod golf
resort this month to make
their case, it was plainly a
signal moment. "It has
the feeling of being summoned
by the king," said Colin
F. Camerer, a star behaviorist
who teaches at the California
Institute of Technology.
"Sort of like: `I
understand you're the finest
lute player in the region.
Will you come and play for
me?' "
Until the
last few years, behavioral
economics — which blends
psychology, economics and,
increasingly, neuroscience to
argue that emotion plays a
huge role in how people make
economic decisions — was an
extremely tight-knit group. It
had little influence and few
practitioners. One economist
at the bank's conference
recalled an Alaska kayaking
trip that Mr. Camerer took
with another prominent
behaviorist a decade ago.
"If that kayak had
flipped," he said,
"half the field would
have been eradicated."
But the
field has grown, as has its
influence. In 1996, Alan
Greenspan's warning of
"irrational
exuberance" acknowledged,
as the behaviorists do, that
the average investor is hardly
the superrational "homo
economicus" that
mainstream economists depict.
In 2001, the young behaviorist
Matthew Rabin won the John
Bates Clark Medal; last fall,
the psychologist Daniel
Kahneman, a forefather of
behavioral economics, was
awarded the Nobel in economic
science.
And so it
was that the Boston Fed
summoned the behaviorists to
the Wequassett Inn in Chatham,
Mass. The conference was given
the quaint title "How
Humans Behave," as if
monetary policymakers had
suddenly realized that, lo and
behold, on the other end of
all that policy are actual
people. The collection of
mainstream economists and
central bankers would be the
highest-level audience the
behaviorists had ever enjoyed,
the best chance yet for their
new thinking to hit the
bloodstream.
From the
outset the mood was civil,
especially considering that
the behaviorists are
essentially calling for an end
to economics as we know it.
(As one economist grumbled,
"What you have to
understand is that behavioral
economics is attacking the
foundation of what welfare
economics is built on.")
So it was not surprising that
some Fed elders seemed wary,
as if they were at a family
reunion and welcoming a
distant cousin about whom they
had heard only puzzling rumors.
But with the economy stuck in
a condition between dismal and
desperate, the behaviorists'
timing could not have been
better.
"All
our models and forecasts say
we'll see a better second
half," Cathy E. Minehan,
president of the Boston Fed,
said in her opening address.
"But we said that last
year. Now don't get me wrong:
mathematical models are
wonderful tools. But are there
ways this process can be done
better? Can we inform the
policymaker from 50,000 feet
with wisdom gained on the
ground, in the human brain, or
in the way humans make
decisions and organize
themselves? I hope so."
Ms. Minehan
and her colleagues were
particularly hoping to learn
why Americans save too little,
acquire too much expensive
debt and perform such achingly
self-destructive feats of
portfolio management. The
behaviorists, for their part,
were put in a tight spot:
eager to prove themselves but
leery of overpromising.
"Virtually everyone doing
behavioral economics agrees we
should go slowly in advocating
policy change," Mr.
Camerer wrote in the paper he
presented. "Our thinking
was also not designed to
precisely answer questions
about welfare and policy, but
this is a good time in the
intellectual history of the
field to say something."
Eldar Shafir,
who teaches psychology and
public affairs at Princeton,
began with a behavioral
economics primer. It was full
of the anomalies the field is
known for, including the
popular "6 jam-vs.-24
jam" experiment. In an
upscale grocery story,
researchers set up a tasting
booth first with 6 jars of
jams, and later with 24 jars.
In the first case, 40 percent
of the customers stopped to
taste and 30 percent bought;
in the second, 60 percent
tasted but only 3 percent
bought. The point is that too
many options can flummox a
consumer — and if 24 jars of
jam pose a problem, imagine
what 8,000 mutual funds can
do. Standard economics would
argue that people are better
off with more options. But
behavioral economics argues
that people behave less like
mathematical models than like
— well, people.
Among the
behaviorists, there is the
common sentiment that
economics has been ruined by
math. "Neoclassical
economists came along in the
mid-19th century and wanted to
mathematize the new science of
economics," said George
Loewenstein, a professor at
Carnegie Mellon University.
"They couldn't include
`the passions,' or emotions,
in their models, because they
were too unruly, too complex.
But they also thought that the
emotions were
unknowable."
Mr.
