"The Case For Mindless Economics", 10 years on

Ten years ago, two economic theorists, Faruk Gul and Wolfgang Pesendorfer, wrote an essay called "The Case for Mindless Economics". The essay pushes back against the enthusiasm for neuroeconomics and behavioral economics. It's a very interesting read, both for people interested in philosophy of science, and anyone who wants to know how economists think about what they do. (Before you read this post, consider reading the whole essay, because there's lots in there that I gloss over.)

Gul and Pesendorfer don't discount the possibility that neurological and psychological research can be useful in economics. They write:

Neuroeconomics goes beyond the common practice of economists to use psychological insights as inspiration for economic modeling or to take into account experimental evidence that challenges behavioral assumptions of economic models. Neuroeconomics appeals directly to the neuroscience evidence to reject standard economic models or to question economic constructs.

In other words, GP aren't arguing against using neuroscience and psychology to inform economic model-making. What are they arguing against? Two things:

1. The use of neuro/psych findings to support or reject economic models, and

2. The use of neuro/psych to establish new welfare criteria, e.g. happiness.

GP's argument against using neuro/psych to test economic models can basically be summed up by these excerpts:

Standard economics focuses on revealed preference because economic data come in this form. Economic data can — at best — reveal what the agent wants (or has chosen) in a particular situation...The standard approach provides no methods for utilizing non-choice data to calibrate preference parameters. The individual’s coefficient of risk aversion, for example, cannot be identified through a physiological examination; it can only be revealed through choice behavior. If an economist proposes a new theory based on non-choice evidence then either the new theory leads to novel behavioral predictions, in which case it can be tested with revealed preference evidence, or it does not, in which case the modification is vacuous. In standard economics, the testable implications of a theory are its content; once they are identified, the non-choice evidence that motivated a novel theory becomes irrelevant.

I'm not sure I buy the logic of this argument. In general, preemptively throwing away any entire category of evidence seems dangerous to me. Why should economists only validate/reject their models based on choice data?

Here's a concrete example to help explain what I mean. In finance, there is a big and ongoing debate over the reason for Shiller's excess volatility finding - i.e., the finding that market returns are slightly predictable over the long run. Some people say it's due to time-varying risk aversion. Others say that it's due to non-rational expectations. As John Cochrane has pointed out, price data - i.e., choice data - can't distinguish between these explanations. The standard asset pricing equation is of the form p = E[mx], where p is price, m is related to utility, and x is related to expectations/beliefs. You'll never be able to use price data alone to know whether price movements are due to changes in m or changes in x. To do that, you need additional evidence - direct measures of either preferences, beliefs, or both.

That's the kind of evidence that psychology might - in principle - be able to provide. For example, suppose psychologists find that most human beings are incapable of forming the kind of expectations that time-varying utility models say they do. That would mean one of two things. It could mean that the economy as a whole behaves qualitatively differently than the individuals who make it up (in physics jargon, that would mean that the representative agent is "emergent"). Or it could mean that time-varying utility models must not be the reason for excess volatility.

So GP might respond something along the lines of: "So? Why do we care?" Of what use would be the knowledge that excess volatility is caused by psychological constraints rather than time-varying utility, if both ideas lead to the same predictions about prices? The answer is: They don't lead to the same predictions, if you expand the data set. For example, suppose you find that survey expectations can predict price movements. What once could be modeled only as randomness now becomes a partially predictable process. You can make some money with that knowledge! All you do is take a bunch of surveys, and place bets based on the results.

Are survey responses "economic data"? Are they choice data? That question is a bit academic. What if you could use brain scans to predict market movements?

In other words, I think there's not really any conceptual difference between what GP say psych can be used for ("tak[ing] into account experimental evidence that challenges behavioral assumptions of economic models") and what they say it can't be used for ("appeal[ing] directly to the neuroscience evidence to reject standard economic models or to question economic constructs"). It's all just the same thing - using evidence to create theories that help you predict stuff.

Anyway, GP's second point - that psych/neuro evidence can't provide new welfare criteria - also doesn't make sense to me, in principle. Here, in a nutshell, is their argument:

Welfare analysis for neuroeconomics is a form of social activism; it is a recommendation for someone to change his preferences or for someone in a position of authority to intervene on behalf of someone else. In contrast, welfare economics in the standard economic model is integrated with the model’s positive analysis; it takes agents’ preferences as given and evaluates the performance of economic institutions.

I don't see this distinction at all. To be blunt, all welfare criteria seem fairly arbitrary and made-up to me. Data on choices do not automatically give you a welfare measure - you have to decide how to aggregate those choices. Why simply add up people's utilities with equal weights to get welfare? Why not use the utility of the minimum-utility individual (a Rawlsian welfare function)? Or why not use a Nash welfare function? There seems no objective principle to select from the vast menu of welfare criteria already available. The selection of a welfare criterion thus seems like a matter of opinion - i.e., a normative question, or what GP call "social activism". So why not include happiness among the possible welfare criteria? Why restrict our set of possible welfare criteria to choice-based criteria? I don't see any reason, other than pure tradition and habit.

So personally, I find the logic of both of GP's main arguments unconvincing. In principle, it seems like psych/neuro data could help choose between models when choice data is insufficient to do so. And in principle, it seems like neuro-based or psych-based welfare criteria are no more arbitrary than choice-based welfare criteria (or any other welfare criteria, like "virtue").

But that's in principle. What about in practice? It's been 10 years since GP's essay, and many more since psychology and neuroscience entered the economist's toolbox. Psychology seems to have made real contributions to certain areas of economics, in particular finance. In general, those contributions have come in the form of generating hypotheses about constraints - for example, attention constraints - rather than by motivating new behavioral assumptions for standard models. In other words, psych ideas have occasionally given economists power to predict real data in ways that standard behavioral models didn't allow. These contributions have been modest overall, but real.

But I can't really think of examples where neuroscience has made much of a successful contribution to economics yet. That might be because neuroscience is still too rudimentary. It might be that it has, and I just haven't heard of it. Or it might be that it's just incredibly hard to map from neuro concepts to econ models. In fact, GP spend much of their essay showing how incredibly hard it is to map from neuro to econ. They are right about this. (And in fact, GP's essay should be required reading for economists, because the difficulty of mapping between disciplines really gets at the heart of what models are and what we can expect them to do.)

Also, in practice, no psychology-based welfare criterion, including happiness, has gained much popular traction as a replacement for traditional utilitarian welfare criteria based on choices. So while welfare is a matter of opinion, most opinion seems to have sided with GP.

All this doesn't mean I think neuroeconomics is doomed to be useless, just that it seems like it's in its very early days. There are a few hints that neuro might be used to select between competing economic models. And the topic of using happiness as a measure of economic success occasionally crops up in the media. But the task of using neuro (and psych) for economics has turned out to be much harder than wild-eyed optimists probably assumed when the fields of neuroeconomics and behavioral economics were conceived.

So I think that while Gul and Pesendorfer didn't make a watertight logical case, their warnings about the difficulty of using neuro evidence for econ have been borne out in practice - so far. Ten years might seem like a long time, but let's see what happens in forty years.