Loewenstein described how he
and his colleagues want to
prove otherwise — that not
only are emotions not
unknowable but that when it
comes to money, they may be
more powerful than math. This
is why Mr. Loewenstein studies
how people make financial
choices while they are
experiencing various degrees
of sadness, hunger and sexual
arousal. This is why Colin
Camerer has become a student
of brain imaging, trying to
identify where a subject's
brain lights up when, for
instance, a lowball offer
leaves him disgusted.
But the most
radical idea presented at the
conference belonged to Richard
H. Thaler. His paper, written
with the legal scholar Cass R.
Sunstein, was called
"Libertarian Paternalism
Is Not an Oxymoron."
Leonine and youthful at 57,
Mr. Thaler, who teaches at the
University of Chicago, is
widely considered the founder
of behavioral economics (and
some say, its next Nobel
winner). He is more confident
and, accordingly, more
prescriptive than his younger
colleagues.
"Behavioral
economics offers powerful
tools to achieve policy
goals," he told the
conference. "And
libertarian paternalism is an
attractive approach to solving
policy problems. What else? I
think the only other
alternative is inept
neglect."
Mr. Thaler
has concluded that too many
people, no matter how educated
or vigilant, are poor
planners, inconsistent savers
and haphazard investors. His
solution: public and private
institutions should gently
steer individuals toward more
enlightened choices. That is,
they must be saved from
themselves. Mr. Thaler's most
concrete idea is Save More
Tomorrow (SMarT), a savings
plan whereby employees pledge
a share of their future salary
increases to a retirement
account. In test cases, the
plan has proved remarkably
successful.
"This
was not pulled out of thin
air," Mr. Thaler said.
"It was done using what I
call first-grade psychology.
We knew this was going to
work, no question."
Indeed, the SMarT plan takes
advantage of behavioral
economics' basic tenets:
"loss aversion"
(people fear loss because it
causes them far more pain than
the pleasure they receive from
gain; but since the SMarT plan
covers a future raise, they
never feel its loss);
"status-quo bias"
(since people are reluctant to
change, the change can be made
for them); and "mental
accounting" (people have
a pressing need to direct
different streams of money
into different
"accounts").
Mr. Thaler
was followed by David I.
Laibson, a young Harvard
behaviorist who also endorsed
a paternalistic approach.
"There are two enormous
travesties in the financial
services industry," Mr.
Laibson said. "One,
people have too much of their
own company's stock, and two,
mutual-fund management fees
are too high." His
solution to the first problem:
an automatic asset
reallocation to keep an
employee from holding more
than 20 percent of his
portfolio in company stock.
"People
could opt out," he said.
"If you're crazy enough
to do that, fine, that's your
right, but we'd certainly push
them down." His solution
to the second problem: warning
labels about management fees,
modeled after the surgeon
general's cigarette warning.
Mr.
Laibson's and Mr. Thaler's
proposals were warmly received
by the bankers and mainstream
economists. If this is
behavioral economics, what's
not to like? The proposals
seemed to be sound and not
particularly invasive
solutions to Americans'
troubling money habits. All
the earlier talk of
sexual-arousal studies and
brain imaging may have left
them flat; but here were some
real action items.
The
behaviorists, most of whom are
hardcore empiricists, even
felt comfortable enough to
declare their own research
wish lists. Dan Ariely of the
Massachusetts Institute of
Technology trolled the room
for a good contact at the
Internal Revenue Service (he
wants to study the psychology
of tax cheats). Duncan J.
Watts, a sociologist at
Columbia University,
half-jokingly requested access
to the phone and e-mail
records of all Federal Reserve
employees (he is looking for
good data to better understand
how organizations behave).
The warm
reception didn't mean
wholesale conversion. When
Jeffrey C. Fuhrer, the Boston
Fed's chief economist, was
asked about Mr. Camerer's
desire for a new Economics 101
textbook, one that puts
behaviorism at the center and
mathematical modeling on the
fringe, he responded:
"Yeah, that's his `I Have
a Dream' speech. I think
that's still weeks off."
Still, Mr.
Fuhrer, who organized the
conference, was delighted with
its outcome: "I think we
would have been crazy to
expect we'd walk out of this
conference and say, `O.K.,
we're going to our next
meeting, and now we know what
to do because these guys told
us.' But having had these
conversations, where people
look at economics from a
different viewpoint, will we
think a little differently
about how we do research and
exactly which people we might
talk to? You bet we
will."
They may
have little choice. As
Frederick S. Breimyer, chief
economist of the
State Street Corporation
in Boston, said, "We're
looking outside the box
because the box we've been
looking inside is empty."